Item 1. Business
In this Form 10-K the discussion and analysis below, when we refer to “Alloy, Inc.” we are referring to Alloy, Inc., our former parent corporation, and when we refer to “Alloy” we are referring to the Alloy-branded direct marketing and merchandising business that we operate. Similarly, when we refer to “dELiA*s” we are referring to the dELiA*s-branded direct marketing, merchandising and retail store business that we operate, when we refer to “dELiA*s, Inc.,” the “Company” “we,” “us,” or “our,” we are referring to dELiA*s, Inc., its subsidiaries and its predecessors, and when we refer to “the Spinoff”, we are referring to the December 19, 2005 spinoff of the outstanding common shares of dELiA*s, Inc. to the Alloy, Inc. shareholders.
Overview
We are a direct marketing and retail company comprised of two lifestyle brands primarily targeting teenage girls and young women. We generate revenue by selling predominantly to consumers through direct mail catalogs, websites and mall-based specialty retail stores. We operate two brands-dELiA*s and Alloy-each of which we believe are well-established, differentiated, lifestyle brands. Through our e-commerce webpages, catalogs and retail stores, dELiA*s (the brand) offers a wide variety of product categories to teenage girls to cater to an entire lifestyle. We believe Alloy is a prominent branded junior apparel catalog and e-commerce site for young women.
Through our catalogs and the e-commerce webpages, we sell many products of well-known name brands, along with our own proprietary brand products in key spending categories. These products include apparel and accessories. Our mall-based dELiA*s specialty retail stores derive revenue primarily from the sale of proprietary apparel and accessories and, to a lesser extent, branded apparel to teenage girls.
Our focus on a diverse collection of name brands and proprietary brands allows us to adjust our merchandising strategy quickly as fashion trends change. In addition, we strive to keep our merchandise mix fresh by regularly introducing new styles. Our proprietary brands provide us an opportunity to broaden our customer base by offering merchandise of comparable quality to brand name merchandise at a lower price than the brand name merchandise, while permitting improved gross profit margins. Our proprietary brands also allow us to capitalize on emerging fashion trends when branded merchandise is not available in sufficient quantities, and to exercise a greater degree of control over the flow of our merchandise from our vendors to us, and from us to our customers.
We have built comprehensive databases that together include information such as name, address and amounts and dates of purchases in our direct business. In addition to helping us target consumers directly, our databases provide us with access to important demographic information that we believe should allow us to optimize the selection of potential mall-based specialty retail store locations.
On May 31, 2005, Alloy, Inc. announced that its board of directors had approved a plan to pursue a spinoff to its shareholders of all of the outstanding common stock of dELiA*s, Inc. (the “Spinoff”). The Spinoff was completed as of December 19, 2005. In connection with the Spinoff, Alloy, Inc. contributed and transferred to us substantially all of its assets and liabilities related to its direct marketing and retail store segments. By virtue of the completion of the Spinoff, Alloy, Inc. no longer owns any of our outstanding shares of common stock.
In addition, we entered into various agreements with Alloy, Inc. prior to or in connection with the Spinoff. These agreements govern various interim and ongoing relationships between Alloy, Inc. and us following the Spinoff. Certain of these agreements expire by their terms in December 2010. We are currently in discussions with Alloy, Inc. regarding the extension/renegotiation of such agreements. However, if such extension/renegotiation is not successful, the Company has alternative plans and does not expect the outcome of these discussions to have a material adverse effect on our business and operations.
We had also previously operated CCS which was a premiere catalog and e-commerce site for skateboarding and snowboarding equipment, apparel and footwear products, primarily targeting teenage boys (“CCS”). Effective November 5, 2008, we sold the assets and certain liabilities related to the CCS business to a subsidiary of Foot Locker, Inc. Please see the section below titled Discontinued Operations for a more detailed description of this transaction. Our former CCS business is treated as a discontinued operation. All amounts in this Form 10-K are for continuing operations only unless otherwise specified.
We refer to the 52-week fiscal year ended January 30, 2010 as “fiscal 2009”, the 52-week fiscal year ended January 31, 2009 as “fiscal 2008”, and the 52-week fiscal year ended February 2, 2008 as “fiscal 2007”.
The Brands
dELiA*s
dELiA*s develops, markets and sells primarily its own lifestyle brand, and to a lesser extent third-party brands, in its retail stores, as well as via catalogs and the internet. The dELiA*s brand is a distinctive collection of apparel, dresses, swimwear, roomwear, footwear, outerwear and key accessories targeted primarily at trend-setting, fashion-aware teenage girls. While dELiA*s markets to teenage girls, we focus its marketing efforts on potential customers who we believe fit the profile and have the interests of fashion-forward high-school juniors, because we believe that these teenagers influence the buying activities of younger teens. In fiscal 2009, dELiA*s circulated approximately 22.7 million catalogs.
dELiA*s retail stores sell a distinctive collection of lifestyle-oriented apparel and accessories for trend-setting, fashion-aware teenage girls via mall-based specialty retail stores. The majority of dELiA*s’ merchandise is privately branded and sold under the dELiA*s label. As of January 30, 2010, we operated 109 dELiA*s mall-based specialty retail stores. These stores range in size from approximately 2,600 to 5,100 square feet with an average size of approximately 3,800 square feet.
Alloy
Alloy markets and sells branded junior apparel (including extended sizes), dresses, accessories, swimwear, footwear and outerwear targeting young women via catalogs and the internet. Alloy offers a wide selection of well-known, juniors-targeted name brands, such as Federal Jeans, Ralsey, Sour Pop, Paris Blues and Truck Jeans. In fiscal 2009, Alloy circulated approximately 23.3 million catalogs.
Business Strengths
We believe our principal business strengths include:
Broad Access to Teenage Consumers
In fiscal 2009, we reached a significant portion of teenage consumers in the United States by:
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circulating approximately 46.0 million direct mail catalogs for our two brands, with an average of one new book per brand being mailed each month;
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communicating with select segments of our database by sending, on average, 8.4 million emails per week to those of our target audience who have opted into receiving such emails; and
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owning and operating 109 dELiA*s retail stores in 33 states as of January 30, 2010.
Comprehensive Databases
Our dELiA*s and Alloy databases contained information about approximately 11.7 million households who have purchased products or requested catalogs directly from us as of January 30, 2010, including approximately 2.2 million households who have purchased merchandise or requested a catalog within the last two years. In
addition to names and addresses, our databases give us the ability to review a variety of valuable information that may include age range, purchasing history, stated interests, online behavior, educational level and socioeconomic factors. We continually refresh and grow our databases with information we gather through direct marketing programs and purchased customer lists. We also have access to certain information collected through Alloy, Inc.’s data sources. We analyze this data in detail, which we believe enables us to improve response rates from our direct sales efforts, as well as locate new retail stores in customer-rich locations.
Operating Flexibility
We attempt to maintain significant flexibility in the operation of our business so that we can react quickly to changes in customer preferences. We regularly review the sales performance of our merchandise in an effort to identify and respond to changing trends and consumer preferences. When purchasing merchandise from our vendors, we pursue a strategy that is designed to maximize our speed to market. We strive to establish strong and loyal relationships with our suppliers which we believe allows us to quickly obtain merchandise and ship it to our warehouse for direct sales or our retail stores for retail sales. Currently, we are able to replenish a majority of our merchandise within 45 to 60 days. The e-commerce webpages and our databases allow us to quickly update our merchandise presentations, promotions, and display of offerings in an effort to create excitement for our customers with whom we can communicate via email, which, for many, is their chosen media of communication. In fiscal 2009, approximately 83% of our direct marketing revenues were generated through sales made through our e-commerce webpages.
Experienced Management Team
Our senior management has significant retail and direct marketing experience, with an average of over 20 years in the retail, catalog and e-commerce apparel businesses.
Our Business Strategy
Our strategy is to improve upon our strong competitive position as a direct marketing company, to expand and develop our dELiA*s specialty retail stores, and to carry out such strategy while controlling costs. The key elements of our strategy are as follows:
Direct Marketing Strategy
Our direct marketing strategy is designed to minimize our exposure to risks associated with rapidly changing fashion trends and facilitate speed to market and the flexibility with which we are able to purchase and stock a wide assortment of merchandise. Our primary objective is to reflect, rather than shape, styles and tastes. We develop exclusive merchandise and select name brand merchandise from what we believe is quality manufacturers and name brands. Our buyers and merchandisers work closely with our many suppliers to develop products to our specifications. This speed to market gives us flexibility to incorporate the latest trends into our product mix and to better serve the evolving tastes of customers. Through this strategy, we believe we are able to minimize design risk and make final product selections only two to seven months before the products are brought to market, not the typical six to nine months required by many apparel retailers. We believe this allows us to stay current with the tastes of the market, and unlike others in our industry that require a longer lead time to bring goods to the market, we believe our strategy enables us to receive a continuous allotment of goods from our suppliers and carry the proper amount of inventory. A possible trade-off on our supply practice is that we have less control over the manufacturing process, which could potentially lead to problems with quality.
Our direct marketing strategy also enables us to manage our inventory levels efficiently once consumer demand patterns have emerged. We attempt to limit the size of our initial merchandise orders and rely on quick reorder ability. Because we generally do not make aggressive initial orders, we believe we are able to limit our risk of excess inventory. Additionally, we have several methods for clearing slow moving inventory, ranging from clearance media and internet offers to tent sales and third-party liquidators.
Because dELiA*s and Alloy are recognized and popular brands among teenage girls and young women, our e-commerce webpages and catalogs are a valuable marketing tool for our suppliers. As a result, our suppliers often contractually agree to grant us online and catalog exclusivity for products we develop and select, based on our prior relationship with the supplier and the volume we expect to purchase from the supplier. We believe this exclusivity makes the merchandise in the dELiA*s and Alloy catalogs more attractive to our target audience and helps to protect our product margins. Our merchandise selection includes products from many leading suppliers and name brands. dELiA*s primarily carries its own branded merchandise, though it also carries third-party branded merchandise from well-known name brands such as Converse. Brands currently offered through Alloy include nationally-recognized names such as Paris Blues, Vigoss and Nike, as well as smaller, niche labels, including Necessary Objects, Truck Jeans, Space Girlz and Miken.
Our database management and mailing strategy is designed to efficiently gather, maintain and utilize the information collected within our databases. Our databases are maintained by a third-party vendor providing address hygiene, duplicate identification and modeling capabilities. The databases enable detailed selections based on general industry practices, but enable greater specificity when required, based on maintaining any transactional history, plus the ability to overlay demographic information to the extent provided to us, for every individual and household listed in the databases.
Our catalog mailing program, coupled with our e-mail marketing program, seeks to maximize profitability with a continual testing and monitoring program designed to provide our customers with offers and promotions that will be of interest to them.
We believe that high levels of customer service and support are critical to the value of our brands and to retaining and expanding our customer base. We consistently monitor customer service calls at our call center for quality assurance purposes. Additionally, we review our call and fulfillment centers’ policies and distribution procedures on a regular basis. A majority of our catalog and internet orders are shipped within 48 hours of credit approval. In cases in which the order is placed using another person’s credit card and exceeds a specified threshold, the order is shipped only after we have received confirmation from the cardholder. Customers generally receive orders within three to ten business days after shipping. Our shipments are generally carried to customers by the USPS and UPS.
Trained sales personnel are available for the dELiA*s and Alloy brands 24 hours a day, 7 days per week through multiple toll-free telephone numbers. From the hours of 8:00 A.M. to 12:00 A.M. Eastern Time (“ET”), calls are routed to our call center, with overflow calls and calls received from the hours of 12:00 A.M. to 8:00 A.M. ET, being routed to a third-party provider whose sales personnel are also trained by us. Our trained customer service representatives are available for the dELiA*s and Alloy brands from the hours of 8:00 A.M. to 12:00 A.M. ET, and these calls are handled exclusively at our call center. A single management team oversees all sales personnel and customer service representatives.
Retail Strategy
Our current strategy is to grow our stores’ net square footage by approximately 6% in fiscal 2010, and by approximately 5-10% annually thereafter. We monitor the performance of our existing retail stores and may from time-to-time close underperforming stores as appropriate. When we determine to close a retail store, we negotiate with landlords to determine the quickest and most cost-effective way to exit such location. Store activity for the past two fiscal years follows:
* Totals include one store that was closed, remodeled and reopened during fiscal 2009, and two stores that were closed and relocated to alternative sites in the same malls during fiscal 2009.
** Totals include two stores that were closed and relocated to alternative sites in the same malls during fiscal 2008.
We plan our new stores to generate, on average, approximately $1.5 million in net sales in the first full year of operation based on 3,800 gross square feet, to have a four-wall cash contribution margin of at least 15% in the first full year and to have a net build-out cost, including inventory, of approximately $700,000. We define contribution margin as store gross profit less direct cash costs of operating the store.
We designed our dELiA*s stores to be clearly recognizable as a sportswear store for fashion-right teenage girls. Designed by a leading retail architecture firm, the stores have a display window with mannequins featuring the latest items. The entrances are offset and the design intention is to give the customer a sense of privacy in her own exclusive place. The stores average approximately 37 feet in frontage and 3,800 square feet, though individual stores may be smaller or larger than the averages. We believe that frontage and size are critical in projecting importance when compared to our competition in the malls. Our stores are designed to look upscale, appealing to what we believe to be our database customer demographics. We believe that over half our direct customers come from households with incomes of over $75,000 per year and over 25% come from households with income over $125,000 per year. Our fixture plan reflects what we believe to be our customer’s shopping preferences. For instance, much of the merchandise is on tables since our customers show a preference to making purchases in this manner.
Store siting is also a key strategic element of our store expansion plan, which contemplates regionally clustered stores. Clustered stores should benefit from better store supervision, versus stores that are spread out over relatively wide geographical areas. Each store is open during mall shopping hours and has a store management team that always includes a store manager, and depending on the sales volume of the store, one or more of the following additional management; a co-manager, one or more assistant managers and one or more customer experience supervisors, as well as eight to thirty part-time sales associates. Currently, district managers supervise six to eleven stores, with thirteen district managers reporting to two regional managers, who in turn report to a Vice President of Stores. We believe clustering increases store density, as it should enable our district managers to supervise more stores than they do currently, as travel time between stores should be reduced.
Another critical element of our expansion plan is that we are analytical and selective about the malls in which we elect to open stores. We believe our direct businesses provide us with the competitive advantage of
knowing where our customers live, and we will attempt to utilize that knowledge effectively in siting future retail stores. In addition to strong customer demographics, we look for high traffic malls, high economic growth areas and/or high income demographics in selecting new retail store locations.
Our goal is to hire and retain experienced sales associates, store managers and district managers and establish clear performance goals, objectives and related corresponding incentives which are based on planned sales. District managers, store managers, co-managers and assistant store managers participate in an incentive program which is based on achieving predetermined sales-related goals in their respective stores or districts. We have well-established store operating policies and procedures, and emphasize our loss prevention program in order to control inventory shrinkage and ensure policy and procedure compliance.
In addition, during 2009, we installed traffic counters and related software in our retail locations in order to evaluate store by store customer conversion rates. We expect this will be helpful in evaluating and managing store performance, establishing effective staffing models and focusing our training efforts.
Segments
We generate net sales from two reportable segments-direct marketing and retail stores. Because we sell a number of brand-name products in addition to our own proprietary brands, we obtain products from a wide variety of manufacturers, importers and other suppliers. One vendor accounted for approximately 18% of products sold for fiscal 2009. We believe that there are sufficient alternate sources of merchandise at comparable prices for almost all of the products we sell should we decide to or be required to change vendors for any particular product. Therefore, we do not believe that a loss of one or a few vendors would have a material impact on our operations. Net sales, by segment, are as follows:
Direct Marketing Segment
Our direct marketing segment, which consists of the dELiA*s and Alloy catalogs and e-commerce webpages, derives revenues from sales of merchandise via catalog or internet directly to consumers and advertising. Included in our direct marketing net sales of $105.4 million in fiscal 2009 were approximately $0.3 million of advertising revenues.
In fiscal 2009, each of our catalogs and associated e-commerce webpages targeted a particular segment of the market and offered many name brands well known by our target customers, along with our own proprietary brands.
dELiA*s-During fiscal 2009, the dELiA*s catalog ranged from 60 to 92 pages in length. Seventeen full price versions of the dELiA*s catalog were mailed, including remails, and up to six pages per catalog were allocated to our advertising clients and marketing partners. The dELiA*s e-commerce webpages (reached through www.delias.com) are designed to complement the catalog and offer the same merchandise as in the catalog, as well as additional products and special offers.
Alloy-During fiscal 2009, the Alloy catalog ranged in length from 52 to 84 pages. We mailed seventeen full price versions of the Alloy catalog, including remails, and allocated up to seven pages per catalog to our advertising clients and marketing partners. The Alloy e-commerce webpages (reached through www.alloy.com) offer the same merchandise as in the catalog, as well as additional products and special offers.
Retail Store Segment
Our retail store segment derives revenue primarily from the sale of apparel and accessories to consumers through dELiA*s stores. dELiA*s mall-based retail stores sell a distinctive collection of lifestyle-oriented apparel and accessories for trend-setting, fashion-aware teenage girls. As of January 30, 2010, we operated 109 dELiA*s stores in 33 states. The majority of merchandise sold in our retail stores is sold under the dELiA*s label. Our retail stores range in size from approximately 2,600 to 5,100 square feet, with an average size of approximately 3,800 square feet. Retail store segment revenues for fiscal 2009 were approximately $118.5 million.
Financial information about our segments is summarized in note 16 to our consolidated financial statements.
Infrastructure, Operations and Technology
Our operations are dependent on our ability to maintain computer and telecommunications systems in effective working order and to protect our systems against damage from fire, natural disaster, power loss, telecommunications failure, unauthorized intrusion or access to confidential information, or similar events. We have implemented, either directly or through other third parties, appropriate security, redundancy, backup and disaster recovery programs for our various businesses.
We license commercially available technology whenever possible in lieu of dedicating our financial and human resources to developing proprietary online infrastructure solutions. Currently, most services related to maintenance and operation of our e-commerce webpages are through third-party providers located in Sterling, Virginia.
In the call center, other data and voice systems are maintained by a third-party agreement and have been hardened and made redundant with the addition of backup circuits, backup generators and other system upgrades.
In our direct marketing segment, we use third-party licensed software for stockkeeping unit (“SKU”) and classification inventory tracking, purchase order management, and merchandise distribution. Sales in our direct segment, whether through the internet, the call center or the mail, are updated daily and the host system downloads price changes, order status and inventory levels. In addition, we use other licensed software products and services to further supplement our supply chain and merchandise planning and analyze customer behavior. In our retail segment, licensed software is used for SKU and classification inventory tracking, purchase order management, merchandise distribution, automated ticket making, and sales audit.
Sales in our retail segment are updated daily in the third-party licensed merchandising reporting systems by the nightly polling of sales information from each store’s point-of-sale (“POS”) terminals. Our POS system consists of registers providing price look-up, time and attendance, inventory management (transfers and distributions), and credit card/check authorization. This host system downloads price changes and inventory movements (store-to-store transfers and warehouse merchandise distributions). We evaluate information obtained through the nightly polling to implement merchandising decisions, planning and determining the open-to-buy, processing and managing of product purchasing/reorders, managing markdowns and allocating merchandise on a daily basis. For both the direct marketing and retail store segments, we use centralized financial systems for general ledger and accounts payable.
During fiscal 2010, we plan to invest in improvements in our database management capabilities.
Competition
The specialty retail and direct businesses are each highly competitive. Our retail stores compete on the basis of, among other things, the location of our stores, the breadth, quality, style, and availability of merchandise, the level of customer service offered and merchandise price. Although we feel the eclectic mix of products offered in our retail stores helps differentiate us, it also means that we compete against a wide variety of smaller, independent specialty stores, as well as department stores and national specialty chains. Many of our competitors have substantially greater name recognition as well as financial, marketing and other resources. Our specialty retail stores also face competition from small boutiques that offer an individualized shopping experience similar to the one we strive to provide to our target customers.
Along with certain retail segment factors noted above, other key competitive factors for our direct-segment operations include the success or effectiveness of customer mailing lists, response rates, catalog presentation, merchandise delivery and web site design and availability. Our direct-segment operations compete against numerous catalogs and web sites, which may have a greater volume of circulation and web traffic.
Seasonality
Our historical revenues and operating results have varied significantly from quarter to quarter due to seasonal fluctuations in consumer purchasing patterns. Sales of apparel, accessories and footwear through our e-commerce webpages, catalogs and retail stores have generally been higher in our third and fourth fiscal quarters, which contain the key back-to-school and holiday selling seasons, as compared to our first and second fiscal quarters. During the third and the beginning of our fourth fiscal quarters, our noncash working capital requirements increase and may be funded by our cash balances and utilization of our existing Letter of Credit Agreement. Quarterly results of operations may also fluctuate significantly as a result of a variety of factors, including the timing of store openings and the relative proportion of our new stores to mature stores, fashion trends and changes in consumer preferences, calendar shifts of holiday or seasonal periods, changes in merchandise mix, timing of promotional events, general economic conditions, competition and weather conditions.
Intellectual Property
We and Alloy, Inc. have registered, or filed applications to register various trademarks and servicemarks used in our business operations with the United States Patent and Trademark Office (the “PTO”). With respect to certain Alloy trademarks and servicemarks covering goods and services, we and Alloy, Inc. are joint owners by assignment of these trademarks and servicemarks. We and Alloy, Inc. have filed instruments with the PTO to request that the PTO divide these jointly owned trademarks and servicemarks between us such that we each would own the registrations for those trademarks and servicemarks for the registration classes covering the goods and services applicable to our respective businesses. We have further agreed to negotiate in good faith with Alloy, Inc. regarding appropriate usage rights and restrictions if the PTO denies our request. Applications for the registration of certain of our other trademarks and servicemarks are currently pending. We also use trademarks, tradenames, logos and endorsements of our suppliers and partners with their permission. We are not aware of any pending material conflicts concerning our marks or our use of others’ intellectual property.
Government Regulation
We are subject, directly and indirectly, to various laws and governmental regulations relating to our business. The internet is continuing to rapidly evolve and several laws or regulations directly apply to online commerce and community websites. However, due to the increasing popularity and use of the internet, governmental authorities in the United States and abroad may adopt additional laws and regulations to govern internet activities. Laws with respect to online commerce may cover issues such as pricing, taxing, distribution, unsolicited email (“spamming”) and characteristics and quality of products and services. Laws with respect to
community websites may cover content, copyrights, libel, obscenity and personal privacy. Any new legislation or regulation or the application of existing laws and regulations to the internet could have a material and adverse effect on our business, results of operations and financial condition.
Governments of other states or foreign countries might attempt to regulate our transmissions or levy sales or other taxes relating to our activities even though we do not have a physical presence or operations in those jurisdictions. As our products and advertisements are available over the internet anywhere in the world, and we conduct marketing programs in numerous states, multiple jurisdictions may claim that we are required to qualify to do business as a foreign corporation in each of those jurisdictions. Our failure to qualify as a foreign corporation in a jurisdiction where we are required to do so could subject us to taxes and penalties for the failure to qualify.
It is possible that state and foreign governments might also attempt to regulate our transmissions of content on our e-commerce webpages or prosecute us for violations of their laws. For example, a French court has ruled that a website operated by a United States company must comply with French laws regarding content, and an Australian court has applied the defamation laws of Australia to the content of a U.S. publisher posted on the company’s website. We cannot assure you that state or foreign governments will not charge us with violations of local laws or that we might not unintentionally violate these laws in the future, or that foreign citizens will not obtain jurisdiction over us in a foreign country, subjecting us to litigation in that country under the laws of that country.
The United States Congress enacted the Children’s Online Privacy Protection Act of 1999 (“COPPA”) and the Federal Trade Commission (“FTC”) promulgated implementing regulations, which became effective in 2000. The principal COPPA requirements apply to websites, or those portions of websites, directed to children under age 13. COPPA mandates that individually identifiable information about minors under the age of 13 not be collected, used or displayed without first obtaining informed parental consent that is verifiable in light of present technology, subject to certain limited exceptions. As a part of our efforts to comply with these requirements, we do not knowingly collect personally identifiable information from any person under 13 years of age and have implemented age screening mechanisms on certain areas of our websites in an effort to prohibit persons under the age of 13 from registering. This will likely dissuade some percentage of our customers from using our e-commerce webpages, which may adversely affect our business. While we use our commercially reasonable efforts to ensure that we are compliant with COPPA, our efforts may not be successful. If it turns out that our activities are not COPPA compliant, we may face litigation with the FTC or individuals or face a civil penalty, which could adversely affect our business.
A number of government authorities both in the United States and abroad, as well as private parties, are increasing their focus on privacy issues and the use of personal information. The FTC and attorneys general in several states have investigated the use of personal information by some internet companies. In particular, an attorney general may examine privacy policies to ensure that a company fully complies with representations in the policies regarding the manner in which the information provided by consumers and other visitors to a website is used and disclosed by the company. As a result, we review our privacy policies on a regular basis, and we believe we are in compliance with relevant federal and state laws. However, our business could be adversely affected if new regulations or decisions regarding the use and disclosure of personal information are made, or if government authorities or private parties challenge our privacy practices.
In December 2003, the Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003 (“CAN-SPAM”) was enacted by the United States Congress. This legislation regulates “commercial electronic mail messages,” (i.e., email) the primary purpose of which is to promote a product or service. Among its provisions are ones requiring specific types of disclosures in covered emails, requiring specific opt-out mechanisms and prohibiting certain types of deceptive headers. Violations of its provisions may result in civil money penalties and criminal liability. CAN-SPAM further authorizes the FTC to establish a national “Do-Not-E-Mail” registry akin to the recently-adopted Do Not Call Registry. Any entity that sends commercial
email messages, such as our various subsidiaries, and those who re-transmit such messages, must adhere to the CAN-SPAM requirements. Compliance with these provisions may limit our ability to send certain types of emails on our own behalf, which may adversely affect our business. While we intend to operate our businesses in a manner that complies with the CAN-SPAM provisions, we may not be successful in so operating. If it turns out we have violated the provisions of CAN-SPAM, we may face litigation with the FTC or face civil penalties, which could adversely affect our business.
The European Union Directive on the Protection of Personal Data may affect our ability to make our websites available in Europe if we do not afford adequate privacy to European users. Similar legislation was recently passed in other jurisdictions and may have a similar effect. Legislation governing privacy of personal data provided to internet companies is in various stages of development and implementation in other countries around the world and could affect our ability to make our e-commerce webpages available in those countries as future legislation is made effective.
Discontinued Operations
On November 5, 2008, the Company sold its CCS business to Foot Locker, Inc. for $103.2 million. As a result of this transaction, the results of the CCS business have been reported as discontinued operations for fiscal 2009, fiscal 2008, and fiscal 2007. In discontinued operations, the Company has reversed its allocation of shared services to the CCS business and has charged discontinued operations with the administrative and distribution expenses that were attributable to CCS. Also, as part of the transaction, dELiA*s, Inc. provided certain transition services to Foot Locker.
The Company recorded a pre-tax gain of $49.4 million as a result of the sale of CCS. The gain reflected, in part, the allocation of $28.1 million of nondeductible goodwill to the CCS business.
Income from discontinued operations, net of taxes was $16,000, $29.8 million, and $10.0 million for fiscal 2009, fiscal 2008, and fiscal 2007, respectively.
Relationship with JLP Daisy, LLC
In February 2003, dELiA*s Brand LLC, a subsidiary of dELiA*s Corp., entered into a master license agreement with JLP Daisy to license the dELiA*s brand on an exclusive basis for wholesale distribution in certain product categories, primarily in mid- and upper-tier department stores. dELiA*s Brand LLC received a $16.5 million cash advance against future royalties from the licensing ventures. The master license agreement provides that JLP Daisy is entitled to retain all of the royalty income generated from the sale of licensed products until JLP Daisy recoups its advance plus one-third of a preferred return of 18% per year on the unrecouped advance, if ever. Thereafter, we will receive an increasing share of the royalties until JLP Daisy recoups its advance plus a preferred return of 18% per year on the unrecouped advance, at which time we will receive a majority of the royalty stream after brand management fees. The initial term of the master license agreement is approximately 10 years, which is subject to an extension of up to five years under specified circumstances and further will remain in effect until JLP Daisy recoups its advance and preferred return. The master license agreement provides that the advance will be recoupable by JLP Daisy solely out of its share of the royalty payments and not through recourse against dELiA*s Brand LLC, us or any of our properties or assets. The master license agreement may be terminated early under certain circumstances, including, at our option, upon payment to JLP Daisy of an amount based upon royalties received from the sale of the licensed products during a specified period. In addition, dELiA*s Brand LLC granted to JLP Daisy a security interest in the dELiA*s trademarks, although the only event that would entitle JLP Daisy to exercise its rights with respect to these trademarks is a termination or rejection of the master license agreement in a bankruptcy proceeding. We have not recorded any amounts associated with the master license agreement.
Employees
As of January 30, 2010, we had 644 full-time and 2,297 part-time employees. Of the 644 full-time employees, 189 worked in warehouse/fulfillment/customer service; 177 worked in executive, finance, information technology and other corporate and division management and 278 were employed by our dELiA*s retail stores. Of the 2,297 part-time employees, 99 were warehouse/fulfillment/customer service staff and 2,198 were part-time associates at dELiA*s retail stores. None of our employees are covered by a collective bargaining agreement. We consider relations with our employees to be good.
Website Access to Reports
Our corporate website is www.deliasinc.com. Our periodic and current reports are available free of charge on the “Investor Relations” page of this website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC.
Item 1A.
Item 1A. Risk Factors
Risks Related to Our Business
We have a history of operating losses from continuing operations.
We incurred losses from continuing operations for the last five fiscal years. Although we expect to report net profits in the future, our expectations may not be realized and we may continue to experience losses as we continue our retail store expansion program, expand into new geographic markets and continue to maintain the operational and regulatory compliance obligations applicable to a public company. If our revenue grows more slowly than we anticipate, or if our operating expenses are higher than we expect, we may not be able to become profitable, in which case our financial condition would be adversely affected and our stock price could decline.
Our ability to achieve profitability will also depend on our ability to manage and control operating expenses and to generate and sustain increased levels of revenue. We expect to incur significant operating expenses and capital expenditures, including general and administrative costs to support our operations and the costs of being a public company. We also may incur significant increases in operating expenses and capital expenditures in connection with our retail store expansion program.
Additionally, we base our expenses in large part on our operating plans, current business strategies and future revenue projections. Many of our expenses, such as our retail store lease expenses, are fixed in the short term, and we may not be able to quickly reduce expenses and spending if our revenues are lower than we project. In addition, we may find that our costs to maintain or expand our operations, and in particular the costs to purchase inventory, produce our catalogs and build, outfit and employ personnel for our new retail stores, are more expensive than we currently anticipate. Therefore, the magnitude and timing of these expenses may contribute to fluctuations in our quarterly operating results.
We may fail to use our databases and our expertise in marketing to consumers successfully, and we may not be able to maintain the quality and size of our databases.
The effective use of our consumer databases and our expertise in marketing to consumers are important components of our business. If we fail to capitalize on these assets, our business will be less successful. Currently, we have useful data for only a portion of our targeted market. Additionally, as individuals in our databases age, they are less likely to purchase our products and their data is thus of less value to our business. We must, therefore, continuously obtain data on new potential customers and on those persons who are just entering their teenage years in order to maintain and increase the size and value of our databases. If we fail to obtain sufficient numbers of new names and related information, our business could be adversely affected.
The current financial crisis and general economic conditions may adversely impact our results of operations.
Declines in discretionary spending, the availability of consumer credit and consumer confidence may adversely affect our performance. Recent turmoil in worldwide financial markets, accompanied by recessionary domestic and foreign economies, high unemployment rates, increases in fuel, energy and other costs, conditions in the residential real estate and mortgage markets, reductions in available disposable income and access to consumer credit, as well as a lack of consumer confidence in the United States’ economy may all adversely affect consumer spending behavior. As a retailer, our businesses are sensitive to consumer spending patterns and preferences. Our revenues and gross margins from continuing operations have increased during the current fiscal year, and our operating losses from continuing operations have narrowed. However, consumer purchases of discretionary items and retail products have weakened and may continue to decline as a result of the factors noted above, among others. Therefore, our sales, profitability and growth may continue to be adversely affected by the ongoing unfavorable economic conditions. There are no guarantees that present or future government programs will help bring an end to the current economic recession or stabilize factors that may affect our sales and profitability. The length of the current economic downturn cannot be determined and may continue to impact consumer purchases of our merchandise and, accordingly, may adversely impact our results of operations.
Uncertain global economic conditions could have a material adverse effect on the Company’s liquidity and capital resources.
The distress in the financial markets has resulted in extreme volatility in security prices and diminished liquidity and credit availability, and there can be no assurance that our liquidity will not be affected by changes in the financial markets and the global economy or that our capital resources will at all times be sufficient to satisfy our liquidity needs. Although we believe that our existing cash and cash equivalents, cash provided by operations and availability under our Letter of Credit Agreement will be adequate to satisfy our capital needs at least for our current fiscal year, any renewed tightening of the credit markets could make it more difficult for us to access funds, enter into agreements for new indebtedness or obtain funding through the issuance of our securities.
We have significant amounts of cash and cash equivalents invested in money market funds or in deposit accounts at FDIC-insured banks. Some, but not all, of our deposit account balances are currently FDIC insured. With the current financial environment and the instability of financial institutions, we cannot be assured that we will not experience losses on our deposits.
Our agreement with Alloy, Inc. to jointly own our database information may make that information less valuable to us.
We and Alloy, Inc. have agreed that we will jointly own all data collected by dELiA*s and Alloy (excluding credit card data), subject to applicable laws and privacy policies, although Alloy, Inc. has agreed not to provide certain of this data to our competitors, with some limited exceptions. We have full access to all of the data, but we have agreed not to use any of the data other than in connection with our merchandising and retail store activities, except in limited situations. Nevertheless, because we and Alloy, Inc. now jointly own this database information, certain actions that Alloy, Inc. could take, such as breaching its contractual covenants, could result in our losing a significant portion of the competitive advantage we believe our databases provide to us. In such event, our business and results of operations could be adversely affected. In addition, because we have agreed to limitations on our use of that data, we will be unable to sell or license any of that data to third parties, which limits our ability to earn income from that data.
Our success depends largely on the value of our brands, and if the value of our brands were to diminish, our sales are likely to decline.
The prominence of dELiA*s and Alloy catalogs and e-commerce webpages and our dELiA*s specialty retail stores among our teenage target market are integral to our business as well as to the implementation of our
strategies for expanding our business. Maintaining, promoting and positioning our brands will depend largely on the success of our marketing and merchandising efforts and our ability to provide a consistent, high quality customer experience. Moreover, we anticipate that we will continue to increase the number of customers we target, through means that could include broadening the intended audience of our existing brands or creating related businesses with new retail concepts. Misjudgments by us in this regard could damage our existing or future brands. Any adverse affects on our current or future brands could result in decreases in sales.
If we fail to anticipate, identify and respond to changing fashion trends, customer preferences and other fashion-related factors, our sales are likely to decline.
Customer tastes and fashion trends are volatile and tend to change rapidly. Our success depends in part on our ability to effectively predict and respond to changing fashion tastes and consumer demands, and to translate market trends into appropriate, saleable product offerings in a timely manner. If we are unable to successfully predict or respond to changing styles or trends and misjudge the market for our products, our sales may be lower, and we may be faced with unsold inventory. In response, we may be forced to rely on additional markdowns or promotional sales to dispose of excess or slow-moving inventory, which may have a material adverse effect on our financial condition or results of operations.
Our dELiA*s retail store expansion strategy depends on our ability to open and operate a certain number of new stores each year, which could strain our resources and cause the performance of our existing operations to suffer.
Our dELiA*s retail store expansion strategy will largely depend on our ability to find sites for, open and operate new stores successfully. Our ability to open and operate new stores successfully depends on several factors, including, among others, our ability to:
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identify suitable store locations, the availability of which is outside our control;
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negotiate acceptable lease terms;
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prepare stores for opening within budget;
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source sufficient levels of inventory at acceptable costs to meet the needs of new stores;
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hire, train and retain store personnel;
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successfully integrate new stores into our existing operations;
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contain payroll costs; and
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generate sufficient operating cash flows or secure adequate capital on commercially reasonable terms to fund our expansion plans.
Any failure to successfully open and operate our new stores could have a material adverse effect on our results of operations. In addition, our proposed retail store expansion program will place increased demands on our operational, managerial and administrative resources. These increased demands could cause us to operate our business less effectively, which, in turn, could cause deterioration in the financial performance of our individual stores and our overall business.
Our catalog response rates may decline
The number of customers who make purchases from catalogs that we mail to them, which we refer to as “response rates,” may decline due to, among other things, our ability to effectively predict and respond to changing fashion tastes and consumer demands and translate market trends into appropriate, saleable product offerings in a timely manner. Response rates also usually decline when we mail additional catalog editions to the same customers within a short time period. In addition, there can be no assurance that our previously disclosed
strategic circulation cuts will enable us to improve or maintain our response rates. We also have mailed our Alloy catalogs to selected dELiA*s catalog customers and our dELiA*s catalogs to selected Alloy catalog customers (which practice we refer to as cross-mailing), which has resulted in generally lower response rates from the dELiA*s catalogs customers who also are sent Alloy catalogs and vice-versa. Additional cross-mailings of such catalogs could result in further such response rate declines. Although it is our expectation that the additional sales generated by such cross-mailing will more than offset the declines in response rate, we can give no assurance that these expectations will be realized. If we are mistaken, these trends in response rates are likely to have a material adverse effect on our rate of sales growth and on our profitability and could have a material adverse effect on our business.
Traffic to our e-commerce webpages may decline, resulting in fewer purchases of our products. Additionally, the number of e-commerce visitors that we are able to convert into purchasers may decline.
In order to generate online customer traffic, we depend heavily on mailed catalogs, outbound emails and an affiliates program in which we pay third parties for traffic referred from their websites to our e-commerce webpages. Our sales volume and e-commerce webpage traffic generally may be adversely affected by, among other things, declines in the number and frequency of our catalog mailings, reductions in outbound emails and declines in referrals from third parties. Our sales volume may also be adversely affected by economic downturns, system failures and competition from other internet and non-internet retailers.
In addition, the number of e-commerce visitors that we are able to convert into purchasers may decline due to, among other things, our inability to effectively predict and respond to changing fashion tastes and consumer demands and translate market trends into appropriate, saleable product offerings in a timely manner and our inability to keep up with new technologies and e-commerce features. The internet and the e-commerce industry are subject to rapid technological change. If competitors introduce new features and website enhancements embodying new technologies, or if new industry standards and practices emerge, our existing e-commerce webpages, the www.delias.com and www.alloy.com websites that Alloy, Inc. maintains and which link to our e-commerce webpages, and our respective systems may become obsolete or unattractive. Developing our e-commerce webpages and other systems entails significant technical and business risks. We may face material delays in introducing new services, products or enhancements. If this happens, our customers may forego the use of our e-commerce webpages and use websites and e-commerce pages of our competitors. We may use new technologies ineffectively, or we may fail to adequately adapt our website, our transaction processing systems and our computer network to meet customer requirements or emerging industry standards.
We do not own the content websites that direct customers to our e-commerce webpages, and thus have to depend on Alloy, Inc. to maintain those websites as attractive sites for our target customers.
Pursuant to an agreement with Alloy, Inc., they will continue to own and operate the www.delias.com and www.alloy.com websites, the related e-commerce webpages and the related uniform resource locators (“urls”). Although we may transition our e-commerce operations to websites that we own, we will be required to maintain links from those websites to Alloy, Inc.-owned websites, and Alloy, Inc. will be required to maintain links from those websites to our websites. Alloy, Inc. will continue to provide the community and content on each of those websites, and we will have no control over any of such community or content. Because a significant portion of our direct marketing sales come from our e-commerce sites, if Alloy, Inc. fails to maintain those websites, or fails to maintain those websites as attractive sites for the target audiences, our e-commerce activities may suffer.
Because we experience seasonal fluctuations in our revenues, our quarterly results may fluctuate.
Our business is seasonal, reflecting the general pattern of peak sales for teen clothing and accessories, which provide the majority of our sales during the back-to-school and holiday shopping seasons. Typically, a larger portion of our revenues are obtained during our third and fourth fiscal quarters. Any significant decrease in sales during the back-to-school and winter holiday seasons would have a material adverse effect on our financial
condition and results of operations. In addition, in order to prepare for the back-to-school and holiday shopping seasons, we must order and keep in stock significantly more merchandise than we carry during other parts of the year, and we must hire temporary workers and incur additional staffing costs in our warehouse and retail stores to meet anticipated sales demand. If sales for the third and fourth quarters do not meet anticipated levels, then increased expenses may not be offset, which could decrease our profitability. Additionally, any unanticipated decrease in demand for our products during these peak seasons could require us to sell excess inventory at a substantial markdown, which could decrease our profitability.
Our liquidity and ability to raise capital may be limited, and we may be unable to fund our retail store expansion program.
We expect that our total capital expenditures, net of landlord allowances, primarily the costs to build out our new stores, will be approximately $6.5 million in fiscal 2010. Although, we currently expect that the sum of our current cash on hand and our current cash flows from operations will be sufficient to fund our near-term operations, including but not limited to, retail store openings, our expectations may be wrong. If we are wrong, we may need to obtain additional debt or equity financing in the future to fund fully our operations and our retail store expansion strategy. In addition, if we decide to significantly accelerate growth of our retail operations beyond the ranges stated in our retail strategy, additional debt or equity financing may also be required. The type, timing and terms of the financing selected by us would depend on, among other things, our retail growth plans, our cash needs, the availability of other financing sources and prevailing conditions in the financial markets. These sources may not be available to us or, if available, may not be available to us on satisfactory terms.
Competition may adversely affect our business.
The teenage girl retail apparel industry is highly competitive, with fashion, quality, price, location, in-store environment and service being the principal competitive factors. We compete for retail store sales with specialty apparel retailers and certain other youth-focused apparel retailers, such as American Eagle Outfitters, Abercrombie & Fitch, Hollister, Forever 21, and H&M. We also compete for retail store sales with full price and discount department stores such as Target, Nordstrom’s, Macy’s, Bloomingdale’s and others. If we are unable to compete effectively for retail store sales, we may lose market share, which would reduce our revenues and gross profit. In addition, we compete for favorable site locations and lease terms in shopping malls with certain of our competitors as well as numerous other retailers. Many of our competitors are large national chains, which have substantially greater financial, marketing and other resources than we do. The growth of our retail store business depends significantly on our ability to operate stores in desirable locations with capital investments and lease costs that allow us to earn a return that meets or exceeds our financial projections. Desirable new locations may not be available to us at all or at reasonable costs. In addition, we must be able to renew our existing store leases on terms that meet our financial targets. Our failure to secure favorable real estate and lease terms generally and upon renewal, or even being permitted to renew our expiring leases, could cause us to lose market share which would reduce our revenues and gross profit.
Many of our existing competitors, as well as potential new competitors in our target markets, have longer operating histories, greater brand recognition, larger customer bases and significantly greater financial, technical and marketing resources than we do. These advantages allow our competitors to spend considerably more on marketing and may allow them to use their greater resources more effectively than we can use ours. Accordingly, these competitors may be better able to take advantage of market opportunities and be better able to withstand market downturns than us. If we fail to compete effectively, our business will be materially and adversely affected.
Our ability to attract customers to our retail stores depends heavily on the success of the shopping malls in which our stores are located. Any decrease in customer traffic in those malls could negatively impact our sales.
Customer traffic in our retail stores depends heavily on locating our stores in prominent locations within successful shopping malls. Sales are derived, in part, from the volume of traffic in those malls. Our stores benefit from the ability of other tenants in the malls to generate consumer traffic in the vicinity of our stores and the continuing popularity of malls as shopping destinations. Our sales volume and mall traffic generally may be adversely affected by, among other things, economic downturns in a particular area, competition from internet retailers, non-mall retailers and other malls and the closing or decline in popularity of other stores in the malls in which our retail stores are located. A reduction in mall traffic for any reason could have a material adverse effect on our business, results of operations and financial condition.
Closing stores could result in significant costs to us.
Although we expect to increase our retail square footage by approximately 6% in fiscal 2010 and contemplate opening additional new dELiA*s stores in future years as part of our retail store expansion plan, we could, in the future, decide to close dELiA*s retail stores or close or sell businesses or operations that are producing losses or that are not as profitable as we expect. If we decide to close any dELiA*s stores before the expiration of their lease terms, we may incur payments to landlords to terminate or “buy out” the remaining term of the lease. We also may incur costs related to the employees at such stores, whether or not we terminate the leases early. Upon any such closure or sale, the closing costs, fixed assets, and inventory write-downs would adversely affect our earnings and could adversely affect our cash on hand.
Our dELiA*s exclusive branding activities could lead to increased inventory obsolescence.
Our promotion and sale of dELiA*s branded products increases our exposure to risks of inventory obsolescence. Accordingly, if a particular style of product does not achieve widespread consumer acceptance, we may be required to take significant markdowns, which could have a material adverse effect on our gross profit margin and other operating results. Moreover, dELiA*s exclusive brand development plans may include entry into joint ventures and additional licensing or distribution arrangements, which may limit our control of these operations.
Our master license agreement with JLP Daisy LLC could cause us to lose our trademarks or otherwise adversely affect the value of our dELiA*s brand.
In February, 2003, one of our subsidiaries, dELiA*s Brand, LLC, entered into a master license agreement with JLP Daisy LLC (“JLP Daisy”) to license our dELiA*s brand on an exclusive basis for wholesale distribution in certain product categories, primarily in mid and upper-tier department stores, in exchange for an up-front payment from JLP Daisy of $16.5 million, which is applied against royalties otherwise due from JLP Daisy for sales of dELiA*s branded merchandise. The initial term of the master license agreement is approximately 10 years, which is subject to extension under specified circumstances and further will remain in effect until JLP Daisy recoups its advance and preferred return. As part of the master license agreement, dELiA*s Brand, LLC granted to JLP Daisy a security interest in the dELiA*s trademarks, although the only event that would entitle JLP Daisy to exercise its rights with respect to these trademarks is a termination or rejection of the master license agreement in a bankruptcy proceeding. If we become subject to a bankruptcy proceeding, we could lose the rights to our dELiA*s trademarks, which could have a material adverse effect on our business and operating results.
Additionally, because sales of dELiA*s branded products by JLP Daisy’s licensees have been significantly less than we and JLP Daisy expected when we entered into the master license agreement, we expect that JLP Daisy may try to increase the sales of the dELiA*s branded products by its licensees, by expanding the number of licensed products their licensees offer, the number and type of stores in which such licensed products are sold, or both, so that they can recoup more of their initial advance. Sales of dELiA*s branded products by JLP Daisy’s
licensees may negatively impact our customers’ image of the brand, which could have a material adverse effect on our profit margins and other operating results. Additionally, a change in our customers’ image of the brand due to sales of dELiA*s branded products by JLP Daisy’s licensees to greater numbers of retailers may negatively affect our dELiA*s retail store expansion plans.
We depend largely upon a single call center and a single distribution facility.
The call center functions for our dELiA*s and Alloy catalogs and e-commerce webpages are handled from a single, leased facility in Westerville, Ohio. The distribution for our dELiA*s and Alloy catalogs and e-commerce webpages and all our dELiA*s retail stores are handled from a single, owned facility in Hanover, Pennsylvania. Any significant interruption in the operation of the call center or distribution facility due to natural disasters, accidents, system failures, expansion or other unforeseen causes could delay or impair our ability to receive orders and distribute merchandise to our customers and retail stores, which could cause our sales to decline. This could have a material adverse effect on our operations and results.
We depend upon a single co-location facility to connect to the internet in connection with our e-commerce webpages.
We connect to the internet through a single co-location facility in connection with our e-commerce webpages. Any significant interruption in the operations of this facility due to natural disasters, accidents, systems failures, expansion or other unforeseen causes could have a material adverse effect on our operations and results.
We may be required to recognize impairment charges.
Pursuant to generally accepted accounting principles, we are required to perform impairment tests on our identifiable intangible assets with indefinite lives, including goodwill, annually or at any time when certain events occur, which could impact the value and earnings of our business segments. Our determination of whether impairment has occurred is based on a comparison of the assets’ fair market values with the assets’ carrying values. Significant and unanticipated changes could require a provision for impairment in a future period that could substantially affect our reported earnings in a period of such change.
Additionally, pursuant to generally accepted accounting principles, we are required to recognize an impairment loss when circumstances indicate that the carrying value of long-lived tangible and intangible assets with finite lives may not be recoverable. Management’s policy in determining whether an impairment indicator exists (i.e., a triggering event) comprises measurable operating performance criteria as well as qualitative measures. If a determination is made that a long-lived asset’s carrying value is not recoverable over its estimated useful life, the asset is written down to estimated fair value, if lower. The determination of fair value of long-lived assets is generally based on estimated expected discounted future cash flows, which is generally measured by discounting expected future cash flows identifiable with the long-lived asset at our weighted-average cost of capital. We have recognized impairment charges of approximately $454,000 in fiscal 2009 for one store location and $613,000 in fiscal 2008 for two store locations.
If our manufacturers and importers are unable to produce our proprietary-branded goods on time or to our specifications, we could suffer lost sales.
We do not own or operate any manufacturing facilities and, therefore, depend upon independent third party vendors for the manufacture of all of our branded products. Our products are manufactured to our specifications primarily by domestic manufacturers and importers. We cannot control all of the various factors, which include inclement weather, natural disasters, labor disputes and acts of terrorism that might affect the ability of a manufacturer or importer to ship orders of our products in a timely manner or to meet our quality standards. Late delivery of products or delivery of products that do not meet our quality standards could cause us to miss the delivery date requirements of our customers or delay timely delivery of merchandise to our retail stores for those
items. These events could cause us to fail to meet customer expectations, cause our customers to cancel orders or cause us to be unable to deliver merchandise in sufficient quantities or of sufficient quality to our stores, which could result in lost sales.
We rely on third-party vendors for brand-name merchandise sold by our two brands.
Our Alloy business depends largely on the ability of third-party vendors and their subcontractors or suppliers to provide us with current-season, brand-name apparel and other merchandise at competitive prices, in sufficient quantities, manufactured in compliance with all applicable laws and of acceptable quality. Our dELiA*s brand is similarly dependent on such third-parties, albeit to a lesser extent. We do not have any long-term contracts with any vendor and are not likely to enter into these contracts in the foreseeable future. In addition, many of the smaller vendors that we use are factored and have limited resources, production capacities, and operating histories. Additionally, because the fashion market is volatile and customer taste tends to change rapidly, we must, in order to be successful, identify and obtain merchandise from new third-party brands for which our customers show a preference. As a result, we are subject to the following risks:
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our key vendors may fail or be unable to expand with us;
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we may lose or cease doing business with one or more key vendors;
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our current vendor terms may be changed to require increased payments in advance of delivery, and we may not be able to fund such payments through our current credit facility, cash balances, or our cash flow;
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we may not be able to identify or obtain products from new “hot” brands preferred by our customers; and
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our ability to procure products in sufficient quantities may be limited.
Interruption in our or our vendors’ foreign sourcing operations could disrupt production, shipment or receipt of our merchandise, which would result in lost sales and could increase our costs.
We believe, based on the country of origin tags that appear on the products we sell, that a substantial portion of the products sold to us by our third-party vendors and domestic importers are produced in factories located in foreign countries, especially in China and other Asian countries. Any event causing a sudden disruption of manufacturing or imports from Asia or elsewhere, including, but not limited to, the imposition of import restrictions, could materially harm our operations. Many of our and our vendor’s imports are subject to existing or potential duties, tariffs or quotas that may limit the quantity of certain types of goods that may be imported into the United States from countries in Asia or elsewhere. We and our vendors compete with other companies for production facilities and import quota capacity. Our and our vendors’ businesses are also subject to a variety of other risks generally associated with doing business abroad, such as political instability, currency and exchange risks, disruption of imports by labor disputes (both in other countries and in the United States, such as the west coast ports) and local business practices.
Ours and our vendors’ foreign sourcing operations may also be hurt by political and financial instability, strikes, health concerns regarding infectious diseases in countries in which our merchandise is produced, adverse weather conditions or natural disasters that may occur in Asia or elsewhere or acts of war or terrorism in the United States or worldwide. Our future operations and performance will be subject to these factors, which are beyond our control, and these factors could materially hurt our business, financial condition and results of operations or may require us to modify our current business practices and incur increased costs.
We must effectively manage our vendors to minimize inventory risk and maintain our margins.
We seek to avoid maintaining high inventory levels in an effort to limit the risk of outdated merchandise and inventory write-downs. If we underestimate quantities demanded by our customers and our vendors cannot restock, then we may disappoint customers who may then turn to our competitors. We require many of our
vendors to meet minimum restocking requirements, but if our vendors cannot meet these requirements and we cannot find alternate vendors, we could be forced to carry more inventory than we have in the past or we could have a loss in sales. Our risk of inventory write-downs would increase if we were to hold large inventories of merchandise that prove to be unpopular.
We rely on third parties for some essential business operations and services, and disruptions or failures in service or changes in terms may adversely affect our ability to deliver goods and services to our customers.
We currently depend on third parties for important aspects of our business, such as printing, shipping, paper supplies and operation of our e-commerce webpages. We have limited control over these third parties, and we are not their only client. In addition, we may not be able to maintain satisfactory relationships with any of these third parties on acceptable commercial terms. Further, we cannot be certain that the quality or cost of products and services that they provide will remain at current levels or the levels needed to enable us to conduct our business efficiently and effectively.
Increases in costs of shipping, mailing, paper and printing may adversely affect our business.
Postal rate and other shipping rate increases, as well as increases in paper and printing costs, affect the cost of our order fulfillment and catalog mailings. We rely heavily on quantity discounts in these areas. No assurances can be given that we will continue to receive these discounts and that we will not be subject to additional increases in costs in excess of those already announced. Any increases in these costs will have a negative impact on earnings to the extent we are unable or do not pass such increases on directly to customers or offset such increases by raising selling prices or by implementing more efficient printing, mailing and delivery alternatives.
We depend on our key personnel to operate our business, and we may not be able to hire enough additional management and other personnel to manage our growth.
Our performance is substantially dependent on the continued efforts of our executive officers and other key employees. The loss of the services of any of our executive officers or key employees could adversely affect our business. Additionally, we must continue to attract, retain and motivate talented management and other highly skilled employees to be successful. We must also hire and train store managers to support our retail expansion. We may be unable to retain our key employees or attract, assimilate and retain other highly qualified employees in the future.
We may be required to collect sales tax on our direct marketing operations.
At present, with respect to sales generated in the direct marketing segment by our Alloy brand, sales tax or other similar taxes on direct shipments of goods to consumers is only collected in states where Alloy has a physical presence or personal property. With respect to the dELiA*s direct sales, sales or other similar taxes are collected only in states where we have dELiA*s retail stores, another physical presence or personal property. However, various states or foreign countries may seek to impose sales tax collection obligations on out-of-state direct mail companies.
A successful assertion by one or more states that we or one or more of our subsidiaries should have collected or should be collecting sales taxes on the direct sale of our merchandise could have a material adverse effect on our business.
We could face liability from, or our ability to conduct business could be adversely affected by, government and private actions concerning personally identifiable data, including privacy.
Our direct marketing business is subject to federal and state regulations regarding the collection, maintenance and disclosure of personally identifiable information we collect and maintain in our databases. If we do not comply, we could become subject to liability. While these provisions do not currently unduly restrict our
ability to operate our business, if those regulations become more restrictive, they could adversely affect our business. In addition, laws or regulations that could impair our ability to collect and use user names and other information on the e-commerce webpages may adversely affect our business. For example, COPPA currently limits our ability to collect personal information from website visitors who may be under age 13. Further, claims could also be based on other misuse of personal information, such as for unauthorized marketing purposes. If we violate any of these laws, we could face civil penalties. In addition, the attorneys general of various states review company websites and their privacy policies from time to time. In particular, an attorney general may examine such privacy policies to assure that the policies overtly and explicitly inform users of the manner in which the information they provide will be used and disclosed by the Company. If one or more attorneys general were to determine that our privacy policies fail to conform with state law, we also could face fines or civil penalties, any of which could adversely affect our business.
We could face liability for information displayed in our catalogs or displayed on or accessible via e-commerce webpages and our other websites.
We may be subjected to claims for defamation, negligence, copyright or trademark infringement or based on other theories relating to the information we publish in any of our catalogs, on our e-commerce webpages and on any of our other websites. These types of claims have been brought, sometimes successfully, against similar companies in the past. Based upon links we provide to third-party websites, we could also be subjected to claims based upon online content we do not control that is accessible from our e-commerce webpages.
We may be liable for misappropriation of our customers’ personal information.
If third parties or unauthorized employees of ours are able to penetrate our network security or otherwise misappropriate our customers’ personal information or credit card information, or if we give third parties or our employees improper access to our customers’ personal information or credit card information, we could be subject to liability. This liability could include claims for unauthorized purchases with credit card information, impersonation or other similar fraud claims. This liability could also include claims for other misuse of personal information, including unauthorized marketing purposes. Liability for misappropriation of this information could decrease our profitability.
In addition, the Federal Trade Commission and state agencies have been investigating various internet companies regarding their use of personal information. We could incur additional expenses if new regulations regarding the use of personal information are introduced or if government agencies investigate our privacy practices.
We rely on encryption and authentification technology licensed from third parties to provide the security and authentication necessary to effect secure transmission of confidential information such as customer credit card numbers. Advances in computer capabilities, new discoveries in the field of cryptology or other events or developments may result in a compromise or breach of the algorithms that we use to protect customer transaction data. If any such compromise of our security were to occur, it could subject us to liability, damage our reputation and diminish the value of our brands. A party who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations. We may be required to expend significant capital and other resources to protect against such security breaches or to alleviate problems caused by such breaches. Our security measures are designed to prevent security breaches, but our failure to prevent such security breaches could subject us to liability, damage our reputation and diminish the value of our brands and cause our sales to decline.
Our ability to meet our cash requirements depends on many factors.
We currently anticipate that operating revenue, cash on hand, and letters of credit available under our existing Letter of Credit Agreement will be sufficient to cover our operating expenses, including cash requirements in connection with our operations and our near term retail store expansion plan, through at least the
end of our current fiscal year. If we do not meet our targets for revenue growth, however, or if the costs associated with our retail store expansion plan exceed our expectations, our current sources of funds may be insufficient to meet our cash requirements. We may fail to meet our targets for revenue growth for a variety of reasons, including:
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decreased consumer spending in response to weak economic conditions;
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higher energy prices causing a decreased level of disposable income;
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weakness in the teenage market;
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increased competition from our competitors; and
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because our marketing and expansion plans are not as successful as we anticipate.
Additionally, if demand for our products decreases or our retail store expansion plan does not produce the desired sales increases, such developments could reduce our operating revenues. If such funds, together with cash on hand and availability under our Letter of Credit Agreement are insufficient to cover our expenses, we could be required to adopt one or more alternatives listed below. For example, we could be required to:
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delay the implementation of or revise certain aspects of our retail store expansion plan;
•
reduce or delay other capital spending;
•
sell additional equity or debt securities;
•
sell assets or operations; and/or
•
reduce other discretionary spending.
If we are required to take any of these actions, it could have a material adverse effect on our business, financial condition and results of operations, including our ability to grow our business. In addition, we cannot assure you that we would be able to take any of these actions because of (i) a variety of commercial or market factors, or (ii) market conditions being unfavorable for an equity or debt offering. In addition, such actions, if taken, may not enable us to satisfy our cash requirements if the actions do not generate a sufficient amount of additional capital.
Because we are required to provide letters of credit to lenders of many of our vendors, the amount of unrestricted cash is reduced.
The credit extended by these factors often is collateralized by standby letters of credit, which we are required to provide and which we currently obtain under our letter of credit agreement with Wells Fargo. Any increases in the amount of such letters of credit required by such factors reduces, at a rate of 105% of the increase, the amount of unrestricted cash we have available for capital expenditures and general working capital purposes. Any increase in our vendors’ use of factors or decrease in the amount of credit extended by these factors could require us to provide additional standby letters of credit, thereby reducing further the amount of unrestricted cash available. Any such decreases could adversely affect our ability to operate our business, including funding our retail store expansion program or could require us to reduce other discretionary spending, such as on advertising. Any such event could result in reduced sales.
Our inability or failure to protect our intellectual property or our infringement of other’s intellectual property could have a negative impact on our operating results.
Our trademarks are valuable assets that are critical to our success. The unauthorized use or other misappropriation of our trademarks, or the inability for us to continue to use any current trademarks, could diminish the value of our brands and have a negative impact on our business. We are also subject to the risk that we may infringe on the intellectual property rights of third parties. Any infringement or other intellectual property claim made against us, whether or not it has merit, could be time-consuming, result in costly litigation, cause product delays or require us to pay royalties or license fees. As a result, any such claim could have a material adverse effect on our operating results.
In addition, with respect to certain Alloy trademarks and servicemarks, we and Alloy, Inc. have become joint owners by assignment of such trademarks and servicemarks. We and Alloy, Inc. have filed instruments with the PTO to request that the PTO divide these jointly owned trademarks and servicemarks between us such that we each would own the registrations for those trademarks and servicemarks for the registration classes covering the goods and services applicable to our respective businesses. We cannot make assurances that the PTO will grant such request, and, in such event, we would need to enter into long-term agreements with Alloy, Inc., regarding our respective use of those trademarks and servicemarks. We may have a more difficult time enforcing our rights arising out of any breach by Alloy, Inc. of any such agreement than we would enforcing an infringement of our trademarks were the PTO to grant the requested division. In such event, our business and results of operations could be adversely affected.
The bankruptcy or significant deterioration of large commercial and retail landlords could have a material adverse affect on our sales and overall retail strategy.
The current economic downturn has had a significant negative impact on the commercial real estate sector, including large commercial and retail landlords, such as one of our major national landlords, General Growth Properties, Inc. (“GGP”) and many of its affiliates (collectively “GGP Debtors”), which filed petitions for reorganization relief under Chapter 11 of the U.S. Bankruptcy Code. If the current macro-economic conditions continue or deteriorate further, additional commercial landlords may be similarly impacted which in turn could materially adversely impact our sales and operating results.
Risks Related to the Spinoff
We may have potential business conflicts with Alloy, Inc. with respect to our past and ongoing relationships.
Potential business conflicts may arise between Alloy, Inc. and us in a number of areas relating to our past and ongoing relationships, including:
•
labor, tax, employee benefit, pending litigation, indemnification and other matters arising from our separation from Alloy, Inc.;
•
intellectual property matters;
•
joint database ownership and management;
•
sales by Alloy, Inc. of all or any portion of its assets to another party, or merger or consolidation of Alloy, Inc. with another party, which could be to or with one of our competitors; and
•
the nature, quantity, quality, time of delivery and pricing of services we supply to each other under our various agreements with Alloy, Inc.
We may not be able to resolve any potential conflicts. Even if we do so, however, because Alloy, Inc. will be performing a number of services and functions for us, they will have leverage with negotiations over their performance that may result in a resolution of such conflicts that may be less favorable to us than if we were dealing with another third party.
If the Spinoff was not a legal dividend, it could be held invalid by a court and harm our financial condition and results of operations.
The Spinoff was subject to the provisions of Section 170 of the Delaware general corporate law that requires that dividends be made only out of available surplus. Although we believe that the Spinoff complied with the provisions of Section 170, and have received an opinion from outside counsel to that effect, a court could later determine that the Spinoff was invalid under Delaware law and reverse the transaction. The resulting complications, costs and expenses could harm our financial condition and results of operations.
Risks Related to our Common Stock
The price of our common stock may be volatile and you may lose all or a part of your investment.
The price of our common stock may fluctuate widely, depending upon a number of factors, many of which are beyond our control. For instance, it is possible that our future results of operations may be below the expectations of investors and, to the extent our company is followed by securities analysts, the expectations of these analysts. If this occurs, our stock price may decline. Other factors that could affect our stock price include the following:
•
the perceived prospects of our business and the teenage market as whole;
•
changes in analysts’ recommendations or projections, if any;
•
fashion trends;
•
changes in market valuations of similar companies;
•
actions or announcements by our competitors;
•
actual or anticipated fluctuations in our operating results;
•
litigation developments; and
•
changes in general economic or market conditions or other economic factors unrelated to our performance.
In addition, the stock markets have experienced significant price and trading volume fluctuations and the market prices of retail and catalog companies generally, and specialty retail and catalog companies, in particular, have been extremely volatile and have recently experienced sharp share price and trading volume changes. These broad market fluctuations may adversely affect the trading price of our common stock. In the past, following periods of volatility in the market price of a public company’s securities, securities class action litigation has often been instituted against that company. Such litigation could result in substantial costs to us and a likely diversion of our management’s attention.
Provisions of Delaware law and of our charter and by-laws and stockholder rights plan may make a takeover more difficult.
Provisions in our amended and restated certificate of incorporation and by-laws and in the Delaware corporation law may make it difficult and expensive for a third party to pursue a tender offer, change in control or takeover attempt that our management and board of directors oppose. Public stockholders that might wish to participate in one of these transactions may not have an opportunity to do so. For example, our amended and restated certificate of incorporation and by-laws contain provisions:
•
reserving to our board of directors the exclusive right to change the number of directors and fill vacancies on our board of directors, which could make it more difficult for a third party to obtain control of our board of directors;
•
authorizing the issuance of up to 25 million shares of preferred stock which can be created and issued by the board of directors without prior stockholder approval, commonly referred to as “blank check” preferred stock, with rights senior to those of our common stock, which could make it more difficult or expensive for a third party to obtain voting control;
•
establishing advance notice requirements for director nominations or other proposals at stockholder meetings; and
•
generally requiring the affirmative vote of holders of at least 70% of the outstanding voting stock to amend certain provisions of our amended and restated certificate of incorporation and by-laws, which could make it more difficult for a third party to remove the provisions we have included to prevent or delay a change of control.
In addition, we have adopted a stockholder rights plan that may prevent a change in control or sale of us in a manner or on terms not approved by our board of directors. These anti-takeover provisions could substantially impede the ability of public stockholders to benefit from a change in control or to change our management and board of directors.
We have a significant number of options outstanding which, if exercised, would dilute the equity interests of our existing stockholders and adversely affect earnings per share.
As of January 30, 2010, we had outstanding options, of which 4,789,779 were vested, to purchase 6,106,229 shares of common stock at a weighted average exercise price of $7.01 per share. From time to time, we may issue additional options to employees, non-employee directors and consultants pursuant to our equity incentive plans. Our stockholders will experience dilution as these stock options are exercised.
We could be required, under our agreements with Alloy, Inc., to issue a substantial number of shares without receiving any payment. The issuance of these shares would dilute the equity interests of our existing stockholders and adversely affect earnings per share.
Following the Spinoff, we were obligated to issue on behalf of Alloy, Inc. up to 663,155 additional shares of common stock upon the exercise of outstanding Alloy, Inc. warrants (the “Warrants”). At the time of the Spinoff, Alloy had outstanding $69.3 million of 5.375% convertible senior debentures due 2023 (the “Debentures”). Following the Spinoff, we were also obligated to issue up to 4,137,314 additional shares of common stock upon the conversion of the Debentures. In fiscal 2006, 4,053,933 shares of our common stock were issued as a result of these conversions. During fiscal 2008, an additional 82,508 were issued as a result of conversions, and 873 shares attributable to these debentures remain to be issued. We did not receive any payment from Alloy, Inc. or any third party in connection with any conversions of the Debentures. Additionally, although Alloy, Inc. has agreed to pay us a portion of the cash proceeds, if any, it receives from the exercise of any of the Warrants, each of the Warrants permits exercise by a “net exercise” process, under which the exercising holders would not be required to make any cash payment to Alloy, Inc. in connection with the Warrant exercise and instead would be issued a smaller number of shares of our and Alloy, Inc.’s common stock. If the Warrant holders were to exercise their Warrants using this net exercise feature, which is likely, we would not receive any payment in connection with such Warrant exercises. Thus, we may be obligated to issue up to 664,028 of additional shares of common stock for which we will receive no payment. If a significant number of additional shares of our common stock are issued, the equity interests of our existing stockholders would be diluted and our earnings per share will be adversely affected.
We do not intend to pay dividends on our common stock.
We have never declared or paid any cash dividend on our capital stock. We currently intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future. Any determination to pay dividends in the future will be made at the discretion of our board of directors and will depend on our results of operations, financial conditions, contractual restrictions imposed by applicable law and other factors our board deems relevant. Accordingly, investors must be prepared to rely on sales of their common stock after price appreciation to earn an investment return, which may never occur. If our common stock does not appreciate in value, or if our common stock loses value, our stockholders may lose some or all of their investment in our shares.
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2.
Item 2. Properties
The following table sets forth information as of January 30, 2010 regarding the principal facilities that we currently use in our business operations. Except for the property in Hanover, PA, which we own, all such facilities are leased. We believe our facilities are well maintained, in good operating condition and otherwise adequate for our business operations.
The following table sets forth information regarding the states in which we operate retail stores as of January 30, 2010, and the number of stores in each state.
Item 3.
Item 3. Legal Proceedings
(a) The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. Although the amount of any liability that could arise with respect to these actions cannot be determined with certainty, in the Company’s opinion, any such liability will not have a material adverse effect on its consolidated financial position, consolidated results of operations or liquidity.
(b) Mynk Litigation. The Company was a defendant in a litigation brought by Mynk Corporation (“Mynk”) in the Los Angeles Superior Court alleging non-payment for goods. The Company previously had a long-standing relationship with a supplier of goods, Femme Knits, Inc. (“Femme Knits”). Mynk contended that it acquired the right to completed orders for goods from Femme Knits as a result of an acquisition of that right at an alleged Uniform Commercial Code foreclosure sale. In accordance with an agreement between dELiA*s and Femme Knits, among other things, dELiA*s advanced the sum of $600,000 for some price and other concessions and an agreement that dELiA*s could offset against the $600,000 advance future amounts owing to Femme Knits
(Mynk). In July 2008, the Company recovered the advance by paying all other sums due on the purchase of goods from Femme Knits (Mynk) except for the $600,000 owed to it. Mynk contended that it was not bound by the agreement between dELiA*s and Femme Knits. In January 2010, the Company settled the lawsuit with Mynk. The settlement amount was not material to our consolidated financial statements.
Item 4.
Item 4. Reserved
Executive Officers of the Registrant
Robert E. Bernard, age 59, has served as our Chief Executive Officer and a director since December 2005. Mr. Bernard joined Alloy, Inc., a media and marketing services company and our former parent company, in October 2003 and served as Chief Executive Officer of its Retail and Direct Consumer Division until the Spinoff. From 1996 through 2002, Mr. Bernard served as the President and Chief Executive Officer of the Limited Stores Division of Limited Brands, Inc., a mall-based specialty store retailer, and from 1994 through 1996 he served as the President and Chief Operating Officer of J.Crew Group, Inc. (“J.Crew”), a multi-channel specialty retailer.
Walter Killough, age 55, has served as our Chief Operating Officer and a director since December 2005. Mr. Killough joined Alloy, Inc. in March 2003 as a consultant, and served as the Chief Operating Officer of its Retail and Direct Consumer Division from October 2003 until December 2005. Prior to joining Alloy, Inc., Mr. Killough was at J.Crew for 14 years. He was appointed its Chief Operating Officer in 2001, and prior to that served as an executive vice president. As its Chief Operating Officer, he was responsible for all sourcing, catalog circulation and production, warehouse and distribution, retail and direct planning and logistics.
Michele Donnan Martin, age 46, has served as President, dELiA*s Brand since January 2008. Prior to that, Ms. Martin served as Chief Design Officer Women’s for Martin + OSA, a retail brand that is part of American Eagle Outfitters, Inc., from January 2005 to June 2007. From 2003 to 2004, she was Vice President and General Manager of C+M Martin, Inc., an apparel design firm which was a joint venture with Brandix Apparel of Sri Lanka. From 2001 to 2002, Ms. Martin served as Senior Vice President and General Manager of Hold Everything, a retail division of Williams-Sonoma, Inc. which offered storage solutions for the home. From 1992 to 1999, Ms. Martin served as Vice President and General Merchandise Manager, Women’s and Girls’ of Abercrombie & Fitch Co., a mall-based specialty apparel retailer.
David J. Dick, age 43, has served as our Chief Financial Officer and Treasurer since February 2, 2009 and had served as the Company’s Vice President, Controller and Chief Accounting Officer since April 2008. Prior to that, Mr. Dick served as Chief Financial Officer of Charlie Brown’s Acquisition Corp., a multi-concept casual dining restaurant operator, from 2006 to 2007, and from 1993 to 2006, he worked for Linens ‘n Things, Inc., a specialty retailer of home furnishings, where he held a number of positions including Vice President, Controller and Treasurer. From 1987 to 1992, Mr. Dick worked for Ernst & Young LLP. He is a certified public accountant.
Marc G. Schuback, age 48, has served as our Vice President, General Counsel and Secretary since August 2007. Prior to that, Mr. Schuback served as Vice President, Assistant General Counsel and Assistant Corporate Secretary of Footstar, Inc., a nationwide footwear retailer, from July 1996 to August 2007.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our Common Stock has traded on The NASDAQ Global Market under the symbol “DLIA” since December 20, 2005. The table below sets forth the high and low sale prices for our Common Stock during the periods indicated.
Stockholders
As of April 8, 2010 there were approximately 208 holders of record of the 31,309,466 outstanding shares of our Common Stock.
Dividends
We have never declared or paid cash dividends on our Common Stock. We intend to retain any future earnings to finance the growth and development of our business. We do not anticipate paying cash dividends in the foreseeable future.
Unregistered Sales of Securities
There were no unregistered sales of our securities during fiscal 2009.
Issuer Purchases of Equity Securities
During fiscal 2009, the Company did not purchase any shares of its Common Stock.
Item 6.
Item 6. Selected Financial Data
SELECTED FINANCIAL DATA
The selected statements of operations data for the fiscal years ended January 30, 2010 (“fiscal 2009”), January 31, 2009 (“fiscal 2008”), and February 2, 2008 (“fiscal 2007”) have been derived from the audited financial statements included elsewhere in this report which have been audited by BDO Seidman, LLP, independent registered public accountants. Selected balance sheet data as of fiscal 2009 and 2008 has been derived from the audited financial statements included herein. Selected balance sheet data as of fiscal 2007, and the year ended February 3, 2007 (“fiscal 2006”) and January 28, 2006 (“fiscal 2005”) and the selected statements of operations data for fiscal years 2006 and 2005 have been derived from financial statements audited and not included herein. Our historical results are not necessarily indicative of results to be expected for any future period. The data presented below has been derived from financial statements that have been prepared in accordance with generally accepted accounting principles and should be read with our financial statements, including the related notes, and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report. The amounts specified below are for continuing operations only. Our former CCS business is treated as discontinued operations.
(1) See note 3 to the consolidated financial statements for a description of the effect of the discontinued business that has been eliminated from continuing operations. See note 16 to the consolidated financial statements for financial data by reportable segment.
(2) In fiscal 2006, the Company adopted ASC 718-10, Compensation-Stock Compensation, and recorded stock-based compensation expense of approximately $1.1 million for fiscal 2006 related to employee stock options which were included in selling, general and administrative expenses. In fiscal 2009, 2008 and 2007, the Company recorded stock-based compensation expense of $0.9 million, $1.0 million and $1.1 million, respectively. Fiscal 2005 has not been restated to reflect, and does not include, the impact of ASC 718-10.
(3) Comparable store sales also include outlet stores for fiscal 2005. Excluding outlet stores, comparable sales increased 4.6% in fiscal 2005. The calculation for fiscal 2009, 2008, 2007, and 2006 includes all stores open for fifteen full months and whose square footage has not been expanded or reduced by more than 25%. The calculation for fiscal 2005 includes all stores open at least 56 weeks and whose square footage has not been expanded or reduced by more than 25%.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial condition and results of operations together with “Selected Financial Data” and our financial statements and related notes appearing elsewhere in this annual report. Descriptions of all documents included as exhibits hereto are qualified in their entirety by reference to the full text of such documents so referenced.
The results for all periods presented reflect CCS as a discontinued operation. The Company completed its sale of the CCS business on November 5, 2008. Upon closing of the transaction, the Company received $103.2 million in cash proceeds. All financial results in this discussion are for continuing operations only unless otherwise stated.
Executive Summary and Overview
dELiA*s, Inc. is a multi-channel, specialty retailer of apparel, and accessories, comprised of two lifestyle brands-dELiA*s and Alloy. Our merchandise assortment (which includes many name brand products along with our own proprietary brand products), our catalogs, our e-commerce webpages, and our mall-based dELiA*s specialty retail stores are designed to appeal directly to consumers. We reach our customers through our direct marketing segment, which consists of our catalog and e-commerce businesses, and our growing base of retail stores.
Our strategy is to improve upon our strong competitive position as a direct marketing company; to expand and develop our dELiA*s specialty retail stores; and to carry out such strategy while controlling costs.
We expect that growth in our retail stores business, which represented 52.9% of our total net sales in fiscal 2009, will be the key element of our overall growth strategy. Our current expectation is to grow our retail store net square footage by approximately 6% in fiscal 2010 and approximately 5-10% annually thereafter. As market conditions allow, we plan to continue to expand the dELiA*s retail store base over the long term, perhaps to as many as 350-400 stores. In addition, as store performance and market conditions allow, we may plan on accelerating our growth in gross square footage. Should we accelerate our growth, we may need additional equity or debt financing.
dELiA*s, Inc. formerly was an indirect, wholly-owned subsidiary of Alloy, Inc. By virtue of the completion of the Spinoff, Alloy, Inc. does not own any of our outstanding shares of common stock. In addition, we entered into various agreements with Alloy, Inc. prior to or in connection with the Spinoff. These agreements, as subsequently amended, govern various interim and ongoing relationships between Alloy, Inc. and us following the Spinoff.
Goals
We believe that focusing on our brands and implementing the following initiatives should lead to profitable growth and improved results from operations:
•
delivering low-to mid-single digit comparable store sales growth in our dELiA*s retail stores over the long term;
•
driving low-to mid-single digit top-line growth in direct marketing, through targeted circulation in productive mailing segments;
•
improving gross profit margins each year by 50 basis points;
•
developing retail merchandising assortments that emphasize key sportswear categories more effectively;
•
improving our retail store metrics through increased focus on the selling culture, with emphasis on key item selling, and thereby improving productivity;
•
implementing profit-improving inventory planning and allocation strategies such as seasonal carry-in reduction, better store-planning, targeted replenishment by size, tactical fashion investment, and vendor consolidation, to create inventory turn improvement;
•
leveraging our current expense infrastructure and taking additional operating costs out of the business;
•
increasing retail store net square footage by approximately 6% in fiscal 2010 and by approximately 5-10% annually thereafter; and
•
monitoring and opportunistically closing underperforming stores.
Key Performance Indicators
The following measurements are among the key business indicators that management reviews regularly to gauge the Company’s results:
•
store metrics such as comparable store sales, sales per gross square foot, average retail price per unit sold, average transaction values, average units per transaction, traffic conversion rates, and store contribution margin (defined as store gross profit less direct costs of running the store);
•
direct marketing metrics such as demand generated by book, with demand defined as the amount customers seek to purchase without regard to merchandise availability;
•
fill rate, which is the percentage of any particular order we are able to ship for our direct marketing business, from available on-hand inventory or future inventory orders;
•
gross profit;
•
operating income;
•
inventory turnover and average inventory per store; and
•
cash flow and liquidity determined by the Company’s cash provided by operations.
The discussion below includes references to “comparable stores.” We consider a store comparable after it has been open for fifteen full months without closure for more than seven consecutive days and whose square footage has not been expanded or reduced by more than 25% within the past year. If a store is closed during a fiscal quarter, it is removed from the computation of comparable store sales for that fiscal quarter.
Our fiscal year is on a 52-53 week basis and ends on the Saturday nearest to January 31. The fiscal years ended January 30, 2010, January 31, 2009 and February 2, 2008 were all 52-week fiscal years.
Consolidated Results of Operations
The following table sets forth our statements of operations data for the periods indicated, reflected as a percentage of revenues:
Fiscal 2009 Compared with Fiscal 2008 (52 weeks vs. 52 weeks)
Revenues
Total Revenues
Total revenues increased 3.8% to $223.9 million in fiscal 2009 from $215.6 million in fiscal 2008. Revenue increases in the retail segment were driven primarily through new store sales offset by a comparable store sales decrease of 5.9%. Revenue from the retail segment comprised 52.9% of total revenue for fiscal 2009 as compared to 52.4% in fiscal 2008, and revenue from the direct segment comprised 47.1% of total revenue for fiscal 2009 as compared to 47.6% for fiscal 2008.
Direct Marketing Revenues
Direct marketing revenues increased 2.8% to $105.4 million in fiscal 2009 from $102.6 million in fiscal 2008. In the direct segment, increases in the Alloy brand were partially offset by a year-over-year reduction in the dELiA*s brand.
Retail Store Revenues
Retail store revenues increased 4.8% to $118.5 million in fiscal 2009 from $113.1 million in fiscal 2008. The increase in revenue was driven by the twelve new stores (net of relocations and remodels) opened in fiscal 2009 and the full year impact of the eleven stores (net of relocations and remodels) opened in fiscal 2008. This was offset by a comparable store sales decrease of 5.9% for the year.
The following table sets forth select operating data in connection with the revenues of our Company:
* Totals include one store that was closed, remodeled and reopened during fiscal 2009, and two stores that were closed and relocated to alternative sites in the same malls during fiscal 2009.
** Totals include two stores that were closed and relocated to alternative sites in the same malls during fiscal 2008.
Gross Profit
Total Gross Profit
Gross profit for fiscal 2009 was $78.3 million or 35.0% of revenues, as compared to $77.0 million, or 35.7% of revenues in fiscal 2008. New store revenues increased gross profit dollars. The decline in gross profit percentage, however, was principally due to deleveraging of occupancy costs as a result of negative comparable store sales.
Direct Marketing Gross Profit
Direct marketing gross profit for fiscal 2009 was $47.2 million or 44.8% of revenues, as compared to $48.2 million, or 47.0% of revenues in fiscal 2008. The decrease in gross profit percentage was attributable to increased clearance versus full price sales and increased promotional activity in order to drive response rates.
Retail Store Gross Profit
Retail store gross profit for fiscal 2009 was $31.1 million or 26.2% of revenues, as compared to $28.7 million, or 25.4% of revenues in fiscal 2008. The increase in gross profit percentage was primarily due to higher merchandise margins offset, in part, by deleveraging of occupancy costs.
Operating Expenses
Total Selling, General and Administrative
As a percentage of total revenues, our selling, general and administrative (“SG&A”) expenses decreased to 42.4% in fiscal 2009 from 44.3% in fiscal 2008. This decrease was driven by reduced overhead costs offset by the deleveraging of selling and depreciation expense. In total dollars, SG&A expenses decreased 0.6% to $94.9 million in fiscal 2009 from $95.6 million in fiscal 2008.
Direct Marketing Selling, General and Administrative.
As a percentage of revenues, SG&A expenses decreased to 46.2% in fiscal 2009 from 48.5% in fiscal 2008. In total, direct marketing SG&A expenses decreased in dollars to $48.6 million in fiscal 2009 from $49.7 million in fiscal 2008. The improvement in SG&A expenses as a percentage of sales reflects the leveraging of reductions in overhead costs.
Retail Store Selling, General and Administrative.
As a percentage of revenues, SG&A expenses decreased to 39.1% in fiscal 2009 from 40.5% in fiscal 2008. In dollars, retail store SG&A expenses increased 1.1% to $46.3 million in fiscal 2009 from $45.8 million in fiscal 2008. The improvement in SG&A expenses as a percentage of sales reflects the leveraging of reduced overhead costs, partially offset by the additional costs related to the increased store count.
Other Operating Income
Total Other Operating Income
Other operating income for fiscal 2009 was $1.3 million which represents initial gift card breakage income.
Loss from Continuing Operations
Total Loss from Continuing Operations.
Our total loss from continuing operations before interest expense and income taxes was $15.9 million in fiscal 2009 as compared to a loss of $19.2 million in fiscal 2008.
(Loss) income from Direct Marketing Operations.
Direct marketing loss from operations was $0.9 million in fiscal 2009 as compared to a loss of $1.5 million in fiscal 2008. The loss was attributable to the sales decrease, as well as a decrease in gross profit percentage offset by reduced overhead costs and other operating income.
Loss from Retail Store Operations.
Our loss from retail store operations was $15.0 million in fiscal 2009, as compared to $17.7 million in fiscal 2008. This reduction was primarily driven by higher merchandise margins, reduced overhead costs and other operating income offset by a negative comparable store sales performance.
Interest Expense, net
We recognized net interest expense of $235,000 and $309,000 in fiscal 2009 and fiscal 2008, respectively. Interest expense was related to costs from our credit facilities with Wells Fargo and the mortgage note for our Hanover, Pennsylvania facility. Interest income was earned from cash balances in money market accounts.
Income Tax Benefit
We recorded an income tax benefit of $5.7 million in fiscal 2009, compared with a benefit of $6.9 million in fiscal 2008. This decrease in tax benefit was primarily a result of the decreased loss from continuing operations for fiscal 2009. The effective tax rate for fiscal 2009 and 2008 was 35%.
Income from discontinued operations
During the fourth quarter of fiscal 2008, we sold our CCS business for aggregate cash consideration of $103.2 million, resulting in a pre-tax gain of $49.4 million. The results of the CCS business have been classified as discontinued operations in all periods presented. Income from discontinued operations, including the gain from the sale of CCS, net of income taxes, was $29.8 million for fiscal 2008.
Fiscal 2008 Compared with Fiscal 2007 (52 weeks vs. 52 weeks)
Revenues
Total Revenues
Total revenues increased 7.0% to $215.6 million in fiscal 2008 from $201.6 million in fiscal 2007. Revenue increases in the retail segment were driven primarily through new store sales and a comparable store sales increase of 2.8%. Revenue from the retail segment comprised 52.4% of total revenue for fiscal 2008 as compared to 48.7% in fiscal 2007, and revenue from the direct segment comprised 47.6% of total revenue for fiscal 2008 as compared to 51.3% for fiscal 2007.
Direct Marketing Revenues
Direct marketing revenues decreased 1.0% to $102.6 million in fiscal 2008 from $103.5 million in fiscal 2007. In the direct segment, increases in the dELiA*s brand were partially offset by a year-over-year reduction in the Alloy brand.
Retail Store Revenues
Retail store revenues increased 15.3% to $113.1 million in fiscal 2008 from $98.1 million in fiscal 2007. The increase in revenue was driven by the eleven new stores (net of relocations and remodels) opened in fiscal 2008 and the full year impact of the twelve stores (net of relocations and remodels) opened in fiscal 2007. In addition, we experienced a positive comparable store sales increase of 2.8% for the year.
Gross Profit
Total Gross Profit
Gross profit for fiscal 2008 was $77.0 million or 35.7% of revenues, as compared to $72.5 million, or 36.0% of revenues in fiscal 2007. New store revenues increased gross profit dollars. The decline in gross profit percentage, however, was principally due to a higher percentage of total sales coming from the retail segment which has lower margins.
Direct Marketing Gross Profit
Direct marketing gross profit for fiscal 2008 was $48.2 million or 47.0% of revenues, as compared to $49.3 million, or 47.7% of revenues in fiscal 2007. The decrease in gross profit percentage was attributable to an increase in buying, distribution, and outbound freight costs.
Retail Store Gross Profit
Retail store gross profit for fiscal 2008 was $28.7 million or 25.4% of revenues, as compared to $23.2 million, or 23.7% of revenues in fiscal 2007. The increase in gross profit percentage was primarily due to higher merchandise margins and lower inventory obsolescence due to improved inventory management.
Operating Expenses
Total Selling, General and Administrative
As a percentage of total revenues, our selling, general and administrative expenses decreased to 44.3% in fiscal 2008 from 45.2% in fiscal 2007. This decrease was driven by the leveraging of store selling and overhead expenses on higher sales. In total dollars, selling, general and administrative expenses increased 5.0% to $95.6 million in fiscal 2008 from $91.0 million in fiscal 2007. The increase was the result of store operating expenses and depreciation associated with a net increase of twenty-three stores since the beginning of fiscal 2007.
Direct Marketing Selling, General and Administrative.
As a percentage of revenues, selling, general and administrative expenses increased to 48.5% in fiscal 2008 from 47.4% in fiscal 2007. This deleverage was primarily caused by the 1% decrease in sales in fiscal 2008. In total, direct marketing selling, general and administrative expenses increased in dollars to $49.7 million in fiscal 2008 from $49.0 million in fiscal 2007. Fiscal 2007 benefitted from a reversal of an accrual of $0.5 million related to the settlement of various legal matters.
Retail Store Selling, General and Administrative.
As a percentage of revenues, selling, general and administrative expenses decreased to 40.5% in fiscal 2008 from 42.8% in fiscal 2007. This decrease was primarily driven by the leveraging of store selling and overhead costs on higher sales volume. In dollars, retail store selling, general and administrative expenses increased 9.2% to $45.8 million in fiscal 2008 from $42.0 million in fiscal 2007. The increase was primarily due to higher depreciation and amortization expense, and increased store operation costs due to the increase in our number of stores.
Loss from Continuing Operations
Total Loss from Continuing Operations.
Our total loss from continuing operations before interest expense and income taxes was $19.2 million in fiscal 2008 as compared to a loss of $18.5 million in fiscal 2007.
(Loss) income from Direct Marketing Operations.
Direct marketing loss from operations was $1.5 million in fiscal 2008 as compared to income from operations of $0.3 million in fiscal 2007. The loss was attributable to the sales decrease, as well as increased freight, buying, and distribution costs.
Loss from Retail Store Operations.
Our loss from retail store operations was $17.7 million in fiscal 2008, as compared to $18.8 million in fiscal 2007. This reduction was primarily driven by higher merchandise margins and the positive comparable store sales performance.
Interest Expense, net
We recognized net interest expense of $309,000 and $5,000 in fiscal 2008 and fiscal 2007, respectively. Interest expense was related to borrowings under our credit facility with Wells Fargo and the mortgage note for our Hanover, Pennsylvania facility. Interest income was earned from cash balances in money market accounts provided primarily from the proceeds of the sale of our CCS business in fiscal 2008.
Income Tax Benefit
We recorded an income tax benefit of $6.9 million in fiscal 2008, compared with a benefit of $6.2 million in fiscal 2007. This increase in tax benefit was primarily a result of the increased loss from continuing operations for fiscal 2008.
Income from discontinued operations
During the fourth quarter of fiscal 2008, we sold our CCS business for aggregate cash consideration of $103.2 million, resulting in a pre-tax gain of $49.4 million. The results of the CCS business have been classified as discontinued operations in all periods presented. Income from discontinued operations, including the gain from the sale of CCS, net of income taxes, was $29.8 million for fiscal 2008 compared to $10.0 million in the prior fiscal year.
Liquidity and Capital Resources
Our capital requirements include construction, fixture and inventory costs related to the opening of new retail stores, maintenance and remodeling expenditures for existing stores, and information technology, distribution and other infrastructure related investments. Future capital requirements will depend on many factors, including, but not limited to, the pace of new store openings, the availability of suitable locations for new stores, the size of the specific stores we open and the nature of arrangements negotiated with landlords. In that regard, our net investment to open new stores is likely to vary significantly in the future.
In addition, the current financial crisis and general economic conditions, and the resulting decline in discretionary spending, the availability of consumer credit and consumer confidence may adversely impact our liquidity and capital resources. Continuing turmoil in worldwide financial and credit markets, accompanied by recessionary domestic and foreign economies, high unemployment rates, increases in fuel, energy and other costs, conditions in the residential real estate and mortgage markets, reductions in available disposable income and access to consumer credit, as well as a lack of consumer confidence in the United States’ economy, among other factors, have all adversely affected consumer spending behavior. As a retailer, our businesses are sensitive to consumer spending patterns and preferences. During fiscal 2009, our revenues, gross margins and losses from continuing operations have been impacted, as consumer purchases of discretionary items and retail products have weakened and may continue to decline as a result of the factors noted above. Our ability to achieve our goals noted above, including increased revenues and gross margins, profitable operations and positive cash flows, is dependent, among other things, on an improvement in economic conditions and consumer spending.
On November 5, 2008, the Company completed the sale of its CCS business. The Company received gross proceeds of $103.2 million ($95.2 net of transaction costs) for the sale of the CCS assets and assumption of certain related liabilities. The transaction significantly strengthened the Company’s balance sheet and recapitalized the Company.
dELiA*s, Inc. and certain of its wholly-owned subsidiaries were parties to a Second Amended and Restated Loan and Security Agreement (the “Restated Credit Facility”) with Wells Fargo Retail Finance II, LLC (“Wells Fargo”) which expired by its terms on June 26, 2009. The Restated Credit Facility was a secured revolving credit facility that the Company could draw upon for working capital and capital expenditure requirements and had an initial credit limit of $25 million.
The Company was allowed under the Restated Credit Facility, under certain circumstances and if certain conditions were met, to permanently increase the credit limit in $5 million increments, up to a maximum credit limit of $40 million. Each permanent increase in the credit limit required the Company to pay an origination fee of 0.20% of the amount of the increase. During March 2008, the Company permanently increased the credit limit under the Restated Credit Facility by $5 million, from $25 million to $30 million. The Company could also have obtained temporary credit limit increases for up to 90 consecutive days during the period beginning July 15th and ending on December 15th each year. Temporary credit limit increases did not require the payment of an origination fee. In the third quarter of fiscal 2008, the Company obtained a temporary credit increase of $5 million. During June 2008, the Restated Credit Facility was amended to allow for letters of credit up to an aggregate amount of $15 million. The Restated Credit Facility previously allowed for letters of credit up to an aggregate amount of $10 million.
Funds were available under the Restated Credit Facility up to the then existing credit limit or, if lower, the “Borrowing Base” of the Company determined in accordance with a formula set forth in the Restated Credit Facility based upon eligible inventory and accounts receivable, in each case less the sum of (i) outstanding revolving credit loans, (ii) outstanding letters of credit, (iii) certain “Availability Reserves” as determined in accordance with the terms of the Restated Credit Facility, and (iv) the “Availability Block” (which was equal to the greater of 6.5% of the then existing credit limit and $1.5 million). Loans under the Restated Credit Facility bore interest, at the Company’s option, either at the prime rate or the London Interbank Offered Rate plus a variable margin ranging from 1.25% to 1.75% depending on excess availability and cash on hand. A monthly fee of 0.25% per annum was payable based on the unused balance of the Restated Credit Facility. The Restated Credit Facility was secured by substantially all of the assets of the Company and contained various affirmative and negative covenants, representations, warranties and events of default, including restrictions such as limitations on additional indebtedness, other liens, dividends, distributions, stock repurchases, the annual amount of capital expenditures and the number of new stores the Company could open each year.
Upon the expiration of the Restated Credit Facility on June 26, 2009, the Company entered into a letter of credit agreement (“Letter of Credit Agreement”) with Wells Fargo.
The Letter of Credit Agreement, which has a maturity date of June 26, 2011, provides for the issuance of letters of credit to finance the acquisition of inventory from suppliers, to provide standby letters of credit to factors, landlords, insurance providers and other parties for business purposes, and for other general corporate purposes. Aggregate letters of credit issued and to be issued under the Letter of Credit Agreement at any one time outstanding could not exceed the lesser of $15,000,000 or an amount equal to a certain percentage of cash collateral held by Wells Fargo to secure repayment of the Company’s and the Subsidiaries’ respective obligations to Wells Fargo under the Letter of Credit Agreement and related letter of credit documents. The Company had secured these obligations by the pledge to Wells Fargo of cash collateral in the amount of $15,750,000. None of the other assets or properties of the Company, or any of its subsidiaries or affiliates, have been pledged as collateral for these obligations.
The Letter of Credit Agreement calls for the payment by the Company of an unused line fee of 0.75% per annum on the average unused portion of the credit facility under the Letter of Credit Agreement, a letter of credit fee of 2.00% per annum on the average outstanding face amount of letters of credit issued under the Letter of Credit Agreement, as well as other customary fees and expenses generally charged by the letter of credit issuer. The Letter of Credit Agreement does not contain any financial covenants with which the Company or any of its subsidiaries or affiliates must comply during the term of the Letter of Credit Agreement.
On January 28, 2010, the Company entered into a First Amendment to Letter of Credit Agreement (the “First Amendment”) with Wells Fargo. Pursuant to the First Amendment, the Letter of Credit Agreement was amended at the Company’s request to, among other things, reduce the maximum aggregate face amount of letters of credit that may be issued under the Letter of Credit Agreement, to the lesser of (a) $10,000,000 or (b) an
amount equal to a specified percentage of cash collateral held by Wells Fargo. In addition, cash collateral is now only required in an amount equal to 105% of the face amount of outstanding letters of credit issued under the Letter of Credit Agreement, as amended.
As of January 30, 2010, there were approximately $7.2 million of outstanding letters of credit under the Letter of Credit Agreement, and cash collateral required to secure the Company’s obligations under the Letter of Credit Agreement, as amended, was approximately $7.5 million which is shown as restricted cash in noncurrent assets on the accompanying consolidated balance sheet.
A significant portion of our vendor base is factored, which means our vendors have sold their accounts receivable to specialty lenders known as factors. Approximately 43% of our merchandise payables are factored. The credit extended by these factors is enhanced by standby letters of credit that we provide as collateral for our obligations to our vendors, which directly reduce the amount available to us under our Letter of Credit Agreement.
We were a party to a mortgage loan agreement related to the purchase of our distribution facility in Hanover, Pennsylvania. The mortgage note amortized on a fifteen-year schedule and was to mature with a balloon payment of $2.3 million in September 2008. During March 2008, we extended the maturity date on the mortgage note from September 2008 to September 2009. The loan bore interest at LIBOR plus 225 basis points and was subject to quarterly financial covenants. The mortgage loan was secured by the distribution facility and related property. The Company paid off the remaining balance of the mortgage, which was approximately $2.1 million, on September 30, 2009.
Our liquidity was enhanced by the sale of our CCS business for cash. We expect our current cash balance (inclusive of the net proceeds from the sale of CCS), cash flow from operations and availability under our Letter of Credit Agreement will be sufficient to meet our cash requirements for operations and planned capital expenditures at least through the end of our current fiscal year. However, if we decide to accelerate growth of our retail operations beyond the ranges in our present retail strategy, or if cash balances and cash flow from operations are not sufficient to meet our capital requirements, then we may be required to obtain additional equity or debt financing in the future. Such equity or debt financing may not be available to us when we need it (particularly in light of a substantial contraction generally in the availability of financing due to the current financial crisis and the continuing difficult economic conditions noted above) or, if available, may not be on terms that will be satisfactory to us or may be dilutive to our stockholders. If financing is not available when required or is not available on acceptable terms, we may be unable to take advantage of business opportunities or respond to competitive pressures. Any of these events could have a material and adverse effect on our business, results of operations and financial condition.
Net cash used in operating activities was $36.1 million for fiscal 2009 compared to cash provided of $19.4 million in fiscal 2008 and $3.2 million in fiscal 2007. Cash used in operating activities in fiscal 2009 was primarily for the payment of income taxes and the establishment of a restricted cash account as collateral for the Letter of Credit Agreement.
Net cash used in investing activities was $12.6 million in fiscal 2009, $12.2 million in fiscal 2008, and $19.6 million in fiscal 2007. The $12.6 million used in fiscal 2009 was due primarily to capital expenditures associated with the construction of our new retail stores. During fiscal 2010, we expect capital expenditures to be approximately $6.5 million.
Net cash used in financing activities was $2.2 million in fiscal 2009 compared to $0.2 million in fiscal 2008, and cash provided of $0.6 million in fiscal 2007. Cash used in financing activities in fiscal 2009 and fiscal 2008 related to payments on the mortgage note payable. Cash provided by financing activities in fiscal 2007 was primarily related to proceeds from the exercise of stock options.
Contractual Obligations
The following table presents our significant contractual obligations as of January 30, 2010:
(1) Our operating lease obligations are primarily related to dELiA*s retail stores and our corporate headquarters.
(2) Our purchase obligations are primarily related to inventory commitments and service agreements.
(3) Our future severance-related payments primarily consist of severance agreements with existing employees.
We have long-term noncancelable operating lease commitments for retail stores, office space, contact center facilities and equipment. We also have long-term noncancelable capital lease commitments for equipment.
Critical Accounting Estimates
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses, among other things, our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates and judgments, including those related to product returns, bad debts, inventories, investments, intangible assets and goodwill, income taxes, and contingencies and litigation. We base our estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company does not believe there is a great likelihood that materially different amounts would be reported related to the accounting policies described below.
Our significant accounting policies are more fully described in note 2 to our consolidated financial statements. We believe, however, the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
Direct marketing revenues are recognized at the time of shipment to customers. These revenues are net of any promotional price discounts and an allowance for sales returns. The allowance for sales returns is estimated based upon our direct marketing return policy, historical experience and evaluation of current sales and returns trends. Direct marketing revenues also include shipping and handling billed to customers.
Retail store revenues are recognized at the point of sale, net of any promotional price discounts and an allowance for sales returns. The allowance for sales returns is estimated based upon our retail return policy, historical experience and evaluation of current sales and returns trends.
The Company’s policy with respect to gift certificates and gift cards is to record revenue as they are redeemed for merchandise. Prior to their redemption, these gift certificates and gift cards are recorded as a liability. The liability remains on the Company’s books until the earlier of redemption (recognized as revenue) or
when the Company determines the likelihood of redemption is remote (recognized as other operating income). The Company determines the probability of the gift card being redeemed to be remote based on historical redemption patterns. For those gift cards that we determined redemption to be remote, we reversed our liability, and recorded an initial gift card breakage income of $1.3 million in the fourth quarter of fiscal 2009.
Catalog Costs
Catalog costs consist of catalog production and mailing costs. These costs are capitalized and expensed over the expected future revenue stream, which is customarily two to four months from the date the catalogs are mailed.
An estimate of the future sales dollars to be generated from each individual catalog mailing serves as the foundation for our catalog costs policy. The estimate of future sales is calculated for each mailing using historical trends for catalogs mailed in similar prior periods as well as the overall current sales trend for each individual direct marketing brand. This estimate is compared with the actual sales generated-to-date for the catalog mailing to determine the percentage of total catalog costs to be capitalized as prepaid expenses on our consolidated balance sheets. Deferred catalog costs as of January 30, 2010 and January 31, 2009 were approximately $2.4 million and $2.8 million, respectively.
Catalog costs expensed for fiscal 2009, 2008, and 2007 were approximately $24.7 million, $24.6 million, and $24.3 million, respectively, and are included within selling, general and administrative expenses in the accompanying consolidated statements of operations.
Inventories
Inventories, which consist of finished goods, including certain expenses capitalized, are stated at the lower of cost (first-in, first-out method) or market value. Inventories may include items that have been written down to our best estimate of their net realizable value. Our decisions to write-down and establish valuation allowances against our merchandise inventories are based on our current rate of sale, the age of the inventory and other factors. Actual final sales prices to customers may be higher or lower than our estimated sales prices and could result in a fluctuation in gross profit in subsequent periods.
Goodwill and Other Indefinite-Lived Intangible Assets
The Company follows the provisions of ASC-350-10, Intangibles-Goodwill and Other, which requires testing for impairment on an annual basis or between annual tests if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying amount. The Company last performed an annual impairment test as of January 30, 2010.
Determining the fair value of our direct marketing reporting unit under the first step of the goodwill impairment test and determining the fair value of individual assets and liabilities of that reporting unit (including unrecognized intangible assets) under the second step of the goodwill impairment test is judgmental in nature and often involves the use of significant estimates and assumptions. Similarly, estimates and assumptions are used in determining the fair value of our indefinite-lived intangible assets, primarily trademarks. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and also the magnitude of any such charge.
We perform valuation analyses and consider other market information that is publicly available. Estimates of fair value are primarily determined using discounted cash flows and market comparisons. These approaches use significant estimates and assumptions including projected future cash flows (including timing), discount rates reflecting the risk inherent in future cash flows, revenue growth rates, projected long-term growth rates, royalty rates, determination of appropriate market comparables and the determination of whether a premium or discount should be applied to comparables.
Considerable management judgment is necessary to estimate the fair value of our direct marketing reporting unit and indefinite-lived intangible assets which may be impacted by future actions taken by us or our competitors and the economic environment in which we operate. These estimates affect the balance of goodwill as well as intangible assets on our consolidated balance sheets and operating expenses on our consolidated statements of operations.
Results from the Company’s annual goodwill impairment test performed as of January 30, 2010 concluded that its goodwill and indefinite-lived intangible assets were not impaired.
Impairment of Long-Lived Assets
In accordance with ASC 360, Property, Plant, and Equipment, the Company’s management evaluates the value of leasehold improvements and store fixtures associated with retail stores, which have been open for a period of time sufficient to reach maturity. The Company evaluates long-lived assets for impairment at the individual store level, which is the lowest level at which individual cash flows can be identified. Impairment losses are recorded on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of the assets. When events such as these occur, the impaired assets are adjusted to their estimated fair value and an impairment loss is recorded separately as a component of operating income under impairment of long-lived assets.
We measure fair value by discounting estimated future cash flows using an appropriate discount rate. Considerable judgment by us is necessary to estimate the fair value of the assets and accordingly, actual results could vary significantly from such estimates. Our most significant estimates and judgments relating to the long-lived asset impairments include the timing and amount of projected future cash flows and the discount rate selected to measure the risks inherent in future cash flows.
In fiscal 2009 and 2008, we recorded impairment charges of approximately $454,000 and $613,000, respectively, related to under-performing stores (see Note 5).
Income taxes
Income taxes are calculated in accordance with ASC 740-10, Income Taxes, which require the use of the asset and liability method. Deferred tax assets and liabilities are recognized based on the difference between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using current enacted tax rates in effect in the years in which those temporary differences are expected to reverse. Inherent in the measurement of deferred balances are certain judgments and interpretations of enacted tax law and published guidance with respect to applicability to the Company’s operations. The effective tax rate utilized by the Company reflects management’s judgment of the expected tax liabilities within the various taxing jurisdictions.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, net operating loss carryback potential, and tax planning strategies in making these assessments.
On February 4, 2007, the Company adopted amendments to ASC 740-10 which clarified the accounting for uncertainty in income taxes recognized in the financial statements. These amendments prescribe a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by the taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate audit settlement. The adoption of these amendments to ASC 740-10, effective February 4, 2007, resulted in a decrease to stockholders’ equity of approximately $116,000.
The Company recognizes interest accrued for increases in the net liability for unrecognized income tax benefits in interest expense and any related penalties in income tax expense.
The Company’s U.S. subsidiaries join in the filing of a U.S. federal consolidated income tax return. The U.S. federal statute of limitations remains open for the fiscal years 2006 onward. The Company is currently under examination by the Internal Revenue Service. State income tax returns are generally subject to examination for a period of 3 to 5 years after filing of the respective returns. The state impact of any federal changes remains subject to examination by various states for a period of up to one year after formal notification to the states.
Recent Accounting Pronouncements
In February 2010, the FASB issued ASU 2010-09, Subsequent Events. ASU 2010-09 amends ASC 855-10, Subsequent Events, by removing the requirement for SEC filers to disclose the date through which subsequent events have been evaluated. The Company adopted ASU 2010-09 immediately upon its issuance in February 2010, and its provisions are reflected in the consolidated financial statements for fiscal 2009. In accordance with this topic, the Company evaluates subsequent events through the date its financial statements are issued. Except for the removal of the date, the adoption of ASU 2010-09 did not have any impact on the Company’s consolidated financial statements.
In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures. ASU 2010-06 amends ASC 820-10, Fair Value Measurements and Disclosures, and requires new disclosures surrounding certain fair value measurements. ASU 2010-06 is effective for the first interim or annual reporting period beginning on or after December 15, 2009, except for certain disclosures about purchases, sales, issuances, and settlements in the rollforward of activity in Level 3 fair value measurements, which are effective for the first interim and annual reporting periods beginning on or after December 15, 2010. The Company is currently evaluating the impact of this ASU on its consolidated financial statements.
Effective August 2, 2009, the Company adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 105-10, Generally Accepted Accounting Principles (“ASC 105-10”). ASC 105-10 establishes the FASB Accounting Standards Codification (the “Codification”) as the source of authoritative accounting principles recognized by the FASB to be applied to non-governmental entities in the preparation of financial statements in conformity with U.S. GAAP. Rules and interpretative releases of the SEC under authority of Federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority. The Codification superseded all existing non-SEC accounting and reporting standards. All other non-grandfathered, non-SEC accounting literature not included in the Codification is non-authoritative. The FASB will not issue new standards in the form of new Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead it will issue Accounting Standards Updates (“ASUs”). The FASB will not consider ASUs as authoritative in their own right. ASUs will serve only to update the Codification, provide background information about the guidance and provide the bases for conclusions in the change(s) in the Codification. References made to FASB guidance throughout this document have been updated for the Codification.
In May 2009, the FASB issued amendments to ASC 855-10, Subsequent Events, which establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The amendments to ASC 855-10 introduce the concept of financial statements being available to be issued, and required the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date, that is, whether that date represents the date the financial statements were issued or were available to be issued. The Company adopted the amendments to ASC 855-10 during the second quarter of fiscal 2009, but the Company’s adoption of ASU 2010-09, discussed above, eliminated any impact that these amendments to ASC 855-10 had on the Company’s consolidated financial statements.
In April 2009, the FASB issued amendments to ASC 820-10, Fair Value Measurements and Disclosures, which provide guidance for estimating fair value when the volume and level of activity for an asset or liability have significantly decreased. These amendments to ASC 820-10 include guidance on identifying circumstances that indicate when a transaction is not orderly, and are effective for interim reporting periods ending after June 15, 2009. These amendments to ASC 820-10 do not require disclosures for earlier periods presented for comparative purposes at initial adoption, and, in periods after initial adoption, comparative disclosures are only required for periods ending after initial adoption. The Company adopted these amendments to ASC 820-10 during the second quarter of fiscal 2009 and the adoption did not have a material impact on our consolidated financial statements.
In April 2009, the FASB issued amendments to ASC 825-10, Financial Instruments, which require disclosures about the fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. The amendments to ASC 825-10 also require those disclosures in summarized financial information at interim reporting periods. The amendments to ASC 825-10 are effective for interim reporting periods ending after June 15, 2009. The amendments to ASC 825-10 do not require disclosures for earlier periods presented for comparative purposes at initial adoption, and, in periods after initial adoption, comparative disclosures are only required for periods ending after initial adoption. The Company adopted the amendments to ASC 825-10 during the second quarter of Fiscal 2009. The required disclosures are included in “Fair Value of Financial Instruments” above.
In April 2009, the FASB issued updated guidance related to business combinations, which is included in the Codification in ASC 805-20, Business Combinations-Identifiable Assets, Liabilities and Any Non Controlling Interest, (“ASC 805-20”). ASC 805-20 amends and clarifies ASC 805 to address application issues regarding the initial recognition and measurement, subsequent measurement and accounting and disclosures of assets and liabilities arising from contingencies in a business combination. In circumstances where the acquisition-date fair value for a contingency cannot be determined during the measurement period and it is concluded that it is probable that an asset or liability exists as of the acquisition date and the amount can be reasonably estimated, a contingency is recognized as of the acquisition date based on the estimated amount. The Company will apply ASC 805-20 prospectively to any business combinations completed after February 1, 2009.
Effective January 1, 2009, the Company adopted FASB ASC Topic 805, Business Combinations (“ASC 805”). ASC 805 establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree. ASC 805 also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of financial statements to evaluate the nature and financial effects of the business combination. The Company will apply ASC 805 prospectively to any business combinations completed after February 1, 2009.
In June 2008, the FASB issued amendments to ASC 260-10, Earnings Per Share, which require that unvested share-based payment awards that contain rights to receive nonforfeitable dividends (whether paid or unpaid) be considered participating securities and be included in the two-class method of computing earnings per share. These amendments to ASC 260-10 are effective for fiscal years beginning after December 15, 2008, and interim periods within those years. The Company adopted these amendments to ASC 260-10 on February 1, 2009. The adoption of ASC 260-10 had no material impact on the Company’s condensed consolidated financial statements.
On February 3, 2008, the Company adopted FASB ASC 820-10, Fair Value Measurements and Disclosures (“ASC 820-10”), to define fair value, establish a framework for measuring fair value in accordance with generally accepted accounting principles and expand disclosures about fair value measurements except with respect to its non-financial assets and liabilities. ASC 820-10 requires quantitative disclosures using a tabular format in all periods (interim and annual) and qualitative disclosures about the valuation techniques used to measure fair value in all annual periods. On February 1, 2009, the Company adopted ASC 820-10 for its
non-financial assets and liabilities. The Company’s non-financial assets, which include goodwill, property and equipment, and intangible assets are subject to this new guidance and are measured at fair value for impairment assessments. The adoption of ASC 820-10 did not have a material impact on our condensed consolidated financial statements.
Off-Balance Sheet Arrangements
We enter into letters of credit issued under the Letter of Credit Agreement to facilitate the purchase of merchandise.
dELiA*s Brand, LLC, one of our subsidiaries, entered into a license agreement in 2003 with JLP Daisy that grants JLP Daisy exclusive rights (except for our rights) to use the dELiA*s trademarks to advertise, promote and market the licensed products, and to sublicense to permitted sublicensees the right to use the trademarks in connection with the manufacture, sale and distribution of the licensed products to approved wholesale customers. See note 15 to the consolidated financial statements for further discussion of this license agreement.
We do not maintain any other off-balance sheet transactions, arrangements, obligations or other relationships with unconsolidated entities or others that are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Guarantees
We have no significant financial guarantees.
Inflation
In general, our costs, some of which include postage, paper and freight, are affected by inflation and we may experience the effects of inflation in future periods. We believe, however, that such effects have not been material to us during the past.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
We have significant amounts of cash and cash equivalents (money market funds) at financial institutions that are in excess of federally insured limits. With the current financial environment and the instability of financial institutions, we cannot be assured that we will not experience losses on our deposits. As of January 30, 2010, we did not hold any marketable securities and do not own any derivative financial instruments in our portfolio, thus we do not believe there is any material market risk exposure with respect to these items.
Item 8.
Item 8. Financial Statements and Supplementary Data
The consolidated financial statements, financial statement schedule and Notes to the consolidated financial statements of dELiA*s, Inc. and subsidiaries are annexed to and made part of this Annual Report on Form 10-K as pages through. An index of such materials appears on page.
Item 9.
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our “disclosure controls and procedures,” as that term is defined in Rule 13a-15(e) promulgated under the Exchange Act, as of January 30, 2010. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of January 30, 2010 to ensure that the information we are required to disclose in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms, and to ensure that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Securities Exchange Act Rule 13a-15(f). Our system of internal control is evaluated on a cost benefit basis and is designed to provide reasonable, not absolute, assurance that reported financial information is materially accurate.
Under the supervision and with the participation of our management, including our principal executive officers, we conducted an evaluation of the design and effectiveness of our internal control over financial reporting based on the criteria set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our evaluation under the framework in Internal Control-Integrated Framework, our management concluded that our internal control over financial reporting was effective as of January 30, 2010. Our independent registered public accounting firm that audited the financial statements included in this annual report has issued an attestation report on our internal control over financial reporting.
Limitations of the Effectiveness of Internal Control
A control system, no matter how well conceived and operated, can only provide reasonable, not absolute, assurance that the objectives of the internal control system are met. Because of the inherent limitations of any internal control system, no evaluation of controls can provide absolute assurance that all control issues, if any, have been detected.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended January 30, 2010 identified in connection with the evaluation thereof by our management, including the Chief Executive Officer and Chief Financial Officer, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of
dELiA*s, Inc.
New York, New York:
We have audited dELiA*s, Inc. (the “Company”) internal control over financial reporting as of January 30, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying, “Management’s Report on Internal Control Over Financial Reporting.” Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, dELiA*s, Inc. maintained, in all material respects, effective internal control over financial reporting as of January 30, 2010, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of dELiA*s, Inc. as of January 30, 2010 and January 31, 2009, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended January 30, 2010 and our report dated April 15, 2010 expressed an unqualified opinion thereon.
/s/ BDO Seidman, LLP
New York, NY
April 15, 2010
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Except for information with respect to our executive officers set forth in Part I of this Form 10-K under the caption “Executive Officers of the Registrant,” the response to this item is incorporated by reference from the discussion responsive thereto under the captions “CORPORATE GOVERNANCE AND INFORMATION ABOUT DIRECTORS AND EXECUTIVE OFFICERS”- “The Board of Directors,”-“Corporate Governance and Nominating Committee, “ Codes of Business Conduct and Ethics” and “Information About Directors and Executive Officers,” and “OTHER MATTERS”-in our definitive Proxy Statement for our 2010 Annual Meeting of Stockholders, which is expected to be filed with the SEC within 120 days after the close of our fiscal year ended January 30, 2010.
Item 11.
Item 11. Executive Compensation
The response to this item is incorporated by reference from the discussion responsive thereto under the caption “EXECUTIVE COMPENSATION” in our definitive proxy statement for our 2010 Annual Meeting of Stockholders, which is expected to be filed with the SEC within 120 days after the end of our fiscal year ended January 30, 2010, except that the section in the definitive proxy statement entitled “EXECUTIVE COMPENSATION”- “Compensation Committee Report” shall not be deemed incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The response to this item is incorporated by reference from the discussion responsive thereto under the caption “INFORMATION ABOUT DELIA*S SECURITY OWNERSHIP” and “EXECUTIVE COMPENSATION”- “Equity Compensation Plan Information” in our definitive proxy statement for our 2010 Annual Meeting of Stockholders, which is expected to be filed with the SEC within 120 days after the end of our fiscal year ended January 30, 2010.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The response to this item is incorporated by reference from the discussion responsive thereto under the caption “CORPORATE GOVERNANCE AND INFORMATION ABOUT DIRECTORS AND EXECUTIVE OFFICERS”- “The Board of Directors” and “CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS” in our definitive proxy statement for our 2010 Annual Meeting of Stockholders, which is expected to be filed with the SEC within 120 days after the end of our fiscal year ended January 30, 2010.
Item 14.
Item 14. Principal Accountant Fees and Services
The response to this item is incorporated by reference from the discussion responsive thereto under the captions “Audit Fees,” Policy of Audit Committee on Pre-Approval of Audit and Permissible Non-Audit Services of Independent Auditors” and “Percentage of Audit Services Pre-Approved” in our definitive proxy statement for our 2010 Annual Meeting of Stockholders, which is expected to be filed with the SEC within 120 days after the end of our fiscal year ended January 30, 2010.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedule
FINANCIAL STATEMENTS, SCHEDULE AND EXHIBITS
(1) Consolidated Financial Statements.
The financial statements required by this item are set forth on pages through of this Annual Report on Form 10-K, and are incorporated by reference herein.
(2) Financial Statement Schedule.
The schedule required by this item is set forth on page of this Annual Report on Form 10-K, and is incorporated by reference herein.
(3) Exhibits.
The exhibit list required by this item is set forth under the caption “Exhibit Index” in this Annual Report on Form 10-K, and is incorporated by reference herein.
dELiA*s, Inc. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of
dELiA*s, Inc.
New York, New York
We have audited the accompanying consolidated balance sheets of dELiA*s, Inc. and Subsidiaries (the “Company”) as of January 30, 2010, and January 31, 2009 and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the three years in the period ended January 30, 2010. In connection with our audits of the financial statements, we have also audited the schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule 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 and schedule are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedule, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of dELiA*s, Inc. and Subsidiaries at January 30, 2010 and January 31, 2009, and the results of their operations and their cash flows for each of the three years in the period ended January 30, 2010, in conformity with accounting principles generally accepted in the United States.
Also, in our opinion, the schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of dELiA*s, Inc. internal control over financial reporting as of January 30, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated April 15, 2010 expressed an unqualified opinion thereon.
/s/ BDO Seidman, LLP
New York, NY
April 15, 2010
dELiA*s, Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value and share data)
See accompanying notes to consolidated financial statements
dELiA*s, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
See accompanying notes to consolidated financial statements
dELiA*s, Inc.
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(in thousands, except share data)
See accompanying notes to consolidated financial statements
dELiA*s, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying notes to consolidated financial statements
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In these Notes to Consolidated Financial Statements, when we refer to “Alloy, Inc.” we are referring to Alloy, Inc., our former parent corporation, and when we refer to “Alloy” we are referring to the Alloy-branded direct marketing and merchandising business that we operate. Similarly, when we refer to “dELiA*s” we are referring to the dELiA*s-branded direct marketing, merchandising and retail store business that we operate, when we refer to “dELiA*s, Inc.,” the “Company” “we,” “us,” or “our,” we are referring to dELiA*s, Inc., its subsidiaries and its predecessors, and when we refer to “the Spinoff”, we are referring to the December 19, 2005 spinoff of the outstanding common shares of dELiA*s, Inc. to the Alloy, Inc. shareholders.
1. Business and Basis of Presentation
Business
We are a direct marketing and retail company comprised of two lifestyle brands primarily targeting teenage girls and young women. Our two lifestyle brands-dELiA*s and Alloy-generate revenue by selling to consumers through the integration of direct mail catalogs, e-commerce websites and, for dELiA*s, mall-based specialty retail stores. Through our catalogs and the e-commerce webpages, we sell many name brand products along with our own proprietary brand products in key spending categories directly to consumers, including apparel and accessories. Our mall-based specialty retail stores derive revenue primarily from the sale of apparel and accessories to teenage girls.
Fiscal Year
The Company’s fiscal year ends on the Saturday closest to January 31st, typically resulting in a fifty-two week year, but occasionally giving rise to an additional week, resulting in a fifty-three week year. We refer to the 52-week fiscal year ended January 30, 2010 as “fiscal 2009”, to the 52-week fiscal year ended January 31, 2009 as “fiscal 2008”, and to the 52-week fiscal year ended February 2, 2008 as “fiscal 2007”.
Reclassifications
Certain reclassifications have been made to prior year amounts to conform with current year presentation. The effect of these reclassifications is not material.
Basis of Presentation
The accompanying consolidated financial statements include the historical financial statements of and transactions applicable to, the Company and reflect its assets, liabilities, results of operations and cash flows. All financial results in these Notes to Consolidated Financial Statements are for continuing operations only unless otherwise stated.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of dELiA*s, Inc. and our wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
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 the disclosure of contingent assets and liabilities at the date of the financial statements, as well
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
as the reported amounts of revenues and expenses during the reporting period. We based our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.
In preparing the financial statements, management makes routine estimates and judgments in determining the net realizable value of inventory, prepaid expenses, fixed assets, stock based compensation, intangible assets and goodwill. Some of the more significant estimates include the allowance for sales returns, the reserve for inventory valuation, the expected future revenue stream of catalog mailings, risk-free interest rates, expected lives, and expected volatility assumptions used for stock-based compensation expense, the expected useful lives of fixed assets and the valuation of intangible assets and goodwill. Actual results may differ from these estimates under different assumptions and conditions. The Company does not believe there is a great likelihood that materially different amounts would be reported related to the accounting policies described below.
We evaluate our estimates on an ongoing basis and make revisions as new information and experience warrant.
Concentration of Risk
We collect payment for all merchandise, perform credit card authorizations and check verifications for all customers prior to shipment or delivery. Our cash equivalents include amounts derived from credit card purchases from customers and are typically settled within two to four days. Due to the diversified nature of our client base, we do not believe that we are exposed to a concentration of credit risk.
Fair Value of Financial Instruments
We follow the guidance in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurement Disclosures” (“ASC 820”) as it relates to financial and nonfinancial assets and liabilities. We currently have no financial assets or liabilities that are measured at fair value. Our non-financial assets, which include property and equipment, are not required to be measured at fair value on a recurring basis. However, if certain triggering events occur, or if an annual impairment test is required and we are required to evaluate the non-financial asset for impairment, a resulting asset impairment would require that the non-financial asset be recorded at the fair value. ASC 820 prioritizes inputs used in measuring fair value into a hierarchy of three levels: Level 1-quoted prices (unadjusted) in active markets for identical assets or liabilities; Level 2-inputs other than quoted prices included within Level 1 that are either directly or indirectly observable; and Level 3-unobservable inputs in which little or no market activity exists, therefore requiring an entity to develop its own assumptions about the assumptions that market participants would use in pricing.
The carrying amounts of our financial instruments, including cash and cash equivalents, receivables, payables, other accrued liabilities and obligations under capital leases approximated fair value due to the short maturity of these financial instruments. The carrying amount of the mortgage note payable at January 31, 2009 approximated fair value as this debt had a variable interest rate that fluctuated with the market rate (see note 10 to our financial statements). There was no mortgage note payable at January 30, 2010.
Self Insurance
The Company uses a combination of insurance and self-insurance for certain losses related to its employee medical plan. Costs for self-insurance claims filed, as well as claims incurred but not reported, are accrued based on management’s estimates, using information received from plan administrators, historical analysis and other
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
relevant data. Management believes that it has adequately reserved for its self-insurance liability, which is capped through the use of stop loss contracts with insurance companies. However, any significant variation from historical trends in claims incurred but not paid could cause actual expense to differ from the accrued liability.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash, credit card receivables and highly liquid investments with original maturities of three months or less. Highly liquid investments, which primarily consist of money market funds, are recorded at cost, which approximates fair value. Credit card receivable balances included in cash and cash equivalents as of January 30, 2010 and January 31, 2009 were approximately $635,000 and $643,000, respectively.
Inventories
Inventories, which consist of finished goods, including certain expenses capitalized, are stated at the lower of cost (first-in, first out method) or market value. Inventories may include items that have been written down to our best estimate of their net realizable value. Our decisions to write-down and establish valuation allowances against our merchandise inventories are based on our current rate of sale, the age of the inventory and other factors. Actual final sales prices to customers may be higher or lower than our estimated sales prices and could result in a fluctuation in gross profit in subsequent periods.
Prepaid Catalog Costs
Catalog costs consist of catalog production and mailing costs. These costs are capitalized and expensed over the expected future revenue stream, which is customarily two to four months from the date the catalogs are mailed. Deferred catalog costs as of January 30, 2010 and January 31, 2009 were approximately $2.4 million and $2.8 million, respectively. Catalog costs expensed for fiscal 2009, fiscal 2008 and fiscal 2007 were approximately $24.7 million, $24.6 million, and $24.3 million, respectively, and are included within selling, general and administrative expenses in the accompanying consolidated statements of operations.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation. Amortization of leasehold improvements is computed on the straight-line method over the lesser of an asset’s estimated useful life or the life of the related store’s lease (generally 7-10 years). Depreciation on furniture, fixtures and equipment is computed on the straight-line method over the lives noted below. Maintenance and repairs are expensed as incurred.
The following estimated useful lives are used to determine depreciation or amortization:
Construction in progress
N/A
Leasehold improvements
Life of the lease*
Computer software and equipment
3 to 5 Years
Machinery and equipment
3 to 10 Years
Office furniture and store fixtures
5 to 10 Years
Building
39 Years
Land
N/A
* defined as the lesser of an asset’s estimated life or the life of the related lease
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Costs of Computer Software Developed or Obtained for Internal Use
As required by ASC 350-40, Internal-Use Software, the Company capitalizes costs related to internally developed software. Only costs incurred during the development stages, including design, coding, installation and testing are capitalized. These capitalized costs primarily represent internal labor costs for employees directly associated with the software development. Upgrades or modifications that result in additional functionality are capitalized.
Goodwill and Other Indefinite-Lived Intangible Assets
The Company follows the provisions of ASC-350-10, Intangibles-Goodwill and Other, which requires testing for impairment on an annual basis or between annual tests if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying amount. The Company last performed an annual impairment test as of January 30, 2010.
Determining the fair value of our direct marketing reporting unit under the first step of the goodwill impairment test and determining the fair value of individual assets and liabilities of that reporting unit (including unrecognized intangible assets) under the second step of the goodwill impairment test is judgmental in nature and often involves the use of significant estimates and assumptions. Similarly, estimates and assumptions are used in determining the fair value of our indefinite-lived intangible assets, primarily trademarks. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and also the magnitude of any such charge.
We perform valuation analyses and consider other market information that is publicly available. Estimates of fair value are primarily determined using discounted cash flows and market comparisons. These approaches use significant estimates and assumptions including projected future cash flows (including timing), discount rates reflecting the risk inherent in future cash flows, revenue growth rates, projected long-term growth rates, royalty rates, determination of appropriate market comparables and the determination of whether a premium or discount should be applied to comparables.
Considerable management judgment is necessary to estimate the fair value of our direct marketing reporting unit and indefinite-lived intangible assets which may be impacted by future actions taken by us or our competitors and the economic environment in which we operate. These estimates affect the balance of goodwill as well as intangible assets on our consolidated balance sheets and operating expenses on our consolidated statements of operations.
Results from the Company’s annual goodwill impairment test performed as of January 30, 2010 concluded that its goodwill and indefinite-lived intangible assets were not impaired.
Impairment of Long-Lived and Intangible Assets
In accordance with ASC 360, Property, Plant, and Equipment, the Company’s management evaluates the value of leasehold improvements and store fixtures associated with retail stores, which have been open for a period of time sufficient to reach maturity. The Company evaluates long-lived assets for impairment at the individual store level, which is the lowest level at which individual cash flows can be identified. Impairment losses are recorded on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of the assets. When events such as these occur, the impaired assets are adjusted to their estimated fair value and an impairment loss is recorded separately as a component of operating income under impairment of long-lived assets.
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
We measure fair value by discounting estimated future cash flows using an appropriate discount rate. Considerable judgment by us is necessary to estimate the fair value of the assets and accordingly, actual results could vary significantly from such estimates. Our most significant estimates and judgments relating to the long-lived asset impairments include the timing and amount of projected future cash flows and the discount rate selected to measure the risks inherent in future cash flows.
In fiscal 2009 and 2008, we recorded impairment charges of approximately $454,000 and $613,000, respectively, related to under-performing stores (see Note 5).
Sales and Use Tax
In accordance with ASC 605-40, Revenue Recognition, the Company records sales tax charged on merchandise sales on a net basis (excluded from revenue).
Revenue Recognition
Direct marketing revenues are recognized at the time of shipment to customers. These revenues are net of any promotional price discounts and an allowance for sales returns. The allowance for sales returns is estimated based upon our direct marketing return policy, historical experience and evaluation of current sales and returns trends. Direct marketing revenues also include shipping and handling billed to customers.
Retail store revenues are recognized at the point of sale, net of any promotional price discounts and an allowance for sales returns. The allowance for sales returns is estimated based upon our retail return policy, historical experience and evaluation of current sales and returns trends.
The Company’s policy with respect to gift certificates and gift cards is to record revenue as they are redeemed for merchandise. Prior to their redemption, these gift certificates and gift cards are recorded as a liability. The liability remains on the Company’s books until the earlier of redemption (recognized as revenue) or when the Company determines the likelihood of redemption is remote (recognized as other operating income). The Company determines the probability of the gift card being redeemed to be remote based on historical redemption patterns. For those gift cards that we determined redemption to be remote, we reversed our liability, and recorded an initial gift card breakage income of $1.3 million in the fourth quarter of fiscal 2009, which amount was recorded as other operating income.
While the Company will continue to honor all gift certificates and gift cards presented for payment, management reviews unclaimed property laws to determine gift certificate and gift card balances required for escheatment to the appropriate government agency.
We recognize other revenues that consist primarily of advertising provided for third parties in our catalogs, on our e-commerce web-pages, in our outbound packages, and in our retail stores pursuant to specific pricing arrangements with Alloy, Inc. Alloy, Inc. arranges these advertising services on our behalf through a transaction related to the Spinoff (see note 14 to our financial statements). In connection with the Spinoff, we have entered into a media services agreement with Alloy, Inc., as amended. We also recognize revenue from the sale of offline magazine subscriptions to our telephone direct marketing customers at the time of purchase. The revenue from third-party advertising and offline magazine subscription sales was approximately $517,000, $666,000, and $988,000 for fiscal 2009, fiscal 2008 and fiscal 2007, respectively.
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Cost of Goods Sold
Cost of goods sold consists of the cost of merchandise sold to customers, inbound freight costs, shipping costs, buying and merchandising costs, certain distribution costs and store occupancy costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of catalog production and mailing costs; certain fulfillment and distribution costs; store personnel wages and benefits; other store expenses, including supplies, maintenance and visual programs; administrative staff and infrastructure expenses; depreciation; amortization and facility expenses. Credit card fees, insurance and other miscellaneous operating costs are also included in selling, general and administrative expenses.
Stock-based compensation
The Company accounts for stock-based awards in accordance with ASC 718-10, Compensation-Stock Compensation, which requires the measurement and recognition of stock-based compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service period. For awards with performance conditions, an evaluation is made at the grant date and future periods as to the likelihood of the performance criteria being met. Compensation expense is adjusted in future periods for subsequent changes in the expected outcome of the performance conditions until the vesting date. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
Interest (Expense) Income, Net
Interest income and expense is presented net in the consolidated statements of operations. Interest income is derived from cash in bank accounts and held in money market accounts. Interest income for fiscal 2009, fiscal 2008, and fiscal 2007 was $233,000, $450,000, and $508,000, respectively. Interest expense primarily relates to the credit facilities with Wells Fargo and the mortgage note payable (which was paid off in September 2009). Interest expense for the fiscal 2009, fiscal 2008, and fiscal 2007 was $468,000, $759,000, and $513,000, respectively.
(Loss)Income Per Share
Net (loss) income per share is computed in accordance with ASC 260-10, Earnings Per Share. Basic (loss) income per share is computed by dividing the Company’s net (loss) income by the weighted average number of shares outstanding during the period. When the effects are not anti-dilutive, diluted earnings per share is computed by dividing the Company’s net (loss) income by the weighted average number of shares outstanding and the impact of all dilutive potential common shares, primarily stock options, warrants, restricted shares and convertible debentures. The dilutive impact of stock options is determined by applying the “treasury stock” method. For all periods presented in which there were losses, fully diluted losses per share do not differ from basic earnings per share.
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Loss) income per share calculations for each quarter include the appropriate weighted average effect for the quarter; therefore, the sum of quarterly (loss) income per share amounts may not equal year-to-date (loss) income per share amounts, which reflect the weighted average effect on a year-to-date basis.
The total number of potential common shares with an anti-dilutive impact, excluded from the calculation of diluted net (loss) income per share, is detailed in the following table:
Operating leases
The Company leases property for its stores under operating leases. Operating lease agreements typically contain construction allowances, rent escalation clauses and/or contingent rent provisions.
For construction allowances, the Company records a deferred lease credit on the consolidated balance sheet and amortizes the deferred lease credit as a reduction of rent expense on the consolidated statement of operations over the terms of the leases. For scheduled rent escalation clauses during the lease terms, the Company records minimum rental expenses on a straight-line basis over the terms of the leases on the consolidated statement of operations. The term of the lease over which the Company amortizes construction allowances and minimum rental expenses on a straight-line basis begins on the date of initial possession, which is generally when the Company enters the space and begins to make improvements in preparation for its intended use, not necessarily the cash rent commencement date.
Certain leases provide for contingent rents, which are determined as a percentage of gross sales in excess of specified levels. The Company records a contingent rent liability in accrued expenses on the consolidated balance sheets and the corresponding rent expense when management determines that achieving the specified levels during the fiscal year is probable.
Income Taxes
Income taxes are calculated in accordance with ASC 740-10, Income Taxes, which require the use of the asset and liability method. Deferred tax assets and liabilities are recognized based on the difference between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
assets and liabilities are measured using current enacted tax rates in effect in the years in which those temporary differences are expected to reverse. Inherent in the measurement of deferred balances are certain judgments and interpretations of enacted tax law and published guidance with respect to applicability to the Company’s operations. The effective tax rate utilized by the Company reflects management’s judgment of the expected tax liabilities within the various taxing jurisdictions.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion of all of the deferred tax assets will not be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, net operating loss carryback potential, and tax planning strategies in making these assessments.
On February 4, 2007, the Company adopted amendments to ASC 740-10 which clarified the accounting for uncertainty in income taxes recognized in the financial statements. These amendments prescribe a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by the taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate audit settlement. The adoption of these amendments to ASC 740-10, effective February 4, 2007, resulted in a decrease to stockholders’ equity of approximately $116,000.
The Company recognizes interest accrued for increases in the net liability for unrecognized income tax benefits in interest expense and any related penalties in income tax expense.
Recently Issued Accounting Pronouncements
In February 2010, the FASB issued ASU 2010-09, Subsequent Events. ASU 2010-09 amends ASC 855-10, Subsequent Events, by removing the requirement for SEC filers to disclose the date through which subsequent events have been evaluated. The Company adopted ASU 2010-09 immediately upon its issuance in February 2010, and its provisions are reflected in the consolidated financial statements for fiscal 2009. In accordance with this topic, the Company evaluates subsequent events through the date its financial statements are issued. Except for the removal of the date, the adoption of ASU 2010-09 did not have any impact on the Company’s consolidated financial statements.
In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures. ASU 2010-06 amends ASC 820-10, Fair Value Measurements and Disclosures, and requires new disclosures surrounding certain fair value measurements. ASU 2010-06 is effective for the first interim or annual reporting period beginning on or after December 15, 2009, except for certain disclosures about purchases, sales, issuances, and settlements in the rollforward of activity in Level 3 fair value measurements, which are effective for the first interim and annual reporting periods beginning on or after December 15, 2010. The Company is currently evaluating the impact of this ASU on its consolidated financial statements.
Effective August 2, 2009, the Company adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 105-10, Generally Accepted Accounting Principles (“ASC 105-10”). ASC 105-10 establishes the FASB Accounting Standards Codification (the “Codification”) as the source of authoritative accounting principles recognized by the FASB to be applied to non-governmental entities in the preparation of financial statements in conformity with U.S. GAAP. Rules and interpretative releases of the SEC under authority of Federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority. The Codification superseded all existing non-SEC accounting and reporting standards. All other non-grandfathered, non-SEC accounting
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
literature not included in the Codification is non-authoritative. The FASB will not issue new standards in the form of new Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead it will issue Accounting Standards Updates (“ASUs”). The FASB will not consider ASUs as authoritative in their own right. ASUs will serve only to update the Codification, provide background information about the guidance and provide the bases for conclusions in the change(s) in the Codification. References made to FASB guidance throughout this document have been updated for the Codification.
In May 2009, the FASB issued amendments to ASC 855-10, Subsequent Events, which establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The amendments to ASC 855-10 introduce the concept of financial statements being available to be issued, and required the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date, that is, whether that date represents the date the financial statements were issued or were available to be issued. The Company adopted the amendments to ASC 855-10 during the second quarter of fiscal 2009, but the Company’s adoption of ASU 2010-09, discussed above, eliminated any impact that these amendments to ASC 855-10 had on the Company’s consolidated financial statements.
In April 2009, the FASB issued amendments to ASC 820-10, Fair Value Measurements and Disclosures, which provide guidance for estimating fair value when the volume and level of activity for an asset or liability have significantly decreased. These amendments to ASC 820-10 include guidance on identifying circumstances that indicate when a transaction is not orderly, and are effective for interim reporting periods ending after June 15, 2009. These amendments to ASC 820-10 do not require disclosures for earlier periods presented for comparative purposes at initial adoption, and, in periods after initial adoption, comparative disclosures are only required for periods ending after initial adoption. The Company adopted these amendments to ASC 820-10 during the second quarter of fiscal 2009 and the adoption did not have a material impact on our consolidated financial statements.
In April 2009, the FASB issued amendments to ASC 825-10, Financial Instruments, which require disclosures about the fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. The amendments to ASC 825-10 also require those disclosures in summarized financial information at interim reporting periods. The amendments to ASC 825-10 are effective for interim reporting periods ending after June 15, 2009. The amendments to ASC 825-10 do not require disclosures for earlier periods presented for comparative purposes at initial adoption, and, in periods after initial adoption, comparative disclosures are only required for periods ending after initial adoption. The Company adopted the amendments to ASC 825-10 during the second quarter of Fiscal 2009. The required disclosures are included in “Fair Value of Financial Instruments” above.
In April 2009, the FASB issued updated guidance related to business combinations, which is included in the Codification in ASC 805-20, Business Combinations-Identifiable Assets, Liabilities and Any Non Controlling Interest, (“ASC 805-20”). ASC 805-20 amends and clarifies ASC 805 to address application issues regarding the initial recognition and measurement, subsequent measurement and accounting and disclosures of assets and liabilities arising from contingencies in a business combination. In circumstances where the acquisition-date fair value for a contingency cannot be determined during the measurement period and it is concluded that it is probable that an asset or liability exists as of the acquisition date and the amount can be reasonably estimated, a contingency is recognized as of the acquisition date based on the estimated amount. The Company will apply ASC 805-20 prospectively to any business combinations completed after February 1, 2009.
Effective January 1, 2009, the Company adopted FASB ASC Topic 805, Business Combinations (“ASC 805”). ASC 805 establishes principles and requirements for how the acquirer of a business recognizes and
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measures in its financial statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree. ASC 805 also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of financial statements to evaluate the nature and financial effects of the business combination. The Company will apply ASC 805 prospectively to any business combinations completed after February 1, 2009.
In June 2008, the FASB issued amendments to ASC 260-10, Earnings Per Share, which require that unvested share-based payment awards that contain rights to receive nonforfeitable dividends (whether paid or unpaid) be considered participating securities and be included in the two-class method of computing earnings per share. These amendments to ASC 260-10 are effective for fiscal years beginning after December 15, 2008, and interim periods within those years. The Company adopted these amendments to ASC 260-10 on February 1, 2009. The adoption of ASC 260-10 had no material impact on the Company’s condensed consolidated financial statements.
On February 3, 2008, the Company adopted FASB ASC 820-10, Fair Value Measurements and Disclosures (“ASC 820-10”), to define fair value, establish a framework for measuring fair value in accordance with generally accepted accounting principles and expand disclosures about fair value measurements except with respect to its non-financial assets and liabilities. ASC 820-10 requires quantitative disclosures using a tabular format in all periods (interim and annual) and qualitative disclosures about the valuation techniques used to measure fair value in all annual periods. On February 1, 2009, the Company adopted ASC 820-10 for its non-financial assets and liabilities. The Company’s non-financial assets, which include goodwill, property and equipment, and intangible assets are subject to this new guidance and are measured at fair value for impairment assessments. The adoption of ASC 820-10 did not have a material impact on our condensed consolidated financial statements.
3. Discontinued Operations
On November 5, 2008, the Company sold its CCS business to Foot Locker, Inc. for $103.2 million. As a result of this transaction, the results of the CCS business have been reported as discontinued operations for fiscal 2009, fiscal 2008, and fiscal 2007. In discontinued operations, the Company has reversed its allocation of shared services to the CCS business and has charged discontinued operations with the administrative and distribution expenses that were attributable to CCS. Also, as part of the transaction, dELiA*s, Inc. provided certain transition services to Foot Locker.
The Company recorded a pre-tax gain of $49.4 million as a result of the sale of CCS. The gain reflected, in part, the allocation of $28.1 million of nondeductible goodwill to the CCS business.
Income from discontinued operations, net of taxes was $16,000, $29.8 million, and $10.0 million for fiscal 2009, fiscal 2008, and fiscal 2007, respectively.
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Discontinued operations were comprised of:
4. Other Current Assets
Other current assets consisted of the following:
5. Property and Equipment, net
Property and equipment (net) consisted of the following:
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Depreciation and amortization expense related to property and equipment (including capitalized leases) was approximately $10.1 million, $8.7 million, and $7.5 million for fiscal 2009, fiscal 2008, and fiscal 2007, respectively. In August 2008, approximately $2.2 million of fully depreciated assets no longer in use were written off.
Based upon our impairment analysis of long-lived assets during fiscal 2009 and 2008, we recognized impairment charges of approximately $454,000 and $613,000, respectively, related to under-performing stores.
With regard to costs required to complete new stores where build-out had already begun as of January 30, 2010, such amount is expected to be approximately $0.3 million.
6. Goodwill and Intangible Assets
The Company’s intangible assets consisted of the following:
Amortization expense for fiscal 2009, fiscal 2008, and fiscal 2007 was $21,000, $77,000, and $93,000, respectively. As of January 30, 2010, the amortizable intangibles have been fully amortized.
Refer to Note 2, “Summary of Significant Accounting Policies, Goodwill and Other Indefinite-Lived Intangible Assets and Impairment of Long Lived Intangible Assets”, for further details regarding our procedure for evaluating goodwill and other intangible assets for impairment.
7. Restructuring Charges
The following tables summarize our restructuring activities:
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There were no restructuring accruals on our consolidated balance sheets as of January 30, 2010 and January 31, 2009. The final payment of $835,000 was made in September 2008.
8. Credit Facility
dELiA*s, Inc. and certain of its wholly-owned subsidiaries were parties to a Second Amended and Restated Loan and Security Agreement (the “Restated Credit Facility”) with Wells Fargo Retail Finance II, LLC (“Wells Fargo”) which expired by its terms on June 26, 2009. The Restated Credit Facility was a secured revolving credit facility that the Company could draw upon for working capital and capital expenditure requirements and had an initial credit limit of $25 million.
The Company was allowed under the Restated Credit Facility, under certain circumstances and if certain conditions were met, to permanently increase the credit limit in $5 million increments, up to a maximum credit limit of $40 million. Each permanent increase in the credit limit required the Company to pay an origination fee of 0.20% of the amount of the increase. During March 2008, the Company permanently increased the credit limit under the Restated Credit Facility by $5 million, from $25 million to $30 million. The Company could also have obtained temporary credit limit increases for up to 90 consecutive days during the period beginning July 15th and ending on December 15th each year. Temporary credit limit increases did not require the payment of an origination fee. In the third quarter of fiscal 2008, the Company obtained a temporary credit increase of $5 million. During June 2008, the Restated Credit Facility was amended to allow for letters of credit up to an aggregate amount of $15 million. The Restated Credit Facility previously allowed for letters of credit up to an aggregate amount of $10 million.
Funds were available under the Restated Credit Facility up to the then existing credit limit or, if lower, the “Borrowing Base” of the Company determined in accordance with a formula set forth in the Restated Credit Facility based upon eligible inventory and accounts receivable, in each case less the sum of (i) outstanding revolving credit loans, (ii) outstanding letters of credit, (iii) certain “Availability Reserves” as determined in accordance with the terms of the Restated Credit Facility, and (iv) the “Availability Block” (which was equal to the greater of 6.5% of the then existing credit limit and $1.5 million). Loans under the Restated Credit Facility bore interest, at the Company’s option, either at the prime rate or the London Interbank Offered Rate plus a variable margin ranging from 1.25% to 1.75% depending on excess availability and cash on hand. A monthly fee of 0.25% per annum was payable based on the unused balance of the Restated Credit Facility. The Restated Credit Facility was secured by substantially all of the assets of the Company and contained various affirmative and negative covenants, representations, warranties and events of default, including restrictions such as limitations on additional indebtedness, other liens, dividends, distributions, stock repurchases, the annual amount of capital expenditures and the number of new stores the Company could open each year.
Upon the closing of the sale of CCS in November 2008, all outstanding borrowings were repaid. Thus as of January 31, 2009, there were no amounts outstanding under the Restated Credit Facility.
Upon the expiration of the Restated Credit Facility on June 26, 2009, the Company entered into a letter of credit agreement (“Letter of Credit Agreement”) with Wells Fargo.
The Letter of Credit Agreement, which has a maturity date of June 26, 2011, provides for the issuance of letters of credit to finance the acquisition of inventory from suppliers, to provide standby letters of credit to factors, landlords, insurance providers and other parties for business purposes, and for other general corporate purposes. Aggregate letters of credit issued and to be issued under the Letter of Credit Agreement at any one time outstanding could not exceed the lesser of $15,000,000 or an amount equal to a certain percentage of cash collateral held by Wells Fargo to secure repayment of the Company’s and the Subsidiaries’ respective obligations
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to Wells Fargo under the Letter of Credit Agreement and related letter of credit documents. The Company had secured these obligations by the pledge to Wells Fargo of cash collateral in the amount of $15,750,000. None of the other assets or properties of the Company, or any of its subsidiaries or affiliates, have been pledged as collateral for these obligations.
The Letter of Credit Agreement calls for the payment by the Company of an unused line fee of 0.75% per annum on the average unused portion of the credit facility under the Letter of Credit Agreement, a letter of credit fee of 2.00% per annum on the average outstanding face amount of letters of credit issued under the Letter of Credit Agreement, as well as other customary fees and expenses generally charged by the letter of credit issuer. The Letter of Credit Agreement does not contain any financial covenants with which the Company or any of its subsidiaries or affiliates must comply during the term of the Letter of Credit Agreement.
On January 28, 2010, the Company entered into a First Amendment to Letter of Credit Agreement (the “First Amendment”) with Wells Fargo. Pursuant to the First Amendment, the Letter of Credit Agreement was amended at the Company’s request to, among other things, reduce the maximum aggregate face amount of letters of credit that may be issued under the Letter of Credit Agreement, to the lesser of (a) $10,000,000 or (b) an amount equal to a specified percentage of cash collateral held by Wells Fargo. In addition, cash collateral is now only required in an amount equal to 105% of the face amount of outstanding letters of credit issued under the Letter of Credit Agreement, as amended.
As of January 30, 2010, there were approximately $7.2 million of outstanding letters of credit under the Letter of Credit Agreement, and cash collateral required to secure the Company’s obligations under the Letter of Credit Agreement, as amended, was approximately $7.5 million which is shown as restricted cash in noncurrent assets on the accompanying consolidated balance sheet.
9. Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consisted of the following:
10. Long-Term Liabilities
Deferred Credits
Deferred credits consist of deferred rent and tenant allowances. We occupy our retail stores, home office and call center facility under operating leases generally with terms of seven to ten years. Some of these leases have early cancellation clauses, which permit the lease to be terminated if certain sales levels are not met in specific periods. Most of the store leases require payment of a specified minimum rent, plus a contingent rent based on a percentage of the store’s net sales in excess of a specified threshold. Most of the lease agreements have defined escalating rent provisions, which are reported as a deferred rent liability and expensed on a straight-
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line basis over the term of the related lease, commencing with date of possession. This includes any lease renewals deemed to be probable. In addition, we receive cash tenant allowances and have reported these amounts as deferred rent which is amortized to rent expense over the term of the lease, also commencing with date of possession. Deferred rent as of January 30, 2010 and January 31, 2009 was $5.5 million and $4.6 million, respectively.
Mortgage Note Payable
We were a party to a mortgage loan agreement related to the purchase of our distribution facility in Hanover, Pennsylvania. The mortgage note amortized on a fifteen-year schedule and was to mature with a balloon payment of $2.3 million in September 2008. During March 2008, we extended the maturity date on the mortgage note from September 2008 to September 2009. The loan bore interest at LIBOR plus 225 basis points and was subject to quarterly financial covenants. The mortgage loan was secured by the distribution facility and related property. The Company paid off the remaining balance of the mortgage, which was approximately $2.1 million, on September 30, 2009.
11. Stock-Based Compensation
The Company accounts for share-based compensation under the provisions of ASC 718 Compensation-Stock Compensation, which requires share-based compensation related to stock options to be measured based on estimated fair values at the date of grant using an option-pricing model.
The Company estimates the fair value of stock options granted using the Black-Scholes option-pricing model, which requires the Company to estimate the expected term of stock option grants and expected future stock price volatility over the expected term.
The Company recorded stock-based compensation expense of $904,000, $1.0 million, and $1.1 million for fiscal 2009, 2008 and 2007, respectively, related to employee share based awards and such expense is included in selling, general and administrative expense in the statements of operations.
The per share weighted average fair value of stock options granted during fiscal 2009, fiscal 2008, and fiscal 2007 were $1.19, $0.96, and $3.20, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
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The following table summarizes transactions in dELiA*s, Inc. stock options during fiscal 2009:
The intrinsic value of stock options exercised during fiscal 2009 and fiscal 2008 was approximately $1,400 and $-0-, respectively. The aggregate intrinsic value of stock options outstanding and stock options exercisable at January 30, 2010 were approximately $43,400 and $10,900, respectively.
Unexercised options to purchase Alloy, Inc. common stock held by our employees and outstanding on the effective date of the Spinoff were converted to options to acquire our common stock. The stock options, as converted, assumed the same vesting provisions, contractual life and other terms and conditions as the Alloy, Inc. options they replaced. The number of shares and exercise price of each converted stock option were adjusted so that each new option to purchase our common stock had the same ratio of exercise price per share to market value per share and the same aggregate difference between market value and exercise price as the Alloy, Inc. stock options so converted. No new measurement date occurred upon conversion.
A summary of the status of the Company’s non-vested shares as of January 31, 2009, and changes during the twelve month period ended January 30, 2010 is as follows:
As of January 30, 2010, there was approximately $610,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements. That cost is expected to be recognized over a weighted average period of 1.5 years.
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12. Stockholders’ equity
Shares Reserved For Future Issuance
Stock options and restricted shares
Prior to the Spinoff, we issued options to purchase 2,150,000 shares of our common stock at an exercise price of $7.43 to certain senior management of the Company. These options vested over a four-year period.
In connection with the completion of the Spinoff, outstanding Alloy, Inc. stock options and restricted shares held by persons who were not or did not become employees of ours were converted into adjusted options to purchase Alloy, Inc. common stock and new options and restricted shares of our common stock. We issued 3,131,583 options and 98,792 shares of restricted stock to such Alloy, Inc employees who remained with Alloy, Inc. after the Spinoff. We also converted outstanding Alloy, Inc. stock options held by persons who were our employees at the time of the Spinoff, or became our employees after the Spinoff into 956,118 dELiA*s options. These amounts were determined based on the relative market values of our and Alloy, Inc. common stock following the Spinoff so that each replacement dELiA*s, Inc. stock option will have the same aggregate intrinsic value and the same ratio of the exercise price per share to market value per share as the Alloy, Inc. stock option it replaced. Vesting provisions, option terms and other terms and conditions of the replaced Alloy, Inc. options remain unchanged.
Rights Offering
On December 30, 2005, we filed a prospectus under which we distributed at no charge to persons who were holders of our common stock on December 28, 2005 transferable rights to purchase up to an aggregate of 2,691,790 shares of our common stock at a cash subscription price of $7.43 per share (the “rights offering”). The rights offering was made to help fund the costs and expenses of our retail store expansion plan and to provide funds for general corporate purposes following the Spinoff. MLF Investments, LLC (“MLF”), which was controlled by Matthew L. Feshbach, our former Chairman of the Board, agreed to backstop the rights offering, meaning MLF agreed to purchase all shares of our common stock that remained unsold upon completion of the rights offering at the same $7.43 subscription price per share. The rights offering was completed in February 2006 with approximately $20 million of gross proceeds. Our stockholders exercised subscription rights to purchase 2,040,570 shares of dELiA*s common stock, of the 2,691,790 shares offered in the rights offering, raising a total of $15,161,435. On February 24, 2006, MLF purchased the remaining 651,220 shares for a total of $4,838,565. Excluding MLF, approximately 90% of the rights were exercised. MLF received as compensation for its backstop commitment a nonrefundable fee of $50,000 and ten-year warrants to purchase 215,343 shares of our common stock at an exercise price of $7.43 per share. The warrants had a grant date fair value of approximately $900,000 and were recorded as a cost of raising capital. The MLF warrants were subsequently split so that MLF Offshore Portfolio Company, LP owned warrants to purchase 206,548 shares of our common stock and MLF Partners 100, LP owned warrants to purchase 8,795 shares of our common stock. Such warrants were distributed on a pro-rata basis to investors as part of the winding up of operations of MLF and its affiliated funds.
Preferred Stock
We are authorized to issue, without stockholder approval, up to 25,000,000 shares of preferred stock, $0.01 par value per share, having rights senior to those of our common stock. As of December 7, 2005, we had authorized the issuance of 1,000,000 shares of series A junior participating preferred stock, none of which are outstanding as of January 30, 2010.
Warrants and Convertible Debentures
Prior to the Spinoff, Alloy, Inc. had warrants outstanding for the purchase of 1,326,309 shares in the aggregate of Alloy, Inc. common stock that were issued to certain purchasers of (i) Alloy, Inc. common stock in a
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private placement transaction completed on January 25, 2002, and (ii) Alloy, Inc.’s Series A Convertible Preferred Stock (collectively the “Warrants”). Upon consummation of the Spinoff, the Warrants became exercisable into both the number of shares of Alloy, Inc. common stock into which such Warrants otherwise were exercisable and one-half that number of shares, or 663,155 shares of our common stock, none of which have been issued. We have agreed with Alloy, Inc. that we will issue shares of our common stock, without compensation, on behalf of Alloy, Inc. to holders of the Warrants as and when required in connection with any exercise of the Warrants. All other outstanding Alloy, Inc. warrants were unaffected by the Spinoff.
At the time of the Spinoff, Alloy, Inc. had outstanding $69.3 million of 5.375% convertible senior debentures due 2023 (the “Debentures”). The outstanding Debentures were convertible into 8,274,628 shares of Alloy, Inc. common stock. As a result of the Spinoff, the Debentures were convertible into 8,274,628 shares of Alloy, Inc. common stock (before consideration of a subsequent reverse stock split by Alloy, Inc.) and 4,137,314 shares of our common stock if and when the conditions to conversion are satisfied. We have agreed with Alloy, Inc. that as a result of the relative market values of our and Alloy, Inc. common stock following the Spinoff, we would issue shares of our common stock on behalf of Alloy, Inc. to holders of the Debentures as and when required in connection with any conversion of the Debentures. As a result of current market conditions, the combined share values of our common stock and Alloy, Inc.’s common stock have exceeded the conversion price of the Debentures. As of January 30, 2010, 4,136,441 shares of dELiA*s, Inc. common stock had been issued in connection with the Debentures. There are Debentures that are convertible into an additional 873 shares of our common stock that remain outstanding as of January 30, 2010. When these conversions occur, they will be recorded as a component of stockholders’ equity and would not have an impact on the statement of operations.
Restricted Stock
In fiscal 2009 and fiscal 2008, the Company issued 106,952 and 90,908 shares of restricted stock, respectively, which are subject to vesting requirements, to outside board members valued at approximately $200,000 for each year at the date of grant. These shares are charged to stock-based compensation expense ratably over the vesting periods, which is three years. In fiscal 2007, the Company issued 176,976 shares of restricted stock, which are subject to vesting requirements, to outside board members and one employee valued at approximately $505,000 at the dates of grant. These shares are charged to stock-based compensation expense ratably over the vesting periods, which do not exceed four years.
13. Income Taxes
The components of the benefit for income taxes consist of the following for fiscal:
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Included in the fiscal year 2009, 2008, and 2007 income from discontinued operations were federal and state tax provisions of $9,000, $29.6 million, and $6.4 million, respectively.
The reconciliation between the statutory income tax rate and the effective tax rate is as follows:
The types of temporary differences that give rise to our deferred tax assets and liabilities are set out as follows at:
Prior to the completion of the Spinoff, we were included in Alloy, Inc.’s consolidated federal and certain state income tax groups for income tax purposes. For federal income tax purposes, we have unused net operating loss (“NOL”) carry forwards of approximately $22 million at January 30, 2010, expiring through January 31, 2023. The U.S. Tax Reform Act of 1986 contains provisions that limit the NOL carry forwards available to be used in any given year upon the occurrence of certain events, including a significant change of ownership. We have experienced such ownership changes and may experience such future changes. In addition, the annual limitations may result in the expiration of net operating losses before utilization. For state tax purposes, we have unused NOL carry forwards of approximately $64 million at January 30, 2010 which have expiration dates that vary by jurisdiction.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, net operating loss carryback potential, and tax planning strategies in making these assessments.
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Based upon the above criteria, the Company believes that it is more-likely-than-not that $1.1 million of deferred tax assets will be realized; the Company does not believe that it is more-likely-than-not that the remaining net deferred tax assets will be realized. For fiscal 2009, the valuation allowance increased by $1.0 million. This change in the valuation allowance primarily relates to increased state tax NOL carry forwards and is reflected in the State taxes, net of federal benefit line in the rate reconciliation table above. For fiscal 2008, the valuation allowance decreased by $3.3 million.
At January 30, 2010, the Company had a liability for unrecognized tax benefits of $394,000, all of which would favorably affect the Company’s effective tax rate if recognized. Included within the $394,000 is an accrual of $106,000 for the payment of related interest and penalties. The Company does not believe there will be any material changes in the unrecognized tax positions over the next twelve months.
The Company recognizes interest related to unrecognized tax benefits in interest expense and any related penalties in income tax expense. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheet. The Company recorded an additional $13,000 and $20,000 in interest and penalties, respectively, for the fiscal year ended January 30, 2010.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
The Company’s U.S. subsidiaries join in the filing of a U.S. federal consolidated income tax return. The U.S. federal statute of limitations remains open for the fiscal years 2006 onward. The Company is currently under examination by the Internal Revenue Service. State income tax returns are generally subject to examination for a period of 3 to 5 years after filing of the respective returns. The state impact of any federal changes remains subject to examination by various states for a period of up to one year after formal notification to the states.
14. Spinoff Related Transactions
Services and Revenues
We recognize other revenues that consist primarily of advertising provided for third parties in our catalogs, on our e-commerce web-pages, in our outbound packages, and in our retail stores pursuant to specific pricing arrangements with Alloy, Inc. Alloy, Inc. arranges these advertising services on our behalf, through a media services agreement (which was subsequently amended in conjunction with the sale of CCS) entered into in connection with the Spinoff. Revenue under these arrangements is recognized, net of commissions and agency fees, when the underlying advertisement is published or otherwise delivered pursuant to the terms of each arrangement. We recorded revenues of $399,000, $557,000, and $775,000 for fiscal 2009, fiscal 2008, and fiscal 2007, respectively, in our financial statements in accordance with the terms of the media services agreement. We recorded $-0-, $78,000, and $152,000 for fiscal 2009, 2008 and 2007, respectively, related to the CCS business which is included in the discontinued operations caption in our consolidated statements of operations.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Prior to the Spinoff, we and Alloy, Inc. entered into the following agreements that were to define our ongoing relationships after the Spinoff: a distribution agreement, tax separation agreement, trademark agreement, information technology and intellectual property agreement, media services agreement (which was subsequently amended in conjunction with the sale of CCS), and an On Campus Marketing call center agreement. In addition, as part of the transaction involving the sale of our former CCS business, we entered into a Media Placement Services Agreement with Alloy, Inc. pursuant to which we agreed to purchase specified media services over a three year period for $3.3 million. We have compensated Alloy, Inc. approximately $1.3 million, $158,000, and $788,000 for fiscal 2009, fiscal 2008, and fiscal 2007, respectively, in relation to the services provided under these agreements.
15. Commitments and Contingencies
Leases
We lease dELiA*s retail stores, a call center, office space, storage space and certain computer equipment under noncancelable operating leases with various expiration dates through 2020. As of January 30, 2010, future net minimum lease payments are as follows:
Most of the dELiA*s retail store leases require payment of a specified minimum rent, plus a contingent rent based on a percentage of the store’s net sales in excess of a specified threshold. Most of the lease agreements have defined escalating rent provisions, which are expensed over the term of the related lease on a straight-line basis commencing with the date of possession, including any lease renewals deemed to be probable. In addition, most of the leases require payment of real estate taxes, insurance and certain common area and maintenance costs in addition to the future minimum operating lease payments.
Total rental expense during fiscal 2009, 2008 and 2007, including common-area maintenance, was $20.3 million, $18.2 million, and $16.2 million, respectively. There were no contingent excess rent payments made during these periods.
With regard to costs required to complete new stores where build-out had already begun as of January 30, 2010, such amount is expected to be approximately $0.3 million.
Sales Tax
At present, with respect to the Alloy catalogs, sales or other similar taxes are collected in respect of direct shipments of goods to consumers located in states where Alloy has a physical presence or personal property. With respect to the dELiA*s catalogs, sales or other similar taxes are collected only in states where we have dELiA*s retail stores, another physical presence or other personal property. However, various other states or foreign countries may seek to impose sales tax obligations on such shipments in the future. A number of
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proposals have been made at the state and local levels that would impose additional taxes on the sale of goods and services through the internet. A successful assertion by one or more states that we should have collected or be collecting sales taxes on the sale of products could have a material adverse effect on our results of operations.
License Agreement
In February 2003, dELiA*s Brand LLC, a subsidiary of dELiA*s Corp., entered into a master license agreement with JLP Daisy to license the dELiA*s brand on an exclusive basis for wholesale distribution in certain product categories, primarily in mid- and upper-tier department stores. dELiA*s Brand LLC received a $16.5 million cash advance against future royalties from the licensing ventures. The master license agreement provides that JLP Daisy is entitled to retain all of the royalty income generated from the sale of licensed products until JLP Daisy recoups its advance plus one-third of a preferred return of 18% per year on the unrecouped advance, if ever. Thereafter, we will receive an increasing share of the royalties until JLP Daisy recoups its advance plus a preferred return of 18% per year on the unrecouped advance, at which time we will receive a majority of the royalty stream after brand management fees. The initial term of the master license agreement is approximately 10 years, which is subject to an extension of up to five years under specified circumstances and also is extended until JLP Daisy recoups its advance and preferred return. The master license agreement provides that the advance will be recoupable by JLP Daisy solely out of its share of the royalty payments and not through recourse against dELiA*s Brand LLC, us or any of our properties or assets. The master license agreement may be terminated early under certain circumstances, including, at our option, upon payment to JLP Daisy of an amount based upon royalties received from the sale of the licensed products during a specified period. In addition, dELiA*s Brand LLC granted to JLP Daisy a security interest in the dELiA*s trademarks, although the only event that would entitle JLP Daisy to exercise its rights with respect to these trademarks is a termination or rejection of the master license agreement in a bankruptcy proceeding. We have not recorded any amounts associated with the license agreement.
Employment Agreements
The Company has entered into employment agreements with certain key executives. The agreements specify various employment-related matters, including annual compensation, performance incentive bonuses, and severance benefits in the event of termination with or without cause.
In addition, there are three other executives of the Company with severance agreed to in employment agreements and offer letters depending on various circumstances.
Benefit Plan
Full and part-time employees who are at least 21 years of age are eligible to participate in the dELiA*s Inc. 401(k) Profit Sharing Plan (the “Plan”). Under the Plan, employees can defer 1% to 75% of compensation as defined. The Company began in fiscal 2006 to match contributions in cash of $0.50 per employee contribution dollar on the first 5% of the employee contribution. However, in early fiscal 2009, the Company matching contributions were suspended for the remainder of the fiscal year. The employees’ contribution is 100% vested, while the Company’s matching contribution vests at 20% per year of employee service. The Company’s contributions were $11,000, $392,000, and $335,000 for fiscal years 2009, 2008 and 2007, respectively.
Litigation
(a) The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. Although the amount of any liability that could arise with respect to these actions cannot be determined with certainty, in the Company’s opinion, any such liability will not have a material adverse effect on its consolidated financial position, consolidated results of operations or liquidity.
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(b) Mynk Litigation. The Company was a defendant in a litigation brought by Mynk Corporation (“Mynk”) in the Los Angeles Superior Court alleging non-payment for goods. The Company previously had a long- standing relationship with a supplier of goods, Femme Knits, Inc. (“Femme Knits”). Mynk contended that it acquired the right to completed orders for goods from Femme Knits as a result of an acquisition of that right at an alleged Uniform Commercial Code foreclosure sale. In accordance with an agreement between dELiA*s and Femme Knits, among other things, dELiA*s advanced the sum of $600,000 for some price and other concessions and an agreement that dELiA*s could offset against the $600,000 advance future amounts owing to Femme Knits (Mynk). In July 2008, the Company recovered the advance by paying all other sums due on the purchase of goods from Femme Knits (Mynk) except for the $600,000 owed to it. Mynk contended that it was not bound by the agreement between dELiA*s and Femme Knits. In January 2010, the Company settled the lawsuit with Mynk. The settlement amount was not material to our consolidated financial statements.
16. Segment Reporting
The Company’s executive management, being its chief operating decision makers, works together to allocate resources and assess the performance of the Company’s business. The Company’s executive management manages the Company as two distinct operating segments, direct marketing and retail stores. Although offering customers substantially similar merchandise, the Company’s direct and retail operating segments have distinct management, marketing and operating strategies and processes.
The Company’s executive management assesses the performance of each operating segment based on operating income/loss, which is defined as net sales less the cost of goods sold and selling, general and administrative (“SG&A”) expenses both directly identifiable and allocable. For the direct segment, these SG&A expenses primarily consist of catalog development, production and circulation costs, order processing costs, direct personnel costs and allocated overhead expenses. For the retail segment, these SG&A expenses primarily consist of store selling expenses, direct labor costs and allocated overhead expenses. Allocated overhead expenses are costs associated with general corporate expenses and shared departmental services (e.g., executive, accounting, data processing, legal and human resources).
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Operating segment assets are those directly used in or clearly allocable to an operating segment’s operations. For the retail segment, these assets primarily include inventory, fixtures and leasehold improvements. For the direct segment, these assets primarily include inventory and prepaid catalog costs. Corporate and other assets include corporate headquarters, warehouse and fulfillment and contact center facilities, shared technology infrastructure as well as corporate cash and cash equivalents and prepaid expenses. Operating segment depreciation and amortization and capital expenditures incurred are recorded directly to each operating segment. Corporate assets and other depreciation and amortization and capital expenditures are allocated to each reportable segment. The accounting policies of the segments are the same as those described in note 2. Reportable data for our reportable segments were as follows (reflects continuing operations only):
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
17. Quarterly Results (Unaudited)
The following table sets forth unaudited quarterly financial data for each of our last two fiscal years:
(1) Certain fixed overhead costs that were allocated to discontinued operations through the end of the third quarter of fiscal 2008 have been reclassed to continuing operations and are reflected in the fiscal 2008 quarters noted above.
(2) In the fourth quarter of fiscal 2008, the Company sold its CCS business. The gain on sale is included in the fiscal 2008 fourth quarter amount.
(3) In the fourth quarter of 2009, the Company included initial gift card breakage income of $1.3 million recorded in other operating income.
dELiA*s, Inc.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
INDEX TO EXHIBITS
* Filed herewith.