Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

 

[X]

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JANUARY 28, 2012

OR

 

[    ]

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

COMMISSION FILE NUMBER      000-21250

THE GYMBOREE CORPORATION

(Exact name of registrant as specified in its charter)

 

DELAWARE   94-2615258
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)

500 Howard Street,

San Francisco, California

(Address of principal executive offices)

 

94105

(Zip Code)

Registrant’s telephone number, including area code: (415) 278-7000

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 of 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 [X]      No [  ]

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 [  ]      No [  ]*

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 [  ]

 

 

*          The Registrant has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, but is not required to file such reports under such sections.

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

 

Large accelerated filer [  ]

  

Accelerated filer [  ]

Non-accelerated filer [X] (Do not check if a smaller reporting company)

  

Smaller reporting company [  ]

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

As of April 26, 2012, the registrant had 1,000 shares of common stock outstanding, par value $0.001 per share, all of which are owned by Giraffe Holding, Inc., the registrant’s indirect parent holding company, and are not publicly traded.


Table of Contents

DOCUMENTS INCORPORATED BY REFERENCE

None.

 

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THE GYMBOREE CORPORATION

TABLE OF CONTENTS

 

ITEM 1. BUSINESS      4   
ITEM 1A. RISK FACTORS      7   
ITEM 1B. UNRESOLVED STAFF COMMENTS      15   
ITEM 2. PROPERTIES      15   
ITEM 3. LEGAL PROCEEDINGS      15   
ITEM 4. MINE SAFETY DISCLOSURES      15   
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES      16   
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA      17   
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS      19   
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK      28   
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA      30   
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE      74   
ITEM 9A. CONTROLS AND PROCEDURES      75   
ITEM 9B. OTHER INFORMATION      75   
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE      75   
ITEM 11. EXECUTIVE COMPENSATION      78   
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS      84   
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE      86   
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES      88   
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES      89   
SIGNATURES      93   
EXHIBIT INDEX      95   

 

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FORWARD LOOKING STATEMENTS

This annual report contains forward-looking statements. You can identify forward-looking statements because they contain words such as “believe,” “expect,” “may,” “will,” “should,” “could,” “seek,” “intend,” “plan,” “estimate,” or “anticipate” or similar expressions that concern our strategy, plans or intentions. All statements we make relating to: future sales, costs and expenses and gross profit percentages; the continuation of historical trends; our ability to operate our business under our capital and operating structure; and the sufficiency of our cash balances and cash generated from operating and financing activities for future liquidity and capital resource needs are forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may change at any time, and, therefore, our actual results may differ materially from those that we had expected. We derive many of our forward-looking statements from our operating budgets and forecasts, which are based upon many detailed assumptions. While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors, and it is impossible for us to anticipate all factors that could affect our actual results.

Important factors that could cause actual results to differ materially from our expectations (“cautionary statements”) are disclosed under “Item 1A, Risk Factors,” and elsewhere in this annual report. We encourage you to carefully read these risk factor disclosures. We caution investors not to place substantial reliance on the forward-looking statements contained in this annual report. These statements, like all statements in this annual report, speak only as of the date of this annual report (unless another date is indicated), and we undertake no obligation to update or revise the statements in light of future developments, except as otherwise required by law.

NOTE REGARDING TRADEMARKS AND SERVICE MARKS

In the United States, we are the owner of a number of trademarks and service marks, including the trademarks and service marks “Gymboree,” “Janie and Jack,” “Crazy 8” and “Gymboree Play & Music,” and the trademarks “Gymbo” and “Gymbucks.” The mark “Gymboree” is also registered, or is subject to pending applications, in approximately 94 foreign countries. All other trademarks or service marks appearing in this annual report that are not identified as marks owned by us are the property of their respective owners.

PART 1

ITEM 1. BUSINESS

General

The Gymboree Corporation (“we,” “us,” “our,” Gymboree” and “Company”) is one of the largest children’s apparel specialty retailers in North America, offering collections of high-quality apparel and accessories. As of January 28, 2012, we operated a total of 1,149 retail stores and online stores at www.gymboree.com, www.janieandjack.com and www.crazy8.com. We also offered directed parent-child developmental play programs under the Gymboree Play & Music® brand at 703 franchised and Company-operated centers in the United States and 36 other countries. In addition, as of January 28, 2012, third-party overseas partners operated 24 Gymboree® retail stores in the Middle East and South Korea, and a joint venture with Gymboree (China) Commercial and Trading Co. Ltd., and Gymboree (Tianjin) Educational Information Consultation Co. Ltd. (collectively, the “Joint Venture”) operated one Gymboree retail store in China.

Gymboree: As of January 28, 2012, we operated a total of 785 Gymboree stores (including 153 Gymboree Outlet stores), consisting of 738 stores (including 151 Gymboree Outlet stores) in the United States, 41 stores in Canada, three stores in Puerto Rico (including two Gymboree Outlet store), and three stores in Australia. Gymboree stores offer fashionable, age-appropriate apparel and accessories for boys and girls characterized by mix and match colors, patterns and graphics, complex embellishments, comfort, functionality and durability in sizes newborn through 12. Gymboree Outlet stores provide similar high-quality mix-and-match children’s apparel and accessories in the same size ranges but at outlet prices.

Janie and Jack: As of January 28, 2012, we operated a total of 127 Janie and Jack® shops in the United States. Janie and Jack shops offer distinctive, finely crafted clothing and accessories for boys and girls in sizes newborn through 12. Lush fabrics, a hand-made quality and details such as hand-embroidery, smocking and vintage prints are utilized to create classic looks. Shops have a European style reminiscent of a small Parisian boutique.

Crazy 8: As of January 28, 2012, we operated a total of 237 Crazy 8® stores in the United States. Crazy 8 stores provide wholesome age-appropriate fashion for boys and girls at price points approximately 25% to 30% lower than Gymboree. Through merchandise design, product presentation, store environment, customer service and packaging, Crazy 8 stores reflect an upscale store experience at value prices. Crazy 8 apparel is offered in sizes newborn through 14 and is intended to address a broader customer base than Gymboree.

 

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Gymboree Play & Music: Gymboree Play & Music offers children ages newborn through five the opportunity to explore, learn and play in an innovative parent-child program. Gymboree Play & Music offers an array of classes developed by early childhood experts as well as birthday parties and developmental toys, books and music.

Our online stores at www.gymboree.com, www.janieandjack.com and www.crazy8.com offer the entire Gymboree, Janie and Jack and Crazy 8 product offerings, respectively. We fully integrate online stores with retail stores by offering the same products, pricing and promotions. We also have a policy whereby retail stores order merchandise for customers from the online stores and we allow customers to return merchandise purchased online at traditional retail stores and vice versa.

Gymboree was organized in October 1979 as a California corporation and re-incorporated as a Delaware corporation in June 1992.

Retail Stores

The following table summarizes store openings and closures by brand and country for the fiscal year ended January 28, 2012 (“fiscal 2011”). Note that (i) all Janie and Jack and Crazy 8 stores are in the United States, and (ii) retail stores operated by third-party overseas partners and the Joint Venture are excluded.

 

     Store Count as of    Store    Store    Store Count as of
    

  January 29, 2011  

  

      Openings      

  

   Closures   

  

   January 28, 2012   

Gymboree US

   594      1      (8)     587  

Gymboree Canada

   37      4      -         41  

Gymboree Australia

   2      1      -         3  

Gymboree Puerto Rico

   2      -         (1)     1  
  

 

  

 

  

 

  

 

Total Gymboree

   635      6      (9)     632  

Gymboree Outlet

   149      2      -         151  

Gymboree Outlet Puerto Rico

   1      1      -         2  
  

 

  

 

  

 

  

 

Total Gymboree Outlet

   150      3      -         153  

Janie and Jack

   123      7      (3)     127  

Crazy 8

   157      83      (3)     237  
  

 

  

 

  

 

  

 

Total

   1,065      99      (15)     1,149  
  

 

  

 

  

 

  

 

Suppliers

The majority of our apparel is manufactured to our specifications by over 300 independent manufacturers located primarily in Asia (principally China (36%), Indonesia (20%), Thailand (9%), India (8%) and Bangladesh (8%) for the fiscal year ended January 28, 2012). We purchase all products in U.S. dollars. One buying agent manages a substantial portion of our inventory purchases (approximately 80% for the fiscal year ended January 28, 2012). We have no long-term contracts with suppliers and typically transact business on an order-by-order basis. Factories undergo annual audits for social accountability by independent third parties. In addition, all of our products undergo a quality audit performed by independent third parties.

Seasonality and Competition

Our operations are seasonal in nature, with sales from retail operations peaking during the fourth quarter, primarily during the holiday season in November and December. During fiscal 2011, 2010 and 2009, the fourth quarter accounted for approximately 30% of net sales from retail operations.

Our Gymboree, Janie and Jack and Crazy 8 brands compete on a national level with BabyGap and GapKids (divisions of Gap Inc.), certain leading department stores operating in malls, outlet centers or street locations, certain discount

 

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retail chains such as Old Navy (a division of Gap Inc.), The Children’s Place, Wal-Mart, Target and Carter’s, as well as with a wide variety of local and regional specialty stores, with certain other retail chains, and with children’s retailers that sell their products by mail order, online or through outlet malls. The principal factors affecting competition for retail sales are product design, product quality, brand image, customer service and pricing. Our goal is to provide our customers with high-quality apparel at a price that reflects excellent value. We design and produce apparel exclusively for sale at our retail and online stores.

Trademark and Service Marks

In the United States, we are the owner of a number of trademarks and service marks, including the trademarks and service marks “Gymboree,” “Janie and Jack,” “Crazy 8” and “Gymboree Play & Music,” and the trademarks “Gymbo” and “Gymbucks.” These marks and certain other of our marks are registered with the United States Patent and Trademark Office. The mark “Gymboree” is also registered, or is the subject of pending applications, in approximately 94 foreign countries. Each federal registration is renewable indefinitely if the mark is still in use at the time of renewal. The Company’s rights in the “Gymboree,” “Janie and Jack” and “Crazy 8” marks and other marks are a significant part of its business. Accordingly, we intend to maintain the marks and the related registrations. We are not aware of any material claims of infringement or other material challenges to our right to use the “Gymboree,” “Janie and Jack” and “Crazy 8” marks in the United States.

We use a number of other trademarks, certain of which have been registered with the U.S. Patent and Trademark Office and in certain foreign countries. We believe that our registered and common-law trademarks have significant value and that some of our trademarks are instrumental to our ability to both market our products and create and sustain demand for our products.

Employees

As of January 28, 2012, we had approximately 13,754 full-time and part-time employees or 5,470 full-time equivalents. In addition, a significant number of seasonal employees are hired during each holiday selling season. None of our employees are represented by a labor union.

Segment and International Financial Information

Financial information for our four reportable segments (retail stores, Gymboree Play & Music, retail franchise, and one reportable segment related to the activities of the two entities that make up the Joint Venture, which we have determined to be variable interest entities (“VIEs”) and the results of which we have consolidated into our financial statements (see Note 21 to the consolidated financial statements included elsewhere in this annual report), and for our Canadian and Australian subsidiaries, for the fiscal year ended January 28, 2012, the period from November 23, 2010 to January 29, 2011, and from January 31, 2010 to November 22, 2010, and for the fiscal year ended January 30, 2010 is contained in Note 13 to the consolidated financial statements included in this annual report. Due to the growth of our Retail Franchise segment, we have recast our reportable segments to include Retail Franchise. Additionally, as discussed in Notes 2 and 13 to the consolidated financial statements included in this annual report, we have completed the allocation of goodwill to our reporting units and segments.

Less than 5% of our revenues were derived from outside the United States, and less than 3% of our long-lived assets were located outside the United States in the year ended January 28, 2012, in the period from November 23, 2010 to January 29, 2011, and from January 31, 2010 to November 22, 2010, and in the year ended January 30, 2010.

Regulation

Our products are subject to consumer product safety, environmental, health and safety, consumer protection and labor laws, as well as regulations and standards with respect to product quality and safety set by various governmental authorities, including the Consumer Product Safety Commission. Such laws include the Consumer Product Safety Improvement Act of 2008, which imposes significant requirements relating to the presence of lead and other substances in apparel and accessories, and enhances the penalties for noncompliance. In addition, our manufacturers are subject to labor laws. Our sourcing personnel periodically visit and monitor the operations of our independent manufacturers, and we rely on independent third parties to audit factories for compliance with safety and labor laws on an annual basis. We believe that we are in substantial compliance with such laws and regulations.

 

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Available Information

We currently make available on our website at www.gymboree.com, under “Company Information—Financial Resources & SEC filings,” free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such documents as soon as reasonably practicable after we electronically file or furnish such materials to the U.S. Securities and Exchange Commission (“SEC”). We also currently make available under “Company Information—Corporate Governance,” our code of ethics as well as other documents and materials relating to corporate governance. References to the Company’s website address do not constitute incorporation by reference of the information contained on the website, and the information contained on the website is not part of this annual report.

ITEM 1A. RISK FACTORS

Our financial performance is subject to various risks and uncertainties. The risks described below are those which we believe are the material risks we face. Any of the risk factors described below could significantly and adversely affect our business, prospects, sales, revenues, gross profit, cash flows, financial condition and results of operations.

Risks Related to Our Indebtedness and Certain Other Obligations

Our substantial leverage 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.

As a result of the Transactions (as defined under “Item 6. Selected Consolidated Financial Data”), we are highly leveraged. The following chart shows our level of indebtedness as of January 28, 2012:

 

     January 28, 2012  
     ($ in millions)  

Term Loan(1)

   $ 812               

ABL Facility(1)

     —               

9.125% senior notes due 2018 (“Notes”)

     400               
  

 

 

 

Total indebtedness

   $           1,212               
  

 

 

 

 

(1)

The Company’s senior credit facilities (collectively, the “Senior Credit Facilities”) are comprised of an $820 million secured term loan agreement (“Term Loan”) and a $225 million asset backed revolving credit facility (“ABL Facility”). Amounts available under the ABL Facility are subject to customary borrowing base limitations and are reduced by letter of credit utilization. The Senior Credit Facilities also allow an aggregate of $200 million in uncommitted incremental facilities, the availability of which is subject to our meeting certain conditions. No incremental facilities are currently in effect.

Our high degree of leverage could have important consequences. For example, it could:

 

   

make it more difficult for us to make payments on our indebtedness;

   

increase our vulnerability to general economic and industry conditions;

   

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

   

expose us to the risk of increased interest rates as the borrowings under our Senior Credit Facilities will be at variable rates of interest;

   

restrict us from making strategic acquisitions or cause us to make non-strategic divestitures;

   

limit our ability to obtain additional financing for working capital, capital expenditures, research and development, debt service requirements, acquisitions and general corporate or other purposes; and

   

limit our ability to adjust to changing market conditions and place us at a competitive disadvantage compared to our competitors who are less highly leveraged.

Despite current indebtedness levels and restrictive covenants, we and our subsidiaries may incur additional indebtedness in the future. This could further exacerbate the risks associated with our substantial financial leverage.

The terms of the indenture governing the Notes and the Senior Credit Facilities permit us to incur a substantial amount of additional debt, including secured debt. Any additional borrowings under the Senior Credit Facilities, and any other

 

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secured debt, would be effectively senior to the Notes and any guarantees thereof to the extent of the value of the assets securing such indebtedness. 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.

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

Our Senior Credit Facilities and the indenture governing the Notes contain various covenants that limit our and our restricted subsidiaries’ ability to engage in specified types of transactions. These covenants limit our and our restricted subsidiaries’ ability to, among other things, incur or guarantee additional indebtedness, pay dividends on, or redeem or repurchase, our capital stock, make certain acquisitions or investments, enter into sale-leaseback transactions, materially change our business, incur or permit to exist certain liens, enter into transactions with affiliates or sell our assets to, or merge or consolidate with or into, another company. Further, our ability to comply with such covenants under the indenture may be affected by actions taken by the variable interest entities which we do not control, but the results of which we have consolidated into our financial statements and which are treated as restricted subsidiaries under the indenture (see Note 21 to the consolidated financial statements included elsewhere in this annual report). In addition to the foregoing covenants, under certain circumstances, the ABL Facility requires us to satisfy a financial test. Our ability to satisfy this test may be affected by events outside of our control.

Upon the occurrence of an event of default under the Senior Credit Facilities, the lenders could elect to declare all amounts outstanding under the Senior Credit Facilities to be immediately due and payable and terminate all commitments to extend further credit. If we were unable to repay those amounts, the lenders under the Senior Credit Facilities could proceed against the collateral granted to them to secure that indebtedness. We have pledged substantially all of our assets as collateral under the Senior Credit Facilities. If the lenders under the Senior Credit Facilities accelerate the repayment of borrowings, we cannot assure you that we will have sufficient assets to repay the Senior Credit Facilities, as well as our other secured and unsecured indebtedness, including the Notes.

To service our indebtedness, we require a significant amount of cash and our ability to generate cash depends on many factors beyond our control.

Our ability to make cash payments on and to refinance our indebtedness and to fund planned capital expenditures depend on our ability to generate significant operating cash flow in the future. This ability is, to a significant extent, subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.

Our business may not generate sufficient cash flow from operations, and future borrowings may not be available under our Senior Credit Facilities, in an amount sufficient to enable us to pay our indebtedness, including the Notes, or to fund our other liquidity needs. In any such circumstance, we may need to refinance all or a portion of our indebtedness on or before maturity. We may not be able to refinance any of our indebtedness, including the Senior Credit Facilities and the Notes, on commercially reasonable terms or at all. If we cannot service our indebtedness, we may have to take actions such as selling assets, seeking additional equity or reducing or delaying capital expenditures, strategic acquisitions and investments. Any such action, if necessary, may not be effected on commercially reasonable terms or at all. Our Senior Credit Facilities and the indenture governing the Notes restrict our ability to sell assets and use the proceeds from such sales.

If we are unable to generate sufficient cash flow or are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our indebtedness, or if we otherwise fail to comply with the various covenants in the instruments governing our indebtedness (including covenants in our Senior Credit Facilities and the indenture governing the Notes), we could be in default under the terms of the agreements governing such indebtedness. In the event of such default, the holders of such indebtedness could elect to declare all the funds borrowed thereunder to be due and payable, together with accrued and unpaid interest, the lenders under our Senior Credit Facilities could elect to terminate their commitments thereunder, cease making further loans and institute foreclosure proceedings against our assets, and we could be forced into bankruptcy or liquidation. If our operating performance declines, we may in the future need to obtain waivers from the required lenders under our Senior Credit Facilities to avoid being in default. If we breach our covenants under our Senior Credit Facilities and seek a waiver, we may not be able to obtain a waiver from the required lenders. If this occurs, we would be in default under our Senior Credit Facilities, the lenders could exercise their rights, as described above, and we could be forced into bankruptcy or liquidation.

 

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Risks Related to the Business

Global economic conditions may adversely affect our financial performance.

During the recent economic recession, global financial markets experienced extreme volatility, disruption and credit contraction. The volatility and disruption to the capital markets significantly and adversely affected global economic conditions, resulting in additional significant recessionary pressures and declines in employment levels, consumer and business confidence, disposable income and actual and perceived wealth. Although there have been some recent improvements, continuing or worsened adverse economic conditions, including higher unemployment, gasoline, energy and health care costs, taxes and tighter credit, could continue to affect consumer confidence and discretionary consumer spending adversely and may adversely affect our sales, cash flows and results of operations. Additionally, renewed financial turmoil in the financial and credit markets could adversely affect our costs of capital and the sources of liquidity available to us.

Further, we work with a large number of small vendors, some of whom have been or may be significantly impacted by any of the factors described above. If a number of these vendors fail, the delays and costs that we would likely incur in replacing them and in finding replacement goods and services could have a material adverse effect on our business, financial condition and operating results.

Our results may be adversely affected by our failure to anticipate and respond to changes in consumer preferences in a timely manner.

Our sales and profitability depend upon the continued demand by customers for our apparel and accessories. We believe that our success depends in large part upon our ability to anticipate, gauge and respond in a timely manner to changing consumer demands and preferences and upon the appeal of our products. Further, current economic conditions and levels of discretionary spending also affect consumer preferences. We may not be able to anticipate, gauge and respond effectively to changes in consumer preferences, and the demand for our apparel or accessories may decline as a result. In addition, since much of our inventory is sourced from vendors located outside the United States, we usually must order merchandise and enter into contracts for the purchase and manufacture of such merchandise, up to nine months in advance of the applicable selling season and frequently before trends are known. A decline in demand for our apparel and accessories or a misjudgment could, among other things, lead to lower sales, excess inventories and higher markdowns, each of which could have a material adverse effect on our business, financial condition and operating results.

Increased production costs may adversely affect our results.

We are affected by inflation and changing prices primarily through purchasing products from our global suppliers, increased operating costs and expenses, and fluctuations in interest rates. Commodity costs and, in some cases, labor costs have increased from historic levels in the countries where our products are manufactured. For example, in the past year, prices for cotton, a key input of our apparel products, reached a level significantly higher than the long-term average. We anticipate the impact of these increases to continue for at least the first two quarters of fiscal 2012. If our customers are resistant to paying higher prices for our products, and if we are unable to absorb increased costs of goods by reducing our manufacturing or supply chain costs or lowering our overall cost structure, our profitability may be materially adversely affected.

Our business may be negatively impacted by consumer product safety laws, regulations or related legal actions.

Our products are subject to consumer product safety laws, as well as regulations and standards with respect to product quality and safety set by various governmental authorities, including the Consumer Product Safety Commission. New consumer product safety laws or changes to existing laws and regulations may make certain products unsalable or require us to incur significant compliance costs, which could have a material adverse effect on our earnings. Our inability, or that of our vendors or manufacturers, to comply on a timely basis with such laws and regulatory requirements could result in significant fines or penalties, which could adversely affect our reputation and earnings.

Although we currently test products sold in our stores and at our Gymboree Play & Music sites, we have in the past and may in the future need to recall products that we may later determine may present safety issues. If we or the Consumer Product Safety Commission recall a product sold in our stores, we could experience negative publicity and product liability lawsuits, which could have a material adverse effect on our reputation, financial position and earnings.

 

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Our business may be harmed by additional U.S. regulation of foreign trade or delays caused by additional U.S. customs requirements.

Our business is subject to the risk that the United States may adopt additional regulations relating to imported apparel products, including quotas, duties, taxes and other charges or restrictions on imported apparel. We cannot predict whether additional U.S. quotas, duties, taxes or other charges or restrictions will be imposed upon the importation of our products in the future, or what effect any such actions would have on our business, financial position and operating results. If the U.S. government imposes any such charges or restrictions, our supply of products could be disrupted and their cost could substantially increase, either of which could have a material adverse effect on our operating results. Unforeseen delays in customs clearance of any goods could have a material adverse effect on our ability to deliver complete shipments to our stores in a timely manner, which in turn could have a material adverse effect on our business and operating results.

Competition and the strength of our competitors may impair our ability to maintain or grow our sales and adversely affect our operating results.

The apparel segment of the specialty retail industry is highly competitive. The principal factors of competition for retail sales are product design, product quality, brand image, customer service and pricing. Our Gymboree, Janie and Jack and Crazy 8 brands compete on a national level with BabyGap and GapKids (divisions of Gap Inc.), certain leading department stores operating in malls, outlet centers or street locations, certain discount retail chains such as Old Navy (a division of Gap Inc.), The Children’s Place, Wal-Mart, Target and Carter’s, as well as a wide variety of local and regional specialty stores, certain other retail chains, and children’s retailers that sell their products by mail order, online or through outlet malls. Many of these competitors are larger than us and have substantially greater financial, marketing and other resources. Increased competition may reduce sales and gross margins, and increase operating expenses, each of which could have a material adverse effect on our operating results.

Because we purchase our products abroad, our business is sensitive to risks associated with international business.

Our products are currently manufactured to our specifications by independent factories located primarily in Asia. As a result, our business is subject to the risks generally associated with doing business abroad, such as foreign governmental regulations, currency fluctuations, adverse conditions such as epidemics, natural disasters, wars, acts of terrorism, social or political unrest, disruptions or delays in transportation or customs clearance, local business practices and changes in economic conditions in countries in which our suppliers are located. We cannot predict the effect of such factors on our business relationships with foreign suppliers or on our ability to deliver products into our stores in a timely manner. If even a small portion of our current foreign manufacturing sources or textile mills were to cease doing business with us for any reason, such actions could have a material adverse effect on our operating results and financial position. If we experience significant increases in demand or need to replace an existing vendor, there can be no assurance that additional manufacturing capacity will be available when required on terms that are acceptable to us, or at all, or that any vendor would allocate sufficient capacity to us in order to meet our requirements.

In addition, even if we are able to expand existing or find new manufacturing sources, we may encounter delays in production and added costs as a result of the time it takes to train our vendors in our methods, products, quality control standards, and environmental, labor, health, and safety standards. Moreover, in the event of a significant disruption in the supply of the fabrics or raw materials used by our vendors in the manufacture of our products, our vendors might not be able to locate alternative suppliers of materials of comparable quality at an acceptable price, or at all. Any delays, interruption, or increased costs in the manufacture of our products could have an adverse effect on our ability to meet consumer demand for our products and result in lower sales and net income. In addition, we are currently pursuing strategies to reduce product costs. These strategies may result in sourcing products from factories from which we have not previously purchased products and which may be in countries in which we have not done business before and may subject us to additional risk.

Currency exchange rate fluctuations may adversely affect our business and operating results.

There has been significant volatility in the value of the U.S. dollar against other foreign currencies in the recent past. While our business is primarily conducted in U.S. dollars, we purchase substantially all of our products overseas (primarily from China, Indonesia, Thailand, India and Bangladesh). Cost increases caused by currency exchange rate fluctuations could make our products less competitive or have an adverse effect on our profitability. Currency exchange rate fluctuations could also disrupt the business of the third-party manufacturers that produce our apparel by making their purchases of raw materials more expensive and more difficult to finance. Such fluctuations could have a material adverse effect on our business and earnings as a result.

 

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We are dependent on one facility for distribution of all of our merchandise.

We handle merchandise distribution for all of our stores (including our three online stores) from a single facility in Dixon, California. Any significant interruption in the operation of this distribution facility due to natural disasters, accidents, system failures or other events beyond our control or unforeseen causes could delay or impair our ability to distribute merchandise to our stores or customers, which could cause sales to decline and have a material adverse effect on our earnings and financial position. In addition, if the capacity of our distribution facility is exceeded (such as due to a high level of demand during peak periods), we may not be able to timely fulfill store and customer orders, which may have an adverse effect on our results of operations and our reputation.

In addition, we use an automated unit sortation system to manage the order processing for all of our direct-to-consumer businesses. In the event that this unit sortation system becomes inoperable for any reason, we would not be able to ship all direct-to-consumer orders in the timely manner that our customers expect. As a result, we could experience a reduction in our direct-to-consumer business, which could negatively impact sales and profitability.

We may be subject to negative publicity or legal action if our manufacturers violate labor laws or engage in practices that our customers believe are unethical.

We require our independent manufacturers to operate their businesses in compliance with the laws and regulations that apply to them. Our sourcing personnel periodically visit and monitor the operations of our independent manufacturers, but we cannot control their business or labor practices. We also rely on independent third parties to audit factories annually for compliance with safety and labor laws. If one of our independent manufacturers violates or is suspected of violating labor laws or other applicable regulations, or if such manufacturer engages in labor or other practices that diverge from those typically acceptable in the United States or any of the other countries in which we operate, we could in turn experience negative publicity or be subject to legal action. Negative publicity or legal actions regarding our manufacturers or the production of our products could have a material adverse effect on our reputation, sales, business, financial position and operating results.

The loss of a key buying agent could disrupt our ability to deliver our inventory supply in a timely fashion, impacting its value.

One buying agent manages a substantial portion of our inventory purchases (approximately 80% in fiscal year 2011). Although we believe that other buying agents could be identified and retained to place our required foreign production, the loss of this buying agent could result in delays in procuring inventory, which could result in a material adverse effect on our business and operating results.

We are dependent on third parties for critical business functions, and their failure to provide services to us, or our inability to timely replace them when necessary, could have a material adverse effect on our business and operating results.

We rely on third parties for critical functions involving credit card processing and store communications. These third parties may experience financial difficulties and unforeseen business disruptions that could adversely affect their ability to perform their contractual obligations to us, including their obligations to comply with Payment Card Industry (“PCI”) data security standards. Any such failure to provide services to us or to comply with PCI security requirements could impact our internal communications systems, including our ability to accept payment cards, which could have an adverse impact on business operations and lead to lower sales. Although we believe that other vendors could be identified and retained to provide these services, we may not find an adequate replacement timely, which could result in a material adverse effect on our business and operating results and adverse publicity.

Damage to our computer systems could severely impair our ability to manage our business.

Our operations depend on our ability to maintain and protect the computer systems we use to manage our purchase orders, store inventory levels, web applications, accounting functions and other critical aspects of our business. Our systems are vulnerable to damage from fire, floods, earthquakes, power loss, telecommunications failures and similar events. We have computer systems in each of our stores, with the main database servers for our systems located in San Francisco, California, and additional web site support systems located in Redwood City, California, which are located on or near known earthquake fault zones. An earthquake or other disaster could have a material adverse impact on our business and operating results not only by damaging our stores or corporate headquarters, but also by damaging our main servers, which could disrupt our business for an indeterminate length of time.

 

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Our business may be harmed if our or our vendors’ computer network security or any of the databases containing customer or other personal information maintained by us or our third-party providers is compromised.

The protection of customer, employee and company data in the information technology systems we utilize (including those maintained by third-party providers) is critical. Despite the efforts by us and our vendors to secure computer networks utilized for our business, security could be compromised, confidential information, such as customer credit card numbers or other personally identifiable customer information we or our vendors collect, could be misappropriated, or system disruptions could occur. Improper activities by third parties, advances in technical capabilities, new tools and discoveries and other events or developments may facilitate or result in a breach of our or our vendors’ computer network security. Any of these events could lead to costly investigations and litigation, as well as potential regulatory or other actions by governmental agencies. As a result of any of the foregoing, we may experience adverse publicity, loss of sales, the cost of remedial measures, and/or significant expenditures to reimburse third parties for damages, which could adversely impact our results of operations.

We believe that we are currently compliant with PCI data security standards, which require annual audits by independent qualified security assessors to assess compliance. Failure by us or our vendors to comply with the security requirements or rectify a security issue may result in fines and the imposition of restrictions on our ability to accept payment cards, which could adversely affect our operations. There can be no assurance that we will be able to continue to satisfy PCI security standards. In addition, PCI is controlled by a limited number of vendors who have the ability to impose changes in PCI’s fee structure and operational requirements without negotiation. Such changes in fees and operational requirements may result in our failure to comply with PCI security standards, as well as significant unanticipated expenses.

Our ability to successfully implement significant information technology systems is critical to our business.

Our information technology infrastructure is in regular need of upgrades, which we plan to continue to implement. Such technology systems changes are complex and could cause disruptions that may adversely affect our business, such as when our new or upgraded systems fail to perform adequately. While we strive to ensure the orderly implementation of various information technology systems, we may not be able to successfully execute these changes without potentially incurring a significant disruption to our business. Even if we are successful with implementation, we may not achieve the expected benefits from these initiatives, despite having expended significant capital. We may also determine that additional investment is required to bring our systems to their desired state, which could result in a significant investment of additional time and money and increased implementation risk. Furthermore, we intend to rely on third parties to fulfill contractual obligations related to some of these system upgrades. Failure of these third parties to fulfill their contractual obligations could lead to significant expenses or losses due to a disruption in business operations.

We must timely and effectively deliver merchandise to our stores and customers.

We cannot control all of the various factors that might affect our fulfillment rates for online sales and timely and effective merchandise delivery to our stores. We rely upon third-party carriers for our merchandise shipments to and from stores and reliable data regarding the timing of those shipments. In addition, we are heavily dependent upon two carriers for the delivery of our merchandise to online customers. Labor disputes, union organizing activity, inclement weather, natural disasters and acts of terrorism could affect those carriers’ ability to provide delivery services to meet our shipping needs. Failure to deliver merchandise in a timely and effective manner could damage our reputation and sales.

Our online businesses face distinct operating risks.

The successful operation of our online businesses depends on efficient and uninterrupted operation of our order-taking and fulfillment operations. Disruptions or slowdowns in these areas could result from disruptions in telephone service or power outages, inadequate system capacity, system issues, computer viruses, human error, changes in programming, natural disasters or adverse weather conditions. Our online businesses are generally vulnerable to additional risks and uncertainties associated with the Internet, including changes in required technology and other technical failures, as well as changes in applicable federal and state regulations, security breaches, and consumer privacy concerns. Problems in any of these areas could result in a reduction in sales, increased costs and damage to our reputation and brands.

We may not be able to successfully operate if we lose key personnel, are unable to hire qualified additional personnel, or experience turnover of our management team.

Our continued success is largely dependent on the individual efforts and abilities of our senior management team and certain other key personnel and on our ability to retain current management and to attract and retain qualified key personnel in the future. The loss of certain key employees or our inability to continue to attract and retain other qualified key employees could have a material adverse effect on our growth, operations and financial position.

 

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Our growth would be hampered if we are unable to locate new stores and relocate existing stores in appropriate retail venues and shopping areas.

Our stores must be located in appropriate retail spaces in areas with demographic characteristics consistent with our customer base. These locations tend to be limited to malls and similar venues where the market for available space has historically been very competitive. The location of acceptable store sites and the negotiation of acceptable lease arrangements require considerable time, effort and expense. Our ability to lease desirable retail space for expansion and relocation of stores, and to renew our existing store leases, on favorable economic terms is essential to our revenue and earnings growth. Approximately 90, 108 and 90 store leases will come up for renewal during fiscal 2012, fiscal 2013 and fiscal 2014, respectively. We are also in the process of negotiating lease terms for approximately 69 stores, which are currently operating under month-to-month terms. There can be no assurance that we will be able to achieve our store expansion goals, effectively manage our growth, successfully integrate the planned new stores into our operations, or profitably operate our new and remodeled stores. Failure to obtain and renew leases for a sufficient number of stores on acceptable terms could have a material adverse effect on our revenues and operating results.

We may be unable to protect our trademarks and other intellectual property rights.

We believe that our trademarks and service marks are important to our success and our competitive position due to their name recognition with our customers. We devote substantial resources to the establishment and protection of our trademarks and service marks on a worldwide basis. We are not aware of any material claims of infringement or material challenges to our right to use any of our trademarks and service marks in the United States or abroad. Nevertheless, the actions we have taken to establish and protect our trademarks and service marks may not be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products as a violation of the trademarks, service marks and proprietary rights of others, particularly as we continue to expand our business outside the United States. Also, others may assert rights in, or ownership of, trademarks and other proprietary rights of ours and we may not be able to successfully resolve these types of conflicts to our satisfaction. In addition, the laws of certain foreign countries may not protect proprietary rights to the same extent as do the laws of the United States.

We are, and may continue to be in the future, a party to legal proceedings that could result in unexpected adverse outcomes.

From time to time, we are a party to legal proceedings, including matters involving personnel and employment issues, personal injury and other proceedings arising in the ordinary course of business. In addition, there are an increasing number of cases being filed in the retail industry generally that contain class action allegations, such as such those relating to privacy and wage and hour laws. We evaluate our exposure to these legal proceedings and establish reserves for the estimated liabilities in accordance with generally accepted accounting principles. Assessing and predicting the outcome of these matters involves substantial uncertainties. Although not currently anticipated by management, unexpected outcomes in these legal proceedings, or changes in management’s evaluations or predictions and accompanying changes in established reserves, could have a material adverse impact on our financial results.

We may experience fluctuations in our tax obligations and effective tax rate.

We are subject to income taxes in federal and applicable state and local tax jurisdictions in the United States, Canada, China, Australia, Puerto Rico, and South Korea. We record tax expense based on our estimates of future payments, which include reserves for estimates of uncertain tax positions. At any time, many tax years are subject to audit by various taxing jurisdictions. The results of these audits and negotiations with taxing authorities may impact the ultimate settlement of these tax positions. As a result, we expect that there could be ongoing variability in our quarterly tax rates as taxable events occur and exposures are re-evaluated. Further, our effective tax rate in a given financial statement period may be materially impacted by changes in the mix and level of earnings.

We are also subject to sales and use taxes, as well as other local taxes, in applicable jurisdictions in the United States, Canada, China, Australia, Puerto Rico, and South Korea. At any time, many tax years are subject to audit by various taxing jurisdictions. The results of these audits and negotiations with taxing authorities may adversely impact the ultimate settlement of these tax positions and our financial results.

Our performance is dependent on attracting and retaining a large and growing number of qualified team members.

Many of those team members are in entry-level or part-time positions with historically high rates of turnover. Our ability to meet our labor needs while controlling our costs is subject to external factors such as unemployment levels,

 

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minimum wage legislation, health care legislation and changing demographics. In addition, our labor costs are influenced by health care and workers’ compensation costs, both of which have been rising in recent years. If we cannot hire enough qualified employees, or if there is a disruption in the supply of personnel we hire from third-party providers, especially during our peak season or certain high-volume events, our customer service levels and our operations could be negatively impacted.

Changes in seasonal consumer spending patterns that are beyond our control could harm our business.

Historically, a significant portion of our retail sales have been realized during the holiday season in November and December. We have also experienced periods of increased sales activity in the early spring, during the period leading up to the Easter holiday, and in the early fall, in connection with back-to-school sales. Changes in seasonal consumer spending patterns for reasons beyond our control could result in lower-than-expected sales during these periods. For example, the nature and pace of the recovery from the global economic downturn may have unanticipated effects on consumer spending patterns. Such circumstances could cause us to have excess inventory, necessitating markdowns to dispose of these excess inventories, which would reduce our profitability. Any failure by us to meet our business plan for, in particular, the third or fourth quarter of any fiscal year could have a material adverse effect on our earnings, which in all likelihood would not be offset by satisfactory results achieved in other quarters of the same fiscal year in which sales are less concentrated. Also, because we typically spend more in labor costs during the holiday season to hire temporary store employees in anticipation of increased holiday business volume, a shortfall in expected sales during that period could result in a disproportionate decrease in our net income.

Our growth could be hampered if we are unable to successfully open new stores.

Our growth depends in large part on our ability to successfully open new stores in both the United States and abroad, which in turn is dependent on a number of factors, including our ability to hire and train skilled store operating and management teams, secure appropriate retail space, and complete construction within planned timelines and budgets. There can be no assurance that we will successfully open the number of stores we plan, and the resulting impact on our growth rate could have an adverse effect on our results of operations and financial condition.

Our performance is dependent on customer traffic in shopping malls.

We are dependent upon the continued popularity of malls as a shopping destination and the ability of shopping mall anchor tenants and other attractions to generate customer traffic. A sluggish recovery of the United States economy or an uncertain economic outlook could continue to lower consumer spending levels and cause a decrease in shopping mall traffic, each of which could adversely affect our growth, sales, and profitability. Further, any terrorist act, natural disaster, or public health concern, including infectious diseases, that decreases the level of mall traffic or other shopping traffic, or that affects our ability to open and operate stores in affected areas, could have a material adverse effect on our business.

In addition, we lease a large number of our stores in malls owned and operated by highly leveraged real estate development companies. The inability of any one of these companies to refinance its debt when it comes due could result in mall closures or in foreclosures and distress sales of the mall properties. The closure of a mall or a change of ownership that results in changes or disruptions in mall operations, changes in tenant mix, or that otherwise impacts the character of the mall could affect the performance of our stores in those malls and could in turn have a material adverse effect on our business, financial condition and operating results.

Our efforts to expand internationally through franchising and similar arrangements may not be successful and could impair the value of our brands.

We have entered into franchise agreements with unaffiliated third parties to operate stores in certain countries in the Middle East and in South Korea and with an affiliate of the Company (that we do not control) to operate stores in China. Under these agreements, third parties operate stores that sell apparel, purchased from us, under the Gymboree name. We have limited experience managing apparel retail franchise relationships and these arrangements may ultimately not be successful. While we expect that this will be a small part of our business in the near future, we plan to continue to increase these types of arrangements over time as part of our international expansion efforts. The effect of these arrangements on our business and operating results is uncertain and will depend upon various factors, including the demand for our products in new markets and our ability to successfully identify appropriate third parties to act as franchisees, distributors, or in a similar capacity. In addition, certain aspects of these arrangements are not directly within our control. Other risks that may affect these third parties include general economic conditions in specific countries or markets, changes in diplomatic and trade relationships, and political instability. Moreover, while the agreements we have entered into and plan to enter into in the future provide us with certain termination rights, to the extent that these parties do not operate their stores in a manner consistent with our requirements regarding our Gymboree brand identity and customer experience standards, the value of our Gymboree brand could be impaired. A failure to protect the value of our Gymboree brand or any other harmful acts or omissions by a franchisee could have an adverse effect on our operating results and our reputation.

 

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We may acquire businesses in the future to support long-term growth. We have limited experience acquiring and integrating businesses into our organization and we may not be successful.

We regularly evaluate businesses as potential acquisition targets to support our long-term growth. We have not acquired significant businesses in the past and we have limited experience acquiring, integrating and growing existing businesses. The acquisition of a business could divert management’s attention from our existing brands and operations, require significant operational support and increase demands on systems and staffing. All of these effects could negatively impact our existing business. In addition, the acquisition and integration of an acquired business could result in significant additional costs that could negatively impact our working capital position, cash flow and operating results.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

We lease approximately 162,400 square feet of office space in a building in San Francisco, California, for our corporate offices. The lease expires in April 2018.

We own a 444,000 square-foot distribution center on approximately 31 acres in Dixon, California. All of our products are distributed from this facility. We also lease an additional 200,000 square feet of warehouse space in Dixon to supplement the Company-owned distribution center’s storage and processing capacity. This lease expires in July 2014.

As of January 28, 2012, our 1,149 stores included an aggregate of approximately 2,332,000 square feet of space. Store leases typically have 10-year terms and include a termination clause if minimum revenue levels are not achieved during a specified 12-month period during the lease term. Some leases are structured with a minimum rent component plus a percentage rent based on the store’s net sales in excess of a certain threshold. Substantially all of the leases require us to pay insurance, utilities, real estate taxes, and common area repair and maintenance expenses. Approximately 90, 108 and 90 store leases will come up for renewal during fiscal 2012, 2013 and 2014, respectively. We are also in the process of negotiating lease terms for approximately 69 stores currently operating under month-to-month terms. As of January 28, 2012, we also operated 7 Gymboree Play & Music corporate-owned sites in California, Florida and Arizona under leases that expire between fiscal 2012 and fiscal 2016. See Note 3 to the consolidated financial statements included elsewhere in this annual report.

ITEM 3. LEGAL PROCEEDINGS

The Company is subject to various legal proceedings and claims arising in the ordinary course of business. Our management does not expect that the results of any of these legal proceedings, either individually or in the aggregate, could have a material effect on our financial position, results of operations or cash flows.

ITEM 4. MINE SAFETY DISCLOSURES

None.

 

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Gymboree Holding, Ltd., domiciled in the Cayman Islands, through Giraffe Holding, Inc. (“Parent”), and other direct and indirect subsidiaries, indirectly owns all of our outstanding equity interests. Shares of our common stock are not registered on any national securities exchange or otherwise publicly traded, there is no established public trading market for our common stock and none of the shares of our common stock are convertible into shares of any other class of stock or other securities.

We paid cash dividends of $12.2 million in the aggregate on our common stock in the fourth quarter of fiscal 2011 to Parent. We do not have an established annual dividend policy. We may issue dividends to our shareholders in the future, but are under no obligation to do so, and would do so only to the extent permitted under financing documents and approved by our Board of Directors.

 

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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following table sets forth selected historical consolidated financial data at the dates and for the periods indicated below. Our selected financial data as of February 2, 2008 (Predecessor), January 31, 2009 (Predecessor), January 30, 2010 (Predecessor), and January 28, 2012 (Successor) and for the years then ended, and our selected financial data as of January 29, 2011 (Successor) and for the periods from January 31, 2010 to November 22, 2010 (Predecessor) and November 23, 2010 to January 29, 2011 (Successor), presented in this table have been derived from our historical audited consolidated financial statements

On October 11, 2010, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Giraffe Holding, Inc., a Delaware corporation (“Parent”), and Giraffe Acquisition Corporation, a Delaware corporation and a wholly owned subsidiary of Parent (“Acquisition Sub”), pursuant to which Acquisition Sub merged with and into the Company in accordance with the “short-form” merger provisions available under Delaware law (the “Merger”) on November 23, 2010 (the “Transaction Date”), with the Merger funded through a combination of debt and equity financing (collectively, “the Transactions”). We are continuing as the surviving corporation and 100%-owned indirect subsidiary of Parent. Investment funds sponsored by Bain Capital Partners, LLC (“Bain Capital”) own a controlling interest in Parent. The following selected historical consolidated financial data are presented for the Predecessor and Successor periods, which relate to the periods preceding and succeeding the Transaction Date, respectively.

In deriving the unaudited pro forma fiscal 2010 financial statement data, operating results for the year ended January 29, 2011 were calculated as the mathematical addition of our operating results for the predecessor period from January 31, 2010 to November 22, 2010 and the successor period from November 23, 2010 to January 29, 2011, and include pro forma adjustments. As a result of the Merger on the Transaction Date and the application of purchase accounting, a new basis of accounting began on the Transaction Date. This addition of the predecessor and successor amounts is not consistent with GAAP and may yield results that are not strictly comparable on a period-to-period basis due to the changes of accounting basis during these periods. For further information on the adjustments made to calculate the pro forma fiscal 2010 results, please refer to the section titled “Unaudited Pro Forma Condensed Consolidated Financial Information” in the Company’s prospectus filed with the SEC pursuant to Rule 424(b)(3) of the Securities Act on June 14, 2011.

The following 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 contained in this annual report.

 

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    Successor           Successor     Predecessor  
    Fiscal Year Ended     Pro Forma                 Fiscal Year Ended  
    January 28,     Fiscal Year Ended     November 23, 2010 to     January 31, 2010 to        January 30,         January 31,          February 2,  
    2012     January 29, 2011     January 29, 2011     November 22, 2010     2010     2009       2008  
          (unaudited)                                

Statement of operations data:

               

Net sales:

               

Retail

   $ 1,164,171            $ 1,054,018        $ 244,287        $ 814,863        $ 1,001,527        $ 987,859        $ 909,410     

Gymboree Play & Music

    13,885              13,661          2,814          10,847          13,384          12,819          11,404     

Retail Franchise

    10,232              1,372          447          925          -              -              -         

Other

                   -                                      248                                      -                                     248                         -                             -                            -         

Total net sales

    1,188,288              1,069,299          247,548          826,883          1,014,911          1,000,678          920,814     

Cost of goods sold, including buying and occupancy expenses

          (728,346)                        (570,326)                          (184,483)                       (431,675)               (535,005)               (524,477)             (478,020)    

Gross profit

    459,942              498,973          63,065          395,208          479,906          476,201          442,794     

Selling, general and administrative expenses

    (380,141)             (345,453)         (78,843)         (307,361)         (316,268)         (327,893)         (312,549)    

Goodwill impairment

            (28,300)                                 -                                          -                                      -                              -                             -                           -         

Operating income (loss)

    51,501              153,520          (15,778)         87,847          163,638          148,308          130,245     

Interest income

    168              -              36           295          728          1,690          2,609     

Interest expense

    (89,807)             (91,375)         (17,387)         (248)         (243)         (208)         (179)    

Loss on extinguishment of debt

    (19,563)             -              -              -              -              -              `     

Other (expense) income, net

                 (109)                                 172                                       53                                  119                        610                       (151)                      769     

(Loss) income before income taxes

    (57,810)             62,317          (33,076)         88,013          164,733          149,639          133,444     

Income tax benefit (expense)

                6,626                           (29,295)                              10,032                           (36,449)                 (62,814)                 (56,159)                (53,113)    

Net (loss) income

    (51,184)             33,022          (23,044)         51,564          101,919          93,480          80,331     

Net loss attributable to noncontrolling interest

                5,839                                   -                                          -                                      -                              -                              -                            -         

Net (loss) income attributable to The Gymboree Corporation

   $         (45,345)           $                   33,022        $                     (23,044)       $                     51,564        $        101,919        $           93,480        $         80,331     
 

Cash flows:

               

Net cash provided by operating activities

   $ 91,545            $ 68,839         $ 21,080         $ 90,951         $ 176,595         $ 155,024         $ 107,867     

Net cash (used in) provided by investing activities

    (38,212)             (1,876,860)         (1,833,408)         (43,452)         (39,579)         (56,114)         60,531     

Net cash (used in) provided by financing activities

    (7,723)             1,538,035          1,648,690          (110,655)         (21,535)         9,728          (164,346)    

Capital expenditures

    (36,565)             (47,268)         (5,054)         (42,214)         (39,579)         (56,114)         (68,794)    
 

Balance sheet data:

               

Cash and cash equivalents

   $ 77,910            $ *         $ 32,124         $ *         $ 257,672         $ 140,472         $ 33,313     

Accounts receivable, net

    27,277              *          13,669          *          9,911          18,735          12,640     

Working capital

    169,879              *          113,936          *          287,348          180,040          58,038     

Property and equipment, net

    202,152              *          212,491          *          205,461          204,227          185,357     

Total assets

    2,113,787              *          2,088,125          *          636,130          520,581          397,184     

Total debt

    1,211,800              *          1,215,991          *          -              -              -         

Total equity

    448,639              *          485,811          *          438,753          334,275          208,295     
 

Operating data:

               

Number of stores at end of period

    1,149              1,065          1,065          1,062          953          886          786     

Net sales per gross square foot at period-end (a)

   $ 499            $ 493         $ 114         $ 380         $ 529         $ 564         $ 595     

Net sales per average store (b)

   $ 1,011,940            $ 990,000         $ 229,000         $ 762,000         $ 1,043,000         $ 1,105,000         $ 1,146,000     

Comparable store net sales increase (decrease) (c)

    4%             (2%)          *          *          (4%)          0%         7%    
 

Other financial data:

               

Adjusted EBITDA (d)

   $ 192,585            $ 236,953         $ 57,912         $ 179,040         $ 221,348         $ 203,309          179,233     

 

*

Information not available for this period

(a)

Equals net sales from the Company’s retail stores and online stores, divided by total square feet of store space as of each date presented.

(b)

Equals net sales from the Company’s retail stores and online stores, divided by stores open as of each date presented.

(c)

A comparable store is one that has been open for a full 14 months. Stores that are relocated or expanded by more than 15% of their original square footage become comparable 14 months after final relocation or the completion of the expansion project. Comparable stores net sales include net sales from the Company’s online stores. Comparable store net sales were calculated on a 52 week basis for all periods presented.

(d)

Refer to the table in the section titled ‘Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”) (Non-GAAP Measure)’ found in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” to this annual report.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis in conjunction with our consolidated financial statements and related notes included elsewhere in this report. Except for historical information, the following discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Our actual results could differ materially from results that may be anticipated by such forward-looking statements. The principal factors that could cause or contribute to such differences include, but are not limited to, those discussed in “Item 1A.Risk Factors,” and those discussed elsewhere in this report. We do not intend to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise.

Overview

We are one of the largest children’s apparel specialty retailers in North America, offering collections of high-quality apparel and accessories. As of January 28, 2012, we operated a total of 1,149 retail stores and online stores at www.gymboree.com, www.janieandjack.com and www.crazy8.com. We also offered directed parent-child developmental play programs under the Gymboree Play & Music brand at 703 franchised and Company-operated centers in the United States and 36 other countries. In addition, as of January 28, 2012, third-party overseas partners operated 24 Gymboree retail stores in the Middle East and South Korea and the Joint Venture operated one Gymboree retail store in China.

The following table summarizes store openings and closures by brand and country for fiscal year ended January 28, 2012 (“fiscal 2011”). Note that (i) all Janie and Jack and Crazy 8 stores are in the United States, and (ii) retail stores operated by third-party overseas partners and the Joint Venture are excluded.

 

    Store Count as of
    January 29, 2011  
    Store
    Openings    
    Store
  Closures   
    Store Count as of 
  January 28, 2012   
 

Gymboree US

    594                (8)        587    

Gymboree Canada

    37                -             41    

Gymboree Australia

                  -               

Gymboree Puerto Rico

           -             (1)          
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Gymboree

    635                (9)        632    

Gymboree Outlet

    149                -             151    

Gymboree Outlet Puerto Rico

                  -               
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Gymboree Outlet

    150                -             153    

Janie and Jack

    123                (3)        127    

Crazy 8

    157         83         (3)        237    
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

    1,065         99         (15)        1,149    
 

 

 

   

 

 

   

 

 

   

 

 

 

In fiscal 2012, we plan to continue to execute on our vision to reach every mom in America and moms around the world with our multi-tiered portfolio of brands. As part of our strategy, we plan to open approximately 80 new Crazy 8 stores in fiscal 2012 to reach our more cost-conscious customers. We also plan to continue to roll out additional Company-operated stores with the core Gymboree and Janie and Jack brands and to evaluate other territories that might be appropriate for international expansion with our brand portfolio.

Though commodity prices (including that of cotton) have fallen from highs reached earlier in 2011, due to our production cycle and continued cost pressures, we expect relatively high prices paid for merchandise inventories and to a lesser extent, higher wages in developing countries, to continue to keep pressure on costs and our margins in the first half of fiscal 2012. In light of these likely cost pressures and continued price sensitivity of our customers in the foreseeable future, we plan to build upon cost saving measures successfully implemented in fiscal 2011, including direct sourcing of merchandise and strategies to better optimize our markdown and promotional plans, and leveraging our corporate infrastructure across our multi-brand portfolio of stores in order to maximize the benefits from our selling, general and administrative expenses. Despite these continued efforts, we anticipate some degree of downward pressure on our gross margins for at least the first two quarters of fiscal 2012.

 

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Critical Accounting Policies

Critical accounting policies are those accounting policies and estimates that management believes are important to the portrayal of the Company’s financial condition and results of operations and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain. Management has discussed the development and selection of the critical accounting policies and estimates applicable to the Company as of the date of the completion of the audit for the fiscal year ended January 28, 2012 with the Company’s Audit Committee.

Goodwill Impairment. As of January 28, 2012, we had goodwill of $899 million related to the Merger. Goodwill represents the excess of the acquisition cost over the estimated fair value of assets acquired, less liabilities assumed. At the date of the Merger, we preliminarily allocated goodwill to our reporting units, which we concluded were the same as our operating segments (see Note 13 to the consolidated financial statements included elsewhere in this annual report): Gymboree (including an online store), Gymboree Outlet, Janie and Jack (including an online store), Crazy 8 (including an online store), Gymboree Play & Music and Retail Franchise. We have since finalized our allocation of goodwill to reporting units (see Note 5 to the consolidated financial statements included elsewhere in this annual report). We allocated goodwill to the reporting units by calculating the fair value of each reporting unit and deriving the implied fair value of each reporting unit’s goodwill on the date of the Merger.

Goodwill is not amortized, but is tested annually for impairment in the fourth quarter. We update our impairment tests between annual tests if events or circumstances occur that would more likely than not reduce the fair value of a reporting unit below its carrying amount. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in expected future cash flows; a significant adverse change in legal factors or in the business climate; and unanticipated competition. Any adverse change in these factors could have a significant impact on the recoverability of goodwill and could have a material impact on our consolidated financial statements. The impairment test compares the carrying value of the assets and liabilities associated with a reporting unit, including goodwill, with the fair value of the reporting unit. If the carrying value of the assets and liabilities exceeds the fair value of the reporting unit, we calculate the implied fair value of the reporting unit goodwill as compared with the carrying value of the reporting unit goodwill to determine the appropriate impairment charge. In the fourth quarter of fiscal 2011, we recorded approximately $28.3 million in goodwill impairment related to the Gymboree Outlet reporting unit (see Note 5 to the consolidated financial statements included elsewhere in this annual report). The impairment charge is preliminary and subject to finalization of fair values which we will complete in fiscal 2012. We believe that the preliminary estimate of impairment is reasonable and represents our best estimate of the impairment charge to be incurred; however, it is possible that material adjustments to the preliminary estimate may be required as the analysis is finalized

Calculating the fair value of a reporting unit and the implied fair value of reporting unit goodwill requires significant judgment. The use of different assumptions, estimates or judgments in either step of the goodwill impairment testing process, such as the estimated future cash flows of reporting units, the discount rate used to discount such cash flows, or the estimated fair value of the reporting units’ tangible and intangible assets and liabilities, could significantly increase or decrease the estimated fair value of a reporting unit or its net assets. At the fiscal 2011 annual impairment test date, the conclusion that no indication of goodwill impairment existed for any reporting unit other than Gymboree Outlet would not have changed had the impairment test been conducted assuming: 1) a 100 basis point increase in the discount rate used to discount the aggregate estimated cash flows of reporting units to their net present value (without any change in the aggregate estimated cash flows), or 2) a 100 basis point decrease in the estimated revenue growth rate or terminal period growth rate without a change in the discount rate of each reporting unit. Based on this sensitivity analysis, we do not believe that the recorded goodwill balance is at risk of further impairment at any reporting unit other than Gymboree Outlet at the end of fiscal 2011. However, goodwill impairment charges may be recognized in future periods in one or more of the reporting units to the extent changes in factors or circumstances occur, including deterioration in the macroeconomic environment, deterioration in our performance or future projections, or changes in the our plans for one or more reporting units.

Intangible Assets and Liabilities.    Intangible assets, which amounted to $599 million as of January 28, 2012, primarily represent trade names for each of our brands, contractual customer relationships, and below market leases. Intangible liabilities, which amounted to $12.5 million as of January 28, 2012, represent above market leases and are included in deferred liabilities. Trade names have been assigned an indefinite life and are reviewed for impairment annually in the fourth quarter. We update our impairment tests between annual tests if events or circumstances occur that would more likely than not reduce the fair value of our trade names below their carrying amount. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in expected future cash flows; a significant adverse change in legal factors or in the business climate; and unanticipated

 

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competition. Any adverse change in these factors could have a significant impact on the recoverability of these intangible assets and could have a material impact on our consolidated financial statements. The impairment test compares the fair value of trade names with their carrying amounts. Calculating the fair value of trade names requires significant judgment. The use of different assumptions, estimates or judgments in the intangible asset impairment testing process, such as the estimated future cash flows of assets, the royalty rate and the discount and terminal growth rates used to discount such cash flows, could significantly increase or decrease the estimated fair value of an asset, and therefore, impact the related impairment charge.

In fiscal 2011, our conclusion regarding impairment of our trade names would not have changed had the test been conducted assuming: 1) a 100 basis point increase in the discount rate used to discount the aggregate estimated cash flows of the assets to their net present value (without any change in the aggregate estimated cash flows of reporting units) or 2) a 50 basis point decrease in the royalty rate applied to the forecasted net sales stream of the assets. Actual results could vary significantly from these estimates and could result in material impairment charges in the future. All other intangible assets and liabilities are amortized on a straight-line basis over their estimated useful lives (see Note 5 to the consolidated financial statements included elsewhere in this annual report). Intangible assets and liabilities with finite lives are evaluated for impairment using a process similar to that used for store asset impairment as described below. An impairment loss is recognized for the amount by which the carrying value exceeds fair value.

Inventory Valuation. Merchandise inventories are recorded at the lower of cost or market (“LCM”), determined on a weighted-average basis. We review our inventory levels to identify slow-moving merchandise and broken assortments (items no longer in stock in a sufficient range of sizes) and record an adjustment when the future estimated selling price is less than cost. We take a physical count of inventories in all stores once a year and in some stores twice a year, and perform cycle counts throughout the year in our distribution center. We record an inventory shrink adjustment based upon physical counts and also provide for estimated shrink adjustments for the period between the last physical inventory count and each balance sheet date. Our inventory shrink estimate can be affected by changes in merchandise mix and changes in actual shrink trends. Our LCM estimate can be affected by changes in consumer demand and the promotional environment. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our LCM or inventory shortage adjustments. However, if estimates regarding consumer demand are inaccurate or our actual physical inventory shortage differs significantly from our estimates, our operating results could be affected.

Store Asset Impairment. We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. If the undiscounted future cash flows from the asset group are less than the carrying value, we recognize a loss equal to the difference between the carrying value of the asset group and its fair value. The fair value of the asset group is estimated based on discounted future cash flows using a discount rate commensurate with the risk. The asset group is determined at the store level, which is the lowest level for which identifiable cash flows are available. Decisions to close a store or facility can also result in accelerated depreciation over the revised useful life. For locations to be closed that are under long-term leases, we record a charge for lease buyout expense, or the difference between our rent and the rate at which we expect to be able to sublease the properties and related cost, as appropriate. Most closures occur upon the lease expiration. Our estimate of future cash flows is based on historical experience and typically third-party advice or market data. These estimates can be affected by factors that are difficult to predict, such as future store profitability, real estate demand and economic conditions. We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions we use to calculate impairment losses of long-lived assets. Our recorded asset impairment charges have not been and are not expected to be material. However, if actual results are not consistent with our estimates and assumptions used in the calculations, we may be exposed to losses that could be material.

Income Taxes. We recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. We maintain valuation allowances when it is more likely than not that all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances from period to period are included in the tax provision in the period of change. In determining whether a valuation allowance is warranted, we take into account such factors as prior earnings history, expected future earnings, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. We are subject to periodic audits by the Internal Revenue Service (the “IRS”) and other taxing authorities. These audits may challenge certain of our tax positions, such as the timing and amount of deductions and allocation of taxable income to the various tax jurisdictions. Determining income tax expense for tax contingencies requires us to make assumptions that are subject to factors such as proposed assessments by tax authorities, changes in facts and circumstances, issuance of new regulations, and resolution of tax audits. Actual results could materially differ from these estimates and could significantly affect the effective tax rate and cash flows in future years.

Revenue Recognition. While revenue recognition does not involve significant judgment, it represents an important accounting policy for us. Revenue is recognized at the point of sale in retail stores. Online revenue is recorded when we

 

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estimate merchandise is delivered to the customer. Online customers generally receive merchandise within three to six days of shipment. Shipping fees received from customers are included in net sales and the associated shipping costs are included in cost of goods sold. We also sell gift cards in our retail store locations, through our online stores and through third parties. Revenue is recognized in the period that the gift card is redeemed. We recognize unredeemed gift card and merchandise credit balances when we can determine the portion of the liability for which redemption is remote (generally three years after issuance). These amounts are recorded as other income within selling, general and administrative expenses. Sales are presented net of a sales return reserve, which is estimated based on historical return trends. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our sales return reserve. However, if the actual rate of sales returns significantly increases, our operating results could be adversely affected.

Effect of the Merger

On October 11, 2010, we entered into a Merger Agreement with Parent and Acquisition Sub, pursuant to which Acquisition Sub merged with and into the Company in accordance with the “short-form” merger provisions available under Delaware law (the “Merger”) on November 23, 2010 (the “Transaction Date”), with the Merger funded through a combination of debt and equity financing (collectively, “the Transactions”). The application of purchase accounting as a result of the Merger required the adjustment of our assets and liabilities to their fair value, which resulted in an increase in amortization expense related to intangible assets acquired as a result of the Merger. Also, as a result of the Transactions, our borrowings and interest expense significantly increased. The excess of purchase price over the estimated fair value of our net assets and identified intangible assets was allocated to goodwill. Our indefinite-lived intangible assets and goodwill are subject to periodic tests for impairment. The subsection “Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”) (Non-GAAP Measure)” below shows other purchase accounting adjustments that affected fiscal 2011 and 2010, as well as a reconciliation of such measures to net income (loss).

Results of Operations

Fiscal 2011 compared to Pro Forma Fiscal 2010

In presenting a comparison of our results of operations for fiscal 2011 to our results of operations for the fiscal year ended January 29, 2011, we have presented unaudited pro forma results for the fiscal year ended January 29, 2011 (“fiscal 2010”). This presentation does not comply with generally accepted accounting principles (GAAP).

Net Sales

Net retail sales for fiscal 2011 increased to $1.2 billion from pro forma net retail sales of $1.1 billion in fiscal 2010, an increase of $110.2 million, or 10.5%. This increase was primarily due to net store and square footage growth of 84 stores and approximately 194,000 square feet. Comparable store sales increased by 4% in fiscal 2011.

Retail franchise sales for fiscal 2011 increased to $10.2 million from pro forma sales of $1.4 million in fiscal 2010, an increase of $8.8 million. This increase was the direct result of international expansion, with 22 new Gymboree stores opened by third-party overseas partners in fiscal 2011. There were 24 franchised Gymboree stores in the Middle East and South Korea at the end of fiscal 2011, compared to 2 franchised Gymboree stores in the Middle East at the end of fiscal 2010.

Gross Profit

Gross profit for fiscal 2011 decreased to $459.9 million from pro forma gross profit of $499.0 million in fiscal 2010. As a percentage of net sales, gross profit decreased 8.0 percentage points to 38.7% from pro forma gross profit of 46.7% last year. The decrease in gross profit was primarily due to higher average unit costs in fiscal 2011 resulting from higher commodity prices (primarily cotton) and a higher level of markdown selling.

Selling, General and Administrative Expenses

Selling, general and administrative (“SG&A”) expenses, which principally consist of non-occupancy store expenses, corporate overhead and distribution expenses, increased to $380.1 million in fiscal 2011 from pro forma SG&A of $345.5 million in fiscal 2010, an increase of $34.6 million, or 10.0%. As a percentage of net sales, SG&A decreased 0.3 percentage points to 32% in fiscal 2011 from pro forma SG&A 32.3% in fiscal 2010. The SG&A decrease as a percentage of net sales for fiscal 2011 was primarily due to lower stock-based and incentive compensation costs partially offset by a one-time charge related to the termination of our master franchise relationship in China (see Note 20 to the consolidated financial statements included elsewhere in this annual report) and increased costs related to the operations of the Joint Venture (see Note 21 to the consolidated financial statements included elsewhere in this annual report).

 

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Goodwill Impairment

In the fourth quarter of 2011, due to higher average unit costs resulting from higher commodity prices (primarily cotton) and a higher level of markdown selling, we concluded that there was impairment related to goodwill allocated to Gymboree Outlet, one of our reporting units. Although our analysis has not been completed due to its complexity, based on the work we performed to date, we have recorded a preliminary estimate of the impairment charge for goodwill of $28.3 million.

Interest Expense

Interest expense decreased to $89.8 million in fiscal 2011 from pro forma interest expense of $91.4 million in fiscal 2010 due to a fiscal 2011 refinance of our Term Loan (in February 2011), which, among other things, lowered the interest rate.

Loss on Extinguishment of Debt

Loss on extinguishment of debt was approximately $19.6 million for fiscal 2011 and was due to the refinancing of our Term Loan. In February 2011, we refinanced our Term Loan through an amendment and restatement of our existing credit agreement to lower the interest rate, remove certain financial covenants and extend the maturity date from November 2017 to February 2018.

Income Taxes

Income tax benefit for fiscal 2011 and pro forma income tax expense for fiscal 2010 resulted in effective tax rates of approximately 11.5% and 47.0%, respectively. The fiscal 2011 rate is comparatively low as a percentage of pre-tax loss due primarily to the non-deductible goodwill impairment charge and non-deductible costs associated with the VIEs. The fiscal 2010 rate is comparatively high as a percentage of pro forma pre-tax income due primarily to one-time non-deductible costs associated with the Merger.

Pro Forma Fiscal 2010 Compared to Fiscal 2009

Net Sales

Pro forma net retail sales for fiscal 2010 increased to $1.1 billion from net retail sales of $1.0 billion in fiscal 2009, an increase of $52.5 million, or 5.2%. This increase was largely due to net store growth of 112 stores and an aggregate square footage growth of approximately 259,000 square feet. Comparable store sales decreased by 2% in fiscal 2010, primarily due to the continuing difficult retail environment and slow economic recovery. We operated a total of 1,065 retail stores at the end of fiscal 2010 compared to 953 at the end of fiscal 2009.

Pro forma Gymboree Play & Music net sales for fiscal 2010 increased to $13.7 million from $13.4 million in fiscal 2009. The increase was primarily due to an increase in royalties from international franchisees, as well as an increase in revenues from our corporate-owned sites. These increases were partially offset by a decrease in equipment sales. There were 688 Gymboree Play & Music sites (including 8 corporate-owned sites) at the end of fiscal 2010 compared to 650 sites at the end of fiscal 2009 (including 8 Company-operated sites).

Pro forma retail franchise net sales for fiscal 2010 were $1.4 million. The franchise business was launched August 2010. As of January 29, 2011, a franchisee operated 2 Gymboree stores in the Middle East.

Gross Profit

Pro forma gross profit for fiscal 2010 increased to $499.0 million from a gross profit of $479.9 million in fiscal 2009. As a percentage of net sales, pro forma gross profit decreased 0.6 percentage points to 46.7% from a gross profit of 47.3% in fiscal 2009. This decrease was primarily due to deleveraging of occupancy costs. In the period from November 23, 2010 to January 29, 2011, cost of goods sold included $45.5 million of amortization expense resulting from an increase in the net book value of inventory that was eliminated in the pro forma results for fiscal 2010.

 

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Selling, General and Administrative Expenses

Pro forma SG&A increased to $345.5 million in fiscal 2010 from SG&A of $316.3 million in fiscal 2009, an increase of $29.2 million, or 9.2%. Pro forma SG&A as a percentage of net sales increased 1.1 percentage points to 32.3% in fiscal 2010 from SG&A of 31.2% in fiscal 2009. This increase was primarily due to amortization expense related to intangible assets recognized as a result of the Merger, and was partially offset by a decrease in stock-based and incentive compensation. The pro forma results for fiscal 2010 include a full year of amortization expense for intangible assets. In the period from November 23, 2010 to January 29, 2011, as a result of the Transactions, we incurred $13.5 million of transaction expenses and a $27.7 million stock-based compensation charge that are not included in the pro forma results for fiscal 2010.

Interest Income

Pro forma interest income decreased to zero in fiscal 2010 from $0.7 million in fiscal 2009 mainly due to lower interest rates and lower average cash balances. In addition, the pro forma results for fiscal 2010 eliminated our interest income to reflect our capitalization after the Merger.

Interest Expense

Interest expense increased to $91.4 million in fiscal 2010 from $0.2 million in fiscal 2009, primarily due to interest on the Senior Credit Facilities entered into, and the Notes issued in connection with the Merger, as well as amortization of deferred financing costs related to the Merger and accretion of the original issue discount on our new senior secured Term Loan.

Income Taxes

Pro forma income tax expense for fiscal 2010 and income tax expense for fiscal 2009 resulted in effective tax rates of approximately 47.0% and 38.1%, respectively. The effective tax rate increased in fiscal 2010 due to non-deductible costs associated with the Merger.

Liquidity and Capital Resources

Cash and cash equivalents totaled $77.9 million as of January 28, 2012, $4.9 million of which is held by the two entities that make up the Joint Venture, which we have determined to be VIEs of which we are the primary beneficiary, and the results of which we have consolidated into our financial statements (see Note 21 to the consolidated financial statements included elsewhere in this annual report) and $32.1 million as of January 29, 2011. The assets of the VIEs cannot be used by us. Working capital as of January 28, 2012 totaled $169.9 million as compared to $113.9 million as of January 29, 2011.

Net cash provided by operating activities for fiscal 2011 was $91.5 million compared to $21.1 million for the period from November 23, 2010 to January 29, 2011 and $91.0 million for the period from January 31, 2010 to November 22, 2010. The decrease in cash provided by operating activities in fiscal 2011 was primarily due to interest payments on our Senior Credit Facilities entered into, and Notes issued, in connection with the Merger as well as increased average unit costs for inventory. The Senior Credit Facilities are comprised of an $820 million senior secured Term Loan and a $225 million ABL Facility.

Net cash provided by operating activities was $21.1 million for the period from November 23, 2010 to January 29, 2011 and $91.0 million for the period from January 31, 2010 to November 22, 2010, compared to $176.6 million in fiscal 2009. The decrease in cash provided by operating activities in fiscal 2010 was primarily due to:

 

   

a decrease in operating income during the period from January 31, 2010 to November 22, 2010 and an operating loss during the period from November 23, 2010 to January 29, 2011; and

 

   

an increase in prepaid income taxes due to tax deductions related to the Transactions.

The factors above were partially offset by:

 

   

an increase in accrued liabilities due to costs related to the Transactions and interest accrued on our new Senior Credit Facilities; and

 

   

an increase in accounts payable due to costs related to the Transactions and timing of payments.

 

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Net cash used in investing activities was $38.2 million in fiscal 2011 compared to $1.8 billion during the period from November 23, 2010 to January 29, 2011 and $43.5 million during the period from January 31, 2010 to November 22, 2010. The $38.2 million used in fiscal 2011 primarily consisted of $36.6 million in capital expenditures related to the opening of new stores, relocation, remodeling and/or expansion of existing stores, information technology improvements, and investments in our distribution center (see the table below for further information on store openings in fiscal 2011). In the period from January 31, 2010 to November 22, 2010 and in fiscal 2009, net cash used in investing activities was $43.5 and $39.6 million, respectively, and was comparable in composition to the aforementioned components of capital expenditures for fiscal 2011. Net cash used in investing activities during the period from November 23, 2010 to January 29, 2011 primarily related to acquisition costs related to the Merger.

We estimate capital expenditures for fiscal 2012 will approximate $45 million and will be used to open approximately 105 new stores (shown in table below), as well as to continue investment in our distribution center and systems infrastructure. Our current plans for Gymboree, Gymboree Outlet, Janie and Jack, and Crazy 8 will require increasing capital expenditures for new stores for the next several years. The following table summarizes store openings for 2011 and planned openings for 2012 (excluding activity from our VIEs and third-party overseas partners):

 

         New Stores in    
fiscal 2011
       New Stores in  
fiscal 2012
 

Gymboree US

     1             

Gymboree Canada

     4             

Gymboree Australia

     1             
  

 

 

    

 

 

 

Total Gymboree

     6             

Gymboree Outlet

     2             

Gymboree Outlet Puerto Rico

     1           -        
  

 

 

    

 

 

 
     3             

Janie and Jack

     7           10    

Crazy 8

     83           80    
  

 

 

    

 

 

 
     99           105     
  

 

 

    

 

 

 

Net cash used in financing activities in fiscal 2011 was $7.7 million compared to net cash provided by financing activities of $1.6 billion during the period from November 23, 2010 to January 29, 2011, compared to net cash used in financing activities of $110.7 million during the period from January 31, 2010 and November 22, 2010. The net cash used in fiscal 2011 was primarily due to a $12.2 million cash dividend on our common stock paid to Parent, which was used by the shareholders of Parent to fund their equity investment in the Joint Venture (see Note 21 to the consolidated financial statements included elsewhere in this annual report), $8.2 million in quarterly principal payments on our Term Loan and $6.7 million in deferred financing costs paid in connection with the February 2011 refinancing of our Term Loan, partially offset by capital contributions made by Parent to us of $14.9 million and to the VIEs by their immediate corporate parent of $4.5 million. The change during the period from November 23, 2010 to January 29, 2011 was primarily due to $1.2 billion in borrowings on our Senior Credit Facilities and the Notes in connection with the Transactions, as well as a $508 million equity investment made by Parent, partially offset by deferred financing costs of $63.3 million paid in connection with the Transactions and $12.1 million paid for the purchase of four interest rate cap contracts. Net cash used in financing activities during the period from January 31, 2010 to November 22, 2010 was primarily for stock repurchases. Net cash used by financing activities was $21.5 million in fiscal 2009 and was primarily related to stock repurchases.

We have an $820 million Term Loan and a $225 million ABL Facility. As of January 28, 2012, $811.8 million was outstanding under the Term Loan. Amounts available under the ABL are subject to customary borrowing base limitations and are reduced by letter of credit utilization. No amounts were outstanding and there was approximately $127.8 million of undrawn availability under the ABL as of January 28, 2012. The Term Loan and ABL also allow an aggregate of $200 million in uncommitted incremental facilities, the availability of which is subject to our meeting certain conditions. No incremental facilities are currently in effect. The Term Loan and ABL contain covenants that, among other things, restrict our ability to incur additional indebtedness and pay dividends. The ABL also contains financial covenants. As of January 28, 2012, we were in compliance with these covenants. In March 2012, we amended and restated the terms of our ABL Facility to, among other things, lower the interest rate and extend the maturity date from November 2015 to March 2017.

 

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The Term Loan requires us to make quarterly payments each equal to 0.25% of the original $820 million principal amount of the Term Loan made on the closing date plus accrued and unpaid interest thereon, with the balance due in February 2018. The Term Loan also has mandatory and voluntary pre-payment provisions, including a requirement that we prepay the Term Loan with a certain percentage of our annual excess cash flow beginning with the excess cash flow for fiscal 2011. In fiscal 2012, we expect to prepay approximately $15.7 million of the Term Loan with a portion of our excess cash flow for fiscal 2011. We may (but are not required to) apply a portion of this prepayment toward our quarterly amortization payments payable under the Term Loan in fiscal 2012.

Pursuant to authorization from the Board of Directors, we repurchased and retired 2,613,375 shares of our common stock at an aggregate cost of approximately $113.6 million, or approximately $43.49 per share, during the period from January 31, 2010 to November 22, 2010 and 627,156 shares of our common stock at an aggregate cost of approximately $26.4 million, or approximately $42.02 per share, in fiscal 2009. We did not repurchase and retire any shares of our stock during fiscal 2011.

Subject to certain limitations imposed on business combinations under the agreements governing our indebtedness, the Company’s capital resources allow us to consider business acquisitions as an alternative means of growth. We review acquisition opportunities from time to time and, while we do not have significant experience in acquiring an existing business, we would consider doing so in the future with respect to an appropriate opportunity.

We believe that cash and cash equivalents generated by operations, the remaining funds available under our Senior Credit Facilities and existing cash and equivalents will be sufficient to meet working capital requirements, service our debt and finance capital expenditures over the next twelve months. We cannot assure you, however, that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under the Senior Credit Facilities in amounts sufficient to enable us to repay our indebtedness, including the Notes, or to fund other liquidity needs. See “Item 1A. Risk Factors—Risks Related to Our Indebtedness and Certain Other Obligations”.

Summary Disclosures about Contractual Obligations and Commercial Commitments

The following table reflects a summary of our contractual obligations as of January 28, 2012:

 

    Payments due by period  
($ in thousands)  

  Less than  

1 year

        1-3 years              3-5 years             After 5 years           Total    

Standby-by letters of credit

  $ 5,893        $ -            $ -            $ -            $ 5,893     

Operating leases (1)

    87,006          155,729          133,318          140,958          517,011     

Inventory purchase obligations (2)

    223,148          -          -          -          223,148     

Other purchase obligations (3)

    13,890          4,471            -          18,361     

Senior Credit Facilities (4)

    17,698          6,902          16,400          770,800          811,800     

Notes (5)

                    -                          -                            -                     400,000                   400,000     

Total contractual cash obligations

  $      347,635        $      167,102        $        149,718        $         1,311,758        $       1,976,213     

 

(1)

Other lease-required expenses such as utilities, real estate taxes and common area repairs and maintenance are excluded. See Note 3 to the consolidated financial statements included elsewhere in this annual report for discussion of the Company’s operating leases.

 

(2)

Inventory purchase obligations include outstanding purchase orders for merchandise inventories that are enforceable and legally binding on the Company and that specify all significant terms (including fixed or minimum quantities to be purchased), fixed, minimum or variable price provisions, and the approximate timing of the transaction.

 

(3)

Other purchase obligations include commitments for fixtures and equipment, information technology and professional services.

 

(4)

The Senior Credit Facilities are comprised of an $811.8 million Term Loan and a $225 million ABL Facility. The amounts presented in the table above do not include interest on the Senior Credit Facilities.

 

(5)

Represents an aggregate principal amount of $400 million of our Notes. The amounts presented in the table above do not include interest on the Notes.

 

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As of January 28, 2012, we had unrecognized tax benefits of $5.7 million, accrued interest of $1.7 million, and accrued penalties of $0.7 million. These amounts have been excluded from the contractual obligations table because a reasonably reliable estimate of the timing of future tax settlements cannot be determined.

The expected timing of payment of the obligations discussed above is estimated based on current information. The timing of payments and actual amounts paid may differ depending on the timing of receipt of services, or, for some obligations, changes to agreed-upon amounts.

Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”) (Non-GAAP Measure)

In the table below, we present Adjusted EBITDA (which is defined as net income (loss) attributable to The Gymboree Corporation before interest expense, interest income, income tax expense/benefit, and depreciation and amortization (EBITDA) adjusted for the other items described below), which is considered a non-GAAP financial measure. We present Adjusted EBITDA in this annual report because we consider it an important supplemental measure of performance used by management and we believe it is frequently used by securities analysts, investors and other interested parties in the evaluation of companies in the retail industry. Adjusted EBITDA is calculated in substantially the same manner as “EBITDA” under the indenture governing the Notes and “Consolidated EBITDA” under the agreement governing our Senior Credit Facilities. We believe that the inclusion of supplementary adjustments applied to EBITDA in presenting Adjusted EBITDA is appropriate to provide additional information to investors about certain non-cash items and unusual or non-recurring items that we do not expect to continue in the future and to provide additional information with respect to our ability to meet our future debt service and to comply with various covenants in documents governing our indebtedness. However, Adjusted EBITDA is not a presentation made in accordance with GAAP, and our computation of Adjusted EBITDA may vary from others in the retail industry. Adjusted EBITDA should not be considered an alternative to operating income or net income (loss), as a measure of operating performance or cash flow, or as a measure of liquidity. Adjusted EBITDA has important limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. For example, Adjusted EBITDA:

 

   

does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments;

   

does not reflect changes in, or cash requirements for, our working capital needs;

   

does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;

   

excludes income tax payments that represent a reduction in cash available to us; and

   

does not reflect the impact of earnings or charges resulting from matters we consider not to be indicative of ongoing operations.

 

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The following table is a reconciliation of net (loss) income attributable to The Gymboree Corporation to Adjusted EBITDA for the periods indicated (in thousands):

 

   

 

Successor

   

 

Predecessor

 
    52 Weeks Ended     November 23, 2010 to     January 31, 2010 to     52 Weeks Ended  
      January 28, 2012           January 29, 2011           November 22, 2010         January 30, 2010        January 31, 2009       February 2, 2008   

Net (loss) income attributable to The Gymboree Corporation

   $ (45,345)        $ (23,044)        $ 51,564        $ 101,919        $ 93,480        $ 80,331    
Interest expense     89,807         17,387         248         243         208         179    
Interest income     (168)         (36)         (295)         (728)         (1,690)         (2,609)    
Income tax (benefit) expense     (6,626)         (10,032)         36,449         62,814         56,159         53,113    
Depreciation and amortization (a)     57,930         10,250         32,550         37,302         34,854         31,151    
Non-cash share-based compensation expense     5,907         482         41,042         18,462         19,850         16,381    
Loss on disposal/impairment on assets     4,339         1,150         880         1,336         448         687    
Loss on extinguishment of debt     19,563         -             -             -             -             -        
Gymboree Play & Music franchise transition     7,200         -             -             -             -             -        
Goodwill impairment     28,300         -             -             -             -             -        
Acquisition-related adjustments (b)     31,678         61,755         16,602         -             -             -        
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ 192,585        $ 57,912         $ 179,040        $ 221,348        $ 203,309        $ 179,233    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
 
(a) Includes the following purchase accounting adjustments (in thousands):              

Amortization of intangible assets (impacts SG&A)

   $ 17,500        $ 3,011        $ -            $ -            $ -            $ -        

Amortization of below and above market leases (impacts COGS)

    (2,090)         (387)         -             -             -             -        
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ 15,410        $ 2,624        $ -          $ -          $ -          $ -      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
 
(b) Includes the following adjustments (in thousands):              

Adjustment to cost of goods sold from an increase in the net book value of inventory as a result of purchase accounting (impacts COGS)

   $ 10,731        $ 45,508        $ -            $ -            $ -            $ -        

Additional rent expense recognized due to the elimination of deferred rent and construction allowances in purchase accounting (impacts COGS)

    9,699         1,628         -             -             -             -        

Legal, accounting and other costs incurred as a result of the Merger (impacts SG&A)

    5,607         13,624         16,602         -             -             -        

Decrease in net sales due to the elimination of deferred revenue related to the Company’s co-branded credit card program in purchase accounting (impacts net sales)

    5,641         995         -             -             -             -        
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ 31,678        $ 61,755        $ 16,602        $ -          $ -          $ -      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We enter into forward foreign exchange contracts with respect to certain purchases in United States dollars of inventory to be sold in our retail stores in Canada. The purpose of these contracts is to protect our margins on the eventual sale of the inventory from fluctuations in the exchange rate for Canadian and United States dollars. The term of the forward exchange contracts is generally less than one year.

The table below summarizes the notional amounts and fair values of our forward foreign exchange contracts in United States dollars (in thousands except weighted-average rate data):

 

     Notional
Amount
     Fair Value
Gain (Loss)
     Weighted-
Average

Rate
 

   January 28, 2012

     $       14,154           $         (13)          $       0.99     

   January 29, 2011

     $ 4,505           $ (33)          $ 1.00     

Interest Rate Risk

We are subject to interest rate risk in connection with our long-term debt. Our principal interest rate risk relates to the Term Loan outstanding under the Senior Credit Facilities. We have $811.8 million outstanding under our Senior Credit Facilities, bearing interest at variable rates. A 0.125% increase in these floating rates applicable to the indebtedness outstanding under the Senior Credit Facilities would have increased annual interest expense by approximately $1.0 million. The Senior Credit Facilities also allow an aggregate of $200 million in uncommitted incremental facilities, bearing interest at variable rates. No incremental facilities are currently in effect.

In December 2010, we purchased four interest rate caps to hedge against rising interest rates associated with our senior secured term loan above the 5% strike rate of the caps through December 23, 2016, the maturity date of the caps. The notional amount of these caps is $700 million. As of January 28, 2012, accumulated other comprehensive income included approximately $10.7 million in unrealized losses related to the interest rate caps. Additional information relating to our derivative instruments is presented in Note 17 to the consolidated financial statements included in this annual report.

 

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Impact of Inflation

Except for the impact of increased cotton prices and higher wages in developing countries as described under “Overview” above, the impact of inflation on results of operations has not been significant in any of the last three fiscal years.

Recently Issued Accounting Standards

In January 2010, the FASB issued guidance which amends and clarifies existing guidance related to fair value measurements and disclosures. This guidance requires new disclosures for (1) transfers in and out of Level 1 and Level 2 and reasons for such transfers; and (2) the separate presentation of purchases, sales, issuances and settlement in the Level 3 reconciliation. It also clarifies guidance around disaggregation and disclosures of inputs and valuation techniques for Level 2 and Level 3 fair value measurements. We adopted this guidance as of January 31, 2010, except for the new disclosures in the Level 3 reconciliation, which were adopted during the first quarter of fiscal 2011. The adoption of this guidance did not have a material impact on our consolidated financial statements.

In May 2011, the FASB issued guidance to amend the accounting and disclosure requirements on fair value measurements. The new guidance limits the highest-and-best-use measure to nonfinancial assets, permits certain financial assets and liabilities with offsetting positions in market or counterparty credit risks to be measured at a net basis, and provides guidance on the applicability of premiums and discounts. Additionally, this guidance requires entities to disclose the categorization by level of the fair value hierarchy for items that are not measured at fair value in the statement of financial position but for which the fair value is required to be disclosed. This new guidance will be effective for us as of January 29, 2012. We anticipate that the adoption of this guidance will not have a material impact on our consolidated financial statements.

In June 2011, the FASB issued guidance to amend the presentation of comprehensive income. This new guidance requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. We early adopted this guidance effective for our fiscal year ended January 28, 2012, as permitted under the standard, and applied retrospectively to all periods presented as required to present the total of comprehensive income, the components of net income, and the components of other comprehensive income in two separate consecutive statements. The adoption of this guidance did not result in a material impact on our consolidated financial statements.

In September 2011, the FASB issued guidance to amend the testing of goodwill for impairment. This new guidance permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. This accounting standards update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. This new guidance will be effective for us as of January 29, 2012. We anticipate that the adoption of this guidance will not have a material impact on our consolidated financial statements.

In December 2011, the FASB issued guidance to amend the disclosure requirements regarding the offsetting of assets and liabilities related to financial and derivative instruments. This new guidance requires an entity to disclose quantitative information in a tabular format to allow users of their financial statements to evaluate the effect or potential effect on the entity’s financial position of netting arrangements. This new guidance will be effective for us as of February 3, 2013. We are currently evaluating the impact of this guidance on our financial statement presentation of our derivative and financial instruments.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     PAGE
Report of Independent Registered Public Accounting Firm    31
Consolidated Balance Sheets as of January 28, 2012 (Successor) and January 29, 2011(Successor)    32
Consolidated Statements of Operations for the year ended January 28, 2012 (Successor), for the periods from November 23, 2010 to January  29, 2011 (Successor), and from January 31, 2010 to November 22, 2010 (Predecessor), and the year ended January 30, 2010 (Predecessor)    33
Consolidated Statements of Comprehensive Income (Loss) for the year ended January 28, 2012 (Successor), for the periods from November  23, 2010 to January 29, 2011 (Successor), and from January 31, 2010 to November 22, 2010 (Predecessor), and the year ended January 30, 2010 (Predecessor)    34
Consolidated Statements of Cash Flows for the year ended January 28, 2012 (Successor), for the periods from November 23, 2010 to January  29, 2011 (Successor), and from January 31, 2010 to November 22, 2010 (Predecessor), and the year ended January 30, 2010 (Predecessor)    35
Consolidated Statements of Stockholders’ Equity for the year ended January 28, 2012 (Successor), for the periods from November  23, 2010 to January 29, 2011 (Successor), and from January 31, 2010 to November 22, 2010 (Predecessor), and the year ended January 30, 2010 (Predecessor)    36
Notes to Consolidated Financial Statements    37

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

The Gymboree Corporation:

We have audited the accompanying consolidated balance sheets of The Gymboree Corporation and subsidiaries (the “Company”) as of January 28, 2012 (Successor) and January 29, 2011 (Successor), and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for the year ended January 28, 2012 (Successor), the period from November 23, 2010 to January 29, 2011 (Successor), the period from January 31, 2010 to November 22, 2010 (Predecessor) and the year ended January 30, 2010 (Predecessor). These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The Gymboree Corporation and subsidiaries as of January 28, 2012 (Successor) and January 29, 2011 (Successor), and the results of their operations and their cash flows for the year ended January 28, 2012 (Successor), the period from November 23, 2010 to January 29, 2011 (Successor), the period from January 31, 2010 to November 22, 2010 (Predecessor) and the year ended January 30, 2010 (Predecessor), in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 1 to the consolidated financial statements, the Company changed its method of presenting comprehensive income for the year ended January 28, 2012, due to the adoption of Financial Accounting Standards Board Accounting Update No. 2011-05, Presentation of Comprehensive Income. The change in presentation has been applied retrospectively to all periods presented.

/s/ DELOITTE & TOUCHE LLP

San Francisco, California

April 26, 2012

 

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THE GYMBOREE CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

    Successor  
ASSETS         January 28,                 January 29,        
    2012     2011  

Current Assets:

   

Cash and cash equivalents

   $ 77,910         $ 32,124     

Accounts receivable, net of allowance of $114 and $-

    27,277          13,669     

Merchandise inventories

    210,212          184,268     

Prepaid income taxes

    3,736          16,116     

Prepaid expenses

    5,532          4,856     

Deferred income taxes

    36,115          6,697     
 

 

 

   

 

 

 

Total current assets

    360,782          257,730     
 

 

 

   

 

 

 

Property and Equipment:

   

Land and buildings

    22,428          22,397     

Leasehold improvements

    146,497          125,153     

Furniture, fixtures, and equipment

    82,606          71,286     
 

 

 

   

 

 

 
    251,531          218,836     

Less accumulated depreciation and amortization

    (49,379)         (6,345)    
 

 

 

   

 

 

 
    202,152          212,491     

Goodwill

    899,097          927,397     

Other Intangible Assets

    599,195          617,810     

Deferred Financing Costs

    47,915          61,983     

Other Assets

    4,646          15,072     
 

 

 

   

 

 

 

Total Assets

   $ 2,113,787         $ 2,092,483     
 

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY    

Current Liabilities:

   

Accounts payable

    $ 79,027         $ 54,494     

Accrued liabilities

    94,178          81,100     

Current portion of long-term debt

    17,698          8,200     
 

 

 

   

 

 

 

Total current liabilities

    190,903          143,794     

Long-Term Liabilities:

   

Long-term debt

    1,192,171          1,207,791     

Lease incentives and other deferred liabilities

    28,681          18,352     

Unrecognized tax benefits

    7,898          7,779     

Deferred income taxes

    245,495          228,956     
 

 

 

   

 

 

 

Total Liabilities

    1,665,148          1,606,672     
 

 

 

   

 

 

 

Commitments and Contingencies (see Note 3)

    -              -         

Stockholders’ Equity:

   

Common stock, including additional paid-in capital
($.001 par value: 1,000 shares authorized, issued and outstanding)

    519,589          508,617     

Accumulated deficit

    (68,389)         (23,044)    

Accumulated other comprehensive (loss) income

    (5,825)         238     
 

 

 

   

 

 

 

Total Stockholders’ Equity

    445,375          485,811     

Noncontrolling interest

    3,264          -         
 

 

 

   

 

 

 

Total Equity

    448,639          485,811     
 

 

 

   

 

 

 

Total Liabilities and Stockholders’ Equity

   $ 2,113,787         $ 2,092,483     
 

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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THE GYMBOREE CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands)

 

    

 

Successor

    Predecessor  
     Year Ended                   Year Ended  
             January 28,                November 23, 2010 to     January 31, 2010 to        January 30,    
     2012        January 29, 2011     November 22, 2010      2010  

Net sales:

            

Retail

    $ 1,164,171          $ 244,287         $ 814,863         $ 1,001,527     

Gymboree Play & Music

     13,885           2,814          10,847           13,384     

Retail Franchise

     10,232           447          925           -         

Other

     -               -              248           -         
  

 

 

    

 

 

   

 

 

    

 

 

 

Total net sales

     1,188,288           247,548          826,883           1,014,911     

Cost of goods sold, including buying and occupancy expenses

     (728,346)          (184,483)         (431,675)          (535,005)    
  

 

 

    

 

 

   

 

 

    

 

 

 

Gross profit

     459,942           63,065          395,208           479,906     

Selling, general and administrative expenses

     (380,141)          (78,843)         (307,361)          (316,268)    

Goodwill impairment

     (28,300)          -              -               -         
  

 

 

    

 

 

   

 

 

    

 

 

 

Operating income (loss)

     51,501           (15,778)         87,847           163,638     

Interest income

     168           36           295           728     

Interest expense

     (89,807)          (17,387)         (248)          (243)    

Loss on extinguishment of debt

     (19,563)          -              -               -         

Other (expense) income, net

     (109)          53          119           610     
  

 

 

    

 

 

   

 

 

    

 

 

 

(Loss) income before income taxes

     (57,810)          (33,076)         88,013           164,733     

Income tax benefit (expense)

     6,626           10,032          (36,449)          (62,814)    
  

 

 

    

 

 

   

 

 

    

 

 

 

Net (loss) income

     (51,184)          (23,044)         51,564           101,919     

Net loss attributable to noncontrolling interest

     5,839           -              -               -         
  

 

 

    

 

 

   

 

 

    

 

 

 

Net (loss) income attributable to The Gymboree Corporation

     $ (45,345)         $ (23,044)        $ 51,564          $ 101,919     
  

 

 

    

 

 

   

 

 

    

 

 

 

See Notes to Consolidated Financial Statements.

 

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THE GYMBOREE CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

 

    

 

Successor

    Predecessor  
           Year Ended                         Year Ended  
           January 28,        November 23, 2010 to         January 31, 2010 to            January 30,  
           2012        January 29, 2011         November 22, 2010            2010  
 

Net (loss) income

     $ (51,184)          $ (23,044)         $ 51,564           $ 101,919     
  

 

 

    

 

 

   

 

 

    

 

 

 

Other comprehensive income, net of tax:

            

Foreign currency translation adjustments

     308           446          (897)          1,740     

Unrealized net (loss) gain on cash flow hedges, net of tax of $3,915, $-, $(83) and $54

     (6,371)          (208)         (297)          25     
  

 

 

    

 

 

   

 

 

    

 

 

 

Total other comprehensive (loss) income, net of tax

     (6,063)          238           (1,194)          1,765     
  

 

 

    

 

 

   

 

 

    

 

 

 

Comprehensive (loss) income

     (57,247)          (22,806)         50,370           103,684     

Comprehensive loss attributable to noncontrolling interest

     5,839           -              -               -         
  

 

 

    

 

 

   

 

 

    

 

 

 

Comprehensive (loss) income attributable to The Gymboree Corporation

     $ (51,408)          $ (22,806)         $ 50,370           $ 103,684     
  

 

 

    

 

 

   

 

 

    

 

 

 

See Notes to Consolidated Financial Statements.

 

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THE GYMBOREE CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

   

Successor

   

Predecessor

 
   

        Year Ended        
         January 28,        
        2012        

   

    November 23, 2010 to    
    January 29,  2011    

   

  January 31, 2010 to  
  November 22, 2010  

    

Year Ended
January 30,
2010

 

CASH FLOWS FROM OPERATING ACTIVITIES:

                    

Net (loss) income

  $      (51,184)       $      (23,044)       $      51,564         $      101,919     

Adjustments to reconcile net (loss) income to net cash provided by operating activities:

                    

Write-off of deferred financing costs and original issue discount

       15,860             -                 -                  -         

Depreciation and amortization

       57,930             10,250             32,550              37,302     

Goodwill impairment

       28,300             -                 -                  -         

Amortization of deferred financing costs and accretion of original issue discount

       6,830             1,357             -                  -         

Interest rate cap contracts - adjustment to market

       51             -                 -                  -         

(Benefit) provision for deferred income taxes

       (8,946)            (11,246)            4,128              2,727     

Share-based compensation expense

       5,907             482             41,042              18,462     

Loss on disposal/impairment of assets

       4,339             1,150             880              1,336     

Other non-cash expense

       4,608             -                 -                  -         

Excess tax benefits from exercise and vesting of share-based awards

       -                 -                 (12,584)             (3,750)    

Tax benefit from exercise of stock options and vesting of restricted stock awards and units

       -                 -                 12,254              2,629     

Change in assets and liabilities:

                    

Accounts receivable

       (11,209)            7,035             (10,791)             8,831     

Merchandise inventories

       (25,646)            48,607             (55,512)             (6,046)    

Prepaid income taxes

       12,385             (345)            (27,312)             6,659     

Prepaid expenses and other assets

       (743)            1,295             (1,346)             (3,865)    

Accounts payable

       24,533             (11,782)            19,749              1,854     

Accrued liabilities

       14,515             (4,820)            32,959              4,843     

Lease incentives and other deferred liabilities

       14,015             2,141             3,370              3,694     
    

 

 

      

 

 

      

 

 

       

 

 

 

Net cash provided by operating activities

       91,545             21,080             90,951              176,595     
    

 

 

      

 

 

      

 

 

       

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

                    

Capital expenditures

       (36,565)            (5,054)            (42,214)             (39,579)    

Acquisition of business, net of cash acquired

       (1,352)            (1,828,308)            -                  -         

Other

       (295)            (46)            (1,238)             -         
    

 

 

      

 

 

      

 

 

       

 

 

 

Net cash used in investing activities

       (38,212)            (1,833,408)            (43,452)             (39,579)    
    

 

 

      

 

 

      

 

 

       

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

                    

Proceeds from Term Loan

       820,000             815,900             -                  -         

Payments on Term Loan

       (828,200)            -                 -                  -         

Proceeds from senior notes

       -                 400,000             -                  -         

Proceeds from ABL facility

       60,656             30,000             -                  -         

Payments on ABL facility

       (60,656)            (30,000)            -                  -         

Deferred financing costs

       (6,665)            (63,266)            -                  -         

Investment by Parent

       14,865             -                 -                  -         

Dividend payment to Parent

       (12,200)            -                 -                  -         

Purchase of interest rate cap contracts

       -                 (12,079)            -                  -         

Proceeds from issuance of common stock

       -                 508,135             1,371              6,055     

Excess tax benefits from exercise and vesting of share-based awards

       -                 -                 12,584              3,750     

Repurchases of common stock

       -                 -                 (124,610)             (31,340)    

Capital contribution to noncontrolling interest

       4,477             -                 -                  -         
    

 

 

      

 

 

      

 

 

       

 

 

 

Net cash (used in) provided by financing activities

       (7,723)            1,648,690             (110,655)             (21,535)    
    

 

 

      

 

 

      

 

 

       

 

 

 

 

Net increase (decrease) in cash and cash equivalents

       45,610             (163,638)            (63,156)             115,481     

 

Effect of exchange rate fluctuations on cash

       176             852             394              1,719     

 

CASH AND CASH EQUIVALENTS:

                    

Beginning of Period

       32,124             194,910             257,672              140,472     
    

 

 

      

 

 

      

 

 

       

 

 

 

End of Period

  $      77,910        $      32,124        $      194,910         $      257,672     
    

 

 

      

 

 

      

 

 

       

 

 

 

 

NON-CASH INVESTING AND FINANCING ACTIVITIES:

                    

Capital expenditures incurred, but not yet paid

  $      3,438        $      3,737        $      5,817         $      3,047     

Non-cash capital contribution to noncontrolling interest

  $      4,626        $      -            $      -             $      -         

Capital contribution receivable from affiliate of Parent, but not yet paid

  $      2,400        $      -            $      -             $      -         

Acquisition costs incurred, but not yet paid

  $      -            $      1,352        $      -             $      -         

Deferred financing costs incurred, but not yet paid

  $      -            $      -            $      1,306         $      -         

OTHER CASH FLOW INFORMATION:

                    

Cash paid (refunds received) during the year for income taxes, net

  $      (10,785)       $      966        $      46,888         $      53,747     

Cash paid during the year for interest

  $      82,021        $      3,818        $      77         $      64     

See Notes to Consolidated Financial Statements.

 

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THE GYMBOREE CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(dollars in thousands)

 

                    Additional               Accumulated
Other
    Total                      
    Common Stock     Paid In     Retained     Comprehensive     Stockholders’     Noncontrolling            
        Shares        

  Amount  

   

    Capital    

   

  Earnings (Deficit)  

   

Income / (Loss)

   

Equity

   

Interest

   

Total Equity

 

PREDECESSOR:

                             

BALANCE AT JANUARY 31, 2009

    29,077,446        $     29        $     175,490        $     160,178        $     (1,422)      

$

    334,275        $     -            $     334,275     

Issuance of common stock under equity incentive plan

    918,836            1            6,054                    6,055                6,055     

Share-based compensation

            18,462                    18,462                18,462     

Stock repurchases

    (627,156)           (1)           (3,785)           (22,566)               (26,352)               (26,352)    

Tax benefit from exercise of stock options and vesting of restricted stock awards and units

            2,629                    2,629                2,629     

Translation adjustments and unrealized net gains on cash flow hedges, net of tax of $54

                    1,765            1,765                1,765     

Net income

                101,919                101,919                101,919     
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

BALANCE AT JANUARY 30, 2010

    29,369,126            29            198,850            239,531            343            438,753            -                438,753     

Issuance of common stock under equity incentive plan

    619,280            1            1,371                    1,372                1,372     

Share-based compensation

            41,042                    41,042                41,042     

Stock repurchases

    (2,613,375)           (3)           (17,512)           (96,132)               (113,647)               (113,647)    

Tax benefit from exercise of stock options and vesting of restricted stock awards and units

            12,254                    12,254                12,254     

Translation adjustments and unrealized net loss on cash flow hedges, net of tax of $(83)

                    (1,194)           (1,194)               (1,194)    

Net income

                51,564                51,564                51,564     
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

BALANCE AT NOVEMBER 22, 2010

    27,375,031        $     27        $     236,005        $     194,963        $     (851)           430,144        $     -            $     430,144     
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

 

 

SUCCESSOR:

                             

BALANCE AT NOVEMBER 23, 2010

    -            $     -            $     -            $     -            $     -            $     -            $     -            $     -         

Issuance of common stock

    1,000                508,000                    508,000                508,000     

Investment by Parent

            135                    135                135     

Share-based compensation

            482                    482                482     

Translation adjustments and unrealized net gains on cash flow hedges, net of tax of $-

                    238            238                238     

Net loss

                (23,044)               (23,044)               (23,044)    
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

BALANCE AT JANUARY 29, 2011

    1,000            -                508,617            (23,044)           238            485,811            -                485,811     

Share-based compensation

            5,907                    5,907                5,907     

Investment by Parent

            14,865                    14,865                14,865     

Capital contribution to noncontrolling interest

            -                        -                9,103            9,103     

Investment by affiliate of Parent

            2,400                    2,400                2,400     

Dividend payment to Parent

            (12,200)                   (12,200)               (12,200)    

Translation adjustments and unrealized net loss on cash flow hedges, net of tax of $3,915

                    (6,063)           (6,063)               (6,063)    

Net loss attributable to noncontrolling interest

                        -                (5,839)           (5,839)    

Net loss attributable to The Gymboree Corporation

                (45,345)               (45,345)               (45,345)    
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

BALANCE AT JANUARY 28, 2012

    1,000        $     -            $     519,589        $     (68,389)       $     (5,825)       $     445,375        $     3,264        $     448,639     
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

See Notes to Consolidated Financial Statements.

 

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Table of Contents

THE GYMBOREE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.  Summary of Significant Accounting Policies

Nature of the Business

The Gymboree Corporation (the “Company,” “we” or “us”) is a specialty retailer, offering collections of high-quality apparel and accessories for children. As of January 28, 2012, we operated a total of 1,149 retail stores (785 Gymboree stores (including 153 Gymboree Outlet stores), 127 Janie and Jack shops and 237 Crazy 8 stores) and online stores at www.gymboree.com, www.janieandjack.com and www.crazy8.com. We also offered directed parent-child developmental play programs under the Gymboree Play & Music® brand at 703 franchised and Company-operated centers in the United States and 36 other countries. In addition, as of January 28, 2012, third-party overseas partners operated 24 Gymboree® retail stores in the Middle East and South Korea and the Joint Venture (as defined under “Basis of Presentation” below) operated 1 Gymboree retail store in China.

Basis of Presentation

On October 11, 2010, The Gymboree Corporation, a Delaware corporation, entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Giraffe Holding, Inc., a Delaware corporation (“Parent”), and Giraffe Acquisition Corporation, a Delaware corporation and a wholly owned subsidiary of Parent (“Acquisition Sub”), pursuant to which Acquisition Sub merged with and into the Company in accordance with the “short-form” merger provisions available under Delaware law on November 23, 2010 (the “Transaction Date”). The Company is continuing as the surviving corporation and a 100%-owned indirect subsidiary of the Parent (the “Merger” or “Transaction”). At the Transaction Date, investment funds sponsored by Bain Capital Partners, LLC (“Bain Capital”) indirectly owned a controlling interest in Parent.

The following principal equity capitalization and financing transactions occurred in connection with the Transaction:

 

   

Immediately prior to the closing of the Transaction, Acquisition Sub exercised the Top-Up Option in the Merger Agreement and irrevocably elected to purchase from the Predecessor Company a total of 30,713,523 Top-Up Option shares at an aggregate price of approximately $2 billion. Acquisition Sub executed a promissory note as payment for the Top-Up Option shares. The Top-Up Option shares and the promissory note were cancelled upon the closing of the Transaction;

   

Aggregate cash equity contributions of approximately $508 million were made by Parent; and

   

The Successor Company (1) entered into a new $225 million asset based revolving credit facility (“ABL”), of which $30 million was drawn at closing, (2) entered into a new $820 million secured term loan agreement (“Term Loan”), of which all but the original issue discount of $4.1 million was drawn at closing, and (3) issued $400 million face amount 9.125% senior notes (“Notes”) due 2018. These financing transactions are described in more detail in Notes 6 and 7.

The proceeds from the equity capitalization and financing transactions, together with approximately $164.9 million of our cash, were used to fund the:

 

   

Purchase of Predecessor Company common stock outstanding of approximately $1.8 billion (the former holders of the Company’s common stock, par value $.001 per share, received $65.40 per share);

   

Settlement of all unvested stock options and restricted stock units of the Predecessor Company of approximately $39.3 million; and

   

Fees and expenses related to the Transaction and the related financing transactions of approximately $17.9 million in the period from January 31, 2010 to November 22, 2010 and $71.2 million in the period from November 23, 2010 to January 29, 2011.

In December 2011, pursuant to a contribution, exchange and subscription agreement, the shareholders of Parent contributed in the aggregate 104,600,007 shares of Class A Common Stock and 11,622,223 shares of Class L Common Stock of Parent, representing all of Parent’s outstanding Common Stock, and approximately $12.2 million in cash to Gymboree Holding, Ltd., a Cayman Islands exempted company, in exchange for 104,600,007 Class A Common Shares, 11,622,223 Class L Common Shares and 1,220,003 Class C Common Shares of Gymboree Holding, Ltd., representing all of the outstanding Common Shares of Gymboree Holding, Ltd. (the “Asia Transaction”). Following the consummation of the Asia Transaction, Gymboree Holding, Ltd. became indirectly a 60% owner of Gymboree (China) Commercial and Trading Co. Ltd. (“Gymboree China”), and Gymboree (Tianjin) Educational Information Consultation Co. Ltd (“Gymboree Tianjin”) (collectively, the “Joint Venture”). While we do not control these two entities, they have been determined to be variable interest entities (“VIEs”), as discussed further below in Note 21, and have been consolidated by the Company. Investment funds sponsored by Bain Capital own a controlling interest in Gymboree Holding, Ltd., which indirectly controls Parent.

 

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Table of Contents

To fund the Asia Transaction and the indirect investment in the Joint Venture, on November 3, 2011, (i) the Company declared and distributed an aggregate amount of $12.2 million in cash to its sole shareholder, Giraffe Intermediate B, Inc., a Delaware corporation and indirectly wholly owned subsidiary of Parent (“Giraffe B”), (ii) Giraffe B declared and distributed an aggregate amount of $12.2 million in cash to its sole shareholder, Giraffe Intermediate A, Inc., a Delaware corporation and indirectly wholly owned subsidiary of Parent (“Giraffe A”) and (iii) Giraffe A declared and distributed an aggregate amount of $12.2 million in cash to its sole shareholder, Parent, Parent then declared a dividend in the aggregate amount of $12.2 million to the holders of the Common Stock of Parent (the “Dividend”). The Dividend was then contributed to Gymboree Holding, Ltd. to fund the investment in the Joint Venture in return for Class C Common Shares of Gymboree Holding, Ltd.

The accompanying consolidated financial statements, which include The Gymboree Corporation and its wholly owned subsidiaries and VIEs (Gymboree China and Gymboree Tianjin) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. The accompanying consolidated statements of operations, statements of comprehensive income (loss), statements of cash flows, and statements of stockholders’ equity, and the notes to the consolidated financial statements are presented for the Predecessor and Successor periods, which relate to the periods preceding the Transaction Date (periods prior to November 23, 2010) and the periods succeeding the Transaction Date (periods subsequent to November 23, 2010), respectively.

Principles of Consolidation

We consolidate entities in which we retain a controlling financial interest or entities that meet the definition of a VIE for which we are deemed to be the primary beneficiary. In performing our analysis of whether we are the primary beneficiary, at initial investment and at each quarterly reporting period, we consider whether we individually have the power to direct the activities of the VIE that most significantly affect the entity’s performance and also have the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. We also consider whether we are a member of a related party group that collectively meets the power and benefits criteria and, if so, whether we are most closely associated with the VIE. All intercompany balances and transactions have been eliminated in consolidation.

Reclassifications

Retail Franchise net sales, previously reported in Other net sales in the period from November 23, 2010 to January 29, 2011, the period from January 31, 2010 to November 22, 2010 and in fiscal 2009, have been separately disclosed to conform to the current year presentation.

Correction of Merger Purchase Price Allocation

In the accompanying consolidated balance sheet as of January 29, 2011, we made adjustments to goodwill and to certain of our other intangible assets and deferred tax liabilities as a result of correcting the final purchase price allocation related to the Merger. Amounts previously reported as of January 29, 2011 have been restated to reflect these adjustments, as summarized in the following table (in thousands):

 

    As of January 29, 2011  
              Balance as           
Previously
Reported
              Adjustments                        Corrected         
Balance
 

Goodwill

   $ 934,639         $ (7,242)        $ 927,397     
 

 

 

   

 

 

   

 

 

 

Trade names

   $ 560,127         $ 6,900         $ 567,027     

Franchise agreements

    1,875          4,700          6,575     

Customer relationships, below market leases, and co-branded credit card agreement

    44,208          -              44,208     
 

 

 

   

 

 

   

 

 

 

Other Intangible Assets

   $ 606,210         $ 11,600         $ 617,810     
 

 

 

   

 

 

   

 

 

 

Total Assets

   $ 2,088,125         $ 4,358         $ 2,092,483     
 

 

 

   

 

 

   

 

 

 

Long-term deferred income tax liability

   $ (224,598)        $ (4,358)        $ (228,956)    
 

 

 

   

 

 

   

 

 

 

Total Liabilities

   $ (1,602,314)        $ (4,358)        $ (1,606,672)    
 

 

 

   

 

 

   

 

 

 

 

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Additionally, the fourth quarter of fiscal 2011 includes a $0.9 million charge for the additional prior period amortization related to the increased book value of amortizable intangible assets resulting from the aforementioned adjustments. Due to immateriality, this charge was recorded in the fourth quarter of fiscal 2011, rather than in the applicable prior periods.

Correction of Other Classifications

In the accompanying consolidated balance sheet as of January 29, 2011, we reclassified approximately $4.4 million of leasehold improvement costs previously reported within “land and buildings” to be reported within “leasehold improvements” to properly classify such costs. Our net property and equipment balance as of January 29, 2011 did not change from such reclassifications.

In addition, in the detail of the components of deferred tax assets and deferred tax liabilities as of January 29, 2011 in Note 9, we reclassified approximately $10.1 million previously reported as the reduction of deferred tax liabilities related to intangible assets, to be reported as a deferred tax asset related to state income taxes, in order to correct such classification. This reclassification did not change the total net deferred tax liability previously reported as of January 29, 2011.

Fiscal Year

Our year end is on the Saturday closest to January 31. The Predecessor and Successor periods presented relate to the period preceding the Transaction Date (fiscal 2009 and January 31, 2010 to November 22, 2010) and the periods succeeding the Transaction Date (November 23, 2010 to January 29, 2011 and fiscal 2011, which included 52 weeks and ended on January 28, 2012), respectively. Fiscal 2009, which included 52 weeks, ended on January 30, 2010.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cost of Goods Sold

Cost of goods sold (“COGS”) includes cost of goods, buying expenses, occupancy expenses and shipping costs. Cost of goods consists of cost of merchandise, inbound freight and other inventory-related costs, such as shrink and lower of cost or market adjustments. Buying expenses include costs incurred to design, produce and allocate merchandise. Occupancy expenses consist of rent and other occupancy costs, including common area maintenance and utilities. Shipping costs consist of third-party delivery services to customers.

Selling, General and Administrative Expenses

Selling, general and administrative (“SG&A”) expenses consist of non-occupancy-related costs associated with our retail stores, distribution center and shared corporate services. These costs include payroll and benefits, depreciation and amortization, credit card fees, advertising and other general expenses. SG&A also includes fees and expenses related to the Transaction.

Cash and Cash Equivalents

Cash equivalents consist of highly liquid investment instruments with a maturity of three months or less at date of purchase. Our cash equivalents are placed primarily in money market funds. We value these investments at their original purchase prices plus interest that has accrued at the stated rate. Income related to these securities is recorded in interest income in the consolidated statements of operations.

 

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Accounts Receivable

Accounts receivable primarily include amounts due from major credit card companies, amounts due from affiliated entities, amounts due from Gymboree Play & Music franchisees for royalties and consumer product sales, and amounts due from landlord construction allowances. Construction allowance receivable due dates vary. Royalties are due within 30 days of each calendar quarter end and receivables from consumer product sales are generally due upon shipment. Amounts due from major credit card companies are generally collected within five days. We estimate our allowance for doubtful accounts by considering a number of factors, including the length of time accounts receivable are past due and our previous loss history. The provision for doubtful accounts receivable is included in SG&A expenses. A summary of activity in the allowance for doubtful accounts is as follows (in thousands):

 

          

Successor

            

Predecessor

 

        

        Fiscal 2011        

      

November 23, 2010
  to January 29, 2011  

            

January 31, 2010

  to November 22, 2010  

      

      Fiscal 2009

Balance at beginning of period

       $   -            $   -                 $   434       $   388 

Provision for doubtful accounts receivable

       180       287             (7)       110 

Accounts written off

       (66)       (287)            -           (64) 

 

      

 

    

 

         

 

    

 

Balance at end of period

       $   114       $   -                 $   427       $   434 

 

      

 

    

 

         

 

    

 

Concentrations

Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash and cash equivalents. At times, cash balances held at financial institutions are in excess of federally insured limits.

In fiscal 2011, the period from November 23, 2010 to January 29, 2011, the period from January 31, 2010 to November 22, 2010 and fiscal 2009, one company acting as our buying agent managed approximately 80%, 90%, 80% and 90%, respectively, of our inventory purchases, which may potentially subject us to risks of concentration related to sourcing of our inventory.

Fair Value Measurements

The accounting guidance for fair value measurements and disclosure defines and establishes a framework for measuring fair value and expands related disclosures (see Note 18).

Merchandise Inventories

Merchandise inventories are recorded at the lower of cost or market (“LCM”), determined on a weighted-average basis. We review our inventory levels to identify slow-moving merchandise and broken assortments (items no longer in stock in a sufficient range of sizes) and record an adjustment when the future estimated selling price is less than cost. We take a physical count of inventories in all stores once a year and in some stores twice a year, and perform cycle counts throughout the year in our distribution center. We record an inventory shrink adjustment based upon physical counts and also provide for estimated shrink adjustments for the period between the last physical inventory count and each balance sheet date. Our inventory shrink estimate can be affected by changes in merchandise mix and changes in actual shrink trends. Our LCM estimate can be affected by changes in consumer demand and the promotional environment.

Property and Equipment

Property and equipment acquired in the Transaction are stated at estimated fair value as of the Transaction Date, less accumulated depreciation and amortization recorded subsequent to the Transaction. Property and equipment acquired subsequent to the Transaction Date are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which range from approximately 3 to 25 years, except for our distribution center in Dixon, California, which has a useful life of 39 years. Leasehold improvements, which include an allocation of directly-related internal payroll costs for employees dedicated to real estate construction projects, are amortized over the lesser of the applicable lease term, which ranges from 5 to 13 years, or the estimated useful life of the improvements. Software costs are amortized using the straight-line method based on an estimated useful life of three to seven years. Construction in progress was $2.7 million and $3.7 million as of January 28, 2012 and January 29, 2011, respectively. Repair and maintenance costs are expensed as incurred.

Deferred Financing Costs

As a result of the Transaction, we recorded approximately $63.3 million of deferred financing costs related to the financing transactions described in Notes 6 and 7. In February 2011, we refinanced the Term Loan through an amendment and restatement of our existing credit agreement and, as a result of the refinancing, approximately $14.1 million of deferred financing costs were written off. Deferred financing costs allocated to the Term Loan and Notes are amortized over the term of the related financing agreements using the effective interest method. Deferred financing costs allocated to the asset-based revolving credit facility are amortized on a straight-line basis. The weighted-average remaining amortization period is approximately 6.33 years. Amortization of deferred financing costs is recorded in interest expense and was approximately $6.5 million for fiscal 2011 and $1.4 million during the period from November 23, 2010 to January 29, 2011.

 

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Amortization expense for each of the next five fiscal years is estimated below (in thousands):

 

Fiscal                       

2012

      $              6,901     

2013

     7,267     

2014

     7,666     

2015

     7,799     

2016

     6,980     
  

 

 

 

Total

      $            36,613     
  

 

 

 

Goodwill Impairment.

As of January 28, 2012, we had goodwill of $899 million related to the Merger. Goodwill represents the excess of the acquisition cost over the estimated fair value of assets acquired, less liabilities assumed. At the date of the Merger, we allocated goodwill to our reporting units, which we concluded were the same as our operating segments (see Note 13): Gymboree (including an online store), Gymboree Outlet, Janie and Jack (including an online store), Crazy 8 (including an online store), Gymboree Play & Music and Retail Franchise. We allocated goodwill to the reporting units by calculating the fair value of each reporting unit and deriving the implied fair value of each reporting unit’s goodwill on the date of the Merger.

Goodwill is not amortized, but is tested annually for impairment in the fourth quarter. We update our impairment tests between annual tests if events or circumstances occur that would more likely than not reduce the fair value of a reporting unit below our carrying amount. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in expected future cash flows; a significant adverse change in legal factors or in the business climate; and unanticipated competition. Any adverse change in these factors could have a significant impact on the recoverability of goodwill and could have a material impact on our consolidated financial statements. The impairment test compares the carrying value of the assets and liabilities associated with a reporting unit, including goodwill, with the fair value of the reporting unit.

If the carrying value of the assets and liabilities exceeds the fair value of the reporting unit, we calculate the implied fair value of the reporting unit goodwill as compared with the carrying value of the reporting unit goodwill to determine the appropriate impairment charge. Calculating the fair value of a reporting unit and the implied fair value of reporting unit goodwill requires significant judgment. The use of different assumptions, estimates or judgments in either step of the goodwill impairment testing process, such as the estimated future cash flows of reporting units, the discount rate used to discount such cash flows, or the estimated fair value of the reporting units’ tangible and intangible assets and liabilities, could significantly increase or decrease the estimated fair value of a reporting unit or its net assets. In the fourth quarter of fiscal 2011, we recorded an impairment charge of $28.3 million related to goodwill that was allocated to our Gymboree Outlet reporting unit (see Note 5).

Intangible Assets and Liabilities.

Intangible assets primarily represent trade names for each of our brands, contractual customer relationships, and below market leases. We also capitalize the legal costs incurred in registering and renewing trademarks and service marks. Intangible liabilities represent above market leases and are included in deferred liabilities. Trade names have been assigned an indefinite life and are reviewed for impairment annually in the fourth quarter. We update our impairment tests between annual tests if events or circumstances occur that would more likely than not reduce the fair value of our trade names below their carrying amount. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in expected future cash flows; a significant adverse change in legal factors or in the business climate; and unanticipated competition. Any adverse change in these factors could have a significant impact on the recoverability of these intangible assets and could have a material impact on our consolidated financial statements. The impairment test compares the fair value of trade names with their carrying amounts. Calculating the fair value of trade names requires significant judgment. The use of different assumptions, estimates or judgments in the intangible asset impairment testing process, such as the estimated future cash flows of assets, the royalty rate and the discount and terminal growth rates used to discount such cash flows, could significantly increase or decrease the estimated fair value of an asset, and therefore, impact the related impairment charge. All other intangible assets and liabilities are amortized on a straight-line basis over their estimated useful lives. Intangible assets with finite lives are evaluated for impairment using a process similar to that used to evaluate store assets.

 

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Store Asset Impairment

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. If the undiscounted future cash flows from the asset group are less than the carrying value, a loss is recognized equal to the difference between the carrying value of the asset group and its fair value. The fair value of the asset group is estimated based on discounted future cash flows using a discount rate commensurate with the risk. The asset group is determined at the store level, which is the lowest level for which identifiable cash flows are available. Decisions to close a store or facility can also result in accelerated depreciation over the revised useful life. For locations to be closed that are under long-term leases, we record a charge for lease buyout expense or the difference between our rent and the rate at which we expect to be able to sublease the properties and related costs, as appropriate. Most closures occur upon the lease expiration. The estimate of future cash flows is based on historical experience and typically third-party advice or market data. These estimates can be affected by factors such as future store profitability, real estate demand and economic conditions that can be difficult to predict.

Income Taxes

We recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities. We maintain valuation allowances when it is more likely than not that all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances from period to period are included in the tax provision in the period of change. In determining whether a valuation allowance is warranted, we take into account such factors as prior earnings history, expected future earnings, carryback and carryforward periods, and tax planning strategies that could potentially enhance the likelihood of realization of a deferred tax asset. We are subject to periodic audits by the Internal Revenue Service and other taxing authorities. These audits may challenge certain of our tax positions such as the timing and amount of deductions and allocation of taxable income to the various tax jurisdictions. Determining income tax expense for tax contingencies requires management to make assumptions that are subject to factors such as proposed assessments by tax authorities, changes in facts and circumstances, issuance of new regulations, and resolution of tax audits. Actual results could materially differ from these estimates and could significantly affect the effective tax rate and cash flows in future years.

Rent Expense

Many of our operating leases contain free rent periods and predetermined fixed increases of the minimum rental rate during the initial lease term. For these leases, we recognize the related rental expense on a straight-line basis over the life of the lease, starting at the time we take physical possession of the property. Certain leases provide for contingent rents that are not measurable at inception. These amounts are excluded from minimum rent and are included in the determination of rent expense when it is probable that an expense has been incurred and the amount is reasonably estimable.

Construction Allowance

As part of many lease agreements, we may receive construction allowances from landlords. The construction allowances are included in lease incentives and other deferred liabilities and are amortized as a reduction of rent expense on a straight-line basis over the term of the lease, starting at the time we take physical possession of the property. Construction allowances of $7.8 million, $1.0 million, $8.8 million and $8.7 million were granted during fiscal 2011, the period from November 23, 2010 to January 29, 2011, the period from January 31, 2010 to November 22, 2010 and fiscal 2009, respectively.

Workers’ Compensation Liabilities

We are partially self-insured for workers’ compensation insurance. We record a liability based on claims filed and an actuarially determined amount of claims incurred, but not yet reported. This liability approximated $4.2 million and $3.0 million as of January 28, 2012 and January 29, 2011, respectively. Any actuarial projection of losses is subject to a high degree of variability due to external factors, including future inflation rates, litigation trends, legal interpretations, benefit level changes and claim settlement patterns. If the actual amount of claims filed exceeds our estimates, reserves recorded may not be sufficient and additional accruals may be required in future periods.

Foreign Currency Translation

Assets and liabilities of foreign subsidiaries are translated into United States dollars at the exchange rates effective on the balance sheet date. Revenues, costs of sales, expenses and other income are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are recorded as other comprehensive income within stockholders’ equity.

Store Pre-opening Costs

Store pre-opening costs are expensed as incurred.

 

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Advertising

We capitalize direct costs for the development, production, and circulation of direct response advertising and amortize such costs over the expected sales realization cycle, typically four to six weeks. Deferred direct response costs, included in prepaid expenses, were $0.7 million as of January 28, 2012 and $0.6 million as of January 29, 2011.

All other advertising costs are expensed as incurred. Advertising expense, including costs related to direct mail campaigns, totaled approximately $18.6 million, $2.7 million, $14.5 million and $16.7 million for fiscal 2011, the period from November 23, 2010 to January 29, 2011, the period from January 31, 2010 to November 22, 2010 and fiscal 2009, respectively.

Revenue Recognition

Revenue is recognized at the point of sale in retail stores. Online revenue is recorded when we estimate merchandise is delivered to the customer. Online customers generally receive merchandise within three to six days of shipment. Shipping fees received from customers are included in net sales and the associated shipping costs are included in cost of goods sold. We also sell gift cards in our retail store locations, through our online stores and through third parties. Revenue is recognized in the period that the gift card is redeemed. We recognize unredeemed gift card and merchandise credit balances when we can determine the portion of the liability for which redemption is remote (generally three years after issuance). These amounts are recorded as other income within SG&A expenses and totaled $1.3 million, $0.4 million, $1.2 million and $1.5 million in fiscal 2011, the period from November 23, 2010 to January 29, 2011, the period from January 31, 2010 to November 22, 2010 and fiscal 2009, respectively. From time to time, customers may earn Gymbucks or Rise and Shine coupons and redeem them for merchandise at a discount during the redemption period. A liability is recorded for coupons earned, but not redeemed, within an accounting period. Sales are presented net of sales return reserve, which is estimated based on historical return trends. Net retail sales also include revenue from our co-branded credit card (see Note 14). We present taxes collected from customers and remitted to governmental authorities on a net basis (excluded from revenues).

A summary of activities in the sales return reserve is as follows (in thousands):

          

Successor

            

Predecessor

 

        

        Fiscal 2011        

      

November 23, 2010
  to January 29, 2011  

            

January 31, 2010
  to November 22, 2010  

      

      Fiscal 2009 

Balance at beginning of period

       $   2,224       $   4,763             $   2,608        $   3,202  

Provision for sales returns

       30,804       6,015             25,867        29,712  

Actual sales returns

       (30,665)       (8,554)            (23,712)       (30,306) 

 

      

 

    

 

         

 

    

 

Balance at end of period

       $   2,363       $   2,224             $   4,763        $   2,608  

 

      

 

    

 

         

 

    

 

For the Gymboree Play & Music operations, initial franchise and transfer fees for all sites sold in a territory are recognized as revenue when the franchisee has paid the initial franchise or transfer fee, in the form of cash and/or a note payable, the franchisee has fully executed a franchise agreement and we have substantially completed our obligations under such agreement. We receive royalties based on each franchisee’s gross receipts from operations. Such royalty fees are recorded when earned. We also recognize revenues from consumer products and equipment sold to franchisees at the time title transfers to the franchisees.

In the third quarter of fiscal 2011, we terminated our agreement with a Gymboree Play & Music master franchisee in China and assumed the role of master franchisor upon this termination (see Note 20). We subsequently entered into a Master Service Agreement with Gymboree Tianjin (see Note 12) to service all of the unit franchises in China and to provide us certain services in connection with such unit franchises. Gymboree Tianjin has been determined to be a VIE, and the results have been consolidated into our financial statements for the year ended January 28, 2012 (see Note 21).

For our retail franchise business launched in August 2010, revenues may consist of initial franchise fees, royalties and/or sales of authorized product. Initial franchise fees relating to area franchise sales are recognized as revenue when the franchisee has met all material services and conditions and we have substantially completed our obligations under such agreement, typically upon store opening. Royalties are based on each franchisee’s gross receipts from operations and are recorded when earned. Revenues from consumer products sold to franchisees are recorded at the time title transfers to the franchisees, subject to an annual minimum purchase commitment.

We present taxes withheld by international franchises and remitted to governmental authorities on a gross basis (included in revenues), except for taxes withheld by the Joint Venture, which are reported on a net basis (excluded from revenues).

 

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In December 2011, we entered into an exclusive franchise agreement with Gymboree China to operate branded retail stores in the China market (see Note 12). This entity has been determined to be a VIE, and the results have been consolidated into our financial statements for the year ended January 28, 2012 (see Note 21).

Loyalty Program

Customers who enroll in the Gymboree Rewards program earn points with every purchase at Gymboree and Gymboree Outlet stores. Those customers who reach a cumulative purchase threshold receive a coupon that can be used towards the future purchase of goods at Gymboree and Gymboree Outlet stores. We estimate the cost of rewards that will ultimately be redeemed and record this cost in net retail sales as reward points are accumulated. This liability was approximately $1.8 million and $1.1 million at January 28, 2012 and January 29, 2011, respectively.

Comprehensive Income (Loss)

Comprehensive income (loss) consists of net income (loss), foreign currency translation adjustments and fluctuations in the fair market value of certain derivative financial instruments and is shown in the consolidated statements of comprehensive income (loss).

Derivative Instruments

We record all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether we have elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. All of our derivatives are cash flow hedges. Hedge accounting for cash flow hedges generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the earnings effect of the hedged forecasted transactions (see Note 17).

Share-Based Compensation

We recognize compensation expense on a straight-line basis for options and awards with time-based service conditions and on an accelerated basis for awards with performance conditions (see Note 10).

Recently Issued Accounting Standards

In January 2010, the Financial Accounting Standards Board (“FASB”) issued guidance which amends and clarifies existing guidance related to fair value measurements and disclosures. This guidance requires new disclosures for (1) transfers in and out of Level 1 and Level 2 and reasons for such transfers; and (2) the separate presentation of purchases, sales, issuances and settlement in the Level 3 reconciliation. It also clarifies guidance around disaggregation and disclosures of inputs and valuation techniques for Level 2 and Level 3 fair value measurements. We adopted this guidance as of January 31, 2010, except for the new disclosures in the Level 3 reconciliation, which were adopted during the first quarter of fiscal 2011. The adoption of this guidance did not have a material impact on our consolidated financial statements.

In May 2011, the FASB issued guidance to amend the accounting and disclosure requirements on fair value measurements. The new guidance limits the highest-and-best-use measure to nonfinancial assets, permits certain financial assets and liabilities with offsetting positions in market or counterparty credit risks to be measured at a net basis, and provides guidance on the applicability of premiums and discounts. Additionally, this guidance requires entities to disclose the categorization by level of the fair value hierarchy for items that are not measured at fair value in the statement of financial position but for which the fair value is required to be disclosed. This new guidance will be effective for us as of January 29, 2012. We anticipate that the adoption of this guidance will not have a material impact on our consolidated financial statements.

In June 2011, the FASB issued guidance to amend the presentation of comprehensive income. This new guidance requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. We early adopted this guidance effective for our fiscal year ended January 28, 2012, as permitted under the standard, and applied retrospectively to all periods presented as required to present the total of comprehensive income, the components of net income, and the components of other comprehensive income in two separate consecutive statements. The adoption of this guidance did not result in a material impact on our consolidated financial statements.

In September 2011, the FASB issued guidance to amend the testing of goodwill for impairment. This new guidance permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. This accounting standards update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. This new guidance will be effective for us as of January 29, 2012. We anticipate that the adoption of this guidance will not have a material impact on our consolidated financial statements.

 

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In December 2011, the FASB issued guidance to amend the disclosure requirements regarding the offsetting of assets and liabilities related to financial and derivative instruments. This new guidance requires an entity to disclose quantitative information in a tabular format to allow users of their financial statements to evaluate the effect or potential effect on the entity’s financial position of netting arrangements. This new guidance will be effective for us as of February 3, 2013. We are currently evaluating the impact of this guidance on our financial statement presentation of our derivative and financial instruments.

2.  Acquisition

As described in Note 1, on November 23, 2010, investment funds sponsored by Bain Capital, consummated the Merger, whereby we became a 100%-owned indirect subsidiary of Parent. The Transaction was funded as follows on the Transaction Date (in thousands):

 

Term Loan

     $          815,900   

ABL

        30,000    

Notes

        400,000    

Cash equity contributions

        508,000    

Cash from Company’s balance sheet

                    164,917    
     

 

 

 
     $         1,918,817    
     

 

 

 

The terms of the Term Loan, ABL and Notes are described in detail in Notes 6 and 7. The funds in the table above were used as follows (in thousands):

 

Consideration paid to equity holders

   $           1,829,660    

Transaction costs

                      89,157    
     

 

 

 
   $           1,918,817    
     

 

 

 

Equity holders received $65.40 per share of Company common stock owned on November 23, 2010. Option holders received $65.40 per option held as of November 23, 2010, less the option exercise price. Transaction costs include legal and accounting fees and other external costs directly related to the Transaction and to the issuance of debt. Approximately $74.4 million in transaction costs were incurred in the period from November 23, 2010 to January 29, 2011, and $17.9 million were incurred in the period from January 31, 2010 to November 22, 2010. Approximately $63.3 million of these costs were determined to be related to the issuance of debt and were deferred initially, though $14.1 million of this was subsequently written off when the Term Loan was refinanced in February 2011 (see Note 1).

Our acquisition was accounted for as a business combination. The purchase price was allocated to the assets acquired and liabilities assumed based upon their estimated fair values as of the Transaction Date. The excess of the purchase price over the net tangible and identifiable intangible assets acquired less liabilities assumed was recorded as goodwill. Goodwill was preliminarily allocated to our reporting units at the Transaction Date. None of the goodwill recognized is expected to be deductible for income tax purposes.

During the measurement period (which is not to exceed one year from the acquisition date), we are required to retrospectively adjust the provisional assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets or liabilities as of that date. We corrected the final purchase price allocation in the fourth quarter of fiscal 2011. The related adjustments made to goodwill, other intangible assets and long-term deferred tax liability are summarized in Note 1.We have also completed our allocation of goodwill to our reporting units, segments (see Note 13), and guarantor/non-guarantor subsidiaries (see Note 21).

 

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The following table summarizes the allocation of the purchase price to assets acquired and liabilities assumed at the Transaction Date and includes the effect of the purchase price adjustments explained in Note 1 (in thousands):

 

Inventory

       $                232,839     

Other current assets

     222,094     

Property and equipment

     218,179     

Goodwill

     927,397     

Trade names

     567,000     

Franchise agreements

     6,600     

Below market leases

     7,049     

Customer relationships

     36,400     

Co-branded credit card agreement

     4,000     

Other long-term assets

     4,515     

Gift card and merchandise credit liability

     (15,981)    

Current deferred income tax liability

     (8,983)    

Other current liabilities

     (122,532)    

Above market leases

     (16,623)    

Long-term deferred income tax liability

     (224,379)    

Other long-term liabilities

     (7,915)    
  

 

 

 

Total purchase price

       $              1,829,660    
  

 

 

 

Inventory – We determined the fair value of inventory as of the Transaction Date using the cost approach. Under this approach, the fair value of an asset is determined by adjusting the asset’s reproduction or replacement cost by losses in value attributable to physical and functional depreciation, and economic obsolescence. As a result of its valuation, we recorded an increase in inventory of approximately $56.2 million as of November 23, 2010. This adjustment was expensed to COGS over a three month period.

Property and equipment – We determined the fair value of property and equipment as of the Transaction Date using the cost approach. As a result of our valuation, we recorded an increase in property and equipment of approximately $1.9 million and a decrease in land of approximately $0.8 million as of November 23, 2010. The increase in property and equipment is amortized over the remaining useful lives of the related assets, which approximates 25 years.

Trade names – We determined the fair value of our trade names to be approximately $567 million as of the Transaction Date using the relief from royalty method of the income approach, which is based on the projected cost savings attributable to the ownership of the trade names. We assigned indefinite lives to our trade names because these assets are expected to generate cash flows indefinitely.

Franchise agreements – We determined the fair value of our franchise agreements to be approximately $6.6 million as of the Transaction Date using the multi-period excess earnings (“MPEE”) method of the income approach. Under the MPEE method, the value of an intangible asset is equal to the present value of the incremental after-tax cash flows attributable only to the subject intangible asset after deducting contributory asset charges. We assigned the Gymboree Play & Music franchise agreements intangible asset a useful life of 14 years based on the average life of a franchise relationship and the retail franchise agreement intangible asset a useful life of six years based on the estimated economic life of the contract.

Below and above market leases – The intangible asset and liability recorded were determined as the difference between market rent and the contract rent for the remainder of the lease term, discounted back to a net present value. The below market lease asset of approximately $7.0 million and above market lease liability of approximately $16.6 million are amortized over the remaining term of the related leases.

Customer relationships – We determined the fair value of our contractual customer relationships to be approximately $36.4 million as of the Transaction Date using the MPEE method. We concluded that we have contractual customer relationships with customers that enrolled in the Gymboree Rewards program. The customer relationship intangible asset is amortized over 2.3 years, which is estimated to be the average length of a customer relationship based on customer attrition data.

Co-branded credit card agreement – We determined the fair value of our co-branded credit card agreement (see Note 14) to be approximately $4.0 million as of the Transaction Date using the MPEE method. This intangible asset is amortized over 6.5 years, which is the estimated remaining contract term.

 

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Gift card and merchandise credit liability – We determined the fair value of our gift card and merchandise credit liability as of the Transaction Date using the discounted cash flow method of the income approach, whereby expected cash flows are directly assigned to the asset and discounted with an appropriate discount rate. As a result of our valuation, we reduced our gift card and merchandise credit liability by approximately $1.6 million. This adjustment is amortized over three years, which is the estimated life of a gift card or merchandise credit based on historical redemption trends.

Deferred revenue – As of the Transaction Date, we had deferred revenue of approximately $13.7 million related to our co-branded credit card agreement. These amounts were assigned a fair value of zero in purchase accounting because they do not represent a performance obligation as of the Transaction Date.

Deferred rent and lease incentives – As of the Transaction Date, we had deferred rent and lease incentives of approximately $65.2 million. These amounts were assigned a fair value of zero in purchase accounting because they do not represent a performance obligation as of the Transaction Date.

Deferred income taxes – Because the purchase price allocated to assets acquired and liabilities assumed differs for financial reporting and tax purposes, we have recognized deferred tax assets or liabilities for the deferred tax effects of those temporary differences. As a result, we have recognized net deferred tax liabilities of $233.4 million on the Transaction Date.

The following table reflects supplemental pro-forma net sales and net income as though the Transaction had taken place on February 1, 2009 (in thousands):

 

    Year Ended  
         January 29, 
2011
         January 30, 
2010
 

Supplemental pro-forma net sales

   $ 1,069,299        $ 1,008,608    

Supplemental pro-forma net income

   $ 32,586        $ 28,622    

3.  Commitments and Contingencies

We lease our retail store locations, corporate headquarters, certain warehouse space and certain fixtures and equipment under operating leases. The leases expire at various dates through fiscal 2023. Store leases typically have 10-year terms and include a cancellation clause if minimum revenue levels are not achieved during a specified 12-month period during the lease term. Some leases are structured with a minimum rent component plus a percentage rent based on the store’s net sales in excess of a certain threshold. Substantially all of the leases require us to pay insurance, utilities, real estate taxes, and common area repair and maintenance expenses.

Future minimum rental payments under non-cancelable operating leases at January 28, 2012 are as follows (in thousands):

 

Fiscal          

      

2012

      $              87,006     

2013

     80,676     

2014

     75,053     

2015

     69,224     

2016

     64,094     

Later years

     140,958     
  

 

 

 

Total

      $            517,011     
  

 

 

 

Rent expense for all operating leases totaled $138.3 million, $24.6 million, $99.7 million and $112.8 million in fiscal 2011, the period from November 23, 2010 to January 29, 2011, the period from January 31, 2010 to November 22, 2010 and fiscal 2009, respectively, and includes common area maintenance expenses, real estate taxes, utilities, percentage rent expense and other lease required expenses of $46.8 million, $8.2 million, $35.1 million and $40.4 million in fiscal 2011, the period from November 23, 2010 to January 29, 2011, the period from January 31, 2010 to November 22, 2010 and fiscal 2009, respectively. Percentage rent expense was approximately $0.5 million, $0.1 million, $0.5 million and $0.5 million in fiscal 2011, the period from November 23, 2010 to January 29, 2011, the period from January 31, 2010 to November 22, 2010 and fiscal 2009, respectively. Rent expense for fiscal 2011 and the period from November 23, 2010 to January 29, 2011 includes approximately $2.1 million and $0.4 million, respectively, in income related to amortization of below and above market leases.

 

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Contingencies

Between October 12 and October 18, 2010, three purported class action complaints were filed in the Superior Court of the State of California, County of San Francisco, captioned Halliday v. The Gymboree Corporation, et al., Case No. CGC-10-504544, Himmel v. Gymboree Corp., et al., Case No. CGC-10-504550, and Harris v. The Gymboree Corporation, et al., Case No. CGC-10-504693. The complaints challenged the transaction pursuant to which investment funds sponsored by Bain Capital commenced a tender offer for the outstanding shares of the Company, which was followed by a merger of a subsidiary of investment funds sponsored by Bain Capital with and into the Company (as described in Notes 1 and 2). The various complaints named as defendants the Company, the Company’s Board of Directors, the Company’s former Chief Financial Officer (collectively, the “Individual Defendants”), Bain Capital and the two subsidiaries of the investment funds sponsored by Bain Capital that were created to consummate the Merger (collectively, the “Bain Defendants”). The suits alleged generally that the Individual Defendants breached their fiduciary duties in connection with the Transaction and that the Company and the Bain Defendants aided and abetted those alleged breaches. The complaints sought, among other things, to (i) enjoin the Transaction unless and until the Company adopted and implemented a procedure to obtain the highest possible value for stockholders, and (ii) rescinded the Merger Agreement between entities controlled by investment funds sponsored by Bain Capital and the Company.

While the Individual Defendants and the Bain Defendants (collectively, “Defendants”) believed that the complaints were without merit and that the Defendants had valid defenses to all claims, in an effort to minimize the burden and expense of further litigation relating to such complaints, on November 12, 2010, the Defendants reached an agreement in principle with the plaintiffs in these actions (collectively, the “Plaintiffs”) to settle the litigation in its entirety and resolve all allegations by the Plaintiffs against the Defendants in connection with the Transaction. The settlement provided for a settlement and release by the purported class of the Company’s stockholders of all claims against the Defendants in connection with the Transaction. In exchange for such settlement and release, and after arm’s length discussions between and among the Defendants and the Plaintiffs, the Company provided certain additional supplemental disclosures to its Schedule 14D-9, although the Company did not make any admission that such additional supplemental disclosures were material or otherwise required. After reaching agreement on the substantive terms of the settlement, the Plaintiffs applied to the court for an award of attorneys’ fees and reimbursement of expenses up to $0.8 million, which Defendants agreed not to oppose. The settlement, including the award of attorneys’ fees and expenses, was approved by the court and an Order for Final Judgment was entered on January 10, 2012. As of January 29, 2011, we had accrued $0.8 million that was paid out in January 2012.

The Company is subject to various other legal proceedings and claims arising in the ordinary course of business. Our management does not expect that the results of any of these other legal proceedings, either individually or in the aggregate, would have a material effect on our financial position, results of operations or cash flows.

4.  Investment by Parent

On or about January 31, 2011, Parent entered into subscription agreements with certain members of our management team. Under the subscription agreements, such members of the management team purchased an aggregate of 1,580,769 Class A Shares and 175,641 Class L Shares of Parent. The aggregate cash consideration paid for the shares was $7.9 million (see Note 12). This amount was indirectly contributed to us by Parent.

In February 2011, investment funds sponsored by Bain Capital purchased an aggregate of 419,231 Class A Shares and 46,581 Class L Shares of Parent for $2.1 million. In addition, an unrelated party purchased an aggregate of 1,000,000 Class A Shares and 111,111 Class L Shares of Parent for $5.0 million. These amounts were indirectly contributed to us by Parent.

In December 2011, the shareholders of Parent exchanged their shares of Parent for shares of Gymboree Holding, Ltd. (see Note 1).

 

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5.  Goodwill and Intangible Assets and Liabilities

Intangible Assets and Liabilities:

Intangible assets and liabilities consist of the following (in thousands):

 

    January 28, 2012  
    Gross
      Carrying      
Amount
    Accumulated
  Amortization  
      Net Amount    

Intangible Assets Not Subject to Amortization:

 

Trade names

    $ 567,288            $ 567,288     
 

 

 

     

 

 

 

Intangible Assets Subject to Amortization:

     

Customer relationships

    36,400          (18,699)         17,701     

Below market leases

    7,055          (1,637)         5,418     

Co-branded credit card agreement

    4,000          (727)         3,273     

Franchise agreements

    6,600          (1,085)         5,515     
 

 

 

   

 

 

   

 

 

 
    54,055          (22,148)         31,907     
 

 

 

   

 

 

   

 

 

 

Total other intangible assets

    $ 621,343          $ (22,148)         $ 599,195     
 

 

 

   

 

 

   

 

 

 

Intangible Liabilities Subject to Amortization:

     
Above market leases (included in Lease Incentives and Other Deferred Liabilities)     $ (16,631)         $ 4,114          $ (12,517)    
 

 

 

   

 

 

   

 

 

 
    January 29, 2011  
    Gross
       Carrying      
Amount
    Accumulated
  Amortization  
      Net Amount    

Intangible Assets Not Subject to Amortization:

 

Trade names (see Note 1)

    $ 567,027            $ 567,027     
 

 

 

     

 

 

 

Intangible Assets Subject to Amortization:

     

Customer relationships

    36,400          (2,874)         33,526     

Below market leases

    7,049          (255)         6,794     

Co-branded credit card agreement

    4,000          (112)         3,888     

Franchise agreements (see Note 1)

    6,600          (25)         6,575     
 

 

 

   

 

 

   

 

 

 
    54,049          (3,266)         50,783     
 

 

 

   

 

 

   

 

 

 

Total other intangible assets

    $ 621,076          $ (3,266)         $ 617,810     
 

 

 

   

 

 

   

 

 

 

Intangible Liabilities Subject to Amortization:

     
Above market leases (included in Lease Incentives and Other Deferred Liabilities)     $ (16,623)         $ 642          $ (15,981)    
 

 

 

   

 

 

   

 

 

 

We had intangible assets of approximately $2.4 million prior to the Transaction Date, which were assigned a fair value of zero in purchase accounting. We had goodwill of approximately $0.2 million prior to the Transaction Date, which was assigned a fair value of zero in purchase accounting.

 

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The Company assigned the following useful lives to its intangible assets:

 

   

Useful Life

 

Location of

Amortization Expense

Trade names

  Indefinite   -

Customer relationships

  2.3 years   SG&A

Below market leases

  Remaining lease term   COGS

Co-branded credit card agreement

  6.5 years   SG&A

Retail franchise agreement

  6 years   SG&A

Gymboree Play & Music franchise agreements

  14 years   SG&A

Above market leases

  Remaining lease term   COGS

During fiscal 2011 and the period from November 23, 2010 to January 29, 2011, we recorded amortization income of approximately $2.1 million and $0.4 million in COGS, respectively, and amortization expense of approximately $17.5 and $3.0 million in SG&A, respectively. We estimate that amortization expense (income) related to intangible assets and liabilities will be as follows in each of the next five fiscal years (in thousands):

 

Fiscal            

     

  Below Market  
Leases

       

Above Market
Leases

       

Other

  Intangibles  

       

      Total      

       

2012

 

$

    1,376        $     (3,253)       $     17,361        $     15,484        

2013

      1,162            (2,651)           3,409            1,920        

2014

      1,066            (2,071)           1,534            529        

2015

      843            (1,612)           1,534            765        

2016

      485            (1,460)           1,393            418        

Goodwill:

Changes in the carrying amount of goodwill for fiscal 2011 are as follows (in thousands):

 

          Retail Stores  
Segment
    Gymboree Play
      & Music Segment  
          Retail Franchise  
Segment
            Total        

Balance as of January 29, 2011 (see Note 1)

    $ 887,372          $ 16,389          $ 23,636          $ 927,397     

Impairment - Gymboree Outlet reporting unit

    (28,300)         -              -              (28,300)    
 

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of January 28, 2012

    $ 859,072          $ 16,389          $ 23,636          $ 899,097     
 

 

 

   

 

 

   

 

 

   

 

 

 

As discussed in Note 2, we completed our allocation of goodwill and certain other intangible assets to our reporting units, our segments and our guarantor/non-guarantor subsidiaries in the fourth quarter of fiscal 2011. The table above shows the final allocation of goodwill to our segments. The retail stores segment above includes approximately $39.8 million in goodwill allocated to our Canada and Australia geographical segments. As of January 29, 2011, all of our goodwill had been allocated to the retail stores segment in the United States. The segment disclosures in Note 13 have been restated to reflect the final allocation of goodwill and certain other intangible assets for all periods presented. As of January 29, 2011, all of our goodwill and certain other intangible assets had been allocated to The Gymboree Corporation for the purposes of our guarantor/non-guarantor subsidiaries disclosure. In the fourth quarter of fiscal 2011, we finalized our allocation of goodwill and certain other intangible assets to these subsidiaries, which resulted in $887.6 million and $39.8 million of goodwill being allocated to guarantor and non-guarantor subsidiaries, respectively and $3.9 million of other intangible assets being allocated to our guarantor subsidiaries. Our guarantor and non-guarantor subsidiaries disclosure has been restated to reflect the final allocation of goodwill and certain other intangible assets for all periods presented (see Note 22).

We test goodwill for impairment annually in the fourth quarter, or whenever events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount, by initially comparing the fair value of each of our six reporting units to their related carrying values. If the fair value of the reporting unit is less than its carrying value, we perform an additional step to determine the implied fair value of goodwill associated with that reporting unit. The implied fair value of goodwill is determined by first allocating the fair value of the reporting unit to all of its assets and liabilities and then computing the excess of the reporting unit’s fair value over the amounts assigned to the assets and liabilities. If the carrying value of goodwill exceeds the implied fair value of goodwill, such excess represents the amount of goodwill impairment, and, accordingly, we recognize such impairment.

The goodwill impairment analysis for the Gymboree Outlet reporting unit was based on our projection of revenues, gross margin, operating costs and cash flows considering historical and estimated future results, general economic and market

 

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c