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AEROPOSTALE INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Cautionary Note Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements involve certain risks and uncertainties, including statements regarding our strategic direction, prospects and future results. Certain factors, including factors outside of our control, may cause actual results to differ materially from those contained in the forward-looking statements. Among the factors that could cause actual results to materially differ from those projected in the forward-looking statements, include changes in the competitive marketplace, including the introduction of new products or pricing changes by our competitors; changes in the economy and other events leading to a reduction in discretionary consumer spending; seasonality; risks associated with changes in social, political, economic and other conditions and the possible adverse impact of changes in import restrictions; risks associated with uncertainty relating to the Company's ability to implement its growth strategy and risks associated with the Company's ability to implement and realize the anticipated benefits of the Company's strategic initiatives and cost reduction program. In addition, the risk factors included in Part I, Item 1A, Risk Factors, in our Annual Report on Form 10-K for the fiscal year ended February 1, 2014 should be read in connection with evaluating our business and future prospects. All forward-looking statements included in this report are based on information available to us as of the date hereof, and we assume no obligation to update or revise such forward-looking statements to reflect events or circumstances that occur after such statements are made. Introduction Management's Discussion and Analysis of Financial Condition and Results of Operations, or "MD&A," is intended to provide information to help you better understand our financial condition and results of operations. Our business is highly seasonal, and historically we realize a significant portion of our sales and cash flow in the second half of the year, driven by the impact of the back-to-school selling season in our third quarter and the holiday selling season in our fourth quarter. Therefore, our interim period unaudited condensed consolidated financial statements may not be indicative of our full-year results of operations, financial condition or cash flows. We recommend that you read this section along with the unaudited condensed consolidated financial statements and notes included in this report and along with our Annual Report on Form 10-K for the year ended February 1, 2014. The discussion in the following section is on a consolidated basis, unless indicated otherwise. Overview While the United States macro-economic environment and mall traffic continue to remain challenging, we are focused on executing our key merchandising, operational and financial initiatives to improve our performance. As part of our on-going initiative to change perception of the brand and accelerate customer adoption, we created a new brand platform that we have identified as AERO NOW. This new brand platform aims to convey our brand's authenticity, emotion and relevance to today's teen. We also continue to make progress on our key initiative of increasing the fashion in our overall assortment, including our exclusive sub-brand businesses, Live Love Dream and the Bethany Mota Collection. We also continue to make progress on our key financial strategies of maintaining appropriate levels of liquidity, optimizing our real estate portfolio and managing our capital spending prudently. With regard to liquidity, on February 21, 2014, we increased the aggregate borrowing capacity on our revolver from $175.0 million to $230.0 million (see Note 10 to the Notes to Unaudited Condensed Consolidated Financial Statements). Additionally, on May 23, 2014, to enhance our liquidity, we entered into $150.0 million in senior secured credit facilities with Sycamore Partners (see Note 3 to the Notes to Unaudited Condensed Consolidated Financial Statements). During the second quarter of 2014, we received an income tax refund of approximately $45 million. Operationally, on April 30, 2014, following a strategic review and assessment of changing consumer patterns, management and the Board of Directors approved a comprehensive plan to both restructure the P.S. from Aéropostale business and to reduce costs. We have identified key initiatives we estimate will generate approximately $30.0 million to $35.0 million in annualized pre-tax savings, of which approximately $5.0 million to $10.0 million is expected to be achieved during fiscal 2014. Based on changing consumer patterns, we plan to close approximately 125 mall-based P.S. from Aéropostale stores on or around the end of fiscal 2014. We plan to focus on faster growing sales channels, including off-mall locations (including outlets), e-commerce and international licensing of P.S. from Aéropostale. We are also exploring other potential third party distribution channels. By taking these steps, we expect to eliminate pre-tax losses of approximately $15.0 million that were generated in the mall-based business in fiscal 2013, excluding any impairment charges. We anticipate that substantially all of the planned store closures will be completed by the end of fiscal 2014. As of August 2, 2014, four stores have been closed. The cost reduction program will also target both direct and 26-------------------------------------------------------------------------------- Table of Contents indirect spending across the organization. This has included the reduction of approximately 100 open or occupied corporate positions to align with our current business strategies. We estimate that we will incur pre-tax restructuring and impairment charges related to these actions totaling approximately $40.0 million to $65.0 million throughout fiscal 2014, of which approximately $25.0 million to $40.0 million are estimated to be cash expenses. Included in the estimate of total pre-tax charges are approximately: • $5.0 million of consulting and severance expenses resulting from the announced corporate cost reduction initiatives, of which $1.7 million were recorded during the second quarter of 2014 and $4.7 million during the first twenty-six weeks of 2014. • $30.5 million of the charges relate to fixed asset impairments resulting primarily from the expected closures of the P.S. from Aéropostale stores, all of which were recorded during the first quarter of 2014. • $4.0 million of additional severance resulting from the store closures, of which $1.3 million was recorded during the second quarter of 2014 and the first twenty-six weeks of 2014. These costs are expected to be recorded by or around the remainder of fiscal 2014. • The remainder of the charges relate to estimated lease costs in conjunction with the store closures, which are expected to be recorded during the remainder of fiscal 2014. We cannot yet estimate when the remaining lease charges will be paid. The charges will be recognized in restructuring charges in the statements of operations. The amounts of these estimated costs and charges are preliminary and remain subject to change, pending, among other factors, the outcome of negotiations with third parties. Total charges, actual savings and timing may vary positively or negatively from these estimates due to changes in the scope, underlying assumptions or execution risk of the program throughout its duration. We also continue to consider the potential closure of a total of approximately 175 Aéropostale stores, in addition to the 125 mall-based P.S. from Aéropostale stores discussed above. On August 18, 2014, we entered into an Employment Agreement with Julian R. Geiger pursuant to which he will serve as our Chief Executive Officer. The Board of Directors and Thomas P. Johnson have mutually agreed that Mr. Johnson will step down as Chief Executive Officer of the Company and will no longer serve as a member of the Board, effective as of August 18, 2014. Results of Operations The following table sets forth our results of operations as a percentage of net sales. We also use this information to evaluate the performance of our business: 13 weeks ended 26 weeks ended August 2, August 3, August 2, August 3, 2014 2013 2014 2013 Net sales 100.0 % 100.0 % 100.0 % 100.0 % Gross profit 15.8 % 17.9 % 16.8 % 20.1 % Selling, general and administrative expenses 30.6 % 27.5 % 30.4 % 27.2 % Restructuring charges 0.8 % - % 4.7 % - % Loss from operations (15.6 )% (9.6 )% (18.3 )% (7.1 )% Interest expense 0.6 % - % 0.4 % - % Loss before income taxes (16.2 )% (9.6 )% (18.7 )% (7.1 )% Income tax benefit (0.1 )% (2.2 )% (0.9 )% (2.0 )% Net loss (16.1 )% (7.4 )% (17.8 )% (5.1 )% 27-------------------------------------------------------------------------------- Table of Contents Key Performance Indicators We use a number of key indicators of financial condition and operating performance to evaluate the performance of our business, some of which are set forth in the following table. Comparable changes for the 13-weeks ended August 2, 2014 are compared to the 13-weeks ended August 3, 2013. 13 weeks ended 26 weeks ended August 2, August 3, August 2, August 3, 2014 2013 2014 2013 Net sales (in millions) $ 396.2 $ 454.0 $ 792.0 $ 906.3 Total store count at end of period 1,072 1,119 1,072 1,119 Comparable store count at end of period 1,008 1,023 1,008 1,023 Net sales change (13 )% (6 )% (13 )% (8 )% Comparable sales change (including the e-commerce channel) (13 )% (15 )% (13 )% (14 )% Comparable average unit retail change (including the e-commerce channel) 6 % (5 )% 4 % (7 )% Comparable units per sales transaction change (including the e-commerce channel) (5 )% (1 )% (5 )% 2 % Comparable sales transaction change (including the e-commerce channel) (14 )% (10 )% (12 )% (10 )% Net sales per average square foot $ 88 $ 99 $ 174 $ 198 Gross profit (in millions) $ 62.6 $ 81.2 $ 133.0 $ 182.6 Loss from operations (in millions) $ (61.7 ) $ (43.8 ) $ (145.1 ) $ (64.3 ) Diluted loss per share $ (0.81 ) $ (0.43 ) $ (1.79 ) $ (0.59 ) Average square footage growth over comparable period (2 )% 3 % (1 )% 3 % Change in total inventory over comparable period (15 )% 1 % (15 )% 1 % Change in store inventory per retail square foot over comparable period (11 )% (3 )% (11 )% (3 )% Percentages of net sales by category: Young Women's 64 % 63 % 64 % 64 % Young Men's 36 % 37 % 36 % 36 % Comparison of the 13 weeks ended August 2, 2014 to the 13 weeks ended August 3, 2013 Net Sales Net sales consist of our sales from comparable stores, our non-comparable stores, our e-commerce business and international licensing revenue. Our wholly-owned stores are included in comparable store sales after 14 months of operation. Additionally, we have included GoJane sales in our comparable sales beginning in February of fiscal 2014. We consider a remodeled or relocated store with more than a 25% change in square feet to be a new store. Prior period sales from stores that have closed are not included in comparable store sales. Net sales decreased by $57.9 million for the second quarter of 2014. Both net sales and comparable store sales declined by 13%, compared to the same period last year. The net sales decrease reflects: • a decrease of $49.3 million in comparable store sales (excluding the e-commerce channel) • a decrease of $5.7 million in non-comparable store sales • a decrease of $5.3 million in our e-commerce business • an increase of $2.4 million in international licensing revenue primarily due to the increase in licensee operated locations to 162 as of August 2, 2014 from 56 as of August 3, 2013. 28-------------------------------------------------------------------------------- Table of Contents Consolidated comparable sales, including the e-commerce channel, decreased by 15% in our young men's category and 12% in our young women's category. The overall comparable sales, including the e-commerce channel, reflected decreases of 14% in the number of sales transactions and 5% in units per sales transaction, partially offset by an increase of 6% in average unit retail. Cost of Sales and Gross Profit Cost of sales includes costs related to merchandise sold, including inventory valuation adjustments, distribution and warehousing, freight from the distribution center to the stores, shipping and handling costs, payroll for our design, buying and merchandising departments and occupancy costs. Occupancy costs include rent, contingent rents, common area maintenance, real estate taxes, utilities, repairs and maintenance, depreciation and amortization and store impairment charges. Gross profit decreased by $18.6 million for the second quarter of 2014 compared to the same period last year. Gross profit included asset impairment charges of $19.0 million during the second quarter of 2014 and $8.0 million for the second quarter of 2013. Gross profit, as a percentage of net sales, decreased by 2.1 percentage points. Included in gross profit for the second quarter of 2014 are higher asset impairment charges of 3.0 percentage points compared to the same period last year. Merchandise margin increased by 2.6 percentage points. This increase was partially offset by 1.8 percentage points of deleverage impact in occupancy expense and distribution and transportation expense resulting from the above mentioned decrease in store sales. SG&A SG&A includes costs related to selling expenses, store management and corporate expenses such as payroll and employee benefits, marketing expenses, employment taxes, information technology maintenance costs and expenses, insurance and legal expenses, e-commerce transaction expenses, store pre-opening costs and other corporate level expenses. Store pre-opening costs include store level payroll, grand opening event marketing, travel, supplies and other store pre-opening expenses. SG&A decreased by $3.8 million for the second quarter of 2014 compared to the second quarter of 2013. The decrease was due to lower store-line expenses of $5.6 million, which primarily consisted of payroll resulting from cost savings initiatives, and transaction expenses of $1.7 million primarily due to lower sales. These decreases were partially offset by corporate expenses of $1.9 million and higher marketing costs of $1.6 million, primarily to support our brand awareness initiatives. SG&A, as a percentage of net sales, was 30.6% for the second quarter of 2014 compared to 27.5% for the same period last year. The increase in SG&A, as a percentage of sales, was due primarily to the deleverage in corporate expenses of 1.5 percentage points, marketing expenses of 0.8 percentage points and store-line expenses of 0.7 percentage points, which primarily consisted of payroll. Restructuring Charges Restructuring charges related to the cost reduction program discussed above were $3.0 million, or 0.8% as a percentage of net sales, for the second quarter of 2014. These charges included severance charges of $1.5 million and other exit costs of $1.5 million. Loss from Operations As a result of the above, consolidated loss from operations was $61.7 million for the second quarter of 2014, compared to $43.8 million for the second quarter of 2013. The consolidated loss from operations included income from operations from our international licensing segment was $6.9 million for the second quarter of 2014 compared with of $4.9 million for the second quarter of 2013. The increase from international licensing was due to the increase in licensee locations as discussed above. Income taxes The effective tax rate was 0.4% for the second quarter of 2014 and 23.3% for the second quarter of 2013. During the first quarter of 2014, we accounted for the utilization of most remaining available NOL carrybacks. While the balance of 2014 anticipated losses can be carried forward and utilized against future taxable income, the related deferred tax assets have a full valuation allowance. The lower tax rate for the second quarter of 2014 was primarily due to the valuation allowance provided for these assets. We expect that our effective tax rate for fiscal 2014 will continue to be unfavorably impacted by the establishment of valuation allowances against deferred tax assets. 29-------------------------------------------------------------------------------- Table of Contents Net loss Net loss was $63.8 million, or $0.81 per diluted share, for the second quarter of 2014, compared to net loss of $33.7 million, or $0.43 per diluted share, for the second quarter of 2013. Comparison of the 26 weeks ended August 2, 2014 to the 26 weeks ended August 3, 2013 Net Sales Net sales decreased by $114.3 million for the first twenty-six weeks of 2014. Both net sales and comparable store sales declined by 13% compared to the same period last year. The net sales decrease reflects: • a decrease of $94.6 million in comparable store sales (excluding the e-commerce channel) • a decrease of $15.0 million in non-comparable store sales • a decrease of $12.5 million in our e-commerce business • an increase of $7.8 million in international licensing revenue primarily due to the increase in licensee operated locations to 162 as of August 2, 2014 from 56 as of August 3, 2013. Consolidated comparable sales, including the e-commerce channel, decreased by 14% in our young men's category and 12% in our young women's category. The overall comparable sales, including the e-commerce channel, reflected decreases of 12% in the number of sales transactions and 5% in units per sales transaction, partially offset by an increase of 4% in average unit retail. Cost of Sales and Gross Profit Cost of sales includes costs related to merchandise sold, including inventory valuation adjustments, distribution and warehousing, freight from the distribution center to the stores, shipping and handling costs, payroll for our design, buying and merchandising departments and occupancy costs. Occupancy costs include rent, contingent rents, common area maintenance, real estate taxes, utilities, repairs and maintenance, depreciation and amortization and store impairment charges. Gross profit decreased by $49.6 million for the first twenty-six weeks of 2014 compared to the same period last year. Gross profit included asset impairment charges of $21.6 million during the first twenty-six weeks of 2014 and $8.6 million for the first twenty-six weeks of 2013. Gross profit, as a percentage of net sales, decreased by 3.3 percentage points. Included in gross profit are higher asset impairment charges of 1.8 percentage points compared to the same period last year. Additionally, the deleverage impact in occupancy expense and distribution and transportation expense of 2.0 percentage points was partially offset by an increase in merchandise margin of 0.6 percentage points. SG&A SG&A includes costs related to selling expenses, store management and corporate expenses such as payroll and employee benefits, marketing expenses, employment taxes, information technology maintenance costs and expenses, insurance and legal expenses, e-commerce transaction expenses, store pre-opening costs and other corporate level expenses. Store pre-opening costs include store level payroll, grand opening event marketing, travel, supplies and other store pre-opening expenses. SG&A decreased by $6.3 million for the first twenty-six weeks of 2014 compared to the first twenty-six weeks of 2013. The decrease was due to lower store-line expenses of $9.1 million, which primarily consisted of payroll resulting from cost savings initiatives, and transaction expenses of $4.8 million primarily due to lower sales. These decreases were partially offset by higher marketing costs of $4.7 million, primarily to support our brand awareness initiatives, and higher corporate expenses of $3.0 million. SG&A, as a percentage of net sales, was 30.4% for the first twenty-six weeks of 2014 compared to 27.2% for the same period last year. The increase in SG&A, as a percentage of sales, was due primarily to the deleverage impact in corporate expenses of 1.5 percentage points, store-line expenses of 0.9 percentage points, which primarily consisted of payroll and marketing expenses of 1.0 percentage points. These increases were partially offset by 0.2 percentage points of leverage from transaction costs. Restructuring Charges Restructuring charges related to the cost reduction program discussed above were $37.5 million, or 4.7% as a percentage of net sales, for the first twenty-six weeks of 2014. These charges included P.S. from Aéropostale store impairment charges of $30.5 million, other exit costs of $3.4 million, severance charges of $2.5 million and lease costs of $1.1 million. 30-------------------------------------------------------------------------------- Table of Contents Loss from Operations As a result of the above, consolidated loss from operations was $145.1 million for the first twenty-six weeks of 2014, compared to $64.3 million for the first twenty-six weeks of 2013. The consolidated loss from operations included income from operations from our international licensing segment was $13.8 million for the first twenty-six weeks of 2014 compared with of $6.7 million for the first twenty-six weeks of 2013. The increase from international licensing was due to the increase in licensee locations as discussed above. Income taxes The effective tax rate was 4.9% for the first twenty-six weeks of 2014 and 29.0% for the first twenty-six weeks of 2013. Please see the comparison of the 13 weeks ended August 2, 2014 to the 13 weeks ended August 3, 2013 for a further discussion about the effective tax rates. Net loss Net loss was $140.6 million, or $1.79 per diluted share, for the first twenty-six weeks of 2014, compared to net loss of $45.9 million, or $0.59 per diluted share, for the first twenty-six weeks of 2013. Liquidity and Capital Resources Our cash requirements are primarily for working capital, construction of new stores, remodeling or updating of existing stores, and the improvement or enhancement of our information technology systems. Due to the seasonality of our business, we have historically realized a significant portion of our cash flows from operations during the second half of the year. Generally, our cash requirements have been met primarily through cash and cash equivalents on hand during the first half of the year, and through cash flows from operations during the second half of the year. We expect to meet our operating and investing net cash requirements for the next twelve months through existing cash and cash equivalents and by utilizing our revolving credit facility, if necessary. As of August 2, 2014, we had working capital of $171.4 million, cash and cash equivalents of $152.3 million and $133.6 million of long-term debt as a result of the closing of the financing transaction with Sycamore Partners, an owner of a portion of our outstanding common stock and a related party, on May 23, 2014. We plan to use the proceeds of this financing transaction for working capital and other general corporate purposes (see Note 3 to the Notes to Unaudited Condensed Consolidated Financial Statements for a further discussion). As of August 2, 2014, we had no borrowings outstanding under our revolving credit facility. On February 21, 2014, we increased the aggregate borrowing capacity under our revolving credit facility from $175.0 million to $230.0 million (see Note 10 to the Notes to Unaudited Condensed Consolidated Financial Statements). During the second quarter of 2014, we received an income tax refund of approximately $45.0 million. Additionally, while we have in the past repurchased our common stock under a stock repurchase program (see Note 6 to the Notes to Unaudited Condensed Consolidated Financial Statements), we do not currently expect to do so during fiscal 2014. The following table sets forth our cash flows for the period indicated: 26 weeks ended August 2, August 3, 2014 2013 (In thousands) Net cash used in operating activities $ (65,519 ) $ (84,951 ) Net cash used in investing activities (17,399 ) (44,468 ) Net cash provided by (used in) financing activities 128,689 (1,566 ) Effect of exchange rate changes (14 ) (225 ) Net increase (decrease) in cash and cash equivalents $ 45,757 $ (131,210 ) Operating activities - Net cash used in operating activities decreased by $19.4 million for the first twenty-six weeks of 2014 compared to the same period in 2013. Lower cash used for inventory and cash from income taxes receivable were partially offset by the increase in period to period net loss and the timing of expenditures. Merchandise inventory decreased by 15% in total, or 11% on a per retail square foot basis as of August 2, 2014 compared with August 3, 2013. During the second quarter of 2014, we received an income tax refund of approximately $45.0 million. 31-------------------------------------------------------------------------------- Table of Contents Investing activities - Investments in capital expenditures are principally for the construction of new stores, remodeling of existing stores and investments in information technology. Net cash used in investing activities decreased by $27.1 million for the first twenty-six weeks of 2014 compared to the same period in 2013 primarily due to lower capital expenditures. Our future capital requirements will depend primarily on the number of new stores we open, the number of existing stores we remodel and the timing of these expenditures. During fiscal 2014, we plan to invest a total of approximately $22.0 million in capital expenditures. During the first twenty-six weeks of 2014, we invested $15.2 million, which excludes accruals related to purchases of property and equipment. During the first twenty-six weeks of 2014, we opened four Aéropostale stores and one combination store and remodeled ten Aéropostale stores. During the remainder of the fiscal year, we plan to open three Aéropostale stores and and remodel two Aéropostale stores. During the first twenty-six weeks of 2013, we invested $44.1 million in capital expenditures, primarily to construct five new Aéropostale stores, 43 P.S. from Aéropostale stores, to remodel 11 Aéropostale stores and for a number of information technology investments. Financing activities - Net cash provided by financing activities increased by $130.3 million for the first twenty-six weeks of 2014 compared to the same period in 2013. Net cash provided by financing activities during the first twenty-six weeks of 2014, included $137.6 million of net proceeds related to the Sycamore transaction offset by $6.2 million of related deferred financing fees paid in connection with the transaction (see Note 3 to the Notes to Unaudited Condensed Consolidated Financial Statements for a further discussion). Revolving Credit Facility and Financing Transaction with Related Party In September 2011, we together with certain of our direct and indirect subsidiaries entered into a Third Amended and Restated Loan and Security Agreement with the Lenders party thereto, and Bank of America, N.A., as agent for the ratable benefit of the Credit Parties (the "Credit Facility"). The Credit Facility originally provided for a revolving credit line up to $175.0 million. On February 21, 2014, the Credit Facility was amended, among other things, to increase from $175.0 million to $230.0 million the aggregate amount of loans and other extensions of credit available to the Borrower under the Credit Facility. The Credit Facility is available for working capital and general corporate purposes (see Note 10 to the Notes to Unaudited Condensed Consolidated Financial Statements for a further discussion). On May 23, 2014, we entered into (i) a Loan and Security Agreement (the "Loan Agreement") with affiliates of Sycamore Partners, (ii) a Stock Purchase Agreement (the "Stock Purchase Agreement") with Aero Investors LLC, an affiliate of Sycamore Partners ("Investor"), for the purchase of 1,000 shares of Series B Convertible Preferred Stock of the Company, $0.01 par value (the "Series B Preferred Stock"), and (iii) an Investor Rights Agreement (the "Investor Rights Agreement") with Investor. The Loan Agreement makes available to us term loans in the principal amount of $150.0 million, consisting of two tranches: a five-year $100.0 million term loan facility (the "Tranche A Loan") and a 10-year $50.0 million term loan facility (the "Tranche B Loan" and, together with the Tranche A Loan, the "Term Loans"). The net proceeds of the Term Loans are to be used for working capital and other general corporate purposes (see Note 3 to the Notes to Unaudited Condensed Consolidated Financial Statements for a further discussion). 32-------------------------------------------------------------------------------- Table of Contents Contractual Obligations The following table summarizes our contractual obligations as of August 2, 2014: Payments Due Balance of In 2015 In 2017 After Total 2014 and 2016 and 2018 2018 (In thousands) Contractual Obligations Real estate operating leases $ 910,093 $ 142,646 $ 242,710 $ 205,514 $ 319,223 Short-term borrowings 1 - - - - - Sycamore Tranche A Loan principal 100,000 - - - 100,000 Sycamore Tranche B Loan principal 2 50,000 - 5,000 10,000 35,000 Sycamore Tranche A Loan interest 40,000 - 15,000 20,000 5,000 Employment agreement 3 1,756 479 1,277 - - Equipment operating leases 9,191 1,861 5,112 2,218 -Total contractual obligations $ 1,111,040 $ 144,986 $ 269,099 $ 237,732 $ 459,223 1 The short-term borrowings were repaid on May 23, 2014. 2 Although interest is imputed on the Tranche B Loan and recorded as interest expense, the Tranche B Loan does not require any contractual interest payments. The Tranche B Loan will be paid off in equal annual installments of 10% per annum. The Tranche B Loan is scheduled to mature on the earlier of (a) tenth anniversary of the end of the Start-Up Period (as such term is defined in the Sourcing Agreement) and (b) the expiration or termination of the Sourcing Agreement. Under the Sourcing Agreement, MGF is required to pay to us an annual rebate equal to a fixed amount multiplied by the percentage of annual purchases made by us (including purchases deemed to be made by virtue of payment of the shortfall commission) relative to the Minimum Volume Commitment to be applied towards the payment of the required amortization on the Tranche B Loan. The Sourcing Agreement also provides for certain carryover credits if we purchase a volume of product above the Minimum Volume Commitment during the applicable Minimum Volume Commitment Period. See Note 3 to the Notes to Unaudited Condensed Consolidated Financial Statements for a further discussion. 3 On August 18, 2014 we entered into an Employment Agreement with Mr. Geiger pursuant to which he will serve as our Chief Executive Officer. The Employment Agreement has a three-year term at a base salary of $1.5 million per annum. The Board of Directors and Mr. Johnson have mutually agreed that Mr. Johnson will step down as Chief Executive Officer of the Company and will no longer serve as a member of the Board, effective as of August 18, 2014. Mr. Johnson will be entitled to receive his severance amounts which are estimated to approximate $2.5 million, retirement plan payment currently estimated at $5.7 million and paid six months from retirement date, and other items pursuant to his employment agreement with the Company and the Company's early retirement policy, all of which are excluded from the table above. See Note 17 to the Notes to Unaudited Condensed Consolidated Financial Statements for a further discussion. Such amounts are not reflected in the table above. The real estate operating leases included in the above table do not include contingent rent based upon sales volume, which amounted to approximately 6% of minimum lease obligations in fiscal 2013. In addition, the above table does not include variable costs paid to landlords such as maintenance, insurance and taxes, which represented approximately 53% of minimum lease obligations in fiscal 2013. As discussed in Note 11 to the Notes to Unaudited Condensed Consolidated Financial Statements, we have a SERP liability of $11.0 million and other retirement plan liabilities of $4.4 million at August 2, 2014. Such liability amounts are not reflected in the table above. We expect to make a payment in the next 12 months of approximately $5.7 million from our SERP which is included in the total SERP liability of $11.0 million. Our total liabilities for unrecognized tax benefits were $9.0 million at August 2, 2014. Of this amount, $6.2 million was recorded as a direct reduction of the related deferred tax assets. We cannot make a reasonable estimate of the amount and timing of related future payments. Therefore this amount was not included in the above table. 33-------------------------------------------------------------------------------- Table of Contents In June 2012, Bank of America, N.A. issued a stand-by letter of credit under the Credit Facility. As of August 2, 2014, the outstanding letter of credit was $0.2 million and expires on June 30, 2015. We have not issued any other stand-by or commercial letters of credit as of August 2, 2014. The above table also does not include contingent bonus compensation agreements with certain of our employees. The bonuses become payable if the individual is employed by us on the future payment date. The amount of contingent bonuses that may be paid is $0.2 million during the remainder of fiscal 2014, $0.7 million during fiscal 2015 and $0.2 million during fiscal 2016. The above table does not reflect contingent purchase consideration related to the fiscal 2012 acquisition of GoJane that is discussed in Note 5 to the Notes to Unaudited Condensed Consolidated Financial Statements. The purchase price includes contingent cash payments of up to an aggregate of $8.0 million if certain financial metrics are achieved by the GoJane business during the five year period beginning on the acquisition date. The fair value of the contingent payments as of August 2, 2014 was estimated to be $5.9 million based on expected probability of payment and we have recorded such liability on a discounted basis. We have not issued any third party guarantees or commercial commitments as of August 2, 2014. Off-Balance Sheet Arrangements Other than operating lease commitments set forth in the table above, and an outstanding letter of credit of $0.2 million, we are not party to any material off-balance sheet financing arrangements. We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating our business. We do not have any arrangements or relationships with entities that are not consolidated into the financial statements that are reasonably likely to materially affect our liquidity or the availability of capital resources. As of August 2, 2014, we have not issued any letters of credit for the purchase of merchandise inventory or any capital expenditures. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements. These estimates and assumptions also affect the reported amounts of revenues and expenses. Estimates by their nature are based on judgments and available information. Therefore, actual results could materially differ from those estimates under different assumptions and conditions. Critical accounting policies are those that are most important to the portrayal of our financial condition and the results of operations and require management's most difficult, subjective and complex judgments as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our most critical accounting policies have been discussed in our Annual Report on Form 10-K for the fiscal year ended February 1, 2014. In applying such policies, management must use significant estimates that are based on its informed judgment. Because of the uncertainty inherent in these estimates, actual results could differ from estimates used in applying the critical accounting policies. Changes in such estimates, based on more accurate future information, may affect amounts reported in future periods. As of August 2, 2014, there have been no material changes to any of the critical accounting policies as disclosed in our Annual Report on Form 10-K for the fiscal year ended February 1, 2014. |