Item 1.
Business
Overview
Aéropostale, Inc., a Delaware corporation, originally incorporated as MSS-Delaware, Inc. on September 1, 1995 and later changed to Aéropostale, Inc. on February 1, 2000, is a mall-based specialty retailer of casual apparel and accessories. We design, market and sell our own brand of merchandise principally targeting 14 to 17 year-old young women and young men. Jimmy’Z Surf Co., Inc., a wholly owned subsidiary of Aéropostale, Inc., is a California lifestyle-oriented brand targeting trend-aware young women and men aged 18 to 25. We also sell Aéropostale merchandise through our e-commerce website, www.aeropostale.com. As of February 2, 2008, we operated 828 stores, consisting of 802 Aéropostale stores in 47 states, 12 Aéropostale stores in Canada, and 14 Jimmy’Z stores in 11 states.
Our Aéropostale concept provides the customer with a focused selection of high-quality, active-oriented, fashion and fashion basic merchandise at compelling values. Our Jimmy’Z concept provides the customer with a broad selection of California lifestyle-oriented merchandise, targeting trend-aware young men and women. We maintain control over our proprietary brands by designing and sourcing all of our merchandise. Our Aéropostale products are sold only at our stores and online through our e-commerce website, www.aeropostale.com, while Jimmy’Z products are sold only at our Jimmy’Z stores. We strive to create a fun, high-energy shopping experience through the use of creative visual merchandising, colorful in-store signage, popular music and an enthusiastic well-trained sales force. Our average Aéropostale store is generally smaller than that of our mall-based competitors. We believe this enables us to achieve higher sales productivity and project a sense of greater action and excitement in the store.
The Aéropostale brand was established by R.H. Macy & Co., Inc., as a department store private label initiative, in the early 1980’s targeting men in their twenties. Macy’s subsequently opened the first mall-based Aéropostale specialty store in 1987. Over the next decade, Macy’s, and then Federated Department Stores, Inc. (now Macy’s, Inc.), expanded Aéropostale to over 100 stores. In August 1998, Federated sold its specialty store division to our management team and Bear Stearns Merchant Banking. In May of 2002, Aéropostale management took us public through an initial public offering and listed our common stock on the New York Stock Exchange. In July of 2003, we effectuated a secondary offering of our common stock. In April 2004 and then again in August 2007, we completed three-for-two stock splits on all shares of our common stock. Both of these stock splits were distributed in the form of a stock dividend. All prior period share and per share amounts presented in this report were restated to give retroactive recognition to these common stock splits.
Our fiscal year ends on the Saturday nearest to January 31. Fiscal 2007 was the 52-week period ended February 2, 2008, fiscal 2006 was the 53-week period ended February 3, 2007 and fiscal 2005 was the 52-week period ended January 28, 2006. Fiscal 2008 will be the 52-week period ending January 31, 2009.
Growth Strategy
Continue to open new Aéropostale stores. We consider our merchandise and our stores as having broad national appeal that continues to provide substantial new store expansion opportunities. Over the last three fiscal
years we opened 281 new Aéropostale stores. We plan to continue our growth by opening a total of approximately 85 new Aéropostale stores during fiscal 2008, which will include approximately 15 new Aéropostale stores in Canada and our first three new stores in Puerto Rico. We plan to open stores both in markets where we currently operate stores, and in new markets. (see the section “Stores - Store design and environment” below).
Enhance our brand and increase our store productivity. We seek to capitalize on the success of our core Aéropostale brand, while continuing to enhance our brand recognition through in-store as well as external marketing initiatives.
We seek to produce comparable store sales growth, increased net sales per average square foot, and increased average unit retail. We expect to continue employing our promotional pricing strategies, while also identifying and capitalizing upon developing trends in the market.
E-Commerce. We launched our Aéropostale e-commerce business in May 2005. The Aéropostale web store is accessible at our website, www.aeropostale.com. A third party provides fulfillment services for our e-commerce business, including warehousing our inventory and fulfilling our customers’ sales orders. We purchase, manage and own the inventory sold through our website and we recognize revenue from the sale of these products when the customer receives the merchandise.
Jimmy’Z. In 2004, we acquired the rights to and existing registrations for the JIMMY’Z® and Woody Car Design brand and trademarks in the United States and Canada for clothing and related goods and services. In 2005, we opened our first 14 Jimmy’Z stores. These stores average approximately 3,800 square feet. Jimmy’Z is positioned as a California lifestyle-oriented brand, targeting trend-aware young men and women aged 18 to 25. Merchandise sold at Jimmy’Z stores is at initial price points higher than merchandise sold at our Aéropostale stores. We are not planning to open any new Jimmy’Z stores in fiscal 2008, but instead plan on further refining our merchandising and brand building strategies.
New Concept. We are developing a new retail store concept that we believe will build upon our core competencies, while targeting a younger demographic than the Aéropostale customer. We anticipate opening the first stores of this new concept during fiscal 2009.
Stores
Existing stores. We locate our stores primarily in shopping malls, outlet centers and, to a lesser degree, lifestyle and off-mall shopping centers, all located in geographic areas with the highest possible concentrations of our target customers. We generally locate our stores in mall locations near popular teen gathering spots, including food courts, music stores and other teen-oriented retailers. As of February 2, 2008, we operated 828 stores in the following 47 U.S. states and two Canadian provinces:
The following table highlights the number of stores opened and closed since the beginning of fiscal 2005:
Store design and environment. We launched our new Aéropostale store design during fiscal 2006, and we currently operate 97 stores in this new format. We plan to design all of our new Aéropostale stores in this format. In addition, all Aéropostale stores planned for remodel will be renovated into the new format. We design our stores in an effort to create an energetic shopping environment, featuring powerful in-store promotional signage, creative visuals and popular music. The enthusiasm of our associates is integral to our store environment. Our stores feature display windows that provide high visibility for mall traffic. Our strategy is to create fresh and exciting merchandise assortments by updating our floor sets numerous times throughout the year. Visual merchandising directives are initiated at the corporate level, seeking to maintain consistency throughout all of our stores.
Store management. Our stores are organized by region and further into districts. A regional manager manages each of our ten regions and each region encompasses approximately eight to ten districts. Each district is managed by a district manager and encompasses approximately seven to ten individual stores. Our corporate headquarters directs the merchandise assortments, merchandise pricing, store layout, inventory management and in-store visuals for our stores.
Expansion opportunities and site selection. We focus on opening new stores in an effort to penetrate further the existing markets we are already in, as well as enter new markets. We plan to continue increasing our store base during fiscal 2008 by opening approximately 85 new Aéropostale stores, including approximately 15 new stores in Canada and our first three new stores in Puerto Rico (see the section “Growth Strategy” above).
In selecting a specific site, we generally target high traffic locations in malls, outlet centers and, to a lesser degree, lifestyle and off-mall shopping centers, with suitable demographics and favorable lease economics. As a result, we tend to locate our stores in malls in which comparable teen-oriented retailers have performed well. A primary site evaluation criterion includes average sales per square foot, co-tenancies, traffic patterns and occupancy costs.
We have implemented our store format across a wide variety of mall classifications and geographic locations. For new Aéropostale stores opened in fiscal 2007 under our new store design, our average net investment was
approximately $469,000 per store location, which included capital expenditures adjusted for landlord contributions and initial inventory at cost, net of payables (see the section “Store design and environment” above for a further discussion).
Aéropostale stores which we opened in fiscal 2006 and fiscal 2005 achieved, during their first twelve months of their operations, average net sales of approximately $1.8 million and net sales of $492 per average square foot.
Pricing
We believe that a key component of our success is our ability to understand what our customers want and what they can afford. Our merchandise, which we believe is of comparable quality to that of our primary competitors, is generally priced lower than our competitors’ merchandise. We conduct promotions in our stores throughout the year generally lasting anywhere from two to four weeks in length.
Design and Merchandising
Both our Aéropostale and Jimmy’Z design and merchandising teams focus on designing merchandise that meets the demands of their core customers’ lifestyles. We maintain separate design and merchandising groups for each of our brands and within those brands, for each of the young women’s, young men’s and accessories product lines.
Design. We offer a focused collection of apparel, including graphic t-shirts, tops, bottoms, sweaters, jeans, outerwear and accessories. Our “design-driven, merchant-modified” philosophy, in which our designers’ visions are refined by our merchants’ understanding of the current market for our products, helps to ensure that our merchandise styles reflect the latest trends while not becoming too fashion-forward for our customers’ tastes. Much of our merchandise features our brands’ logos. We believe that both our Aéropostale and Jimmy’Z logo apparel appeals to our young customers and reinforces our brand image.
Merchandising and Planning. Our merchandising organization, together with our planning organization, determines the quantities of units needed for each product category. By monitoring sales of each style and color and employing our flexible sourcing capabilities, we are able to adjust our merchandise assortments to capitalize upon emerging trends.
Sourcing
We seek to employ a sourcing strategy that expedites our speed to market and allows us to respond quickly to our customers’ preferences. We believe that we have developed strong relationships with our vendors, some of who rely upon us for a significant portion of their overall business.
During fiscal 2007, we sourced approximately 69% of our merchandise from our top five merchandise vendors. Most of our vendors maintain sourcing offices in the United States, with the majority of their production factories located in Europe, Asia and Central America. In an effort to minimize currency risk, all payments to our vendors and sourcing agents are made in U.S. dollars. We engage a third party independent contractor to visit the production facilities that supply us with our products. This independent contractor assesses the compliance of the facility with, among other things, local and United States labor laws and regulations as well as fair trade and business practices.
During fiscal 2007, we ceased doing business with South Bay Apparel Inc., previously one of our largest suppliers of graphic T-shirts and fleece. We have replaced this business both with new vendors and our existing vendor base (see Note 6 to the Notes to Consolidated Financial Statements for a further discussion).
Marketing and Advertising
We utilize numerous initiatives to increase our brand recognition and communicate our merchandise assortment. We view our stores as the primary means to communicate our message and provide our brand experience. Our marketing efforts are focused on in-store communications, promotions and internal as well as external advertising. We expand, test and modify our marketing efforts based on focus groups, surveys and consumer feedback.
We believe that the enthusiasm and commitment of our store-level employees is a key element in enhancing our brand with our target customers. We also view the use of our logo on our merchandise as a means for expanding our brand awareness and visibility. We market in-store with large images in the store-front windows and at the checkout area, information alongside product displays and other touch points such as handouts and shopping bags. We also invest in select external advertising during key selling periods. Our advertisements appear in publications and in malls and on the radio on a regional basis. Periodically, we also partner with select third parties such as magazines, television shows and musical bands, to create marketing programs which we believe will be appealing to our customers.
Our website, www.aeropostale.com supports all of our internet marketing and promotional initiatives and also offers a large portion of our merchandise assortment for purchase. We maintain a database of our customers and send emails and distribute information on special offers and promotions on a frequent basis.
Distribution
We maintain two distribution centers to process merchandise and to warehouse inventory needed to replenish our stores. We lease a 315,000 square foot distribution center facility in South River, New Jersey. We also lease a second distribution facility in Ontario, California with 360,000 square feet of space that began operations in September 2007.
The staffing and management of both distribution facilities are outsourced to a third party provider that operates each distribution facility and processes our merchandise. This third party provider employs personnel represented by a labor union. There have been no work stoppages or disruptions since the inception of our relationship with this third party provider in 1991, and we believe that the third party provider has a good relationship with its employees. In addition, we outsource the shipment of our merchandise through third party transportation providers. These third parties ship our merchandise from our distribution facilities to our stores.
We continue to invest in systems and automation to improve processing efficiencies, automate functions that were previously performed manually and to support our store growth. Our distribution facilities utilize automated sortation materials handling equipment to receive, process and ship goods to our stores. These facilities also serve our other warehousing needs, such as storage of new store merchandise, floor set merchandise and packaging supplies.
All of our products destined for our Canada stores are first shipped to the United States and processed through our distribution centers. We have engaged a third party to assist us in recapturing certain duties and tariffs which we paid on these goods.
Information Systems
Our management information systems provide a full range of retail, financial and merchandising applications. We utilize industry specific software systems to provide various functions related to:
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point-of-sale;
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inventory management;
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supply chain;
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planning and replenishment; and
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financial reporting.
We continue to invest in technology to align our systems with our business requirements and to support our continuing growth. In the past year we invested in, among other things, a roll-out across all of our stores of a new point-of-sale system and the development of a new merchandise allocation system. We plan to continue to invest strategically in our infrastructure in the future.
Trademarks
We own, through our wholly owned subsidiary, Aéropostale West, Inc., a Delaware corporation, federal trademark registrations in the U.S. Patent and Trademark Office for our principal marks AÉROPOSTALE®, AÉRO®, 87® and other related marks for clothing, a variety of accessories, including sunglasses, belts, socks and hats, and as a service mark for retail clothing stores, as well as state registrations for these marks. We also have certain registrations pending for trademarks and service marks for clothing, retail stores and online services. Additionally, we have applied for or have already obtained a registration for the AÉROPOSTALE and related marks in over 60 foreign countries. We plan to continue this focus on expanding our international registrations of our marks in the future.
In 2004, we acquired the rights to and existing registrations for the JIMMY’Z® and Woody Car Design brand and marks in the United States and Canada for clothing and related goods and services. We have also made further filings for the JIMMY’Z and Woody Car Design marks for use in the United States and Canada that are pending.
We regard our trademarks and other proprietary intellectual property as valuable assets of the Company that we continually maintain and protect.
Competition
The teen apparel market is highly competitive. We compete with a wide variety of retailers including other specialty stores, department stores, mail order retailers and mass merchandisers. Specifically, we compete with other teen apparel retailers including, but not limited to, American Eagle Outfitters®, Hollister®, Old Navy®, Pacific Sunwear®, and Tween Brands®. Stores in our sector compete primarily on the basis of design, price, quality, service and selection.
Many of our competitors are considerably larger and have substantially greater financing, marketing, and other resources. We cannot assure you that we will be able to compete successfully in the future, particularly in geographic locations that represent new markets for us.
Employees
As of February 2, 2008, we employed 3,210 full-time and 7,945 part-time employees. We employed 500 of our employees at our corporate offices and in the field, and 10,655 at our store locations. The number of part-time employees fluctuates depending on our seasonal needs. None of our employees are represented by a labor union and we consider our relationship with our employees to be good.
Seasonality
Our business is highly seasonal, and historically we have realized a significant portion of our sales, net income and cash flows in the second half of the year, attributable to the impact of the back-to-school selling season in the third quarter, and the holiday selling season in the fourth quarter. As a result, our working capital requirements fluctuate during the year, increasing in mid-summer in anticipation of the third and fourth quarters. Our business is also subject, at certain times, to calendar shifts which may occur during key selling times such as school holidays, Easter and regional fluctuations in the calendar during the back-to-school selling season.
Available Information
We maintain an internet website, www.aeropostale.com, through which access is available to our annual reports on Form 10-K, quarterly reports on Form 10-Q, Proxy Statements and current reports on Form 8-K, and all amendments of these reports filed, or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, after they are filed with the Securities and Exchange Commission.
Our Corporate Governance Guidelines and the charters for our Audit Committee, Nominating and Corporate Governance Committee and Compensation Committee may also be found on our internet website at www.aeropostale.com. In addition, our website contains the Charter for our Lead Independent Director and Code
of Business Conduct and Ethics, which is our code of ethics and conduct for our directors, officers and employees. Any waivers to our Code of Business Conduct and Ethics will be promptly disclosed on our website.
In fiscal 2007, our Chief Executive Officer certified, in accordance with section 303.12(a) of the NYSE Listed Company Manual, that he was not aware of any violation by us of the NYSE’s corporate governance listing standards as of the date of such certification.
Item 1A.
Item 1A.
Risk Factors
Cautionary Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements involve certain risks and uncertainties, including statements regarding our strategic direction, prospects and future results. Certain factors, including factors outside of our control, may cause actual results to differ materially from those contained in the forward-looking statements. The following risk factors should be read in connection with evaluating our business and future prospects. All forward looking statements included in this report are based on information available to us as of the date hereof, and we assume no obligation to update or revise such forward-looking statements to reflect events or circumstances that occur after such statements are made. Such uncertainties include, among others, the following factors:
If we were unable to identify and respond to consumers’ fashion preferences in a timely manner, our profitability would decline.
We may not be able to keep pace with the rapidly changing fashion trends and consumer tastes inherent in the teen apparel industry. We produce casual, comfortable apparel, a majority of which displays either the “Aéropostale” or “Aéro” logo. There can be no assurance that fashion trends will not move away from casual clothing or that we will not have to alter our design strategy to reflect changes in consumer preferences. Failure to anticipate, identify or react appropriately to changes in styles, trends, desired images or brand preferences, could have a material adverse effect on our sales, financial condition and results of operations.
Our retail store operations may be adversely affected by unfavorable local, regional or national economic conditions.
Our business is sensitive to consumer spending patterns and preferences. Various economic conditions affect the level of spending on the merchandise we offer, including general business conditions, interest rates, taxation, fuel costs, the availability of consumer credit and consumer confidence in future economic conditions. Accordingly, consumer purchases of discretionary items and retail products, including our products, may decline during recessionary periods and also may decline at other times when disposable income is lower. Therefore, our growth, sales and profitability may be adversely affected by unfavorable economic conditions on a local, regional or national level.
Fluctuations in comparable store sales and quarterly results of operations may cause the price of our common stock to decline substantially.
Our comparable store sales and quarterly results of operations have fluctuated in the past and are likely to continue to fluctuate in the future. In addition, there can be no assurance that we will be able to maintain our historic levels of comparable store sales. Our comparable store sales and quarterly results of operations are affected by a variety of factors, including:
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fashion trends;
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changes in our merchandise mix;
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the effectiveness of our inventory management;
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actions of competitors or mall anchor tenants;
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calendar shifts of holiday or seasonal periods;
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changes in general economic conditions and consumer spending patterns;
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the timing of promotional events; and
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weather conditions.
If our future comparable store sales fail to meet the expectations of investors, then the market price of our common stock could decline substantially. You should refer to the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information.
Foreign suppliers manufacture most of our merchandise and the availability and costs of these products may be negatively affected by risks associated with international trade.
Trade restrictions such as increased tariffs or quotas, or both, could affect the importation of apparel generally and increase the cost and reduce the supply of merchandise available to us. Much of our merchandise is sourced directly from foreign vendors in Europe, Asia and Central America. In addition, many of our domestic vendors maintain production facilities overseas. Some of these facilities are also located in regions that may be affected by political instability that could cause a disruption in trade. Any reduction in merchandise available to us or any increase in its cost due to tariffs, quotas or local political issues could have a material adverse effect on our results of operations. If manufacturing costs were to rise significantly, our business may be adversely affected.
We rely on a small number of vendors to supply a significant amount of our merchandise.
During fiscal 2007, we sourced approximately 69% of our merchandise from our top five merchandise vendors. During fiscal 2006, we sourced approximately 66% of our merchandise from our top five merchandise vendors. Our relationships with our suppliers generally are not on a long-term contractual basis and do not provide assurances on a long-term basis as to adequate supply, quality or acceptable pricing. Most of our suppliers could discontinue selling to us at any time. If one or more of our significant suppliers were to sever their relationship with us, we may not be able to obtain replacement products in a timely manner, which would have a material adverse effect on our sales, financial condition and results of operations.
Our business could suffer as a result of a manufacturer’s inability to produce merchandise on time and to our specifications.
We do not own or operate any manufacturing facilities and therefore we depend upon independent third parties to manufacture all of our merchandise. We utilize both domestic and international manufacturers to produce our merchandise. The inability of a manufacturer to ship orders in a timely manner or meet our quality standards could cause delivery date requirements to be missed, which could result in lost sales. In addition, if manufacturing costs were to rise significantly, our business may be adversely affected.
Our ability to attract customers to our stores depends heavily on the success of the shopping malls in which we are located.
In order to generate customer traffic, we must locate our stores in prominent locations within successful shopping malls. We cannot control the development of new shopping malls, the availability or cost of appropriate locations within existing or new shopping malls, or the success of individual shopping malls. A significant decrease in shopping mall traffic could have a material adverse effect on our results of operations.
Failure of new business concepts would have a negative effect on our results of operations.
We expect that the introduction of new brand concepts and other business opportunities will play an important role in our overall growth strategy. The operation of any new retail concept, including our Jimmy’Z concept, is subject to numerous risks, including unanticipated operating problems, lack of prior experience, lack of customer acceptance, new vendor relationships, competition from existing and new retailers, and could also be a diversion of management’s attention from our core Aéropostale business. For example, the Jimmy’Z concept involves, among
other things, implementation of a retail apparel concept which is subject to many of the same risks as Aéropostale, as well as additional risks inherent with a more fashion-driven concept, including risks of difficulty in merchandising, uncertainty of customer acceptance, fluctuations in fashion trends and customer tastes, as well as the attendant markdown risks. Risks inherent in any new concept are particularly acute with respect to Jimmy’Z because this is the first significant new venture by us, and the nature of the Jimmy’Z business differs in certain respects from that of our core Aéropostale business. There can be no assurance that the Jimmy’Z stores will achieve sales and profitability levels justifying our investments in this business. Consolidated net income included net losses from our Jimmy’Z subsidiary of $12.4 million, or $0.17 per diluted share (includes asset impairment charges discussed below of $5.7 million after-tax, or $0.08 per diluted share) for fiscal 2007, $6.7 million, or $0.08 per diluted share for fiscal 2006 and $4.7 million, or $0.06 per diluted share for fiscal 2005.
We periodically evaluate the need to recognize impairment losses relating to long-lived assets. After the completion of the fiscal 2007 holiday season, which represented the largest quarterly sales and profit contribution for the year, we determined that each of our fourteen Jimmy’Z stores would not be able to recover the carrying value of the store property and equipment through expected cash flows over the remaining life of the related assets. As a result, we recorded asset impairment charges of $9.0 million ($5.7 million after-tax, or $0.08 per diluted share), in the fourth quarter of fiscal 2007 related to our Jimmy’Z store concept. In the event we were to decide to exit this business in the future, or close any or all of these stores, we may be required to record additional inventory impairment, lease termination charges, and severance and other charges.
Our business could suffer if a manufacturer fails to use acceptable labor practices.
Our sourcing agents and independent manufacturers are required to operate in compliance with all applicable foreign and domestic laws and regulations. While our vendor operating guidelines promote ethical business practices for our vendors and suppliers, we do not control these manufacturers or their labor practices. The violation of labor or other laws by an independent manufacturer, or by one of the sourcing agents, or the divergence of an independent manufacturer’s or sourcing agent’s labor practices from those generally accepted as ethical in the United States, could interrupt, or otherwise disrupt the shipment of finished products or damage our reputation. Any of these, in turn, could have a material adverse effect on our financial condition and results of operations. To help mitigate this risk, we engage a third party independent contractor to visit the production facilities from which we receive our products. This independent contractor assesses the compliance of the facility with, among other things, local and United States labor laws and regulations as well as foreign and domestic fair trade and business practices.
Our foreign sources of production may not always be reliable, which may result in a disruption in the flow of new merchandise to our stores.
The large majority of the merchandise we purchase is manufactured overseas. We do not have any long-term merchandise supply contracts with our vendors and the imports of our merchandise by our vendors are subject to existing or potential duties, tariffs and quotas. We also face a variety of other risks generally associated with doing business in foreign markets and importing merchandise from abroad, such as: (i) political instability; (ii) enhanced security measures at United States ports, which could delay delivery of goods; (iii) imposition of new legislation relating to import quotas that may limit the quantity of goods which may be imported into the United States from countries in a region within which we do business; (iv) imposition of additional or greater duties, taxes, and other charges on imports; (v) delayed receipt or non-delivery of goods due to the failure of our vendors to comply with applicable import regulations; and (vi) delayed receipt or non-delivery of goods due to unexpected or significant port congestion at United States ports. Any inability on our part to rely on our vendors and our foreign sources of production due to any of the factors listed above could have a material adverse effect on our business, financial condition and results of operations.
Our growth strategy relies on the continued addition of a significant number of new stores each year, which could strain our resources and cause the performance of our existing stores to suffer.
Our growth will largely depend on our ability to open and operate new stores successfully. We opened 88 Aéropostale stores in fiscal 2007, 74 Aéropostale stores in fiscal 2006 and 105 Aéropostale and 14 Jimmy’Z stores in fiscal 2005. We plan to open approximately 85 new Aéropostale stores in fiscal 2008, including approximately 15
new stores in Canada and our first three new stores in Puerto Rico. We expect to continue to open new stores in the future. We also anticipate remodeling a portion of our existing Aéropostale store base at the appropriate times. To the extent that our new store openings are in existing markets, we may experience reduced net sales volumes in previously existing stores in those same markets.
Our continued expansion plan is dependent on a number of factors which, if not implemented, could delay or prevent the successful opening of new stores and penetration into new markets.
Unless we continue to do the following, we may be unable to open new stores successfully and, in turn, our continued growth would be impaired:
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identify suitable markets and sites for new store locations;
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negotiate acceptable lease terms;
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hire, train and retain competent store personnel;
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foster current relationships and develop new relationships with vendors that are capable of supplying a greater volume of merchandise;
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manage inventory and distribution effectively to meet the needs of new and existing stores on a timely basis;
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expand our infrastructure to accommodate growth; and
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generate sufficient operating cash flows or secure adequate capital on commercially reasonable terms to fund our expansion plans.
In addition, we will open new stores in markets in which we currently have few or no stores. Our experience in these markets is limited and there can be no assurance that we will be able to develop our brand in these markets or adapt to competitive, merchandising and distribution challenges that may be different from those in our existing markets. Our inability to open new stores successfully and/or penetrate new markets would have a material adverse effect on our revenue and earnings growth.
The loss of the services of key personnel could have a material adverse effect on our business.
Our key executive officers have substantial experience and expertise in the retail industry and have made significant contributions to the growth and success of our brands. The unexpected loss of the services of one or more of these individuals could adversely affect us. Specifically, if we were to lose the services of Julian R. Geiger, our Chairman and Chief Executive Officer or Mindy C. Meads, our President and Chief Merchandising Officer, our business could be adversely affected. In addition, any significant departures by senior executives or other key performers in the Company could adversely affect our operations.
A substantial interruption in our information systems could have a material adverse effect on our business.
We depend on our management information systems for many aspects of our business. We will be materially adversely affected if our management information systems are disrupted or we are unable to improve, upgrade, maintain, and expand our management information systems.
There is an increased risk in operating stores in foreign countries.
During fiscal 2007, we opened 12 Aéropostale stores in Canada, and we plan to open approximately 15 additional new Canadian stores during fiscal 2008. There can be no assurance that we will be able to address in a timely fashion the risks of operating stores in foreign countries, such as governmental requirements over merchandise importation, employment, taxation and multi-lingual requirements. Additionally, since entering Canada, we will have to continue to obtain suitable store locations, hire personnel, establish distribution methods, and advertise our brand and its distinguishing characteristics to consumers who may not be familiar with them. There can be no assurance that we will be able to open and operate new stores in Canada on a timely and profitable basis. The costs associated with opening these new stores in Canada may negatively affect our profitability.
Our net sales and inventory levels fluctuate on a seasonal basis.
Our net sales and net income are disproportionately higher from August through January each year due to increased sales from back-to-school and holiday shopping. Sales during this period cannot be used as an accurate indicator for our annual results. Our net sales and net income from February through July are typically lower due to, in part, the traditional retail slowdown immediately following the winter holiday season. 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 would carry during other parts of the year. Any unanticipated decrease in demand for our products during these peak shopping seasons could require us to sell excess inventory at a substantial markdown, which could reduce our net sales and gross margins and negatively impact our profitability. Additionally, our business is also subject, at certain times, to calendar shifts which may occur during key selling times such as school holidays, Easter and regional fluctuations in the calendar during the back-to-school selling season.
We rely on a third party to manage our distribution centers.
The efficient operation of our stores is dependent on our ability to distribute, in a timely manner, merchandise to our store locations throughout the United States. An independent third party operates our two distribution and warehouse facilities. We depend on this third party to receive, sort, pack and distribute substantially all of our merchandise. This third party employs personnel represented by a labor union. Although there have been no work stoppages or disruptions since the inception of our relationship with this third party provider beginning in 1991, there can be no assurance that work stoppages or disruptions will not occur in the future. We also use separate third party transportation companies to deliver our merchandise from our warehouse to our stores. Any failure by any of these third parties to respond adequately to our warehousing and distribution needs would disrupt our operations and negatively impact our profitability.
We rely on a third party to manage the warehousing and order fulfillment for our E-Commerce business.
We rely on one third party, GSI Commerce, pursuant to an e-commerce agreement, to host our e-commerce website, warehouse all of the inventory sold through our e-commerce website, and fulfill all of our e-commerce sales to our customers. Any significant interruption in the operations of GSI Commerce, over which we have no control, would have a material adverse effect on our e-commerce business.
Failure to protect our trademarks adequately could negatively impact our brand image and limit our ability to penetrate new markets.
We believe that our key trademarks AÉROPOSTALE®, AERO® and 87® are integral to our logo-driven design strategy. We have obtained federal registrations of these trademarks in the United States and have applied for or obtained registrations in most foreign countries in which our vendors are located, as well as elsewhere. We use these trademarks in many constantly changing designs and logos even though we have not applied to register every variation or combination thereof for adult clothing. We also believe that the JIMMY’Z and Woody Car Design marks may become a part of our future growth strategy. We have acquired federal registrations in the United States and in Canada and have expanded the scope of our filings in the United States Patent and Trademark Office for a greater number of apparel and accessory categories. There can be no assurance that the registrations we own and have obtained will prevent the imitation of our products or infringement of our intellectual property rights by others. If any third party imitates our products in a manner that projects lesser quality or carries a negative connotation, our brand image could be materially adversely affected. Because we have not registered the AERO mark in all forms and categories and have not registered the “AÉROPOSTALE”, “JIMMY’Z” and Woody Car Design marks in all categories or in all foreign countries in which we now or may in the future source or offer our merchandise, international expansion and our merchandising of non-apparel products using these marks could be limited.
In addition, there can be no assurance that others will not try to block the manufacture, export or sale of our products as a violation of their trademarks or other proprietary rights. Other entities may have rights to trademarks that contain the word “AERO” or may have registered similar or competing marks for apparel and accessories in foreign countries in which our vendors are located. Our applications for international registration of the
AÉROPOSTALE® mark have been rejected in several countries in which our products are manufactured because third parties have already registered the mark for clothing in those countries. There may also be other prior registrations in other foreign countries of which we are not aware. In addition, we do not own the Jimmy’Z brand outside of the United States and Canada. Accordingly, it may be possible, in those few foreign countries where we were not been able to register the AÉROPOSTALE® mark, or in the countries where the Jimmy’Z brand is owned by a third party, for a third party owner of the national trademark registration for “AÉROPOSTALE”, “JIMMY’Z” or the Woody Car Design to enjoin the manufacture, sale or exportation of Aéropostale or Jimmy’Z branded goods to the United States. If we were unable to reach a licensing arrangement with these parties, our vendors may be unable to manufacture our products in those countries. Our inability to register our trademarks or purchase or license the right to use our trademarks or logos in these jurisdictions could limit our ability to obtain supplies from or manufacture in less costly markets or penetrate new markets should our business plan change to include selling our merchandise in those jurisdictions outside the United States.
Any disruption of our distribution activities could have a material adverse impact on our business.
We operate two distribution facilities, one in South River, New Jersey, and the other in Ontario, California. These distribution centers manage collectively the receipt, storage, sortation, packaging and distribution of our merchandise to all of our stores. Any significant interruption in the operation of either of our distribution centers due to natural disasters, accidents, system failures, economic and weather conditions, demographic and population changes or other unforeseen events and circumstances could have a material adverse effect on our business, financial condition and results of operations.
The effects of war or acts of terrorism could have a material adverse effect on our operating results and financial condition.
The continued threat of terrorism and the associated heightened security measures and military actions in response to acts of terrorism has disrupted commerce and has intensified uncertainties in the U.S. economy. Any further acts of terrorism or a future war may disrupt commerce and undermine consumer confidence, which could negatively impact our sales revenue by causing consumer spending and/or mall traffic to decline. Furthermore, an act of terrorism or war, or the threat thereof, or any other unforeseen interruption of commerce, could negatively impact our business by interfering with our ability to obtain merchandise from foreign vendors. Inability to obtain merchandise from our foreign vendors or substitute other vendors, at similar costs and in a timely manner, could adversely affect our operating results and financial condition.
Item 1B.
Item 1B.
Unresolved Staff Comments
None
Item 2.
Item 2.
Properties
We lease all of our store locations. Most of our stores are located in shopping malls throughout the U.S., and, beginning in 2007, Canada. Most of our store leases have a term of ten years, and require us to pay additional rent based on specified percentages of sales, after we achieve specified annual sales thresholds. Generally, our store leases do not contain extension options. Our store leases typically include a pre-opening period of approximately 60 days that allows us to take possession of the property to construct the store. Typically rent payment commences when the stores open. We recognize rent expense in our consolidated financial statements on a straight-line basis over the non-cancelable term of each individual underlying lease, commencing when we take possession of the property. Generally, our leases allow for termination by us after a certain period of time if sales at that site do not exceed specified levels.
We lease 89,000 square feet of office space at 112 West 34th Street in New York, New York. The facility is used as our corporate headquarters and for our design, sourcing and production teams. This lease expires in 2016.
We also lease 40,000 square feet of office space at 201 Willowbrook Boulevard in Wayne, New Jersey. This facility is used as administrative offices for finance, operations and information systems personnel. This lease expires in 2012, but provides us with a 5 year option to extend at the end of the initial term.
In addition, we lease a 315,000 square foot distribution and warehouse facility in South River, New Jersey. This lease expires in 2016. We also lease a second 360,000 square foot distribution facility in Ontario, California and began operating this distribution center in September 2007. This lease expires in 2015. These facilities are used to warehouse inventory needed to replenish and back-stock all of our stores, as well as to serve our general warehousing needs.
Item 3.
Item 3.
Legal Proceedings
On January 15, 2008, we learned that the Securities and Exchange Commission (the “SEC”) had issued a formal order of investigation with respect to matters arising from those events disclosed in our Form 8-K, dated November 8, 2006, which resulted from the activities of Christopher L. Finazzo, our former Executive Vice President and Chief Merchandising Officer. The SEC’s investigation is a non-public, fact-finding inquiry to determine whether any violations of law have occurred. We are cooperating fully with the SEC in its investigation.
On November 30, 2007, we entered into an agreement (the “Agreement”) with Mr. Finazzo settling disputes between us. Pursuant to the terms of the Agreement, Mr. Finazzo has paid us $5.0 million, and in turn, we paid Mr. Finazzo, simultaneously with his payment to the Company, approximately $0.9 million, which represented the value of Mr. Finazzo’s benefits under our Supplemental Executive Retirement Plan.
We are also party to various litigation matters and proceedings in the ordinary course of business. In the opinion of our management, dispositions of these matters are not expected to have a material adverse affect on our financial position, results of operations or cash flows.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of our shareholders during the fourth quarter of the fiscal year covered by this report.
PART II
Item 5.
Item 5.
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the New York Stock Exchange under the symbol “ARO”. The following table sets forth the range of high and low sales prices of our common stock as reported on the New York Stock Exchange since January 29, 2006. The stock prices below have been revised to reflect a three-for-two stock split effected in August 2007.
As of March 20, 2008, there were 60 stockholders of record. However, when including others holding shares in broker accounts under street name, we estimate the shareholder base at approximately 36,444.
PERFORMANCE GRAPH
The following graph shows the changes, for the period commencing January 31, 2003 and ended February 1, 2008 (the last trading day during fiscal 2007), in the value of $100 invested in shares of our common stock, the Standard & Poor’s MidCap 400 Composite Stock Price Index (the “S&P MidCap 400 Index”) and the Standard & Poor’s Apparel Retail Composite Index (the “S&P Apparel Retail Index”). The plotted points represent the closing price on the last trading day of the fiscal year indicated.
CUMULATIVE TOTAL RETURN
Based upon an initial investment of $100 on January 31,
with dividends reinvested
Copyright© 2008, Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved.
We have not paid a dividend on our common stock during our last three fiscal years, and we do not have any current intention to pay a dividend on our common stock.
We repurchase our common stock from time to time under a stock repurchase program. On November 12, 2007, our Board of Directors approved a $250.0 million increase in repurchase availability under the program, bringing total repurchase authorization, since inception of the program, to $600.0 million. We used a portion of this authorization to execute an Accelerated Share Repurchase program to repurchase $125.0 million of our common shares (see Note 13 to the Notes to Consolidated Financial Statements). The repurchase program may be modified or terminated by the Board of Directors at any time, and there is no expiration date for the program. The extent and timing of repurchases will depend upon general business and market conditions, stock prices, opening and closing of our stock trading window, and liquidity and capital resource requirements going forward. Our purchases of treasury stock for the fourth quarter of fiscal 2007 and remaining availability pursuant to our share repurchase program were as follows:
(a)
On November 12, 2007, our Board of Directors approved a $250.0 million increase in repurchase availability under the program, bringing total repurchase authorization, since inception of the program, to $600.0 million.
(b)
The repurchase program may be modified or terminated by the Board of Directors at any time, and there is no expiration date for the program.
(c)
Includes additional $250.0 million of repurchase availability that was approved on November 12, 2007.
Item 6.
Item 6.
Selected Financial Data
The following selected financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and with our consolidated financial statements and other financial information appearing elsewhere in this document:
Per share amounts have been restated to reflect the three-for-two splits of our common stock that were affected in August 2007 and April 2004.
(1)
Includes gift card breakage income of $7.7 million ($4.8 million, after tax, or $0.07 per diluted share), other operating income of $4.1 million ($2.6 million, after tax, or $0.04 per diluted share) as a result of an agreement with our former Executive Vice President and Chief Merchandising Officer, partially offset by an asset impairment charge of $9.0 million ($5.7 million, after tax, or $0.08 per diluted share).
(2)
Includes $7.4 million ($4.5 million, after tax, or $0.05 per diluted share), net of professional fees, representing concessions, primarily from South Bay Apparel Inc., to us for prior purchases of merchandise and other operating income of $2.1 million ($1.3 million, after tax, or $0.02 per diluted share) from the resolution of a dispute with a vendor regarding the enforcement of our intellectual property rights.
(3)
53 week fiscal year.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations Introduction
Aéropostale, Inc. is a mall-based specialty retailer of casual apparel and accessories. Our target customers are both young women and young men from age 14 to 17, and we provide our customers with a selection of high-quality, active-oriented, fashion basic merchandise at compelling values in a high-energy store environment. We maintain control over our proprietary brand by designing and sourcing all of our own merchandise. Our products can be purchased in our stores, which sell Aéropostale merchandise exclusively and on-line through our e-commerce website, www.aeropostale.com. Jimmy’Z Surf Co., Inc., a wholly owned subsidiary of Aéropostale, Inc., is a California lifestyle-oriented brand targeting trend-aware young women and men aged 18 to 25. As of February 2, 2008, we operated 828 stores, consisting of 802 Aéropostale stores in 47 states, 12 Aéropostale stores in Canada, and 14 Jimmy’Z stores in 11 states, in addition to www.aeropostale.com, our e-commerce site (see the section “Growth Strategy” in Item I of this report for a further discussion).
Our fiscal year ends on the Saturday nearest to January 31. Fiscal 2007 was the 52-week period ended February 2, 2008, fiscal 2006 was the 53-week period ended February 3, 2007 and fiscal 2005 was the 52-week period ended January 28, 2006. Fiscal 2008 will be the 52-week period ending January 31, 2009.
On July 11, 2007, we announced a three-for-two stock split on all shares of our common stock that was completed on August 21, 2007 in the form of a stock dividend to all shareholders of record on August 6, 2007. All share and per share amounts presented in this report were retroactively adjusted for the common stock split, and all previously reported periods were restated for such.
The discussion in the following section is on a consolidated basis, unless indicated otherwise. In addition, comparable store sales data included in this section are compared to the corresponding period in the prior year, due to the 53rd week in the fiscal 2006 calendar. We believe that the disclosure of comparable store sales data on a pro-forma basis due to the 53rd week in fiscal 2006, which is a non-GAAP financial measure, provides investors useful information to help them better understand our results.
Overview
We achieved net sales of $1.591 billion during fiscal 2007 (52 weeks), an increase of $177.7 million or 12.6% from fiscal 2006 (53 weeks). Net sales for the fourth quarter of fiscal 2007 included $7.7 million of sales related to our initial recognition of gift card breakage. Gross profit, as a percentage of net sales, increased by 2.6 percentage points for fiscal 2007, primarily due to a 2.8 percentage point increase in merchandise margin. Selling, general and administrative expense, or SG&A, as a percentage of net sales, increased by 1.2 percentage points in fiscal 2007. We recorded asset impairment charges of $9.0 million during the fourth quarter related to our Jimmy’Z stores. Other operating income of $4.1 million in fiscal 2007 was the result of an agreement with our former Executive Vice President and Chief Merchandising Officer. Interest income decreased by $0.5 million in fiscal 2007 due primarily to an increase in share repurchases. The effective tax rate was 38.2% for fiscal 2007, compared with 39.0% for fiscal 2006. Net income for fiscal 2007 was $129.2 million, or $1.73 per diluted share, compared with net income of $106.6 million, or $1.32 per diluted share, for fiscal 2006.
As of February 2, 2008, we had working capital of $87.3 million, cash and cash equivalents of $111.9 million, no short-term investments and no third party debt outstanding. Merchandise inventories increased by 20% on a square foot basis as of February 2, 2008 compared to last year. Cash flows from operating activities were $171.1 million for fiscal 2007. We operated 828 total stores as of February 2, 2008, an increase of 11.6% from the same period last year.
We use a number of key indicators of financial condition and operating performance to evaluate the performance of our business, including the following:
Results of Operations
The following table sets forth our results of operations expressed as a percentage of net sales. We also use this information to evaluate the performance of our business:
Sales
Net sales consist of sales from comparable stores and non-comparable stores, and from our e-commerce business. A store is included in comparable store sales after 14 months of operation. We consider a remodeled or
relocated store with more than a 25% change in square feet to be a new store. Prior period sales from stores that have closed are not included in comparable store sales, nor are sales from our e-commerce business.
Net sales increased by $177.7 million, or by 12.6% in fiscal 2007 (52 weeks), as compared to fiscal 2006 (53 weeks). This increase was due to average square footage growth of 10.3%, as well as an increase in comparable store sales. Comparable store sales increased by $43.8 million, or by 3.3%, reflecting comparable store sales increases in our young men’s and women’s categories and a slight decrease in our accessories category. The comparable store sales increase reflected a 2.4% increase in units per sales transaction, a 3.4% increase in the number of sales transactions, and a 2.5% decrease in average unit retail. The decrease in the average unit retail reflected lower pricing in certain categories, in addition to a shift in sales mix. Non-comparable store sales increased by $126.1 million, or by 8.7%, primarily due to 86 more stores open at the end of fiscal 2007 versus fiscal 2006. Net sales for the fourth quarter of fiscal 2007 also included $7.7 million of sales related to our initial recognition of gift card breakage, of which $5.9 million related to gift cards issued in periods prior to fiscal 2007 (see Note 1 to the Notes to Consolidated Financial Statements for a further discussion).
Net sales increased by $208.9 million, or by 17.3% in fiscal 2006 (53 weeks), as compared to fiscal 2005 (52 weeks). Average square footage growth of 14% drove the net sales increase, as well as an increase in comparable store sales. Comparable store sales increased by $22.6 million, or by 2.0%, reflecting comparable store sales increases in our young men’s and accessories categories and a slight decrease in our young women’s category. The comparable store sales increase reflected a 3.0% increase in average unit retail, a 0.5% increase in the number of sales transactions, and a 1.5% decrease in units per sales transaction. The increase in the average unit retail reflected lower promotional activity. Non-comparable store sales increased by $186.3 million, or by 14.3%, primarily due to 71 more stores open at the end of fiscal 2006 versus fiscal 2005. The fifty-third week accounted for $16.4 million of the net sales increase during fiscal 2006.
Cost of Sales and Gross Profit
Cost of sales includes costs related to merchandise sold, including inventory valuation adjustments, distribution and warehousing, freight from the distribution center and warehouse to the stores, payroll for our design, buying and merchandising departments, and occupancy costs. Occupancy costs include rent, contingent rents, common area maintenance, real estate taxes, utilities, repairs, maintenance and all depreciation.
Gross profit, as a percentage of net sales, increased by 2.6 percentage points in fiscal 2007. This increase was due to a 2.8 percentage point increase in merchandise margin, primarily from lower unit costs from graphic tee shirts and improved levels and composition of our merchandise assortment. This increase was partially offset by a 0.2 percentage point increase in depreciation, primarily as a result of store growth and strategic investments, and occupancy costs.
Gross profit, as a percentage of net sales, increased by 2.1 percentage points in fiscal 2006, primarily due to a 2.5 percentage point increase in merchandise margin, and partially offset by a 0.4 percentage point increase in depreciation, primarily as a result of store growth and strategic investments, and occupancy costs. Merchandise margin for fiscal 2006 was favorably impacted by $7.4 million, or by 0.5 percentage points, of vendor concessions, primarily from an agreement with South Bay Apparel, Inc. (see Note 6 to the Notes to Consolidated Financial Statements for a further discussion). The remaining increase in merchandise margin was primarily due to decreased promotional activity.
SG&A
SG&A includes costs related to selling expenses, store management and corporate expenses such as payroll and employee benefits, marketing expenses, employment taxes, information technology maintenance costs and expenses, insurance and legal expenses, store pre-opening and other corporate expenses, and e-commerce shipping expenses. Store pre-opening expenses include store payroll, grand opening event marketing, travel, supplies and other store pre-opening expenses.
SG&A increased by $56.1 million, or by 1.2 percentage points, as a percentage of net sales, during fiscal 2007. The increase in SG&A was largely due to a $26.7 million increase in store-line expenses. The remainder of the
increase was due to higher store transaction costs and store operations costs of $13.4 million resulting primarily from new store growth and increased sales. The balance of the increase in SG&A was primarily due to a $13.8 million increase in corporate expenses consisting of higher incentive compensation of $4.9 million, stock-based compensation of $3.5 million, and other corporate expenses of $5.4 million. The SG&A increase during fiscal 2007, as a percentage of net sales, was primarily due to a 0.5 percentage point increase in store-line expenses, primarily resulting from increased payroll due to minimum wage increases and loss prevention initiatives; a 0.5 percentage point increase in corporate incentive and stock-based compensation; and a 0.4 percentage point increase in e-commerce expenses, resulting from growth in related sales.
SG&A increased by $62.7 million, or by 1.6 percentage points, as a percentage of net sales, during fiscal 2006. The increase in SG&A was due largely to a $28.0 million increase in payroll and benefits, consisting primarily of store payroll from new store growth. The remainder of the increase was predominantly due to increased store transaction costs of $8.8 million, resulting from both sales growth and new store growth, a $7.4 million increase in incentive compensation, a $5.9 million increase in marketing costs and a $4.1 million increase in stock-based compensation, primarily as a result of the adoption of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, a revision of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123(R)”) (see Note 11 to the Notes to Consolidated Financial Statements for a further discussion). The SG&A increase during fiscal 2006, as a percentage of net sales, was primarily due to a 0.5 percentage point increase in incentive compensation, a 0.3 percentage point increase in both stock-based compensation and marketing costs, and a 0.2 percentage point increase in store payroll.
Other Operating Income
We recognized $4.1 million in net other operating income during the fourth quarter of 2007 as a result of an agreement with our former Executive Vice President and Chief Merchandising Officer (see Note 6 to the Notes to Consolidated Financial Statements for a further discussion).
We recognized $2.1 million in other operating income during the second quarter of fiscal 2006 in connection with the resolution of a dispute with a vendor regarding the enforcement of our intellectual property rights.
Interest Income
Interest income, net of interest expense, decreased by $0.5 million in fiscal 2007. The decrease was primarily due to cash used for share repurchases of $266.7 million during 2007, including the ASR in the fourth quarter of 2007 (see below under Financing Activities for a further discussion).
Interest income, net of interest expense, increased by $3.4 million in fiscal 2006. Increases in interest rates and increases in cash and cash equivalents, together with short-term investments, were the primary drivers of the increase in net interest income. Cash and cash equivalents, together with short-term investments, increased by $51.0 million at the end of fiscal 2006.
Income Taxes
Our effective tax rate was 38.2% for fiscal 2007, compared to 39.0% for fiscal 2006, and 39.6% for fiscal 2005. The decrease in the effective tax rate during fiscal 2007 is primarily due to favorable state tax accrual adjustments. The decrease in the effective income tax rate during fiscal 2006 was primarily due to a decrease in certain net permanent differences. The tax rate for fiscal 2008 is estimated to approximate 40.0%.
Net Income and Earnings Per Share
Net income was $129.2 million, or $1.73 per diluted share, for fiscal 2007, compared with net income of $106.6 million, or $1.32 per diluted share, for fiscal 2006 and net income of $84.0 million, or $1.00 per diluted share, for fiscal 2005.
Net income for fiscal 2007 was favorably impacted by $7.7 million ($4.8 million after-tax, or $0.07 per diluted share), resulting from our initial recognition of gift card breakage (see Note 1 to the Notes to Consolidated Financial Statements for a further discussion). Net income for fiscal 2007 was also favorably impacted by $4.1 million
($2.6 million after-tax, or $0.04 per diluted share), from the above mentioned other operating income. The asset impairment charges unfavorably impacted net income for fiscal 2007 by $9.0 million ($5.7 million after-tax, or $0.08 per diluted share) (see Note 5 to the Notes to Consolidated Financial Statements for a further discussion).
Net income for fiscal 2006 was favorably impacted by $7.4 million ($4.5 million after-tax, or $0.05 per diluted share), resulting from the recognition of vendor concessions, primarily from an agreement with South Bay Apparel, Inc. (see Note 6 to the Notes to Consolidated Financial Statements for a further discussion). Net income for fiscal 2006 was also favorably impacted by $2.1 million ($1.3 million after-tax, or $0.02 per diluted share), from the above mentioned other operating income. The previously discussed adoption of SFAS No. 123(R) unfavorably impacted net income for fiscal 2006 by $2.2 million, or $0.03 per diluted share.
Consolidated net income included net losses from our Jimmy’Z subsidiary of $12.4 million, or $0.17 per diluted share, for fiscal 2007 (includes above mentioned asset impairment charges of $5.7 million after-tax, or $0.08 per diluted share), compared with net losses of $6.7 million, or $0.08 per diluted share, for fiscal 2006 and $4.7 million, or $0.06 per diluted share, for fiscal 2005.
Liquidity and Capital Resources
Our cash requirements are primarily for working capital, construction of new stores, remodeling of existing stores, and the improvement and enhancement of our information technology systems. Due to the seasonality of our business, we have historically realized a significant portion of our cash flows from operations during the second half of the year. Most recently, our cash requirements have been met primarily through cash and cash equivalents on hand during the first half of the year, and through cash flows from operations during the second half of the year. We expect to continue to meet our cash requirements for the next twelve months primarily through cash flows from operations, existing cash and cash equivalents and our credit facility. In addition, on November 13, 2007, we amended and restated our revolving credit facility (the “New Credit Facility”) with Bank of America, N.A. (“Bank of America”), which expanded our availability from a maximum of $75.0 million to $150.0 million (see Note 9 to the Notes to Consolidated Financial Statements). A portion of the availability under the New Credit Facility was used to fund the ASR to repurchase $125.0 million of our common shares (see Note 13 to the Notes to Consolidated Financial Statements). At February 2, 2008, we had working capital of $87.3 million and cash and cash equivalents of $111.9 million.
The following table sets forth our cash flows for the period indicated (in thousands):
Operating Activities
Cash flows from operating activities, our principal form of liquidity on a full-year basis, decreased by $6.4 million in fiscal 2007 and increased by $33.1 million in fiscal 2006, as compared to the prior fiscal year. The primary components of cash flows from operations for fiscal 2007 included an increase in net income, as adjusted for depreciation and amortization and other non-cash items, of $41.5 million. This increase was more than offset by an increase in cash used for accrued expenses, which resulted from the timing of income tax payments.
In accordance with the provisions of SFAS No. 123 (R), excess tax benefits from stock-based compensation of $5.5 million and $7.6 million were reported as a financing activity for fiscal 2007 and fiscal 2006, respectively. Excess tax benefits from stock-based compensation of $4.8 million in fiscal 2005 was reported as an operating activity.
The primary components of cash flows from operations for fiscal 2006 were net income, as adjusted for non-cash items, of $119.9 million, tenant allowances received from landlords of $13.4 million, and excess tax benefits from stock-based compensation of $7.6 million. The primary components of cash flows from operations for fiscal 2005 were net income, as adjusted for non-cash items, of $111.8 million, tenant allowances received from landlords of $21.1 million, and excess tax benefits from stock-based compensation of $4.8 million.
Working capital decreased to $87.3 million at February 2, 2008 from $234.0 million at February 3, 2007 primarily due to the increase in stock repurchases in fiscal 2007 (see below for further discussion). Total inventories increased by 20% on a square foot basis as of February 2, 2008 compared to last year. This increase was due to a change in the timing of our floor-sets, primarily resulting from an earlier Easter holiday in 2008.
Investing Activities
We invested $82.3 million in capital expenditures in fiscal 2007, primarily for the construction of 88 new Aéropostale stores, to remodel seven existing stores, to complete the rollout of upgraded point of sale systems to our store chain, to open a second distribution center and for certain other information technology investments. Our future capital requirements will depend primarily on the number of new stores we open, the number of existing stores we remodel and other strategic investments. We plan to invest approximately $80.0 million in capital expenditures in fiscal 2008. These plans include investments of approximately $50.0 million to open approximately 85 new Aéropostale stores in our new store format including approximately 15 in Canada and our first three new stores in Puerto Rico. Capital expenditure plans also include approximately $10.0 million to remodel approximately 18 existing stores to our new store format and approximately $20.0 million for other initiatives.
We had no short-term investments at February 2, 2008. We had $76.2 million in short-term investments as of February 3, 2007, consisting of auction rate debt and preferred stock securities. These securities were all sold during fiscal 2007.
Financing Activities
We repurchase our common stock from time to time under a stock repurchase program. The repurchase program may be modified or terminated by the Board of Directors at any time, and there is no expiration date for the program. The extent and timing of repurchases will depend upon general business and market conditions, stock prices, opening and closing of the stock trading window, and liquidity and capital resource requirements going forward. During fiscal 2007, including the ASR program, we repurchased 11.7 million shares of our common stock for $266.7 million, as compared to 4.7 million shares for $91.4 million during fiscal 2006 and 2.7 million shares for $44.5 million during fiscal 2005.
On November 12, 2007, our Board of Directors approved a $250.0 million increase in repurchase availability under the program, bringing total repurchase authorization, since inception of the program, to $600.0 million. We used a portion of the additional authorization to immediately execute an ASR program to repurchase $125.0 million of common shares as described below.
On November 13, 2007, we entered into a confirmation agreement with Bank of America. Pursuant to the ASR, Bank of America purchased shares of our common stock in the open market during the fourth quarter of fiscal 2007. The final number of shares repurchased by Bank of America under the ASR amounted to 4,786,759, which was based upon the volume weighted average share price of our common shares over the term of the ASR. The ASR was subject to collar provisions that established the minimum and maximum price for the shares, which in turn determined the final number of shares repurchased under the ASR. The initial price of the shares purchased by us from Bank of America was subject to a price adjustment based on the volume weighted average price of the shares during this period. The ASR transaction was completed on January 11, 2008.
With the latest increase in repurchase authorization, and after taking into account the $125.0 million ASR, total Company share repurchases since inception of the program are $466.2 million. Accordingly, we have approximately $133.8 million of repurchase authorization remaining under our share repurchase program as of February 2, 2008.
On November 13, 2007, we entered into an amended and restated revolving credit facility with Bank of America, N.A., as Lender which expanded availability from a maximum of $75.0 million to $150.0 million (the “New Credit Facility”). The New Credit Facility provides for a $150.0 million revolving credit line. The New Credit Facility is available for working capital and general corporate purposes, including the repurchase of our capital stock and for our capital expenditures. A portion of the availability under the New Credit Facility was used to fund our ASR to repurchase $125.0 million of our common shares. The New Credit Facility is scheduled to expire on November 13, 2012. At November 13, 2007, we had $31.3 million outstanding under the New Credit Facility that was repaid in full on November 27, 2007 (see Note 9 to the Notes to Consolidated Financial Statements for a further discussion, including covenants and events of default).
Inflation
We do not believe that our sales revenue or operating results have been materially impacted by inflation during the past three fiscal years. There can be no assurance, however, that our sales revenue or operating results will not be impacted by inflation in the future.
Contractual Obligations
The following table summarizes our contractual obligations as of February 2, 2008:
The operating leases included in the above table do not include contingent rent based upon sales volume, which represented approximately 16% of minimum lease obligations in fiscal 2007, or variable costs such as maintenance, insurance and taxes, which represented approximately 75% of minimum lease obligations in fiscal 2007.
Our open purchase orders are cancelable without penalty and are therefore not included in the above table.
In addition to the above table, we project making a benefit payment of approximately $14.6 million from our supplementary executive retirement plan in 2010, which reflects expected future service, and assumes retirement at age 65 (see Note 12 to the Notes to Consolidated Financial Statements for a further discussion).
There were no financial guarantees outstanding as of February 2, 2008. We had no commercial commitments outstanding as of February 2, 2008.
Effective at the beginning of the first quarter of 2007, we adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”) as described in Note 11 to the Notes to Consolidated Financial Statements. Our total liabilities for unrecognized tax benefits were $11.5 million at February 2, 2008. We cannot make a reasonable estimate of the amount and period of related future payments for $3.7 million of these liabilities. Therefore these liabilities were not included in the above table.
Off-Balance Sheet Arrangements
Other than operating lease commitments set forth in the table above, we are not a party to any material off-balance sheet financing arrangements. We have not created, and are not a party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating our business. We do not have any
arrangements or relationships with entities that are not consolidated into the financial statements that are reasonably likely to materially affect our liquidity or the availability of capital resources. As of February 2, 2008, we have not issued any letters of credit for the purchase of merchandise inventory or any capital expenditures.
Critical Accounting Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements. These estimates and assumptions also affect the reported amounts of revenues and expenses. Estimates by their nature are based on judgments and available information. Therefore, actual results could materially differ from those estimates under different assumptions and conditions.
Critical accounting policies are those that are most important to the portrayal of our financial condition and the results of operations and require management’s most difficult, subjective and complex judgments as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our most critical accounting policies have been discussed in Note 1 of the Notes to Consolidated Financial Statements. In applying such policies, management must use significant estimates that are based on its informed judgment. Because of the uncertainty inherent in these estimates, actual results could differ from estimates used in applying the critical accounting policies. Changes in such estimates, based on more accurate future information, may affect amounts reported in future periods.
Merchandise Inventory
Merchandise inventory consists of finished goods and is valued utilizing the cost method at lower of cost or market on a weighted-average basis. We use estimates during interim periods to record a provision for inventory shortage. We also make certain assumptions regarding future demand and net realizable selling price in order to assess that our inventory is recorded properly at the lower of cost or market. These assumptions are based on both historical experience and current information. We believe that the carrying value of merchandise inventory is appropriate as of February 2, 2008. However, actual results may differ materially from those estimated and could have a material impact on our consolidated financial statements. A 10% difference in our estimate of inventory at the lower of cost or market as of February 2, 2008 would have impacted net income by $0.8 million for the fiscal year ended February 2, 2008.
Defined Benefit Pension Plans
We maintain a Supplemental Executive Retirement Plan, or SERP, which is a non-qualified defined benefit plan for certain officers. The plan is non-contributory, is not funded and provides benefits based on years of service and compensation during employment. Pension expense is determined using various actuarial cost methods to estimate the total benefits ultimately payable to officers, and this cost is allocated to service periods. The actuarial assumptions used to calculate pension costs are reviewed annually. We believe that these assumptions have been appropriate and that, based on these assumptions, the SERP liability of $17.8 million is appropriately stated as of February 2, 2008. However, actual results may differ materially from those estimated and could have a material impact on our consolidated financial statements. If we had changed the expected discount rate by 0.5% in 2007, pension expense would have changed by less than $50,000. We adopted Statement of Financial Accounting Standards No. 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS No. 158”) during fiscal 2006.
Long-Lived Assets
We periodically evaluate the need to recognize impairment losses relating to long-lived assets. Long-lived assets are evaluated for recoverability whenever events or changes in circumstances indicate that an asset may have been impaired. Factors we consider important that could trigger an impairment review include the following:
•
significant changes in the manner of our use of assets or the strategy for our overall business;
•
significant negative industry or economic trends;
•
store closings; or
•
under-performing business trends.
In evaluating an asset for recoverability, we estimate the future cash flows expected to result from the use of the asset and eventual disposition. If the sum of the expected future cash flows is less than the carrying amount of the asset, we would write the asset down to fair value and we would record an impairment charge. Accordingly, we recorded an asset impairment charge of $9.0 million related to our Jimmy’Z stores during fiscal 2007 (see Note 5 to the Notes to Consolidated Financial Statements for a further discussion). We believe that the carrying values of finite-lived assets, and their useful lives, are appropriate as of February 2, 2008. However, actual results may differ materially from those estimated and could have a material impact on our consolidated financial statements.
Income Taxes
Income taxes are accounted for in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (“SFAS No. 109”). Under SFAS No. 109, income taxes are recognized for the amount of taxes payable for the current year and deferred tax assets and liabilities for the future tax consequence of events that have been recognized differently in the financial statements than for tax purposes. Deferred tax assets and liabilities are established using statutory tax rates and are adjusted for tax rate changes. We consider accounting for income taxes critical to our operations because management is required to make significant subjective judgments in developing our provision for income taxes, including the determination of deferred tax assets and liabilities, and any valuation allowances that may be required against deferred tax assets.
Effective at the beginning of the first quarter of fiscal 2007, we adopted FIN 48. This interpretation clarifies the accounting for uncertainty in income tax recognized in an entity’s financial statements in accordance with SFAS No. 109. FIN 48 requires companies to determine whether it is “more likely than not” that a tax position will be sustained upon examination by the appropriate taxing authorities before any part of the benefit can be recorded in the financial statements. For those tax positions where it is “not more likely than not” that a tax benefit will be sustained, no tax benefit is recognized. Where applicable, associated interest and penalties are also recorded. This interpretation also provides guidance on derecognition, classification, accounting in interim periods, and expanded disclosure requirements (see Note 14 to the Notes to Consolidated Financial Statements).
Recent Accounting Developments
See the section “Recent Accounting Developments” included in Note 1 in the Notes to Consolidated Financial Statements for a discussion of recent accounting developments and their impact on our consolidated financial statements.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
At November 13, 2007, we had $31.3 million outstanding under the New Credit Facility that was repaid in full on November 27, 2007. Prior to November 13, 2007 we had no outstanding borrowings under the Prior Credit Facility since November 2002. In addition, we had no stand-by or commercial letters of credit issued under the New Credit Facility. To the extent that we may borrow pursuant to the New Credit Facility in the future, we may be exposed to market risk related to interest rate fluctuations.
We are exposed to foreign currency risk as a result of entering the Canadian market in July 2007. We are subject to changes in the foreign currency exchange rates in the Canadian dollar, which could impact our financial condition. Foreign exchange risk arises from our exposure to fluctuation in foreign currency exchange rates because our reporting currency is the U.S. dollar. We also face transactional currency exposures relating to merchandise that our Canadian subsidiary purchases using U.S. dollars. We do not hedge our exposure to this currency exchange fluctuation. A 10% movement in quoted foreign currency exchange rates could result in a fair value translation fluctuation of approximately $1.8 million in our net investment, which would be recorded in other comprehensive income as an unrealized gain or loss.
Item 8.
Item 8.
Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Aéropostale, Inc.:
We have audited the accompanying consolidated balance sheets of Aéropostale, Inc. and its subsidiaries (the “Company”) as of February 2, 2008 and February 3, 2007, and the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended February 2, 2008. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and the financial statement 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 are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of February 2, 2008 and February 3, 2007, and the results of its operations and its cash flows for each of the three years in the period ended February 2, 2008, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such consolidated financial statement 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.
As discussed in Note 1 to the Notes to Consolidated Financial Statements, the Company adopted Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, effective February 4, 2007. Also, as discussed in Note 1 to the Notes to Consolidated Financial Statements, the Company adopted Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, relating to the recognition and related disclosure provisions, effective February 3, 2007. Also, as discussed in Note 1 to the Notes to Consolidated Financial Statements, the Company adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, as revised, effective January 29, 2006.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of February 2, 2008, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated April 1, 2008 expressed an unqualified opinion on the Company’s internal control over financial reporting.
/s/ Deloitte & Touche LLP
New York, New York
April 1, 2008
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Aéropostale, Inc.:
We have audited the internal control over financial reporting of Aéropostale, Inc. and its subsidiaries (“the Company”) as of February 2, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. 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 management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of 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, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and 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 by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the Company’s board of directors, management, and other personnel 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 the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the 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, the Company maintained in all material respects effective internal control over financial reporting as of February 2, 2008, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended February 2, 2008, of the Company and our report dated April 1, 2008, expressed an unqualified opinion on those financial statements and the financial statement schedule and includes an explanatory paragraph relating to the Company’s adoption of Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, effective February 4, 2007.
/s/ Deloitte & Touche LLP
New York, New York
April 1, 2008
AÉROPOSTALE, INC.
CONSOLIDATED BALANCE SHEETS
See Notes to Consolidated Financial Statements.
AÉROPOSTALE, INC.
CONSOLIDATED STATEMENTS OF INCOME
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
See Notes to Consolidated Financial Statements.
AÉROPOSTALE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
See Notes to Consolidated Financial Statements.
AÉROPOSTALE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See Notes to Consolidated Financial Statements.
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.
Summary of Significant Accounting Policies
Organization
References to the “Company,” “we,” “us,” or “our” means Aéropostale, Inc. and its subsidiaries, except as expressly indicated or unless the context otherwise requires. We are a mall-based specialty retailer of casual apparel and accessories for young women and men. As of February 2, 2008, we operated 828 stores, consisting of 802 Aéropostale stores in 47 states, 12 Aéropostale stores in Canada, and 14 Jimmy’Z stores in 11 states.
Fiscal Year
Our fiscal year ends on the Saturday nearest to January 31. Fiscal 2007 was the 52-week period ended February 2, 2008, fiscal 2006 was the 53-week period ended February 3, 2007 and fiscal 2005 was the 52-week period ended January 28, 2006. Fiscal 2008 will be the 52-week period ending January 31, 2009.
Use of Estimates
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. Actual results could differ materially from those estimated.
The most significant estimates made by management include those made in the areas of merchandise inventory, defined benefit retirement plans, long-lived assets, and income taxes. Management periodically evaluates estimates used in the preparation of the consolidated financial statements for continued reasonableness. Appropriate adjustments, if any, to the estimates used are made prospectively based on such periodic evaluations.
Seasonality
Our business is highly seasonal, and historically we have realized a significant portion of our sales, net income, and cash flow in the second half of the fiscal year, attributable to the impact of the back-to-school selling season in the third quarter and the holiday selling season in the fourth quarter. Additionally, working capital requirements fluctuate during the year, increasing in mid-summer in anticipation of the third and fourth quarters.
Translation of Foreign Currency Financial Statements and Foreign Currency Transactions
The financial statements of our Canadian subsidiary have been translated into United States dollars by translating balance sheet accounts at year-end exchange rates and statement of operations accounts at average exchange rates for the year. Foreign currency translation gains and losses are reflected in the equity section of our consolidated balance sheet in Accumulated Other Comprehensive Loss and are not adjusted for income taxes as they relate to a permanent investment in our subsidiary in Canada. The balance of the unrealized foreign currency translation gain included in Accumulated Other Comprehensive Loss was $1.2 million as of February 2, 2008. Foreign currency transaction gains and losses are charged or credited to earnings as incurred.
Cash Equivalents
We include credit card receivables and all short-term investments with an original maturity of three months or less in cash and cash equivalents.
Fair Value of Financial Instruments
The fair value of cash and cash equivalents, short-term investments, receivables, and accounts payable approximates their carrying value due to their short-term maturities.
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Merchandise Inventory
Merchandise inventory consists of finished goods and is valued utilizing the cost method at the lower of cost or market determined on a weighted-average basis. Merchandise inventory includes warehousing, freight, merchandise and design costs as an inventory product cost. We make certain assumptions regarding future demand and net realizable selling price in order to assess that our inventory is recorded properly at the lower of cost or market. These assumptions are based on both historical experience and current information. We recorded adjustments to inventory and cost of sales for lower of cost or market of $8.1 million as of February 2, 2008, $8.0 million as of February 3, 2007, and $7.4 million as of January 28, 2006.
Fixtures, Equipment and Improvements
Fixtures, equipment and improvements are stated at cost. Depreciation and amortization are provided for by the straight-line method over the following estimated useful lives:
Evaluation for Long-Lived Asset Impairment
We periodically evaluate the need to recognize impairment losses relating to long-lived assets in accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-lived Assets (“SFAS No. 144”). Long-lived assets are evaluated for recoverability whenever events or changes in circumstances indicate that an asset may have been impaired. In evaluating an asset for recoverability, we estimate the future undiscounted cash flows expected to result from the use of the asset and eventual disposition. If the sum of the expected future cash flows is less than the carrying amount of the asset, we write the asset down to fair value and we record an impairment charge, accordingly. We recorded impairment charges of $9.0 million in fiscal 2007 related to our Jimmy’Z stores (see note 5 for a further discussion).
Pre-Opening Expenses
New store pre-opening costs are expensed as they are incurred.
Leases
Rent expense under our operating leases typically provide for fixed non-contingent rent escalations. Rent payments under our store leases typically commence when the store opens. These leases include a pre-opening period that allows us to take possession of the property to construct the store. We recognize rent expense on a straight-line basis over the non-cancelable term of each individual underlying lease, commencing when we take possession of the property (see note 15 for a further discussion).
In addition, our store leases require us to pay additional rent based on specified percentages of sales, after we achieve specified annual sales thresholds. We use store sales trends to estimate and record liabilities for these additional rent obligations during interim periods. Most of our store leases entitle us to receive tenant allowances from our landlords. We record these tenant allowances as a deferred rent liability, which we amortize as a reduction of rent expense over the non-cancelable term of each underlying lease.
Revenue Recognition
Sales revenue is recognized at the “point of sale” in our stores, and at the time our e-commerce customers take possession of merchandise. Allowances for sales returns are recorded as a reduction of net sales in the periods in
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
which the related sales are recognized. Also included in sales revenue is shipping revenue from our e-commerce customers.
Gift Cards
We sell gift cards to our customers in our retail stores, through our Web site, and through select third parties. We do not charge administrative fees on unused gift cards and our gift cards do not have an expiration date. We recognize income from gift cards when the gift card is redeemed by the customer. In addition, in the fourth quarter of fiscal 2007, we relieved our legal obligation to escheat the value of unredeemed gift cards to the relevant jurisdiction. We therefore determined that the likelihood of certain gift cards being redeemed by the customer was remote, based upon historical redemption patterns of gift cards. For those gift cards that we determined redemption to be remote, we reversed our liability, and recorded gift card breakage income of $7.7 million in net sales in the fourth quarter of fiscal 2007. Of this amount, $5.9 million related to gift cards issued prior to fiscal 2007.
Cost of Sales
Cost of sales includes costs related to merchandise sold, including inventory valuation adjustments, distribution and warehousing, freight from the distribution center and warehouse to the stores, payroll for our design, buying and merchandising departments, and occupancy costs. Occupancy costs include rent, contingent rents, common area maintenance, real estate taxes, utilities, repairs, maintenance and all depreciation.
Selling, General and Administrative Expenses
Selling, general and administrative expenses, or SG&A, include costs related to selling expenses, store management and corporate expenses such as payroll and employee benefits, marketing expenses, employment taxes, information technology maintenance costs and expenses, insurance and legal expenses, store pre-opening and other corporate level expenses, and e-commerce shipping expenses. Store pre-opening expenses include store level payroll, grand opening event marketing, travel, supplies and other store pre-opening expenses. We recorded e-commerce shipping expenses of $5.0 million as of February 2, 2008, $2.6 million as of February 3, 2007, and $0.8 million as of January 28, 2006.
Self-Insurance
We self-insure our workers compensation risk and a portion of our employee medical benefits. The recorded liabilities for these risks are calculated primarily using historical experience and current information. The liabilities include amounts for actual claims and claims incurred but not yet reported.
Retirement Benefit Plans
Our retirement benefit plan costs are accounted for using actuarial valuations required by Statement of Financial Accounting Standards No. 87, Employers’ Accounting for Pensions (“SFAS No. 87”) and Statement of Financial Accounting Standards No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions (“SFAS No. 106”).
We adopted Statement of Financial Accounting Standards No. 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS No. 158”), during fiscal 2006. SFAS No. 158 requires an entity to recognize the funded status of its defined pension plans on the balance sheet and to recognize changes in the funded status that arise during the period but are not recognized as components of net periodic benefit cost, within other comprehensive income, net of income taxes.
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Marketing Costs
Marketing costs, which includes e-commerce, print, radio and other media advertising and collegiate athletic conference sponsorships, are expensed at the point of first broadcast or distribution, and were $7.6 million in fiscal 2007, $11.3 million in fiscal 2006, and $6.8 million in fiscal 2005.
Stock-Based Compensation
On January 29, 2006, the first day of our 2006 fiscal year, we adopted the provisions of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, a revision of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123(R)”), as interpreted by SEC Staff Accounting Bulletin No. 107. Under SFAS No. 123(R), all forms of share-based payment to employees and directors, including stock options, must be treated as compensation and recognized in the income statement. Prior to the adoption of SFAS No. 123(R), we accounted for stock options under the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), and, accordingly, did not recognize compensation expense in our consolidated financial statements.
Segment Reporting
Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS No. 131”), establishes standards for reporting information about a company’s operating segments. It also establishes standards for related disclosures about products and services, geographic areas and major customers. We operate in a single aggregated operating segment, which includes the operation of our Aéropostale and Jimmy’Z specialty retail stores and our Aéropostale e-commerce site. Revenues from external customers are derived from merchandise sales and we do not rely on any major customers as a source of revenue. Our consolidated net sales mix by merchandise category was as follows:
Income Taxes
Income taxes are accounted for in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (“SFAS No. 109”). Under SFAS No. 109, income taxes are recognized for the amount of taxes payable for the current year and deferred tax assets and liabilities for the future tax consequence of events that have been recognized differently in the financial statements than for tax purposes. Deferred tax assets and liabilities are established using statutory tax rates and are adjusted for tax rate changes. Effective at the beginning of the first quarter of fiscal 2007, we adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). This interpretation clarifies the accounting for uncertainty in income tax recognized in an entity’s financial statements in accordance with SFAS No. 109. FIN 48 requires companies to determine whether it is “more likely than not” that a tax position will be sustained upon examination by the appropriate taxing authorities before any part of the benefit can be recorded in the financial statements. For those tax positions where it is “not more likely than not” that a tax benefit will be sustained, no tax benefit is recognized. Where applicable, associated interest and penalties are also recorded.
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Recent Accounting Developments
In February 2008, the FASB issued FSP SFAS 157-2, “Effective Date for FASB Statement No. 157”. This FSP permits the delayed application of SFAS 157 for all nonrecurring fair value measurements of non-financial assets and non-financial liabilities until fiscal years beginning after November 15, 2008. The Company has chosen to adopt SFAS 157 in accordance with the guidance of FSP SFAS 157-2 as stated above.
In December 2007, the Financial Accounting Standards Board (“FASB”) issued the Statement of Financial Accounting Standards No. 141(R), Business Combinations (“SFAS No. 141(R)”). SFAS No. 141(R)’s objective is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after December 31, 2008. We expect that the adoption of SFAS No. 141(R) will not have a material impact on our consolidated financial statements.
In December 2007, the FASB issued the Statement of Financial Accounting Standards No. 160, Noncontrolling Interest in Consolidated Financial Statements (“SFAS No. 160”). SFAS No. 160’s objective is to improve the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements by establishing accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 will be effective for fiscal years and interim periods within those fiscal years, beginning on or after December 15, 2008. We expect that the adoption of SFAS No. 160 will not have a material impact on our consolidated financial statements.
In December 2007, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 110 to extend the use of “simplified method” for estimating the expected terms of “plain vanilla” employee stock options for the awards valuation. The method was initially allowed under SAB 107 in contemplation of the adoption of SFAS 123(R) to expense the compensation cost based on the grant date fair value of the award. SAB 110 does not provide an expiration date for the use of the method. However, as more external information about exercise behavior will be available over time, it is expected that this method will not be used when more relevant guidance is available (see note 11 for a further discussion).
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115 (“SFAS No. 159”). This statement permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective at the beginning of an entity’s first fiscal year that begins after November 15, 2007. We expect that the adoption of SFAS No. 159 will not have a material impact on our consolidated financial statements.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”). This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having concluded in those other accounting pronouncements that fair value is the relevant measurement attribute. This statement is effective for financial assets and liabilities in financial statements issued for fiscal years beginning after November 15, 2007. We expect that the adoption of SFAS No. 157 will not have a material impact on our consolidated financial statements.
2.
Common Stock Split
On July 11, 2007, we announced a three-for-two stock split on all shares of our common stock that was distributed on August 21, 2007 in the form of a stock dividend to all shareholders of record on August 6, 2007. All share and per share amounts presented in this report were retroactively adjusted for the common stock split, and all previously reported periods were restated for such.
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3.
Short-Term Investments
As of February 2, 2008, we did not have any short-term investments. As of February 3, 2007, short-term investments consisted of auction rate debt and preferred stock securities. Auction rate securities are term securities earning income at a rate that is periodically reset, typically within 35 days, to reflect current market conditions through an auction process. These securities are classified as “available-for-sale” securities under the provisions of Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (“SFAS No. 115”). Accordingly, these short-term investments are recorded at fair-value, with any related unrealized gains and losses included as a separate component of stockholders’ equity, net of tax. Investment income is included in interest income and was $4.0 million in fiscal 2007, $6.4 million in fiscal 2006, and $3.6 million in fiscal 2005. We sold all our short-term investments in auction rate debt and preferred stock securities during fiscal 2007.
4.
Supplier Risk Concentration
During fiscal 2007, we sourced approximately 69% of our merchandise from our top five merchandise vendors. During fiscal 2006, we sourced approximately 66% of our merchandise from our top five merchandise vendors. The loss of any of these sources could adversely impact our ability to operate our business. We ceased doing business with South Bay Apparel Inc., one of our largest suppliers of graphic T-shirts and fleece, in July 2007 (see note 6 for a further discussion). We have replaced this business both with new vendors and our existing vendor base.
5.
Asset Impairment
We launched our Jimmy’Z store concept in 2005 and operated fourteen Jimmy’Z stores as of February 2, 2008. These stores have had recurring losses since inception. After the completion of the fiscal 2007 holiday season, which represented the largest quarterly sales and profit contribution for the year, we reviewed the operating performance, and forecasts of future performance, of our fourteen Jimmy’Z stores. As a result of that review, we determined that each of these stores would not be able to recover the carrying value of the store property and equipment through expected undiscounted cash flows over the remaining life of the related assets. As a result, we reduced the carrying value of the assets to fair value, and recorded asset impairment charges of $9.0 million ($5.7 million after-tax, or $0.08 per diluted share), in the fourth quarter of fiscal 2007 related to our Jimmy’Z store concept. In the event we were to decide to exit this business in the future, or close any or all of these stores, we may be required to record additional inventory impairment, lease termination charges, and severance and other charges.
6.
Other Matters
On January 15, 2008, we learned that the SEC had issued a formal order of investigation with respect to matters arising from the activities of Christopher L. Finazzo, our former Executive Vice President and Chief Merchandising Officer, as discussed below. The SEC’s investigation is a non-public, fact-finding inquiry to determine whether any violations of law have occurred. We are cooperating fully with the SEC in its investigation.
On November 30, 2007, we entered into an agreement (the “Agreement”) with Mr. Finazzo settling disputes between us. In the fourth quarter of fiscal 2007, pursuant to the terms of the Agreement, Mr. Finazzo paid us $5.0 million and in turn, we paid to Mr. Finazzo approximately $0.9 million, which represented the value of Mr. Finazzo’s benefits under our Supplemental Executive Retirement Plan. We recorded net other operating income of approximately $4.1 million in the fourth quarter of fiscal 2007.
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
On November 8, 2006, we announced that Mr. Finazzo had been terminated for cause, based upon information uncovered by management and after an independent investigation was conducted at the direction, and under the supervision, of a special committee of our Board of Directors. The investigation revealed that Mr. Finazzo:
•
concealed from management and our Board of Directors, and failed to disclose in corporate disclosure documents, his personal ownership interests in, and officer positions of, certain corporate entities affiliated with one of our primary vendors at the time, South Bay Apparel, Inc.,
•
without the knowledge or authorization of our management, executed a corporate Guaranty Agreement in March 1999, that, had it been enforceable, would have obligated us to guarantee any payments due from South Bay Apparel, Inc. to Tricot Richelieu, Inc., an apparel manufacturer and vendor to South Bay Apparel, Inc., and
•
failed to disclose unauthorized business relationships and transactions between immediate and extended family members of Mr. Finazzo and certain other of our vendors.
These activities, and their concealment, constituted numerous instances of conflicts of interest that were in breach of, among other things, our Code of Business Conduct and Ethics, as well as numerous violations of Mr. Finazzo’s employment agreement.
South Bay Apparel, Inc. had been a vendor to us since 1996, providing apparel products including women’s and men’s graphic tee shirts, fleece and other tops. At least one affiliate of South Bay Apparel Inc., Inc. involved in this matter had received orders from us aggregating approximately $0.6 million during fiscal 2006 and approximately $1.0 million during fiscal 2005. We ceased doing business with this affiliate of South Bay Apparel Inc. during the fourth quarter of fiscal 2006.
Our management and our Board of Directors had no prior knowledge of any of these unauthorized activities by Mr. Finazzo, including the unauthorized Guaranty Agreement discussed above. On December 5, 2006, we entered into a Confirmatory Termination and Revocation Agreement with South Bay Apparel, Inc. and Tricot Richelieu, Inc., whereby all parties agreed that the Guaranty Agreement was thereby and had been permanently, irrevocably and absolutely terminated, revoked and expired in all respects. Therefore, the Guaranty Agreement was not recorded in the accompanying consolidated financial statements.
On December 5, 2006, we entered into an agreement with South Bay Apparel, Inc. and Douglas Dey, South Bay Apparel, Inc.’s President, whereby the parties resolved certain outstanding matters between them. As such, South Bay Apparel, Inc. paid us $8.0 million, representing (i) a concession of $7.1 million by South Bay Apparel, Inc. and Mr. Dey concerning prior purchases of merchandise by us, which was reflected as a reduction in the cost of merchandise in fiscal 2006, and (ii) reimbursement by South Bay Apparel, Inc. of $0.9 million, which offset professional fees that we incurred associated with the negotiation of the Agreement and the investigation of the underlying facts. In addition, South Bay Apparel, Inc. and Mr. Dey reduced the price of merchandise sold to us to a price that we believed represented fair value, based on costs of comparable merchandise. We also agreed to continue purchasing merchandise from South Bay Apparel, Inc. through July 2, 2007, the date the agreement terminated. As of February 2, 2008, there was no Aéropostale merchandise remaining at South Bay Apparel, Inc. Additionally, during fiscal 2007, we ceased doing business with South Bay Apparel Inc. We have replaced this business with both new vendors and our existing vendor base.
Due to the numerous undisclosed conflicts of interests discussed above, we determined that transactions initiated or authorized by Mr. Finazzo, during his employment with us, with the above mentioned related parties cannot be presumed to have been carried out on an arm’s-length basis, as the requisite conditions of competitive, free-market dealings may not have existed. However, we believe that our historical consolidated financial statements were fairly stated in all material respects. In addition, we believe that our historical trend of earnings would not have been materially impacted by any of these items.
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7.
Fixtures, Equipment and Improvements
Fixtures, equipment and improvements consist of the following (in thousands):
Depreciation and amortization expense was $36.8 million in fiscal 2007, $30.0 million in fiscal 2006, and $22.3 million in fiscal 2005.
8.
Accrued Expenses
Accrued expenses consist of the following (in thousands):
9.
Revolving Credit Facility
On November 13, 2007, we entered into an amended and restated revolving credit facility with Bank of America, N.A. (“Bank of America”), as Lender which expanded availability from a maximum of $75.0 million to $150.0 million (the “New Credit Facility”). The New Credit Facility provides for a $150.0 million revolving credit line. The New Credit Facility is available for working capital and general corporate purposes, including the repurchase of our capital stock and for our capital expenditures. A portion of the availability under the New Credit Facility was used to fund our accelerated share repurchase program (“ASR”) to repurchase $125.0 million of our common shares (see note 13 for a further discussion). The New Credit Facility is scheduled to expire on November 13, 2012 and is guaranteed by all of our domestic subsidiaries (the “Guarantors”).
Loans under the New Credit Facility are secured by all of our assets and are guaranteed by the Guarantors. Upon the occurrence of a Cash Dominion Event (as defined in the New Credit Facility) among other limitations, our ability to borrow funds, make investments, pay dividends and repurchase shares of our common stock would be limited.
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The New Credit Facility replaces a maximum $75.0 million Loan and Security Agreement dated October 7, 2003, as amended by the First Amendment to the Loan and Security Agreement dated as of April 22, 2005, by and between us and Bank of America, as agent for the lenders party thereto (the “Prior Credit Facility”). The Prior Credit Facility, which was scheduled to expire in April 2010, was terminated concurrently with the entering into of the New Credit Facility
Except for the use of a portion of the credit under the New Loan Facility to fund our repurchase of shares as described below, as of the date hereof, we had no direct borrowings outstanding under the New Credit Facility. Direct borrowings under the New Credit Facility bear interest at a margin over either LIBOR or a Base Rate (as each such term is defined in the New Credit Facility).
The New Credit Facility also contains covenants that, subject to specified exceptions, restrict our ability to, among other things:
•
incur additional debt or encumber assets of the Company;
•
merge with or acquire other companies, liquidate or dissolve;
•
sell, transfer, lease or dispose of assets; and
•
make loans or guarantees.
Upon the occurrence of an event of default under the New Credit Facility, the lenders may cease making loans, terminate the New Credit Facility, and declare all amounts outstanding to be immediately due and payable. As of February 2, 2008, we were in compliance with all covenants.
Events of default under the New Credit Facility include, subject to grace periods and notice provisions in certain circumstances, failure to pay principal amounts when due, breaches of covenants, misrepresentation, default of leases or other indebtedness, excess uninsured casualty loss, excess uninsured judgment or restraint of business, business failure or application for bankruptcy, institution of legal process or proceedings under federal, state or civil statutes, legal challenges to loan documents, and a change in control. If an event of default occurs, the Lender will be entitled to take various actions, including the acceleration of amounts due there-under and requiring that all such amounts be immediately paid in full as well as possession and sale of all assets that have been used as collateral. As of February 2, 2008, there were no events of default.
At November 13, 2007, we had $31.3 million outstanding under the New Credit Facility that was repaid in full on November 27, 2007. Prior to November 13, 2007, we had not had any outstanding borrowings under the Prior Credit Facility since November 2002. In addition, at February 2, 2008 we had no stand-by or commercial letters of credit issued under the New Credit Facility.
10.
Earnings Per Share
In accordance with Statement of Financial Accounting Standards No. 128, Earnings Per Share (“SFAS No. 128”), basic earnings per share has been computed based upon the weighted average of common shares. Diluted earnings per share gives effect to outstanding stock options.
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Earnings per common share has been computed as follows (in thousands, except per share data):
Options to purchase 511,000 shares in fiscal 2007, 629,000 shares in fiscal 2006, and 581,000 in fiscal 2005 were excluded from the computation of diluted earnings per share because the exercise prices of the options were greater than the average market price of the common shares.
11.
Stock-Based Compensation
On January 29, 2006, the first day of our 2006 fiscal year, we adopted the provisions of SFAS No. 123(R). Under SFAS No. 123(R), all forms of share-based payment to employees and directors, including stock options, must be treated as compensation and recognized in the income statement. Previous to the adoption of SFAS No. 123(R), we accounted for stock options under the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and, accordingly, did not recognize compensation expense in our consolidated financial statements. We adopted the modified prospective transition method provided under SFAS No. 123(R), and consequently, did not retroactively adjust results from prior periods.
We have stock option plans under which we may grant qualified and non-qualified stock options to purchase shares of our common stock to executives, consultants, directors, or other key employees. As of February 2, 2008, a total of 3,692,666 shares were available for future grant under our plans. Stock options may not be granted at less than the fair market value at the date of grant. Stock options generally vest over four years on a pro rata basis and expire after eight years. All outstanding stock options immediately vest upon change in control.
The fair value of options is estimated on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes model requires certain assumptions, including estimating the length of time employees will retain their vested stock options before exercising them (“expected term”), the estimated volatility of our common stock price over the expected term and the number of options that will ultimately not complete their vesting requirements (“forfeitures”). Changes in the subjective assumptions can materially affect the estimate of fair value of stock-based compensation and consequently, the related amount recognized in the consolidated statements of income.
We determined expected volatilities based on median results of a peer group analysis of companies similar in size and financial leverage to us. We have elected to use the simplified method for estimating our expected term as allowed by SAB 107, and extended by SAB 110, to determine expected life. The risk-free rate is indexed to the five-year Treasury note interest at the date of grant and expected forfeiture rate is based on our historical forfeiture information.
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
In accordance with SFAS No. 123(R), the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model based on the following assumptions for grants in the respective periods:
The effects of applying SFAS No. 123(R) and the use of the Black-Scholes option-pricing model results in estimates that may not necessarily be indicative of future values.
We have elected to adopt the simplified method to establish the beginning balance of the additional paid-in capital pool (“APIC Pool”) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC Pool and condensed consolidated statements of cash flows of the tax effects of employee and director share-based awards that were outstanding upon adoption of SFAS No. 123(R).
Prior to the adoption of SFAS No. 123(R), we presented all tax benefits resulting from the exercise of stock options as operating cash flows in the Condensed Consolidated Statement of Cash Flows. SFAS No. 123(R) requires that cash flows resulting from tax deductions in excess of the cumulative compensation cost recognized for options exercised be classified as financing cash flows. Previously, all tax benefits from stock options had been reported as an operating activity. For fiscal 2007, net cash provided by operating activities, and net cash used for financing activities, was decreased by $5.5 million related to excess tax benefits realized from the exercise of stock options compared to $7.6 million for fiscal 2006.
Stock Options
The following tables summarize stock option transactions for common stock for fiscal 2007:
We recognized $4.7 million in compensation expense related to stock options in fiscal 2007 and $3.7 million in fiscal 2006. The weighted-average grant-date fair value of options granted was $12.35 during fiscal 2007, $9.73 during fiscal 2006, and $8.89 during fiscal 2005. The intrinsic value of options exercised was $15.4 million in fiscal 2007, $19.3 million in fiscal 2006, and $12.0 million in fiscal 2005.
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following tables summarize information regarding non-vested stock outstanding stock options as of February 2, 2008:
As of February 2, 2008, there was $7.8 million of total unrecognized compensation cost related to non-vested options that we expect to be recognized over the remaining weighted-average vesting period of 2.6 years. We expect to recognize $3.4 million of this cost in fiscal 2008, $2.5 million in fiscal 2009, $1.6 million in fiscal 2010, and $0.3 million in fiscal 2011. Based on our forfeiture experience, we expect that approximately 905,709 of the above non-vested options will vest.
Prior to fiscal 2006, no compensation expense was recognized for stock options. Had compensation cost for our stock option plans been determined consistent with SFAS No. 123(R), our net income and earnings per share for fiscal 2005 would have been reduced to the following pro forma amounts (in thousands, except per share data):
Non-Vested Stock
Certain of our employees and all of our directors have been awarded non-vested stock, pursuant to non-vested stock agreements. The non-vested stock awarded to employees vests at the end of three years of continuous service with us. Initial grants of non-vested stock awarded to directors vest, pro-rata, over a three-year period, based upon continuous service. Subsequent grants of non-vested stock awarded to directors vest in full one year after the grant-date.
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table summarizes non-vested shares of stock outstanding at February 2, 2008:
Total compensation expense is being amortized over the vesting period. Compensation expense was $4.1 million for fiscal 2007, $2.2 million for fiscal 2006 and $1.7 million for fiscal 2005. As of February 2, 2008, there was $14.1 million of unrecognized compensation cost related to non-vested stock awards that is expected to be recognized over the weighted average period of 1.4 years. In the fourth quarter of 2006, we recorded a reduction of a previously recorded compensation expense of $0.3 million, resulting from the termination for cause of our former Executive Vice President and Chief Merchandising Officer (see note 6 for a further discussion).
Performance Shares
Certain of our executives have been awarded performance shares, pursuant to performance shares agreements. The performance shares vest at the end of three years of continuous service with us, and the number of shares ultimately awarded are contingent upon meeting various cumulative consolidated earnings targets. Compensation cost for the performance shares assumes that the performance goals targets will be achieved. If the probability of achieving targets changes, compensation cost will be adjusted in the period that the probability of achievement changes.
The following table summarizes performance shares of stock outstanding at February 2, 2008:
Total compensation expense is being amortized over the vesting period. Compensation expense was $0.6 million for fiscal 2007, and none in both fiscal 2006 and fiscal 2005. As of February 2, 2008, there was $1.4 million of unrecognized compensation cost related to performance shares awards that is expected to be recognized over the weighted average period of 2.2 years.
12.
Retirement Benefit Plans
We maintain a qualified, defined contribution retirement plan with a 401(k) salary deferral feature that covers substantially all of our employees who meet certain requirements. Under the terms of the plan, employees may contribute up to 14% of gross earnings and we will provide a matching contribution of 50% of the first 5% of gross earnings contributed by the participants. We also have the option to make additional contributions. The terms of the
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
plan provide for vesting in our matching contributions to the plan over a five-year service period with 20% vesting after two years and 50% vesting after year three. Vesting increases thereafter at a rate of 25% per year so that participants will be fully vested after year five. Contribution expense was $0.7 million in fiscal 2007, $0.8 million in fiscal 2006 and $0.5 million in fiscal 2005.
We adopted SFAS No. 158 in fiscal 2006, which impacted our Supplemental Executive Retirement Plan (“SERP”), and our postretirement benefit plan. Since the full recognition of the funded status of an entity’s defined benefit pension plan is recorded on the balance sheet, an additional minimum liability (“AML”) is no longer recorded under SFAS No. 158. However, because the recognition provisions of SFAS No. 158 were adopted in fiscal 2006, we first measured and recorded changes to our previously recognized AML through other comprehensive income and then applied the recognition provisions of SFAS No. 158 through accumulated other comprehensive income to fully recognize the funded status of our defined benefit pension plans.
Our SERP is a non-qualified defined benefit plan for certain officers. The plan is non-contributory and not funded and provides benefits based on years of service and compensation during employment. Participants are fully vested upon entrance in the plan. Pension expense is determined using various actuarial cost methods to estimate the total benefits ultimately payable to officers and this cost is allocated to service periods. The actuarial assumptions used to calculate pension costs are reviewed annually.
The following information about the SERP is provided below (in thousands):
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Pension expense includes the following components (in thousands):
The discount rate was determined by matching a published set of zero coupon yields and associated durations to expected plan benefit payment streams to obtain an implicit internal rate of return.
We currently do not expect to make any contributions to the SERP in fiscal 2008. We project making a benefit payment of approximately $14.6 million in 2010, which reflects expected future service, and assumes retirement at age 65.
We have a long-term incentive deferred compensation plan established for the purpose of providing long-term incentives to a select group of management, with liabilities of $0.4 million as of February 2, 2008 and $0.2 million at February 3, 2007. The plan is a non-qualified, defined contribution plan and is not funded. Participants in this plan include all employees designated by us as Vice President, or other higher-ranking positions that are not participants in the SERP. We will record annual monetary credits to each participant’s account based on compensation levels and years as a participant in the plan. Annual interest credits will be applied to the balance of each participant’s account based upon established benchmarks. Each annual credit is subject to a three-year cliff-vesting schedule, and participants’ accounts will be fully vested upon retirement after completing five years of service and attaining age 55.
We have a postretirement benefit plan for certain executives with liabilities of $0.7 million as of February 2, 2008 and $0.5 million at February 3, 2007.
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
13.
Stock Repurchase Program
We repurchase our common stock from time to time under a stock repurchase program. The repurchase program may be modified or terminated by the Board of Directors at any time, and there is no expiration date for the program. The extent and timing of repurchases will depend upon general business and market conditions, stock prices, opening and closing of the stock trading window, and liquidity and capital resource requirements going forward. During fiscal 2007, including the accelerated share repurchase program (“ASR”) described below, we repurchased 11.7 million shares of our common stock for $266.7 million, as compared to 4.7 million shares for $91.4 million during fiscal 2006 and 2.7 million shares for $44.5 million during fiscal 2005.
On November 12, 2007, our Board of Directors approved a $250.0 million increase in repurchase availability under the program, bringing total repurchase authorization, since inception of the program, to $600.0 million. We used a portion of the additional authorization to immediately execute an ASR to repurchase $125.0 million of our common shares as described below.
On November 13, 2007, we entered into a confirmation agreement with Bank of America, N.A. Pursuant to the ASR, Bank of America purchased shares of our common stock in the open market during the fourth quarter of fiscal 2007. The final number of shares repurchased by Bank of America under the ASR amounted to 4,786,759, which was based upon the volume weighted average share price of our common shares over the term of the ASR. The ASR was subject to collar provisions that established the minimum and maximum price for the shares, which in turn determined the final number of shares repurchased under the ASR. The initial price of the shares purchased by us from Bank of America was subject to a price adjustment based on the volume weighted average price of the shares during this period. The ASR transaction was completed on January 11, 2008.
With the latest increase in repurchase authorization, and after taking into account the $125.0 million ASR, total Company share repurchases since inception of the program are $466.2 million. Accordingly, we have approximately $133.8 million of repurchase authorization remaining under our share repurchase program as of February 2, 2008.
14.
Income Taxes
The provision for income taxes consists of the following (in thousands):
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Reconciliation of the U.S. statutory tax rate with our effective tax rate is summarized as follows:
The components of the net deferred income tax assets are as follows (in thousands):
As of February 2, 2008, we had approximately $34.4 million of NOL’s from certain states that were generated by our Jimmy’Z subsidiary and approximately $1.0 million of Canadian NOL’s generated by our Canadian subsidiary. These NOL’s will expire between 2010 and 2027. We have recorded valuation allowances against certain of the Jimmy’Z NOL’s. Subsequent recognition of these deferred tax assets that were previously reduced by valuation allowances would result in an income tax benefit in the period of such recognition.
The Company has not recognized any United States (“U.S.”) tax expense on undistributed foreign earnings since they are intended to be indefinitely reinvested outside of the U.S.
On February 4, 2007, the first day of our 2007 fiscal year, we adopted FIN No. 48, which clarifies the accounting and disclosure for uncertainty in income taxes. As a result of the adoption, we recorded a decrease to beginning retained earnings of approximately $0.2 million and increased our net liabilities for uncertain tax positions and related interest and penalties by a corresponding amount. As of the adoption date, we recorded liabilities of $10.7 million for uncertain tax positions, which includes interest and penalties. Also as of the adoption date, we recorded deferred tax assets of $7.9 million for federal and, if applicable, state benefits related to the uncertain tax positions. Net uncertain tax positions of $2.8 million as of the adoption date, and $2.4 million as of
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
February 2, 2008, which is inclusive of interest and penalties, would favorably impact our effective tax rate if these net liabilities were reversed.
We recognize interest and, if applicable, penalties, which could be assessed, related to uncertain tax positions in income tax expense. As of the adoption date, the total amount of accrued interest and penalties was $1.7 million before federal and, if applicable, state effect. We recorded approximately $0.2 million in additional interest and penalties, before federal and, if applicable, state tax effect in fiscal 2007.
In May 2007, the FASB issued FASB Staff Position No. FIN 48-1, “Definition of Settlement in FASB Interpretation No. 48” (“FSP FIN 48-1”). This FSP amends FIN 48 to provide guidance on how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. There is no impact to the Company’s financial statements in connection with the adoption of this guidance.
Below is a reconciliation of the beginning and ending amount of the gross unrecognized tax benefits relating to uncertain tax positions, which are recorded in our Consolidated Balance Sheet.
We file income tax returns in the U.S. federal jurisdiction and in various states. Our U.S. federal filings for the years 2002 through 2005 were under examination and we reached agreement with the IRS in the fourth quarter of fiscal 2007. We have paid approximately $7.7 million relating to this examination in the first quarter of fiscal 2008. This liability is included in the above balance of uncertain tax position liabilities at February 2, 2008, and is included in accrued expenses on our consolidated balance sheet. The examination liability related to the timing of taxable revenue from non-redeemed gift cards. For state tax purposes, our 2003 through 2006 tax years remain open for examination by the tax authorities under a four-year statute of limitations. However, certain states may keep their statute open for six to ten years.
15.
Commitments and Contingencies
We are committed under non-cancelable leases for our entire store, distribution centers and office space locations, which generally provide for minimum rent plus additional increases in real estate taxes, certain operating expenses, etc. Certain leases also require contingent rent based on sales.
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The aggregate minimum annual rent commitments as of February 2, 2008 are as follows (in thousands):
Rental expense consists of the following (in thousands):
Employment Agreements - As of February 2, 2008, we had outstanding employment agreements with certain members of our senior management totaling $22.6 million. These employment agreements expire at the end of fiscal 2009 through March 2010, except for the employment agreement with our Chairman and Chief Executive Officer, which expires at the end of fiscal 2010.
Legal Proceedings - On January 15, 2008, the Company learned that the SEC had issued a formal order of investigation with respect to matters arising from the activities of Christopher L. Finazzo, our former Executive Vice President and Chief Merchandising Officer. The SEC’s investigation is a non-public, fact-finding inquiry to determine whether any violations of law have occurred. The Company is cooperating fully with the SEC in its investigation.
On November 30, 2007, the Company entered into an agreement (the “Agreement”) with Mr. Finazzo settling disputes between them. Pursuant to the terms of the Agreement, Mr. Finazzo has paid the Company $5.0 million, and in turn, the Company paid Mr. Finazzo, simultaneously with his payment to the Company, approximately $0.9 million, which represented the value of Mr. Finazzo’s benefits under the Company’s Supplemental Executive Retirement Plan.
We are also party to various litigation matters and proceedings in the ordinary course of business. In the opinion of our management, dispositions of these matters are not expected to have a material adverse affect on our financial position, results of operations or cash flows.
Event Sponsorship and Advertising Agreements - We are a party to event sponsorship and advertising agreements with remaining payment obligations of $2.5 million in fiscal 2008.
Guarantees - We had no financial guarantees outstanding at February 2, 2008. We had no commercial commitments outstanding as of February 2, 2008.
AÉROPOSTALE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
16.
Selected Quarterly Financial Data (Unaudited)
The following table sets forth certain unaudited quarterly financial information (in thousands, except per share amounts):
(1)
- Includes gift card breakage income of $7.7 million ($4.8 million, after tax, or $0.06 per diluted share), other operating income of $4.1 million ($2.6 million, after tax, or $0.04 per diluted share) as a result of an agreement with our former Executive Vice President and Chief Merchandising Officer, partially offset by an asset impairment charge of $9.0 million ($5.7 million, after tax, or $0.08 per diluted share).
(2)
- Includes other operating income of $2.1 million ($1.3 million, after tax, or $0.02 per diluted share) from the resolution of a dispute with a vendor regarding the enforcement of our intellectual property rights.
(3)
- Includes $7.4 million ($4.5 million, after tax, or $0.05 per diluted share), net of professional fees, representing concessions, primarily from South Bay Apparel Inc., to us for prior purchases of merchandise.
Item 9.
Item 9.
Changes in and Disagreements with Accountant on Accounting and Financial Disclosure
None
Item 9A.
Item 9A.
Controls and Procedures
Management’s Report On Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Our internal control over financial reporting is a process designed to provide reasonable assurance to our management and board of directors regarding reliability of financial reporting and the preparation and fair presentation of published financial statements in accordance with generally accepted accounting principles.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in condition, or that the degree of compliance with policies or procedures may deteriorate.
Our management assessed the effectiveness of our internal control over financial reporting as of February 2, 2008. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on that assessment, our management believes that, as of February 2, 2008, our internal control over financial reporting is effective.
Evaluation of Disclosure Controls and Procedures
Pursuant to Rule 13a-15(b) under the Exchange Act, our management carried out an evaluation, under the supervision and with the participation of our Chairman and Chief Executive Officer along with our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls (as defined in Rule 13a-15(e) of the Exchange Act) and procedures. Based upon that evaluation, our Chief Executive Officer along with our Chief Financial Officer concluded that as of the end of our fiscal year ended February 2, 2008, our disclosure controls and procedures are effective.
Changes in Internal Controls over Financial Reporting
There have been no changes in our internal controls or in other factors during our fourth fiscal quarter that materially affected, or are reasonably likely to materially affect our internal controls over financial reporting.
Item 9B.
Item 9B.
Other Information
None
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance of the Registrant
Information with respect to this item is incorporated by reference from our definitive Proxy Statement to be filed with the SEC not later than 120 days after the end of our fiscal year.
Item 11.
Item 11.
Executive Compensation
Information with respect to this item is incorporated by reference from our definitive Proxy Statement to be filed with the SEC not later than 120 days after the end of our fiscal year.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Equity Compensation Plan Information
The following table provides certain information, as of February 2, 2008, about our common stock that may be issued upon the exercise of options, warrants and rights, as well as the issuance of restricted shares granted to employees, consultants or members of our Board of Directors, under our two existing equity compensation plans, the Aéropostale, Inc. 1998 Stock Option Plan and the Aéropostale, Inc. 2002 Long-Term Incentive Plan.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Information with respect to this item is incorporated by reference from our definitive Proxy Statement to be filed with the SEC not later than 120 days after the end of our fiscal year.
Item 14.
Item 14.
Principal Accountant Fees and Services
Information with respect to this item is incorporated by reference from our definitive Proxy Statement to be filed with the SEC not later than 120 days after the end of our fiscal year.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules
(a) 1.
The financial statements listed in the “Index to Consolidated Financial Statements” at page 27 are filed as a part of this Annual Report on Form 10-K
2.
Financial statement schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto
3. Exhibits included or incorporated herein:
See Exhibit Index
EXHIBIT INDEX
*
Filed herewith.
(1)
Incorporated by reference to the Registration Statement on Form S-1, originally filed by Aéropostale, Inc. on March 8, 2002 (Registration No. 333-84056).
(2)
Incorporated by reference to the Registrant’s Current Report on Form 8-K, dated February 6, 2007 (File No. 001-31314).
(3)
Incorporated by reference to the Registrant’s Annual Report on Form 10-K, for the fiscal year ended January 28, 2006 (File No. 001-31314).
(4)
Incorporated by reference to the Registrant’s Current Report on Form 8-K, dated March 8, 2007 (File No. 001-31314).
(5)
Incorporated by reference to the Registrant’s Current Report on Form 8-K, dated November 15, 2007 (File No. 001-31314).
(6)
Incorporated by reference to the Registrant’s Current Report on Form 8-K, dated January 31, 2008 (File No. 001-31314).
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.
AÉROPOSTALE, INC.
By:
/s/ Julian R. Geiger
Julian R. Geiger
Chairman, Chief Executive Officer, and Director
Date: April 1, 2008
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.
AÉROPOSTALE, INC.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS