Item 1. Business
In this Annual Report on Form 10-K , when we refer to “Alloy, LLC” we are referring to Alloy, LLC, our former parent corporation, and when we refer to “Alloy” we are referring to the Alloy-branded direct marketing and merchandising business that we previously operated. Similarly, when we refer to “dELiA*s” we are referring to the dELiA*s-branded direct marketing, merchandising and retail store business that we operate, and when we refer to “dELiA*s, Inc.,” the “Company,” “we,” “us,” or “our,” we are referring to dELiA*s, Inc. and its subsidiaries. When we refer to “the Spinoff,” we are referring to the December 19, 2005 spinoff of the outstanding common shares of dELiA*s, Inc. to the Alloy, LLC shareholders.
Overview
We are a multi-channel retail company with a lifestyle brand marketing and catering to teenage girls. We operate the dELiA*s brand, which we believe is a well-established, differentiated, lifestyle brand. We generate revenues by selling a wide variety of product categories to consumers through our website, direct mail catalogs, and retail stores.
Through our e-commerce website and catalogs, we sell our own proprietary brand products, together with brand name products, in key spending categories directly to consumers, including apparel and accessories. Our mall-based retail stores derive revenues primarily from the sale of proprietary apparel and accessories and, to a lesser extent, branded apparel.
Our focus on our proprietary brand and a diverse collection of name brands allows us to adjust our merchandising strategy quickly as fashion trends change. In addition, we strive to keep our merchandise mix fresh by regularly introducing new trends and styles. Our proprietary brand provides us an opportunity to broaden our customer base by offering merchandise of comparable quality to brand name merchandise, at a lower price, while permitting improved gross profit margins. Our proprietary brand also allows us to capitalize on emerging fashion trends when branded merchandise is not available in sufficient quantities, and to exercise a greater degree of control over the flow of our merchandise from our vendors to us, and from us to our customers.
We have built a comprehensive database that includes information such as name, mailing and email addresses and amounts and dates of purchases in our direct and retail businesses. In addition to helping us target consumers directly, our database provides us with access to important demographic information.
We refer to the 52-week fiscal year ended February 1, 2014 as “fiscal 2013,” the 53-week fiscal year ended February 2, 2013 as “fiscal 2012,” the 52-week fiscal year ended January 28, 2012 as “fiscal 2011” and the 52-week fiscal year ended January 29, 2011 as “fiscal 2010.”
Recent Developments
On February 18, 2014, we sold and issued in a private placement transaction (the “Private Placement”) (i) 199,834 shares of series B preferred stock (“Preferred Stock”) for an aggregate purchase price of $19,983,400, and (ii) an aggregate of $24,116,600 in principal amount of notes (the “Notes”). The Preferred Stock has a stated value of $100 per share and is convertible at the option of the holder into shares of our common stock at a conversion price of $0.80 per share (subject to adjustment), plus an amount in cash per share of Preferred Stock equal to accrued but unpaid dividends on such shares through but excluding the applicable conversion date. The Notes are mandatorily convertible into 241,166 shares of Preferred Stock upon Stockholder Approval (as defined below). The proceeds from the sale of the Notes are currently in an interest bearing account and may not be used by us until we obtain Stockholder Approval. If we obtain Stockholder Approval, we will receive proceeds from the sale of the Notes of approximately $24,116,600, subject to the deduction of placement agent fees and expenses. The Notes mature on the earlier of (i) August 18, 2014 and (ii) the trading day after Stockholder
Approval is not obtained at the Stockholder Meeting (as defined below). If stockholder approval is not obtained, the Notes will mature, we will be required to repay the Notes, together with interest at a rate of 7.25% per annum, and we will not have use of these funds. Based on the $0.75 closing sale price of our common stock on February 18, 2014, the total value of the shares of our common stock issuable upon conversion of the Preferred Stock, and the shares of our common stock issuable upon conversion of the Preferred Stock issuable upon conversion of the Notes, is $41,343,750.
Holders of Preferred Stock are entitled to receive, when, as and if declared by the board of directors of the Company, out of any funds legally available therefore, dividends per share of Preferred Stock in an amount equal to 6.0% per annum of the stated value per share. The first date on which dividends are payable is February 18, 2015, and, thereafter, dividends are payable semi-annually in arrears on February 18 and August 18 of each year. Dividends, whether or not declared, begin to accrue and be cumulative from February 18, 2014. If we do not pay any dividend in full on any scheduled dividend payment date, then dividends thereafter will accrue at an annual rate of 8.0% of the stated value of the Preferred Stock from such scheduled dividend payment date to the date that all accumulated dividends on the Preferred Stock have been paid in cash in full. In addition, if we do not meet minimum borrowing availability tests under our Credit Agreement dated as of June 14, 2013, as amended (the “Credit Agreement”), with Salus Capital Partners, LLC (“Salus”), we may not pay dividends on the Preferred Stock.
We have agreed to use our commercially reasonable efforts to provide each stockholder entitled to vote at a special meeting of our stockholders (the “Stockholder Meeting”) a proxy statement soliciting each such stockholder’s affirmative vote at the Stockholder Meeting for approval of an amendment (the “Charter Amendment”) to the certificate of incorporation of the Company to increase the number of authorized and unissued shares of our common stock by an amount not less than the maximum number of shares of our common stock issuable upon conversion of the Preferred Stock (x) as of February 18, 2014, the closing date of the Private Placement, upon conversion of the shares of Preferred Stock and (y) thereafter upon conversion of shares of Preferred Stock issuable upon conversion of the Notes (such affirmative approval being referred to herein as the “Stockholder Approval,” and the date such Stockholder Approval is obtained, the “Stockholder Approval Date”). The Company has agreed to use its commercially reasonable efforts to hold the Stockholder Meeting within 120 days of the closing of the Private Placement. Each investor in the Private Placement has agreed to vote all shares of our common stock it beneficially owns on the record date applicable to the Stockholder Meeting that are eligible to vote in favor of the Charter Amendment.
Discontinued Operations
On June 4, 2013, A Merchandise, LLC (formerly Alloy Merchandise, LLC), a wholly-owned subsidiary of the Company (“Alloy Merchandising”), and the Company entered into an Asset Purchase Agreement (the “Asset Purchase Agreement”) with HRSH Acquisitions LLC d/b/a Alloy Apparel and Accessories (“Buyer”) and concurrently closed the transaction under the Asset Purchase Agreement. Subject to the terms and conditions of the Asset Purchase Agreement, Alloy Merchandising sold certain assets and transferred certain related liabilities associated with its Alloy business to Buyer, and Buyer purchased such assets and assumed certain related liabilities. Upon closing of the transaction, the Company received $3.7 million in cash proceeds, subject to adjustment as provided in the Asset Purchase Agreement, and the Buyer assumed $3.3 million in liabilities. The final purchase price was approximately $3.4 million. The loss on sale from this transaction was immaterial. The Company also agreed to provide certain transition services to Buyer, for up to one year, at specified rates following the consummation of the transaction. The financial impact of the transitional services was not material. In March 2014, the transitional services provided by the Company to the Buyer were extended to December 31, 2014.
The dELiA*s Brand
We develop, market and sell primarily our own lifestyle brand, and to a lesser extent third-party brands, in our retail stores, as well as via catalogs and the internet. The dELiA*s brand is a distinctive collection of apparel,
dresses, swimwear, footwear, outerwear and accessories marketing primarily to trend-setting, fashion-aware teenage girls. While dELiA*s markets to teenage girls, we focus marketing efforts on potential customers who we believe fit the profile and have the interests of fashion-forward high-school teens. In fiscal 2013, dELiA*s circulated approximately 19.8 million catalogs.
dELiA*s retail stores sell a distinctive collection of lifestyle-oriented apparel and accessories. As of February 1, 2014, we operated 101 dELiA*s retail stores. These stores range in size from approximately 2,600 to 5,000 square feet with an average size of approximately 3,800 square feet.
Business Strengths
We believe our principal business strengths include:
Broad Access to Teenage Girl Consumers
In fiscal 2013, we reached a significant portion of teenage girl consumers in the United States by:
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circulating approximately 19.8 million direct mail catalogs for our dELiA*s brand, with an average of one new book being mailed each month;
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communicating with select segments of our database by sending, on average, approximately 9 million emails per week to those of our target audience who have opted in to receiving such emails;
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engaging our customers through the internet, social media and mobile commerce; and
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owning and operating 101 dELiA*s retail stores in 32 states as of February 1, 2014.
Comprehensive Database
Our dELiA*s database contains information about a significant number of households who have purchased products online or requested catalogs directly from us as of February 1, 2014, including approximately 1.6 million households who have purchased merchandise or requested a catalog within the last two years. In addition to names and addresses, our database gives us the ability to review a variety of valuable information that may include age range, purchasing history and online behavior. We continually refresh and grow our database with information we gather through direct marketing programs and purchased customer lists. We analyze this data in detail, which we believe enables us to improve response rates from our direct sales efforts. We also use selected retail transactions that are added to our database to help identify potential new customers for our direct business.
Operating Flexibility
We attempt to maintain significant flexibility in the operation of our business so that we can react quickly to changes in customer preferences. We regularly review the sales performance of our merchandise in an effort to identify and respond to changing trends and consumer preferences. When purchasing merchandise from our vendors, we pursue a strategy that is designed to maximize our speed to market. We strive to establish strong and loyal relationships with our suppliers which we believe allows us to quickly obtain merchandise and ship it to our distribution center for direct sales or our retail stores for retail sales. Currently, we are able to replenish a majority of our merchandise within 60 to 90 days. Our e-commerce website and database allow us to quickly update our merchandise presentations, promotions, and display of offerings in an effort to create excitement for our customers.
Experienced Management Team
Our senior management has significant retail and direct marketing experience, with an average of over 20 years in the retail, catalog and e-commerce apparel businesses.
Our Business Strategy
Our strategy is to improve upon our position as a multi-channel retail company, to improve the productivity in our dELiA*s retail stores, and to carry out such strategy while controlling costs. In addition, our strategy includes strengthening the dELiA*s brand through alignment across all channels of our business while continuing extended offerings online and in our catalogs. The key elements of our strategy are as follows:
Direct Marketing Strategy
Our direct marketing strategy is designed to minimize our exposure to risks associated with rapidly changing fashion trends and facilitate speed to market and the flexibility with which we are able to purchase and stock a wide assortment of merchandise. Our primary objective is to reflect, rather than shape, styles and tastes while maintaining a specific focus on our customer. We develop exclusive merchandise and select name brand merchandise from what we believe are quality manufacturers and name brands. Our buyers and merchandisers work closely with our many suppliers to develop products to our specifications. This speed to market gives us flexibility to incorporate the latest trends into our product mix and to better serve the evolving tastes of customers. Through this strategy, we believe we are able to minimize design risk and make final product selections only two to seven months before the products are brought to market. We believe this allows us to stay current with the tastes of the market, and unlike others in our industry that require a longer lead time to bring goods to the market, we believe our strategy enables us to receive a continuous allotment of goods from our suppliers and carry the proper amount of inventory.
Our direct marketing strategy also enables us to manage our inventory levels efficiently once consumer demand patterns have emerged. We attempt to limit the size of our initial merchandise orders and rely on quick reorder ability. Because we generally do not make aggressive initial orders, we believe we are able to limit our risk of excess inventory. Additionally, we have several methods for clearing slow moving inventory, ranging from clearance media and internet offers to tent sales and third-party liquidators.
Our merchandise selection includes products from many leading suppliers and also some name brands. dELiA*s primarily carries its own branded merchandise, though it also carries third-party branded merchandise from well-known name brands such as Converse, Keds and Sperry.
Our database management and mailing strategy is designed to efficiently gather, maintain and utilize the information collected within our database. Our database is maintained by a third-party vendor providing address hygiene, duplicate identification and modeling capabilities. The database enables detailed selections based on general industry practices, but enables greater specificity when required, based on maintaining any transactional history, plus the ability to overlay demographic information to the extent provided to us, for selected individuals and households listed in the database.
Our catalog mailing program, coupled with our e-mail marketing program, seeks to maximize profitability with a continual testing and monitoring program designed to provide our customers with offers and promotions that will be of interest to them.
We believe that high levels of customer service and support are critical to the value of our brand and to retaining and expanding our customer base. We consistently monitor customer service calls, through our third-party call center provider, for quality assurance purposes. Additionally, we review our call and distribution centers’ policies and procedures on a regular basis. A majority of our catalog and internet orders are shipped within 48 hours of credit approval. In cases in which the order is placed using another person’s credit card and exceeds a specified threshold, the order is shipped only after we have received confirmation from the cardholder. Customers generally receive orders within three to seven business days after shipping. Our shipments are generally carried to customers by the United States Postal Service and United Parcel Service.
Trained personnel are available for the dELiA*s brand 24 hours a day, seven days per week through multiple toll-free telephone numbers, via our third-party providers.
Retail Strategy
Our current strategy is to concentrate on improving productivity in our existing store base while keeping store growth relatively flat. We monitor the performance of our existing retail stores and may from time to time close underperforming stores as appropriate. When we determine to close a retail store, we typically exercise a sales volume based termination right or negotiate with landlords to determine the quickest and most cost-effective way to exit such location.
We plan our new stores to have a four-wall cash contribution margin of at least 15% in the first full year and to have a net build-out cost, including inventory, of approximately $0.6 million. We define contribution margin as store gross profit less direct cash costs of operating the store.
The stores currently average approximately 3,800 square feet, though individual stores may be smaller or larger than the averages. Our stores are designed to look upscale, appealing to what we believe to be our database customer demographics.
In addition to strong customer demographics, we look for high traffic malls, high economic growth areas and/or high income demographics in selecting new retail store locations. We believe that over half of our dELiA*s direct customers come from households with incomes of over $75,000 per year and over 20% come from households with income over $125,000 per year.
Each store is open during mall shopping hours and has a store management team that always includes a store manager, and depending on the sales volume of the store, one or more of the following additional management: a co-manager, one or more assistant store managers and one or more customer experience supervisors, as well as five to 20 part-time sales associates. Currently, district managers supervise seven to 11 stores, with 11 district managers reporting to two regional managers, who in turn report to a Vice President of Stores.
Our goal is to hire and retain experienced sales associates, store managers and district managers and establish clear performance goals, objectives and related corresponding incentives which are based on planned sales. District managers, store managers, co-managers and assistant store managers participate in an incentive program which is based on achieving predetermined sales-related and customer conversion goals in their respective stores or districts. We have well-established store operating policies and procedures, and emphasize our loss prevention program in order to control inventory shrinkage and ensure policy and procedure compliance.
In addition, we have traffic counters and related software in our retail locations in order to evaluate store-by-store customer conversion rates. We utilize this system in evaluating and managing store performance, establishing effective staffing models and focusing our training efforts.
Segments
We generate net sales from two reportable segments-direct marketing and retail stores. Net sales, by segment, are as follows:
Direct Marketing Segment
Our direct marketing segment, which consists of the dELiA*s e-commerce website and catalogs, derives revenues from sales of merchandise via the internet or catalog directly to consumers and also from advertising. Included in our direct marketing net sales of $41.3 million in fiscal 2013 were approximately $0.1 million of advertising revenues.
In fiscal 2013, our website and catalogs targeted a particular segment of the market and offered our own proprietary brands together with many name brands well known by our target customers.
During fiscal 2013, our catalog ranged from 56 to 84 pages in length. We mailed 17 full price versions of our catalog, including remails. Our e-commerce website (reached through www.delias.com) is designed to complement the catalog and offer the same merchandise as in the catalog, as well as additional products, colors, sizes and special offers.
Retail Store Segment
Our retail store segment derives revenues from the sale of apparel and accessories to consumers through dELiA*s stores. dELiA*s mall-based retail stores sell a distinctive collection of lifestyle-oriented apparel and accessories for trend-setting, fashion-aware teenage girls. As of February 1, 2014, we operated 101 dELiA*s stores in 32 states. The majority of merchandise sold in our retail stores is sold under the dELiA*s label. Retail store segment revenues for fiscal 2013 were $95.4 million.
Financial information about our segments is summarized in Note 14 to our consolidated financial statements.
Merchandise Suppliers
Because we sell a number of brand-name products in addition to our own proprietary brands, we obtain products from a wide variety of manufacturers, importers and other suppliers. No single vendor accounted for more than 7.9%, 7.5% and 15.8% of products sold for fiscal 2013, fiscal 2012 and fiscal 2011, respectively. We believe that there are sufficient alternate sources of merchandise at comparable prices for almost all of the products we sell should we decide to or be required to change vendors for any particular product. Therefore, we do not believe that a loss of one or a few vendors would have a material impact on our operations.
Infrastructure, Operations and Technology
Our operations are dependent on our ability to maintain computer and telecommunications systems in effective working order and to protect our systems against damage from fire, natural disaster, power loss, telecommunications failure, unauthorized intrusion or access to confidential information, or similar events. We have implemented, either directly or through other third parties, appropriate security, redundancy and backup programs for our various businesses.
We license commercially available technology whenever possible in lieu of dedicating our financial and human resources to developing proprietary online infrastructure solutions. Currently, most services related to maintenance and operation of our e-commerce website are through third-party providers located in Petaluma, California.
We outsource our call center function for our e-commerce website and catalog.
In our direct marketing segment, we use third-party licensed software for stockkeeping unit (“SKU”) and classification inventory tracking, purchase order management and merchandise distribution. Sales in our direct segment, whether through the internet, the call center or the mail, are updated daily and the host system
downloads price changes, order status and inventory levels. In addition, we use other licensed software products and services to further supplement our supply chain for merchandise planning and to analyze customer behavior. In our retail segment, licensed software is used for SKU and classification inventory tracking, purchase order management, merchandise distribution, automated ticket making, and sales audit.
Sales in our retail segment are updated daily in the third-party licensed merchandising reporting systems by the nightly polling of sales information from each store’s point-of-sale (“POS”) terminals. Our POS system consists of registers providing price look-up, time and attendance, inventory management (transfers and distributions), and credit card/check authorization. This host system downloads price changes and inventory movements (store-to-store transfers and warehouse merchandise distributions). We evaluate information obtained through the nightly polling to implement merchandising decisions, plan and determine the open-to-buy, process and manage product purchasing/reorders, manage markdowns and allocate merchandise on a daily basis. For both the direct marketing and retail store segments, we use centralized financial systems for general ledger and accounts payable.
During fiscal 2013, we moved our data center which was outsourced in Sterling, Virginia, to an outsourced data center in Clifton, New Jersey.
Competition
The retail and direct businesses are each highly competitive. Our retail stores compete on the basis of, among other things, the location of our stores, the breadth, quality, style, and availability of merchandise, the level of customer service offered and merchandise price. Although we feel the eclectic mix of products offered in our retail stores helps differentiate us, it also means that we compete against a wide variety of smaller, independent specialty stores, as well as department stores and national specialty chains. Many of our competitors have substantially greater name recognition as well as financial, marketing and other resources. Our retail stores also face competition from small boutiques that offer an individualized shopping experience similar to the one we strive to provide to our target customers.
Along with certain retail segment factors noted above, other key competitive factors for our direct-segment operations include the success or effectiveness of customer mailing lists, response rates, catalog presentation, merchandise delivery and website design and availability. Our direct-segment operation competes against numerous catalogs and websites, which may have a greater volume of circulation and web traffic.
Seasonality
Our historical revenues and operating results have varied significantly from quarter to quarter due to seasonal fluctuations in consumer purchasing patterns. Sales of apparel, accessories and footwear through our e-commerce website, catalogs and retail stores have generally been higher in our third and fourth fiscal quarters, which contain the key back-to-school and holiday selling seasons, as compared to our first and second fiscal quarters. During the second, third and the beginning of our fourth fiscal quarters, our working capital requirements increase and may be funded by our cash balances and utilization of our existing Credit Agreement with Salus. Quarterly results of operations may also fluctuate significantly as a result of a variety of factors, including the timing of store openings and the relative proportion of our new stores to mature stores, fashion trends and changes in consumer preferences, calendar shifts of holiday or seasonal periods, changes in merchandise mix, timing of promotional events, general economic conditions, competition and weather conditions.
Intellectual Property
We have registered various trademarks and servicemarks used in our business operations with the United States Patent and Trademark Office. Applications for the registration of certain of our other trademarks and servicemarks are currently pending. We also use trademarks, tradenames, logos and endorsements of our suppliers and partners with their permission. We are not aware of any pending material conflicts concerning our marks or our use of others’ intellectual property.
Government Regulation
We are subject, directly and indirectly, to various laws and governmental regulations relating to our business. The internet continues to rapidly evolve and several laws or regulations directly apply to online commerce and community websites. However, due to the increasing popularity and use of the internet, governmental authorities in the United States and abroad may adopt additional laws and regulations to govern internet activities. Laws with respect to online commerce, including social media, may cover issues such as pricing, taxing, distribution, unsolicited email (“spamming”), content, intellectual property, defamation, privacy and data security, product endorsements, online behavioral advertising and characteristics and quality of products and services. Laws with respect to community websites may cover content, copyrights, libel, obscenity and personal privacy. Any new legislation or regulation or the application of existing laws and regulations to the internet could have a material and adverse effect on our business, results of operations and financial condition.
Governments of other states or foreign countries might attempt to regulate our transmissions or levy sales or other taxes relating to our activities even though we do not have a physical presence or operations in those jurisdictions. As our products and advertisements are available over the internet anywhere in the world, and we conduct marketing programs in numerous states, multiple jurisdictions may claim that we are required to register to do business as a foreign corporation in each of those jurisdictions. Our failure to register as a foreign corporation in a jurisdiction where we are required to do so could subject us to taxes and penalties.
It is possible that state and foreign governments might also attempt to regulate our transmissions of content on our e-commerce website or prosecute us for violations of their laws. For example, a French court has ruled that a website operated by a United States company must comply with French laws regarding content, and an Australian court has applied the defamation laws of Australia to the content of a U.S. publisher posted on the company’s website. We cannot assure you that state or foreign governments will not charge us with violations of local laws or that we might not unintentionally violate these laws in the future, or that foreign citizens will not obtain jurisdiction over us in a foreign country, subjecting us to litigation in that country under the laws of that country.
The United States Congress enacted the Children’s Online Privacy Protection Act of 1999 (“COPPA”) and the Federal Trade Commission (“FTC”) promulgated implementing regulations, which became effective in 2000. The principal COPPA requirements apply to websites, or those portions of websites, directed to children under age 13. COPPA mandates that individually identifiable information about minors under the age of 13 not be collected, used or displayed without first obtaining informed parental consent that is verifiable in light of present technology, subject to certain limited exceptions. As a part of our efforts to comply with these requirements, we do not knowingly collect personally identifiable information from any person under 13 years of age and have implemented age screening mechanisms on certain areas of our websites in an effort to prohibit persons under the age of 13 from registering. This may have the effect of dissuading some percentage of our customers from using our e-commerce website, which may adversely affect our business. While we use our commercially reasonable efforts to ensure that we are compliant with COPPA, our efforts may not be successful. If it turns out that our activities are not COPPA compliant, we may face litigation with the FTC or individuals or face a civil penalty, which could adversely affect our business. The FTC has revised its COPPA regulations and the Company plans to continue to comply with COPPA including upon the effectiveness of such revised regulations.
A number of government authorities both in the United States and abroad, as well as private parties, are increasing their focus on privacy issues and the use of personal information. The FTC and attorneys general in several states have investigated the use of personal information by some internet companies. In particular, an attorney general may examine privacy policies to ensure that a company fully complies with representations in the policies regarding the manner in which the information provided by consumers and other visitors to a website is used and disclosed by the company. As a result, we periodically review our privacy policies, and we believe we are in compliance with relevant federal and state laws. However, our business could be adversely affected if new regulations or decisions regarding the use and disclosure of personal information are made, or if government authorities or private parties challenge our privacy practices.
In December 2003, the Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003 (“CAN-SPAM”) was enacted by the United States Congress. This legislation regulates “commercial electronic mail messages,” (i.e., email) the primary purpose of which is to promote a product or service. Among its provisions are ones requiring specific types of disclosures in covered emails, requiring specific opt-out mechanisms and prohibiting certain types of deceptive headers. Violations of its provisions may result in civil money penalties and criminal liability. CAN-SPAM further authorizes the FTC to establish a national Do Not Email Registry akin to the recently-adopted Do Not Call Registry. Any entity that sends commercial email messages, such as our various subsidiaries, and those who re-transmit such messages, must adhere to the CAN-SPAM requirements. Compliance with these provisions may limit our ability to send certain types of emails on our own behalf, which may adversely affect our business. While we intend to operate our businesses in a manner that complies with the CAN-SPAM provisions, we may not be successful in so operating. If it turns out we have violated the provisions of CAN-SPAM, we may face litigation with the FTC or face civil penalties, which could adversely affect our business.
The European Union Directive on the Protection of Personal Data may affect our ability to make our websites available in Europe if we do not afford adequate privacy to European users. Similar legislation was recently passed in other jurisdictions and may have a similar effect. Legislation governing privacy of personal data provided to internet companies is in various stages of development and implementation in other countries around the world and could affect our ability to make our e-commerce website available in those countries as future legislation is made effective.
Relationship with JLP Daisy LLC
In February 2003, dELiA*s Brand, LLC, a wholly-owned subsidiary of the Company, entered into a master license agreement with JLP Daisy LLC (“JLP Daisy”) to license our dELiA*s brand on an exclusive basis for wholesale distribution in certain product categories, primarily in mid- and upper-tier department stores, in exchange for an up-front payment from JLP Daisy of $16.5 million, which is applied against royalties otherwise due from JLP Daisy for sales of dELiA*s branded merchandise. The initial term of the master license agreement was approximately 10 years, which was extended and, at our option, (i) will remain in effect until JLP Daisy recoups its advance and preferred return or (ii) the term will immediately expire and JLP Daisy will be entitled to be paid the balance of any unrecouped advance and a preferred return calculated at 6% per year (if not already received). As of February 1, 2014, JLP Daisy has not recouped its advance and preferred return and therefore the master license agreement remains in effect. As part of the master license agreement, dELiA*s Brand, LLC granted to JLP Daisy a security interest in the dELiA*s trademarks and copyrightable artwork, although the only event that would entitle JLP Daisy to exercise its rights in respect of the lien is a termination or rejection of the license or the master license agreement in a bankruptcy proceeding. We have not recorded any amounts associated with the master license agreement.
Employees
As of February 1, 2014, we had 499 full-time and 1,190 part-time employees. Of the 499 full-time employees, 94 worked in warehouse/fulfillment/customer service; 140 worked in executive, finance, information technology and other corporate and division management and 265 were employed by our dELiA*s retail stores. Of the 1,190 part-time employees, 34 were warehouse/fulfillment/customer service staff; 6 were in executive, finance, information technology and other corporate and division management and 1,150 were part-time associates at dELiA*s retail stores. None of our employees are covered by a collective bargaining agreement. We consider relations with our employees to be good.
Website Access to Reports
Our corporate website is www.deliasinc.com. Our periodic and current reports are available free of charge on the “Investor Relations” page of this website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC.
Item 1A.
Item 1A. Risk Factors
Risks Related to Our Business
We have a history of operating losses.
We incurred losses from continuing operations for the last five fiscal years. Although our objective is to report net profits in the future, our objectives may not be realized and we may continue to experience losses. If our revenue grows slower than we anticipate, or if our operating expenses are higher than we expect, or if we continue to incur operating losses, we may not be able to become profitable, in which case our financial condition would be adversely affected and our stock price could decline.
Our ability to achieve profitability will also depend on our ability to manage and control operating expenses and to generate and sustain increased levels of revenue. We expect to incur significant operating expenses and capital expenditures, including general and administrative costs to support our operations and the costs of being a public company.
We base our expenses in large part on our operating plans, current business strategies and future revenue projections. Many of our expenses, such as our retail store lease expenses, are fixed in the short term, and we may not be able to quickly reduce expenses and spending if our revenues are lower than we project. In addition, we may find that our costs to maintain or expand our operations, and in particular the costs to purchase inventory, produce our catalogs and build, outfit and employ personnel for our retail stores, are more expensive than we currently anticipate. Therefore, the magnitude and timing of these expenses may contribute to fluctuations in our quarterly operating results.
Our success depends largely on the value of our brand, and if the value of our brand was to diminish, our sales are likely to decline.
The prominence of our catalogs and e-commerce website and our retail stores among our teenage target market are integral to our business as well as to the implementation of our strategies for expanding our business.
Maintaining, promoting and positioning our brand will depend largely on the success of our marketing and merchandising efforts and our ability to provide a consistent, high quality customer experience. Moreover, we anticipate that we will continue to increase the number of customers we target, through means that could include broadening the intended audience of our existing brand. Misjudgments by us in this regard could damage our existing or future brands. Any adverse effects on our current or future brands could result in decreases in sales.
If we fail to anticipate, identify and respond to changing fashion trends, customer preferences and other fashion-related factors, our sales are likely to decline.
Customer tastes and fashion trends are volatile and tend to change rapidly. Our success depends in part on our ability to effectively predict and respond to changing fashion tastes and consumer demands, and to translate market trends into appropriate, saleable product offerings in a timely manner. If we are unable to successfully predict or respond to changing styles or trends and misjudge the market for our products, our sales may be lower, and we may be faced with unsold inventory. In response, we may be forced to rely on additional markdowns or promotional sales to dispose of excess or slow-moving inventory, which may have a material adverse effect on our financial condition or results of operations.
Our ability to attract customers to our retail stores depends heavily on the success of the shopping malls and other retail centers in which our stores are located. Any decrease in customer traffic in those shopping centers could negatively impact our sales.
Customer traffic in our retail stores depends heavily on locating our stores in prominent locations within successful shopping malls or other retail centers. Sales are derived, in part, from the volume of traffic in those
shopping centers. Our stores benefit from the ability of other tenants to generate consumer traffic in the vicinity of our stores and the continuing popularity of the shopping centers as shopping destinations. Our sales volume and customer traffic generally may be adversely affected by, among other things, economic downturns in a particular area, competition from internet retailers, non-mall retailers and other shopping destinations, and the closing or decline in popularity of other stores in the shopping centers in which our retail stores are located. A reduction in customer traffic for any reason could have a material adverse effect on our business, results of operations and financial condition. In addition, some malls that were in prominent locations when we opened stores may cease to be viewed as prominent. If this occurs, our sales may be adversely affected.
Internet sales are subject to numerous risks.
We sell merchandise over the internet through our e-commerce website, www.delias.com. Our internet operations are subject to numerous risks, including:
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changing consumer tastes and preferences;
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the successful implementation of new systems and internet or mobile platforms;
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the failure of the computer systems that operate our websites and their related support systems, causing, among other things, website downtimes and other technical failures;
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reliance on third-party computer hardware/software;
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rapid technological change;
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liability for online content;
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violations of state or federal laws, including those relating to online privacy;
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credit card fraud; and
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telecommunications failures and vulnerability to electronic break-ins and similar disruptions.
Our failure to successfully address and respond to these risks could reduce internet sales, increase costs and damage the reputation of our brand.
We depend on our key personnel to operate our business, and we may not be able to hire enough additional management and other personnel to manage our growth. In addition, we may face risks associated with the transition of senior management.
Our performance is substantially dependent on the continued efforts of our executive officers and other key employees. The loss of the services of any of our executive officers or key employees could adversely affect our business. Additionally, we must continue to attract, retain and motivate talented management and other highly skilled employees to be successful. We must also hire and train store managers to support our retail expansion. We may be unable to retain our key employees or attract, assimilate and retain other highly qualified employees in the future. On March 30, 2013, we announced that Dyan Jozwick, President of dELiA*s Brand, resigned from the Company. On May 30, 2013, we announced that Tracy Gardner, our former Chief Creative Officer who joined the Company on May 1, 2013, was appointed Chief Executive Officer, and Walter Killough, our former Chief Executive Officer, was appointed Chief Operating Officer, in each case, effective June 5, 2013. Mr. Killough left the Company following the expiration of his employment agreement on August 2, 2013. On August 6, 2013, we announced that Daphne Smith was appointed as Executive Vice President of Operations, and on October 15, 2013, we announced that Brian Lex Austin-Gemas was appointed as Chief Operating Officer. There can be no assurance that the new management team will be able to execute our business model in a manner that will allow our Company to sustain growth and continued success. Changes in senior leadership could impact employee stability as well.
We rely on third parties for some essential business operations and services, and disruptions or failures in service or changes in terms may adversely affect our ability to deliver goods and services to our customers.
We currently depend on third parties for important aspects of our business, such as printing, shipping, paper supplies, operation of our e-commerce website, and the outsourcing of our call center function. We have limited control over these third parties, and we are not their only client. In addition, we may not be able to maintain satisfactory relationships with any of these third parties on acceptable commercial terms. Further, we cannot be certain that the quality or cost of products and services that they provide will remain at current levels or the levels needed to enable us to conduct our business efficiently and effectively.
Postal rate and other shipping rate increases, as well as increases in paper and printing costs, affect the cost of our order fulfillment and catalog mailings. We rely heavily on quantity discounts in these areas. No assurances can be given that we will continue to receive these discounts and that we will not be subject to additional increases in costs in excess of those already announced. Any increases in these costs will have a negative impact on earnings to the extent we are unable or do not pass such increases on directly to customers or offset such increases by raising selling prices or by implementing more efficient printing, mailing and delivery alternatives.
Our ability to meet our cash requirements depends on many factors.
Based on our current and anticipated future results of operations and the proceeds we received from the Private Placement, we believe that our current cash balances, cash flow from operations, and availability under our credit facilities will be sufficient to meet our currently anticipated cash requirements. However, depending on results of operations for future periods, as well as our ongoing expense reduction program, our current cash balances, cash flow from operations, and availability under our credit facilities may not be sufficient to meet our future cash requirements, including but not limited to, any retail store openings or remodels. For example, if we do not meet our targets for revenue growth, gross margins, or expenses, or if our costs associated with any retail store expansion plans are not as anticipated, our current sources of funds may be insufficient to meet our cash requirements. We may fail to meet our targets for revenue growth for a variety of reasons, including:
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decreased consumer spending in response to weak economic conditions;
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higher energy prices causing a decreased level of disposable income;
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weakness in the teenage market;
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poor response to our merchandise offerings;
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increased competition from our competitors; and
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marketing and expansion plans that are not as successful as we anticipate.
Additionally, if demand for our products decreases or our retail store plans do not produce the desired sales increases, such developments could reduce our operating revenues. If such funds, together with cash on hand and availability under our existing Credit Agreement with Salus are insufficient to cover our expenses, we could be required to adopt one or more alternatives listed below. For example, we could be required to:
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reduce or delay capital spending;
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reduce discretionary spending;
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sell assets or operations; and/or
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sell additional equity or debt securities, which equity securities may be dilutive.
If we are required to take any of the actions in the first three items immediately above, it could have a material adverse effect on our business, financial condition and results of operations, including our ability to grow our business. In addition, we cannot assure you that we would be able to take any of these actions because
of (i) a variety of commercial or market factors, or (ii) market conditions being unfavorable for an equity or debt offering. In addition, such actions, if taken, may not enable us to satisfy our cash requirements if the actions do not generate a sufficient amount of additional capital.
We may fail to use our database and our expertise in marketing to consumers successfully, and we may not be able to maintain the quality and size of our database.
The effective use of our consumer database and our expertise in marketing to consumers are important components of our business. If we fail to capitalize on these assets, our business will be less successful.
Currently, we have useful data for only a portion of our targeted market. Additionally, as individuals in our database age, they are less likely to purchase our products and their data is thus of less value to our business. We must, therefore, continuously obtain data on new potential customers and on those persons who are just entering their teenage years in order to maintain and increase the size and value of our database. If we fail to obtain sufficient numbers of new names and related information, our business could be adversely affected.
General economic conditions may adversely impact our results of operations.
Our financial performance is subject to world-wide economic conditions and the resulting impact on U.S. consumer confidence and levels of consumer spending, which may remain volatile for the foreseeable future. Some of the factors impacting discretionary consumer spending include general economic conditions, wages and unemployment, consumer debt, reductions in net worth based on market declines, increasing health care costs, residential real estate and mortgage markets, taxation, increases in fuel and energy prices, consumer confidence, failure to increase the debt ceiling in the U.S., and other macroeconomic factors. Consumer purchases of discretionary items, including our merchandise, generally decline during recessionary periods and other periods where disposable income is adversely affected. A downturn in the U.S. economy could affect consumer purchases of our merchandise and adversely impact our results of operations and continued growth.
Our agreement with Alloy, LLC to license our database information may make that information less valuable to us.
We and Alloy, LLC have agreed that we will license data collected by dELiA*s (excluding credit card data), subject to applicable laws and privacy policies, although Alloy, LLC has agreed not to provide certain of this data to our competitors, with some limited exceptions. Certain actions that Alloy, LLC could take, such as breaching its contractual covenants, could result in our losing a significant portion of the competitive advantage we believe our database provides to us. In such event, our business and results of operations could be adversely affected.
New retail store openings could strain our resources and cause the performance of our existing operations to suffer.
Any retail store expansion will largely depend on our ability to find sites to open and operate new stores successfully. Our ability to open and operate new stores successfully depends on several factors, including, among others, our ability to:
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identify suitable store locations, the availability of which is outside our control;
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negotiate acceptable lease terms;
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prepare stores for opening within budget;
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source sufficient levels of inventory at acceptable costs to meet the needs of new stores;
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hire, train and retain store personnel;
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successfully integrate new stores into our existing operations;
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contain payroll costs; and
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generate sufficient operating cash flows or secure adequate capital on commercially reasonable terms to fund any of our expansion plans.
In addition, any retail store expansion will place increased demands on our operational, managerial and administrative resources. These increased demands could cause us to operate our business less effectively, which, in turn, could cause deterioration in the financial performance of our individual stores and our overall business.
Modifications and/or upgrades to our information technology systems may disrupt our operations.
We regularly evaluate our information technology systems and requirements. Modifications may include replacing existing systems with successor systems, making changes to existing systems, or acquiring new systems with new functionality. We are aware of the inherent risks associated with replacing and modifying these systems, including inaccurate system information, system disruptions and user acceptance and understanding. Information technology system disruptions and inaccurate system information, if not anticipated and appropriately mitigated, could have a material adverse effect on our financial condition and results of operations. Additionally, there is no assurance that a successfully implemented system will deliver the anticipated value to us.
Our catalog response rates may decline.
The number of customers who make purchases from catalogs that we mail to them, which we refer to as “response rates,” may decline due to, among other things, our ability to effectively predict and respond to changing fashion tastes and consumer demands and translate market trends into appropriate, saleable product offerings in a timely manner. Response rates also usually decline when we mail additional catalog editions to the same customers within a short time period. In addition, there can be no assurance that any strategic circulation cuts will enable us to improve or maintain our response rates. These trends in response rates may have a material adverse effect on our rate of sales growth and on our profitability and could have a material adverse effect on our business.
Traffic to our e-commerce website may decline, resulting in fewer purchases of our products. Additionally, the number of e-commerce visitors that we are able to convert into purchasers may decline.
In order to generate online customer traffic, we depend heavily on mailed catalogs, outbound emails and an affiliates program in which we pay third parties for traffic referred from their websites to our e-commerce website. Our sales volume and e-commerce website traffic generally may be adversely affected by, among other things, declines in the number and frequency of our catalog mailings, reductions in outbound emails and declines in referrals from third parties. Our sales volume may also be adversely affected by economic downturns, system failures and competition from other internet and non-internet retailers.
In addition, the number of e-commerce visitors that we are able to convert into purchasers may decline due to, among other things, our inability to effectively predict and respond to changing fashion tastes and consumer demands and translate market trends into appropriate, saleable product offerings in a timely manner and our inability to keep up with new technologies and e-commerce features. The internet and the e-commerce industry are subject to rapid technological change. If competitors introduce new features and website enhancements embodying new technologies, or if new industry standards and practices emerge, our existing e-commerce website, the www.delias.com website, and our respective systems may become obsolete or unattractive. Developing our e-commerce website and other systems entails significant technical and business risks. We may face material delays in introducing new services, products or enhancements. If this happens, our customers may forego the use of our e-commerce website and use websites and e-commerce pages of our competitors. We may use new technologies ineffectively, or we may fail to adequately adapt our website, our transaction processing systems and our computer network to meet customer requirements or emerging industry standards.
We do not own the uniform resource locator that directs customers to our e-commerce website.
Pursuant to an agreement with Alloy, LLC, it will continue to own the uniform resource locator that directs customers to the www.delias.com website. Because a significant portion of our direct marketing sales come from our e-commerce site, if Alloy, LLC fails to maintain that uniform resource locater, our e-commerce activities may suffer.
Because we experience seasonal fluctuations in our revenues, our quarterly results may fluctuate.
Our business is seasonal, reflecting the general pattern of peak sales for teen clothing and accessories, which provide the majority of our sales during the back-to-school and holiday shopping seasons. Typically, a larger portion of our revenues are obtained during our third and fourth fiscal quarters. Any significant decrease in sales during the back-to-school and winter holiday seasons would have a material adverse effect on our financial condition and results of operations. In addition, in order to prepare for the back-to-school and holiday shopping seasons, we must order and keep in stock significantly more merchandise than we carry during other parts of the year, and we must hire temporary workers and incur additional staffing costs in our warehouse and retail stores to meet anticipated sales demand. If sales for the third and fourth quarters do not meet anticipated levels, then increased expenses may not be offset, which could decrease our profitability. Additionally, any unanticipated decrease in demand for our products during these peak seasons could require us to sell excess inventory at a substantial markdown, which could decrease our profitability.
Competition may adversely affect our business.
The teenage girl retail apparel industry is highly competitive, with fashion, quality, price, location, in-store environment and service being the principal competitive factors. We compete for retail store sales with specialty apparel retailers and certain other youth-focused apparel retailers, such as American Eagle Outfitters, Abercrombie & Fitch, Aeropostale, Hollister, Wet Seal, Forever 21, H&M and others. We also compete for retail store sales with full price and discount department stores such as Target, Kohl’s, Nordstrom’s, Macy’s, Bloomingdale’s and others. If we are unable to compete effectively for retail store sales, we may lose market share, which would reduce our revenues and gross profit. In addition, we compete for favorable site locations and lease terms in shopping malls with certain of our competitors as well as numerous other retailers. Many of our competitors are large national chains, which have substantially greater financial, marketing and other resources than we do. The growth of our retail store business depends significantly on our ability to operate stores in desirable locations with capital investments and lease costs that allow us to earn a return that meets or exceeds our financial projections. Desirable new locations may not be available to us at all or at reasonable costs. In addition, we must be able to renew our existing store leases on terms that meet our financial targets. Our failure to secure favorable real estate and lease terms generally and upon renewal, or even being permitted to renew our expiring leases, could cause us to lose market share which would reduce our revenues and gross profit.
Many of our existing competitors, as well as potential new competitors in our target markets, have longer operating histories, greater brand recognition, larger customer bases and significantly greater financial, technical and marketing resources than we do. These advantages allow our competitors to spend considerably more on marketing and may allow them to use their greater resources more effectively than we can use ours. Accordingly, these competitors may be better able to take advantage of market opportunities and be better able to withstand market downturns than us. If we fail to compete effectively, our business will be materially and adversely affected.
Closing stores could result in significant costs to us.
We could, in the future, decide to close additional retail stores that are producing losses or that are not as profitable as we expect. If we decide to close any stores before the expiration of their lease terms, we may incur payments to landlords to terminate or “buy out” the remaining term of the lease. We also may incur costs related
to the employees at such stores, whether or not we terminate the leases early. Upon any such closure, the closing costs, fixed assets, and inventory write-downs would adversely affect our results and could adversely affect our cash on hand.
Our dELiA*s exclusive branding activities could lead to increased inventory obsolescence.
Our promotion and sale of dELiA*s branded products increases our exposure to risks of inventory obsolescence. Accordingly, if a particular style of product does not achieve widespread consumer acceptance, we may be required to take significant markdowns, which could have a material adverse effect on our gross profit margin and other operating results. Moreover, dELiA*s exclusive brand development plans may include entry into joint ventures and additional licensing or distribution arrangements, which may also contribute to increased inventory obsolescence as third parties may control more of these operations.
Our master license agreement with JLP Daisy could cause us to lose our trademarks or otherwise adversely affect the value of our dELiA*s brand.
In February 2003, dELiA*s Brand, LLC, a wholly-owned subsidiary of the Company, entered into a master license agreement with JLP Daisy to license our dELiA*s brand on an exclusive basis for wholesale distribution in certain product categories, primarily in mid- and upper-tier department stores, in exchange for an up-front payment from JLP Daisy of $16.5 million, which is applied against royalties otherwise due from JLP Daisy for sales of dELiA*s branded merchandise. The initial term of the master license agreement was approximately 10 years, which was extended and, at our option, (i) will remain in effect until JLP Daisy recoups its advance and preferred return or (ii) the term will immediately expire and JLP Daisy will be entitled to be paid the balance of any unrecouped advance and a preferred return calculated at 6% per year (if not already received). As of February 1, 2014, JLP Daisy has not recouped its advance and preferred return and therefore the master license agreement remains in effect. As part of the master license agreement, dELiA*s Brand, LLC granted to JLP Daisy a security interest in the dELiA*s trademarks and copyrightable artwork, although the only event that would entitle JLP Daisy to exercise its rights in respect of the lien is a termination or rejection of the license or the master license agreement in a bankruptcy proceeding. If we become subject to a bankruptcy proceeding, we could lose the rights to our dELiA*s trademarks, which could have a material adverse effect on our business and operating results.
Additionally, because sales of dELiA*s branded products by JLP Daisy’s licensees have been significantly less than we and JLP Daisy expected when we entered into the master license agreement, we expect that JLP Daisy may try to increase the sales of the dELiA*s branded products by its licensees by expanding the number of licensed products their licensees offer, the number and type of stores in which such licensed products are sold, or both, so that they can recoup more of their initial advance. Sales of dELiA*s branded products by JLP Daisy’s licensees may negatively impact our customers’ image of the brand, which could have a material adverse effect on our profit margins and other operating results. Additionally, a change in our customers’ image of the brand due to sales of dELiA*s branded products by JLP Daisy’s licensees to greater numbers of retailers may negatively affect our dELiA*s retail store expansion plans.
We depend largely upon an outsourced call center and a single distribution facility.
The call center function is outsourced to a third party for our dELiA*s e-commerce website and catalog. The distribution for our dELiA*s e-commerce website and catalog and all our retail stores are handled from a single, owned facility in Hanover, Pennsylvania. Any significant interruption in the operation of the call center function or distribution facility due to natural disasters, accidents, system failures, expansion or other unforeseen causes could delay or impair our ability to receive orders and distribute merchandise to our customers and retail stores, which could cause our sales to decline. This could have a material adverse effect on our operations and results.
We have recorded impairment charges in the past and we may be required to recognize impairment charges in the future.
Pursuant to generally accepted accounting principles, we are required to perform impairment tests on our identifiable intangible assets with indefinite lives, including goodwill, annually or at any time when certain events occur, which could impact the value and earnings of our business segments. Our determination of whether impairment has occurred is based on a comparison of the assets’ fair market values with the assets’ carrying values. Significant and unanticipated changes could require a provision for impairment in a future period that could substantially affect our reported earnings in a period of such change. We recognized a goodwill impairment charge of $4.5 million related to our direct marketing reporting unit in fiscal 2012.
Additionally, pursuant to generally accepted accounting principles, we are required to recognize an impairment loss when circumstances indicate that the carrying value of long-lived tangible and intangible assets with finite lives may not be recoverable. Management’s policy in determining whether an impairment indicator exists (i.e., a triggering event) comprises measurable operating performance criteria as well as qualitative measures. If a determination is made that a long-lived asset’s carrying value is not recoverable over its estimated useful life, the asset is written down to estimated fair value, if lower. The determination of fair value of long-lived assets is generally based on estimated expected discounted future cash flows, which is generally measured by discounting expected future cash flows identifiable with the long-lived asset at our weighted-average cost of capital. We have recognized impairment charges of approximately $3.5 million in fiscal 2013, $0.2 million in fiscal 2012, and $0.5 million in fiscal 2011 related to underperforming store locations.
If our manufacturers and importers are unable to produce our proprietary-branded goods on time or to our specifications, we could suffer lost sales.
We do not own or operate any manufacturing facilities and, therefore, depend upon independent third party vendors for the manufacture of all of our branded products. Our products are manufactured to our specifications primarily by domestic manufacturers and importers. We cannot control all of the various factors, which include inclement weather, natural disasters, labor disputes and acts of terrorism that might affect the ability of a manufacturer or importer to ship orders of our products in a timely manner or to meet our quality standards. Late delivery of products or delivery of products that do not meet our quality standards could cause us to miss the delivery date requirements of our customers or delay timely delivery of merchandise to our retail stores for those items. These events could cause us to fail to meet customer expectations, cause our customers to cancel orders or cause us to be unable to deliver merchandise in sufficient quantities or of sufficient quality to our stores, which could result in lost sales.
There are risks of obtaining products from third parties.
Our business depends largely on the ability of third-party vendors and their subcontractors or suppliers to provide us with current-season, brand-name apparel and other merchandise at competitive prices, in sufficient quantities, manufactured in compliance with all applicable laws and of acceptable quality. We do not have any long-term contracts with any vendor and are not likely to enter into these contracts in the foreseeable future. In addition, many of the vendors that we use are factored and have limited resources, production capacities, and operating histories. Additionally, because the fashion market is volatile and customer taste tends to change rapidly, we must, in order to be successful, identify and obtain merchandise from new third-party brands for which our customers show a preference. As a result, we are subject to the following risks:
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our vendors may fail or be unable to expand with us;
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our current vendor terms may be changed to require increased payments or letters of credit in advance of delivery, and we may not be able to fund such payments through our current credit facility, cash balances, or our cash flow;
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we may not be able to identify or obtain products from new “hot” brands preferred by our customers; and
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our ability to procure products in sufficient quantities, at acceptable prices, may be limited.
We believe, based on the country of origin tags that appear on the products we sell, that a substantial portion of the products sold to us by our third-party vendors and domestic importers are produced in factories located in foreign countries, especially in China and other Asian countries. Any event causing a sudden disruption of manufacturing or imports from Asia or elsewhere, including, but not limited to, the imposition of import restrictions, could materially harm our operations. Many of our and our vendor’s imports are subject to existing or potential duties, tariffs or quotas that may limit the quantity of certain types of goods that may be imported into the United States from countries in Asia or elsewhere. We and our vendors compete with other companies for production facilities and import quota capacity. Our and our vendors’ businesses are also subject to a variety of other risks generally associated with doing business abroad, such as political instability, currency and exchange risks, disruption of imports by labor disputes (both in other countries and in the United States) and local business practices.
Ours and our vendors’ foreign sourcing operations may also be hurt by political and financial instability, strikes, health concerns regarding infectious diseases in countries in which our merchandise is produced, adverse weather conditions or natural disasters or acts of war or terrorism. Our future operations and performance will be subject to these factors, which are beyond our control, and these factors could materially hurt our business, financial condition and results of operations or may require us to modify our current business practices and incur increased costs.
Fluctuations in the cost, availability and quality of raw materials, labor and transportation, could increase our costs.
Fluctuations in the cost, availability and quality of the fabrics or other raw materials used to manufacture our merchandise could have a material adverse effect on our cost of goods and, accordingly, on our results of operations. The prices for those fabrics depend largely on the market prices for the raw materials used to produce them, including cotton. The price and availability of these raw materials may fluctuate significantly, depending on many factors, including, among other things, crop yields and weather patterns. In addition, the cost of labor at many of our third-party manufacturers has been increasing as the middle class in developing countries continues to grow, and we expect this trend to continue. The cost of transportation has been increasing as well and, if the price of oil remains at current levels or increases, that cost pressure will continue. We may not be able to pass all or a portion of higher raw materials prices, labor or transportation costs on to our customers, which could adversely affect our gross margin and our 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 have disrupted commerce and have 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 manufacturers. Our inability to obtain merchandise from our foreign manufacturers or substitute other manufacturers, at similar costs and in a timely manner, could adversely affect our operating results and financial condition.
Weather conditions where our customers are located may impact consumer shopping patterns, which alone or together with natural disasters, particularly in areas where our sales are concentrated, could adversely affect our results of operations.
Uncharacteristic or significant weather conditions can affect consumer shopping patterns, particularly in apparel and seasonal items, which could lead to lost sales or greater than expected markdowns and adversely affect our short-term results of operations. For example, frequent or unusually heavy snowfall, ice storms,
rainstorms or other significant weather conditions over a prolonged period could make it difficult for our customers to travel to our stores and thereby reduce our sales and profitability. Our business is also susceptible to unseasonable weather conditions. For example, extended periods of unseasonably warm temperatures during the winter season or cool weather during the summer season could render a portion of our inventory incompatible with those unseasonable conditions. Natural disasters in areas where our sales are concentrated could result in significant physical damage to or closure of one or more of our stores or distribution center, and cause delays in the distribution of merchandise from our vendors to our distribution center and stores, which could adversely affect our results of operations by increasing our costs and lowering our sales.
We must effectively manage our vendors to minimize inventory risk and maintain our margins.
We seek to avoid maintaining high inventory levels in an effort to limit the risk of outdated merchandise and inventory write-downs. If we underestimate quantities demanded by our customers and our vendors cannot restock, then we may disappoint customers who may then turn to our competitors. We require many of our vendors to meet minimum restocking requirements, but if our vendors cannot meet these requirements and we cannot find alternate vendors, we could be forced to carry more inventory than we have in the past or we could have a loss in sales. Our risk of inventory write-downs would increase if we were to hold large inventories of merchandise that prove to be unpopular.
We may be required to collect sales tax on our direct marketing operations.
With respect to the direct sales, sales or other similar taxes are collected primarily in states where we have retail stores, another physical presence or personal property. However, various states or foreign countries may seek to impose sales tax collection obligations on out-of-state direct mail companies. A successful assertion by one or more states that we or one or more of our subsidiaries should have collected or should be collecting sales taxes on the direct sale of our merchandise could have a material adverse effect on our business.
We could face liability from, or our ability to conduct business could be adversely affected by, government and private actions concerning personally identifiable data, including privacy.
Our direct marketing business is subject to federal and state laws regarding the collection, maintenance and disclosure of personally identifiable information we collect and maintain in our database. If we do not comply, we could become subject to liability. While these provisions do not currently unduly restrict our ability to operate our business, if those regulations become more restrictive, they could adversely affect our business. In addition, laws or regulations that could impair our ability to collect and use user names and other information on the e-commerce website may adversely affect our business. For example, COPPA currently limits our ability to collect personal information from website visitors who may be under age 13. Further, claims could also be based on other misuse of personal information, such as for unauthorized marketing purposes. If we violate any of these laws, we could face civil penalties. In addition, the attorneys general of various states review company websites and their privacy policies from time to time. In particular, an attorney general may examine such privacy policies to assure that the policies overtly and explicitly inform users of the manner in which the information they provide will be used and disclosed by the Company. If one or more attorneys general were to determine that our privacy policies fail to conform with state law, we also could face fines or civil penalties, any of which could adversely affect our business.
We could face liability for information displayed in our catalogs or displayed on or accessible via e-commerce website and our other websites.
We may be subjected to claims for defamation, negligence, copyright or trademark infringement or other theories relating to the information we publish in any of our catalogs, on our e-commerce website and on any of our other websites. These types of claims have been brought, sometimes successfully, against similar companies in the past. Based upon links we provide to third-party websites, we could also be subjected to claims based upon online content we do not control that is accessible from our e-commerce website.
We may be liable for misappropriation of our customers’ personal information.
If third parties or unauthorized employees of ours are able to penetrate our network security or otherwise misappropriate our customers’ personal information or credit card information, or if we give third parties or our employees improper access to our customers’ personal information or credit card information, we could be subject to claims of liability. These claims could include claims for unauthorized purchases with credit card information, impersonation or other similar fraud claims, or negligence claims. This potential liability could also include claims for other misuse of personal information, including unauthorized marketing purposes. Liability for misappropriation of this information could decrease our profitability.
In addition, the FTC and state agencies have been investigating various internet companies regarding their use of personal information. We could incur additional expenses if new regulations regarding the use of personal information are introduced or if government agencies investigate our privacy practices.
We rely on encryption and authentication technology licensed from third parties to provide the security and authentication necessary to effect secure transmission of confidential information such as customer credit card numbers. Advances in computer capabilities, new discoveries in the field of cryptology or other events or developments may result in a compromise or breach of the algorithms that we use to protect customer transaction data. If any such compromise of our security were to occur, it could subject us to claims of liability, damage our reputation and diminish the value of our brand. A party who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations. We may be required to expend significant capital and other resources to protect against such security breaches or to alleviate problems caused by such breaches. Our security measures are designed to significantly reduce the risk of security breaches, but our failure to prevent such security breaches could subject us to claims of liability, damage our reputation and diminish the value of our brand and cause our sales to decline.
Government regulation of the internet and e-commerce is evolving and unfavorable changes could harm our business.
We are subject to regulations and laws specifically governing the internet and e-commerce. Existing and future laws and regulations may impede the growth of our internet or e-commerce services. These regulations and laws may cover taxation, privacy, data protection, pricing, content, copyrights, distribution, mobile communications, electronic contracts and other communications, consumer protection, the provision of e-commerce payment services, and consumer protection. Unfavorable regulations and laws could diminish the on-line demand for our products and services and increase our costs of doing business.
We are subject to litigation risk due to the nature of our business, which may have a material adverse effect on our results of operations and business.
From time to time, we are involved in lawsuits or other legal proceedings arising in the ordinary course of our business. These may relate to, for example, trademark, servicemark, copyright or other intellectual property matters, employment law matters, commercial disputes, consumer protection claims, claims of regulatory authorities, or other matters. In addition, as a public company we could from time to time face claims relating to corporate or securities law matters. In connection with such litigation, we may be subject to significant damages or equitable remedies. Any of such litigation, whether as plaintiff or defendant, could be costly and time consuming and could divert management and key personnel from our regular business operations. We do not currently believe that any of our outstanding litigation will have a material adverse effect on our business, prospects, financial condition or results of operations. However, due to the uncertainty of litigation and depending on the amount and the timing of any claims, an unfavorable resolution of such claims could materially affect our business, prospects, financial condition and results of operations.
Many of our vendors utilize factors and therefore require letters of credit.
All or a portion of the credit extended by factors to our vendors often is collateralized by standby letters of credit, which we are required to provide and which we currently obtain under our Letter of Credit Agreement dated as of June 14, 2013, as amended (the “Letter of Credit Agreement”), with General Electric Capital Corporation (“GE Capital”). Any increases in the amount of such letters of credit required by such factors reduces the amount of availability we have under our Letter of Credit Agreement with GE Capital. Any increase in our vendors’ use of factors or decrease in the amount of credit extended by these factors could require us to provide additional standby letters of credit, thereby reducing further the amount of availability, or require us to obtain increased credit lines which may or may not be readily available to us on acceptable terms. Any such decreases could adversely affect our ability to operate our business, including requiring us to reduce other discretionary spending, such as on advertising. Any such event could result in reduced sales.
Our ability to procure merchandise could be adversely affected by changes in our vendors’ factoring arrangements.
Although we do not have a direct relationship with factors, a portion of our vendors who supply us with merchandise have direct factoring arrangements. Vendors who engage in factoring transactions will typically sell their accounts receivable to a factor at a discount in exchange for cash payments, which can be used to finance the business and operations of the vendors.
If the financial condition of our vendors’ factors were to deteriorate and those vendors were unable to procure alternative factoring arrangements, our ability to timely procure merchandise for our stores could be adversely affected. This also could require the devotion of significant time and attention by our management to adequately resolve such matters. In turn, our results of operations and financial condition could suffer.
Our Credit Agreement with Salus, the Securities Purchase Agreement and the Notes issued in the Private Placement include covenants that impose restrictions on our financial and business operations.
Our Credit Agreement contains covenants that restrict the manner in which we conduct our business under certain circumstances. Subject to certain exceptions, these covenants restrict or limit our ability to, among other things:
•
grant liens on assets;
•
merge, consolidate, dissolve or liquidate;
•
incur certain additional indebtedness and guaranty obligations;
•
make certain restricted payments (including make dividend payments on our common stock);
•
make certain investments or acquisitions;
•
engage in certain sales (including certain sales of stock); and
•
pay dividends.
Until all of the Notes issued in the Private Placement have been converted, redeemed or otherwise satisfied in accordance with their terms, we have agreed, among other things, not to (i) incur any indebtedness, other than pursuant to our existing Credit Agreement; and (ii) grant liens on our assets, other than the liens securing our and our subsidiaries’ obligations under the Credit Agreement or any other liens that are permitted under the Credit Agreement.
If we fail to comply with the covenants and are unable to obtain a waiver or amendment, an event of default would result, and Salus or the holders of the Notes, as the case may be, could declare outstanding borrowings or the Notes, as the case may be, immediately due and payable. If Salus were to declare a default, we cannot guarantee that we would have sufficient liquidity at that time to repay or refinance borrowings under the Credit Agreement.
Our ability to borrow under the Credit Agreement is subject to various conditions precedent. We cannot assure you that we will be able to satisfy the conditions to funding at the time we require the drawdowns.
Pursuant to a private placement Securities Purchase Agreement (“Securities Purchase Agreement”), so long as Valinor Management, LLC (the “Lead Investor”) or Flatbush Watermill LLC (“Flatbush”), as the case may be, beneficially owns at least 10% of our common stock (on an as-converted basis), we are subject to certain restrictive covenants that, subject to certain exceptions, restrict or limit our ability to take the following actions without the prior written consent of the Lead Investor and/or Flatbush, as the case may be:
•
if all accrued dividends on the Preferred Stock have not been paid in full, declare or pay dividends on, or repurchase or redeem, any shares of our capital stock, subject to certain exceptions;
•
authorize, create or issue any class or series of our capital stock that ranks senior or in parity with the Preferred Stock, including any additional Preferred Stock;
•
commence any voluntary liquidation, bankruptcy, dissolution, recapitalization, reorganization, assignment to creditors or similar transaction;
•
incur any additional indebtedness, other than indebtedness under or as permitted under our Credit Agreement with Salus and the Letter of Credit Agreement with GE Capital;
•
grant liens on our assets, other than liens under or as permitted under our Credit Agreement with Salus and our Letter of Credit Agreement with GE Capital;
•
increase the size of the number of directors comprising our board of directors to more than nine members;
•
amend our certificate of incorporation or our bylaws in a manner that materially and adversely affects the rights or voting powers of the Preferred Stock, subject to certain exceptions;
•
enter into any transaction with any person or entity whose beneficial ownership of our voting securities is at least 10% or a director of our Company, subject to certain exceptions; or
•
remove or replace Tracy Gardner as our chief executive officer for reasons other than cause, resignation, death or disability.
Additionally, so long as the Lead Investor or Flatbush, as the case may be, beneficially owns at least 15% of our common stock (on an as-converted basis), we are subject to certain restrictive covenants that, subject to certain exceptions, restrict or limit our ability to engage in, or agree to, the following transactions without the prior written consent of the Lead Investor and/or Flatbush, as the case may be:
•
a sale of all or substantially all of our assets;
•
a merger or consolidation of our Company; or
•
a recapitalization or reorganization of our Company involving consideration in excess of $25 million.
We may not have the cash necessary to pay the dividends on the Preferred Stock.
Holders of Preferred Stock are entitled to receive, when, as and if declared by the board of directors of the Company, out of any funds legally available therefor, dividends per share of Preferred Stock in an amount equal to 6.0% per annum of the stated value per share. The first date on which dividends are payable is February 18, 2015, and, thereafter, dividends are payable semi-annually in arrears on February 18 and August 18 of each year. Dividends, whether or not declared, begin to accrue and be cumulative from February 18, 2014. If we do not pay any dividend in full on any scheduled dividend payment date, then dividends thereafter will accrue at an annual rate of 8.0% of the stated value of the Preferred Stock from such scheduled dividend payment date to the date that all accumulated dividends on the Preferred Stock have been paid in cash in full. In addition, if we do not meet minimum borrowing availability tests under our Credit Agreement with Salus, we may not pay dividends on
the Preferred Stock. No assurance can be given that we will have the cash or financial resources available to us to make these payments, in whole or in part, or that we will meet the minimum borrowing availability tests under our Credit Agreement with Salus. Any failure to make such payments could have a material adverse effect on our business and financial condition.
Our inability or failure to protect our intellectual property or our infringement of other’s intellectual property could have a negative impact on our operating results.
Our trademarks are valuable assets that are critical to our success. The unauthorized use or other misappropriation of our trademarks, or the inability for us to continue to use any current trademarks, could diminish the value of our brands and have a negative impact on our business. We are also subject to the risk that we may infringe on the intellectual property rights of third parties. Any infringement or other intellectual property claim made against us, whether or not it has merit, could be time-consuming, result in costly litigation, cause product delays or require us to pay royalties or license fees. As a result, any such claim could have a material adverse effect on our operating results.
The potential consolidation of commercial and retail landlords could negatively impact us.
Continued consolidation in the commercial retail real estate market could affect our ability to successfully negotiate favorable rental terms for our stores in the future. Should significant consolidation continue, a large proportion of our store base could be concentrated with one or a few entities that could then be in a position to dictate unfavorable terms to us due to their significant negotiating leverage. If we are unable to negotiate favorable rental terms with these entities, this could affect our ability to profitably operate our stores, which could adversely impact our business, financial condition and results of operations.
We may have potential business conflicts with Alloy, LLC with respect to our past and ongoing relationships.
On December 19, 2005, Alloy, LLC completed the Spinoff of all of the outstanding common stock of dELiA*s, Inc. to its stockholders. In connection with the Spinoff, Alloy, LLC contributed and transferred to us substantially all of its assets and liabilities related to its direct marketing and retail store segments.
We entered into various agreements with Alloy, LLC prior to or in connection with the Spinoff. These agreements govern various interim and ongoing relationships between Alloy, LLC and us following the Spinoff. Certain of these agreements expired by their terms on December 19, 2010. We subsequently entered into certain amended and restated agreements effective December 20, 2010 which expire on December 20, 2015.
Potential business conflicts may arise between Alloy, LLC and us in a number of areas relating to our past and ongoing relationships, including:
•
labor, tax, employee benefit, pending litigation, indemnification and other matters arising from our separation from Alloy, LLC;
•
intellectual property matters;
•
joint database ownership and management; and
•
the nature, quantity, quality, time of delivery and pricing of services we supply to each other under our various agreements with Alloy, LLC.
We may not be able to resolve any potential conflicts. Even if we do so, however, because Alloy, LLC will be performing a number of services and functions for us, they will have leverage with negotiations over their performance that may result in a resolution of such conflicts that may be less favorable to us than if we were dealing with another third party.
Our ability to use our net operating losses to offset future taxable income are subject to certain limitations.
We are limited in the portion of net operating loss carryforwards, or NOLs, that we can use in the future to offset taxable income for U.S. federal income tax purposes. At February 1, 2014, we had available U.S. federal NOLs of approximately $119 million. A lack of future taxable income would adversely affect our ability to utilize these NOLs. In addition, under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its NOLs to offset future taxable income. If we receive Stockholder Approval of the conversion of the Notes to Preferred Stock, we believe that we may experience an ownership change under Section 382 of the Code on the Stockholder Approval Date as a result of the Private Placement and both the public offering and private placement we completed on July 31, 2013. As a result of these transactions, we may be limited in our ability to utilize our NOLs as an offset against future taxable income. Consequently, some or all of our NOLs may expire before they can be utilized. In addition, future changes in our stock ownership, including this or future offerings, as well as other changes that may be outside of our control, could result in additional ownership changes under Section 382 of the Code.
The price of our common stock may be volatile and you may lose all or a part of your investment.
The price of our common stock may fluctuate widely, depending upon a number of factors, many of which are beyond our control. For instance, it is possible that our future results of operations may be below the expectations of investors and, to the extent our Company is followed by securities analysts, the expectations of these analysts. If this occurs, our stock price may decline. Other factors that could affect our stock price include the following:
•
the perceived prospects of our business and the teenage market as a whole;
•
changes in analysts’ recommendations or projections, if any;
•
fashion trends;
•
changes in market valuations of similar companies;
•
actions or announcements by our competitors;
•
actual or anticipated fluctuations in our operating results;
•
litigation developments; and
•
changes in general economic or market conditions or other economic factors unrelated to our performance.
In addition, the stock markets can experience significant price and trading volume fluctuations. These broad market fluctuations may adversely affect the trading price of our common stock. In the past, following periods of volatility in the market price of a public company’s securities, securities class action litigation has often been instituted against that company. Such litigation could result in substantial costs to us and a likely diversion of our management’s attention.
Provisions of Delaware law and of our charter and by-laws and stockholder rights plan may make a takeover more difficult.
Provisions in our amended and restated certificate of incorporation and by-laws and in the Delaware corporation law may make it difficult and expensive for a third party to pursue a tender offer, change in control or takeover attempt that our management and board of directors oppose. Public stockholders that might wish to participate in one of these transactions may not have an opportunity to do so. For example, our amended and restated certificate of incorporation and by-laws contain provisions:
•
reserving to our board of directors the exclusive right to change the number of directors and fill vacancies on our board of directors, which could make it more difficult for a third party to obtain control of our board of directors;
•
authorizing the issuance of up to 25 million shares of preferred stock which can be created and issued by the board of directors without prior stockholder approval, commonly referred to as “blank check” preferred stock, with rights senior to those of our common stock, which could make it more difficult or expensive for a third party to obtain voting control;
•
establishing advance notice requirements for director nominations or other proposals at stockholder meetings; and
•
generally requiring the affirmative vote of holders of at least 70% of the outstanding voting stock to amend certain provisions of our amended and restated certificate of incorporation and by-laws, which could make it more difficult for a third party to remove the provisions we have included to prevent or delay a change of control.
In addition, we have adopted a stockholder rights plan that may prevent a change in control or sale of us in a manner or on terms not approved by our board of directors. These anti-takeover provisions could substantially impede the ability of public stockholders to benefit from a change in control or to change our management and board of directors.
We have a significant number of options, Preferred Stock and Notes outstanding which, if exercised or converted, would dilute the equity interests of our existing stockholders and adversely affect earnings per share.
As of April 11, 2014, we had outstanding options, of which 1,177,454 were vested, to purchase 3,418,538 shares of common stock at a weighted average exercise price of $1.81 per share. From time to time, we may issue additional options to employees, non-employee directors and consultants pursuant to our equity incentive plans. We have sold in the Private Placement to the selling stockholders (i) 199,834 shares of Preferred Stock for an aggregate purchase price of $19,983,400, which shares of Preferred Stock are convertible into 24,979,250 shares of our common stock at a conversion price of $0.80 per share, and (ii) an aggregate of $24,116,600 in principal amount of Notes, which Notes are convertible into 241,166 shares of our Preferred Stock following Stockholder Approval. The shares of Preferred Stock issuable upon conversion of the Notes are convertible into 30,145,750 shares of our common stock at a conversion price of $0.80 per share. Our stockholders will experience dilution if these stock options, shares of Preferred Stock and Notes are exercised or converted, as applicable.
If we fail to meet the continued listing standards of Nasdaq, our common stock may be delisted, which may adversely affect the market price and liquidity of our common stock.
Our common stock is currently traded on the Nasdaq Global Market. Nasdaq has requirements we must meet in order to remain listed on the Nasdaq Global Market, including that we maintain a minimum closing bid price of $1.00 per share of our common stock. On January 31, 2014, we received a notification letter from The NASDAQ OMX Group (“Nasdaq”) indicating that the bid price of our common stock for the last 30 consecutive business days had closed below the minimum $1.00 per share required for continued listing under Nasdaq Listing Rule 5450(a)(1). We have been provided a period of 180 calendar days, or until July 30, 2014, to regain compliance. The letter states that the Nasdaq staff will provide written notification that we have regained compliance if at any time before July 30, 2014, the bid price of our common stock closes at $1.00 per share or more for a minimum of ten consecutive business days. As of the close of the market on March 11, 2014, our common stock closed at $1.00 per share or more for ten consecutive business days. Consequently, we received a notification letter from Nasdaq on March 13, 2014 advising us that we are now in compliance with Nasdaq Listing Rule 5450(a)(1). However, since March 24, 2014, the closing bid price of our common stock has been below $1.00 per share. If we become non-compliant again in the future, our common stock may be delisted from the Nasdaq Global Market and transferred to a listing on the Nasdaq Capital Market, or delisted from Nasdaq altogether. There can be no assurance that we will be able to maintain compliance with the requirements for listing our common stock on the Nasdaq Global Market, or we would be eligible for transfer to the Nasdaq Capital Market and remain in compliance with the requirements for listing on that market. The failure to maintain our listing on the Nasdaq Global Market or to qualify for listing on the Nasdaq Capital Market could have an adverse effect on the market price and liquidity of our shares of common stock.
We do not intend to pay dividends on our common stock.
We have never declared or paid any cash dividend on our common stock. We currently intend to retain any future earnings and do not expect to pay any dividends on our common stock in the foreseeable future. Further, we are prohibited under the terms of the Credit Agreement from paying dividends on our common stock. Any determination to pay dividends on our common stock in the future will be made at the discretion of our board of directors and will depend on our results of operations, financial conditions, contractual restrictions imposed by applicable law and other factors our board deems relevant. Accordingly, investors must be prepared to rely on sales of their common stock after price appreciation to earn an investment return, which may never occur. If our common stock does not appreciate in value, or if our common stock loses value, our stockholders may lose some or all of their investment in our shares.
Future sales of our common stock or the issuance of other equity may adversely affect the market price of our common stock.
Following the Stockholder Approval Date and subject to certain preemptive rights of the selling stockholders pursuant to the Securities Purchase Agreement, we are not restricted from issuing additional common stock, including securities that are convertible into or exchangeable for, or that represent the right to receive, common stock. Issuances of our common stock or convertible securities will dilute the ownership interest of our stockholders. Sales of a substantial number of shares of our common stock or other equity-related securities in the public market could depress the market price of our common stock and impair our ability to raise capital through the sale of additional equity securities. We cannot predict the effect that future sales of our common stock or other equity-related securities would have on the market price of our common stock.
Our common stock is an equity security and is subordinate to our existing and future indebtedness.
The shares of common stock are equity interests and do not constitute indebtedness. As such, the shares of common stock will rank junior to all of our indebtedness and to other non-equity claims on us and our assets available to satisfy claims on us, including claims in a bankruptcy, liquidation or similar proceeding. Further, the common stock places no restrictions on our business or operations or on our ability to incur indebtedness or engage in any transactions, subject only to the voting rights available to stockholders generally.
We may incur a material expense upon the conversion of the Notes issued in the Private Placement.
The Notes issued in the Private Placement are mandatorily convertible following Stockholder Approval. If at the time of the conversion of the Notes, the market price of our common stock is above the conversion price of the Notes, we will incur a non-cash charge in an amount equal to the difference between the market price of our common stock at the time of conversion and the conversion price of the Notes. Such a charge could have an adverse effect on our results of operations.
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2.
Item 2. Properties
The following table sets forth information as of February 1, 2014 regarding the principal facilities that we currently use in our business operations. Except for the property in Hanover, Pennsylvania, which we own, all such facilities are leased. We believe our facilities are well maintained, in good operating condition and otherwise adequate for our business operations.
The following table sets forth information regarding the states in which we operate retail stores as of February 1, 2014, and the number of stores in each state.
Item 3.
Item 3. Legal Proceedings
The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. Although the amount of any liability that could arise with respect to these actions cannot be determined with certainty, in the Company’s opinion, any such liability will not have a material adverse effect on its consolidated financial position, consolidated results of operations or liquidity.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
Executive Officers of the Registrant
Tracy Gardner, age 50, has served as our Chief Executive Officer since June 5, 2013, and from May 1, 2013 to June 4, 2013 served as our Chief Creative Officer. She has served as a director since May 1, 2013. From July 2010 to April 2013, Ms. Gardner worked in various consulting capacities, most recently serving as Creative Advisor to The Gap, Inc., a global specialty retailer, from January 2012 to April 2013. From 2007 to 2010, Ms. Gardner served as President-Retail and Direct of J.Crew Group, Inc., a multi-brand apparel and accessories retailer, and from 2004 to 2007 she served as Executive Vice President, Merchandising, Planning & Production of J.Crew. Prior to joining J.Crew, Ms. Gardner held various positions at The Gap, Inc., including Senior Vice President of Adult Merchandising for the Gap brand from 2002 to 2004, Vice President of Women’s Merchandising for the Banana Republic division from 2001 to 2002, Vice President of Men’s Merchandising for the Banana Republic division from 1999 to 2001 and Divisional Merchandising Manager of Men’s Wovens for the Banana Republic division from 1998 to 1999. In March 2014, she was appointed as a director of the publicly-traded company Lands’ End, Inc., a multi-channel retailer of casual clothing, accessories and footwear, as well as home products, under its classic American lifestyle brand.
Brian Lex Austin-Gemas, age 47, has served as our Chief Operating Officer since October 9, 2013. From August 2010 until September 2013, Mr. Gemas served as the Chief Operating Officer of Global Retail for ESPRIT, where he also served in various roles from 2005 to 2009. From 2009 until rejoining ESPRIT in 2010, Mr. Gemas was the Chief Operating Officer of New Look Group. Prior to 2005, he held various leadership roles within GAP, Banana Republic, Victoria’s Secret and Macy’s. Mr. Gemas began his career at Nordstrom.
David J. Dick, age 47, has served as our Senior Vice President, Chief Financial Officer and Treasurer since February 2, 2009 and had served as the Company’s Vice President, Controller and Chief Accounting Officer since April 2008. Prior to that, Mr. Dick served as Chief Financial Officer of Charlie Brown’s Acquisition Corp., a multi-concept casual dining restaurant operator, from 2006 to 2007, and from 1993 to 2006, worked for Linens ‘n Things, Inc., a specialty retailer of home furnishings, where he held a number of positions including Vice President, Controller and Treasurer. From 1987 to 1992, Mr. Dick worked for Ernst & Young LLP. He is a certified public accountant.
Ryan A. Schreiber, age 44, has served as our Senior Vice President, General Counsel and Secretary since September 2013. He previously served as Vice President and General Counsel to New York & Company from 2007 until 2013 and led the legal team upon joining the business in 2004. Prior to that, Mr. Schreiber served as in-house counsel in various capacities for The Children’s Place from 1999 to 2004. Mr. Schreiber also served as an attorney in the commercial real estate and litigation departments of Farer Siegal Fersko, P.A., and as counsel to Party City Corporation and Petrie Retail, Inc. Throughout his career, Mr. Schreiber has overseen legal matters in real estate and contracts, litigation, corporate and securities, intellectual property, employment and labor relations, and social compliance.
David Diamond, age 46, has served as our Senior Vice President, Human Resources since January 2004. Prior to joining dELiA*s, Mr. Diamond worked in executive search focused on the retail industry most recently as a partner with Hudson Highland Partners, a subsidiary of Hudson Highland Group Inc. and was previously with Russell Reynolds Associates Inc., Levy-Kerson Ltd. and Whitehead Mann Plc. Prior to that, Mr. Diamond was a merchant with The May Department Stores Company from 1989 to 1996 working in the G. Fox, Filene’s and Lord & Taylor divisions. Mr. Diamond also currently serves on the Board of Trustees of the Direct Marketing Educational Foundation.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common stock has traded on the NASDAQ Global Market under the symbol “DLIA” since December 20, 2005. The table below sets forth the high and low sale prices for our common stock during the periods indicated as reported by the NASDAQ Global Market.
Stockholders
As of April 11, 2014 there were approximately 193 holders of record of the 70,790,376 outstanding shares of our common stock.
Dividends
We have never declared or paid cash dividends on our common stock. We intend to retain any future earnings to finance the growth and development of our business. We do not anticipate paying cash dividends on our common stock in the foreseeable future.
Unregistered Sales of Securities
There were no unregistered sales of our securities during fiscal 2013. However, as previously disclosed in our Current Report on Form 8-K filed with the SEC on February 18, 2014, the Company sold and issued in a Private Placement (i) 199,834 shares of Preferred Stock for an aggregate purchase price of $19,983,400, and (ii) an aggregate of $24,116,600 in principal amount of Notes.
Issuer Purchases of Equity Securities
During fiscal 2013, the Company did not purchase any shares of its common stock.
Item 6.
Item 6. Selected Financial Data
SELECTED CONSOLIDATED FINANCIAL DATA
The selected statements of operations data for fiscal 2013, fiscal 2012, and fiscal 2011 have been derived from the audited financial statements included elsewhere in this report which have been audited by BDO USA, LLP, independent registered public accountants. Selected balance sheet data as of fiscal 2013 and 2012 has been derived from the audited financial statements included herein. Selected balance sheet data as of January 28, 2012, January 29, 2011 (“fiscal 2010”) and January 30, 2010 (“fiscal 2009”) and the selected statements of operations data for fiscal 2010 and fiscal 2009 have been derived from audited financial statements and not included herein.
Our historical results are not necessarily indicative of results to be expected for any future period. The data presented below has been derived from financial statements that have been prepared in accordance with accounting principles generally accepted in the United States of America and should be read with our financial statements, including the related notes, and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report. The amounts specified below are for continuing operations only. Our former Alloy and CCS businesses are treated as discontinued operations.
(1) The Company sold its CCS business in November 2008 and its Alloy business in June 2013, thus the results of their respective business operations have been reported as discontinued operations. See Note 14 to the consolidated financial statements for financial data by reportable segment.
(2) The Company considers a store comparable after it has been open for 15 full months without closure for more than seven consecutive days and whose square footage has not been expanded or reduced by more than 25% within the past year. If a store is closed during a fiscal quarter, it is removed from the computation of comparable store sales for that fiscal quarter.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial condition and results of operations together with “Selected Consolidated Financial Data” and our financial statements and related notes appearing elsewhere in this annual report, all of which reflect the Company’s Alloy business as a discontinued operation. Descriptions of all documents included as exhibits hereto are qualified in their entirety by reference to the full text of such documents so referenced.
Executive Summary and Overview
We are a multi-channel retail company with a lifestyle brand marketing and catering to teenage girls. We operate the dELiA*s brand, which we believe is a well-established, differentiated, lifestyle brand. We generate revenues by selling a wide variety of product categories to consumers through our website, direct mail catalogs, and retail stores.
Through our e-commerce website and catalogs, we sell our own proprietary brand products, together with brand name products, in key spending categories directly to consumers, including apparel and accessories. Our mall-based retail stores derive revenues primarily from the sale of proprietary apparel and accessories and, to a lesser extent, branded apparel.
Our focus on our proprietary brand and a diverse collection of name brands allows us to adjust our merchandising strategy quickly as fashion trends change. In addition, we strive to keep our merchandise mix fresh by regularly introducing new trends and styles. Our proprietary brand provides us an opportunity to broaden our customer base by offering merchandise of comparable quality to brand name merchandise, at a lower price, while permitting improved gross profit margins. Our proprietary brand also allows us to capitalize on emerging fashion trends when branded merchandise is not available in sufficient quantities, and to exercise a greater degree of control over the flow of our merchandise from our vendors to us, and from us to our customers.
Our strategy is to improve upon our position as a direct marketing company; to increase productivity in our retail stores; and to carry out such strategy while controlling costs. In addition, our strategy includes strengthening the dELiA*s brand through alignment across all channels of our business while continuing extended offerings online and in our catalogs.
We expect that improved productivity in each segment of our business will be the key element of our overall growth strategy. Our focus is to improve productivity in our current retail store base, to invest in web-based marketing programs to drive additional traffic to our website and improve the productivity of catalogs distributed. As productivity improves and market conditions allow, we plan to expand the retail store base over the long term. In addition, as store performance and market conditions allow, we may plan on accelerating our growth in gross square footage. Should we accelerate our growth, we may need additional equity or debt financing.
Goals
We believe that focusing on our dELiA*s brand and implementing the following initiatives should lead to profitable growth and improved results from operations:
•
Leveraging our omni-channel platform in order to drive top line growth;
•
implementing web, mobile and social media initiatives, while optimizing our catalog circulation;
•
developing merchandise assortments that emphasize key categories more effectively and drive improved gross profit margins;
•
employing focused inventory management strategies and creating inventory turn improvement;
•
improving productivity of the existing store base through heightened focus on the selling culture, with emphasis on increased customer conversion;
•
leveraging our current expense infrastructure and taking additional operating costs out of the business, including monitoring and opportunistically closing underperforming stores; and
•
expanding the retail store base over the long-term.
Key Performance Indicators
The following measurements are among the key business indicators that management reviews regularly to gauge the Company’s results:
•
store metrics such as comparable store sales, sales per gross square foot, average retail price per unit sold, average transaction values, average units per transaction, traffic conversion rates and store contribution margin (defined as store gross profit less direct costs of running the store);
•
direct marketing metrics such as average order value and demand generated by book, with demand defined as the amount customers seek to purchase without regard to merchandise availability;
•
web metrics such as unique site visits, carts opened and carts converted, and site conversion;
•
fill rate, which is the percentage of any particular order we are able to ship for our direct marketing business, from available on-hand inventory or future inventory orders;
•
gross profit;
•
operating income;
•
inventory turnover and average inventory per store; and
•
cash flow and liquidity determined by the Company’s cash provided by operations.
The discussion below includes references to “comparable stores.” We consider a store comparable after it has been open for 15 full months without closure for more than seven consecutive days and whose square footage has not been expanded or reduced by more than 25% within the past year. If a store is closed during a fiscal quarter, it is removed from the computation of comparable store sales for that fiscal quarter.
Our fiscal year is on a 52 or 53 week basis and ends on the Saturday nearest to January 31. The fiscal year ended February 1, 2014 was a 52-week fiscal year, while February 2, 2013 was a 53-week fiscal year, and January 28, 2012 was a 52-week fiscal year. We refer to the extra week in fiscal 2012 as the “53rd week.”
Consolidated Results of Operations
The following table sets forth our statements of operations data for the periods indicated, reflected as a percentage of revenues:
Fiscal 2013 Compared with Fiscal 2012 (52 weeks vs. 53 weeks)
Revenues
Total Revenues
Total revenues decreased 24.6% to $136.7 million in fiscal 2013 from $181.2 million in fiscal 2012. Revenues from the retail segment comprised 69.8% of total revenues for fiscal 2013 as compared to 69.3% in fiscal 2012, and revenues from the direct segment comprised 30.2% of total revenues for fiscal 2013 as compared to 30.7% for fiscal 2012. The 53rd week of fiscal 2012 added incremental revenues of approximately $2.1 million.
Direct Marketing Revenues
Direct marketing revenues decreased 25.7% to $41.3 million in fiscal 2013 from $55.6 million in fiscal 2012. The decrease in revenues was primarily due to reduced website traffic as well as lower average order values. The 53rd week of fiscal 2012 added incremental revenues of approximately $1.0 million.
Retail Store Revenues
Retail store revenues decreased 24.1% to $95.4 million in fiscal 2013 from $125.6 million in fiscal 2012. The decrease in revenues included a comparable store sales decrease of 18.4% primarily due to reduced traffic and lower average unit retail, as well as a reduction in store count. The 53rd week of fiscal 2012 added incremental revenues of approximately $1.1 million.
The following table sets forth select operating data in connection with the revenues of our Company:
* Totals include two stores that were closed and relocated to an alternative sites in the same mall during fiscal 2013.
** Totals include one store that was closed and relocaed to an alternative site in the same mall during fiscal 2012.
Gross Profit
Total Gross Profit
Gross profit for fiscal 2013 was $22.2 million or 16.3% of revenues, as compared to $56.7 million or 31.3% of revenues in fiscal 2012. The decrease in gross profit percentage and in dollars was principally due to lower merchandise margins and increased markdown and other inventory reserves in connection with clearing legacy product as well as the deleveraging of reduced occupancy costs.
Direct Marketing Gross Profit
Direct marketing gross profit for fiscal 2013 was $12.8 million or 31.1% of revenues, as compared to $24.4 million or 43.9% of revenues in fiscal 2012. The decrease in gross profit percentage and in dollars was primarily due to lower merchandise margins and increased markdown and other inventory reserves in connection with clearing underperforming legacy inventory as well as increased shipping costs.
Retail Store Gross Profit
Retail store gross profit for fiscal 2013 was $9.4 million or 9.8% of revenues, as compared to $32.3 million or 25.7% of revenues in fiscal 2012. The decrease in gross profit percentage and in dollars was primarily due to lower merchandise margins and increased markdown and other inventory reserves in connection with clearing underperforming legacy inventory, and the deleveraging of occupancy costs on lower revenues.
Operating Expenses
Total Selling, General and Administrative
As a percentage of total revenues, our selling, general and administrative (“SG&A”) expenses increased to 53.1% in fiscal 2013 from 42.8% in fiscal 2012. This increase was primarily attributable to the deleveraging of selling, overhead, stock-based compensation and depreciation expenses on lower revenues. In total dollars, SG&A expenses decreased 6.5% to $72.5 million in fiscal 2013 from $77.5 million in fiscal 2012 due to lower selling, overhead and depreciation expenses.
Direct Marketing Selling, General and Administrative
As a percentage of revenues, direct marketing SG&A expenses increased to 68.4% in fiscal 2013 from 51.9% in fiscal 2012. The increase in direct marketing SG&A expenses as a percentage of revenues reflects the deleveraging of selling, overhead, stock-based compensation and depreciation expenses on lower revenues. In dollars, direct marketing SG&A expenses decreased 1.9% to $28.3 million in fiscal 2013 from $28.8 million in fiscal 2012. The decrease reflects lower selling, overhead and depreciation expenses, partially offset by increased stock-based compensation.
Retail Store Selling, General and Administrative
As a percentage of revenues, retail store SG&A expenses increased to 46.4% in fiscal 2013 from 38.8% in fiscal 2012. The increase in retail store SG&A expenses as a percentage of revenues reflects the deleveraging of selling, overhead, stock-based compensation and depreciation expenses on lower revenues. In dollars, retail store SG&A expenses decreased 9.1% to $44.3 million in fiscal 2013 from $48.7 million in fiscal 2012. The decrease reflects lower selling, overhead and depreciation expenses partially offset by increased stock-based compensation.
Impairment of Goodwill
In fiscal 2012, we recognized a goodwill impairment charge related to the direct marketing reporting unit of $4.5 million primarily as a result of the current and projected future performance of the direct business.
Impairment of Long-Lived Assets
We recognized impairment of long-lived assets related to under-performing stores of $3.5 million and $0.2 million in fiscal 2013 and fiscal 2012, respectively.
Other Operating Income
Other operating income, which represents breakage income, was $1.2 million for fiscal 2013 compared to $2.6 million in fiscal 2012.
Loss from Operations
Total Loss from Operations
Our total loss from operations before interest expense and income taxes was $52.6 million in fiscal 2013 as compared to a loss of $22.9 million in fiscal 2012.
Loss from Direct Marketing Operations
Direct marketing loss from operations was $14.6 million in fiscal 2013 as compared to a loss of $6.7 million in fiscal 2012. This increase was attributable to lower revenues, lower merchandise margins and increased shipping costs. The fiscal 2012 loss included the goodwill impairment charge of $4.5 million noted above.
Loss from Retail Store Operations
Retail store loss from operations was $38.0 million in fiscal 2013, as compared to $16.2 million in fiscal 2012. This increase was primarily attributable to lower revenues and lower merchandise margins partially offset by reduced selling, overhead and depreciation expenses. The operating losses for fiscal 2013 and 2012 included $3.5 million and $0.2 million of non-cash impairment charges related to underperforming stores.
Interest Expense
We recognized interest expense of $4.7 million and $0.7 million in fiscal 2013 and fiscal 2012, respectively. Interest expense was related to costs from our credit facilities. Fiscal 2013 included $2.4 million in non-cash charges related to the conversion of notes payable to equity.
Income Tax Benefit
We recorded income tax expense of $0.1 million in fiscal 2013, compared with a benefit of $0.7 million in fiscal 2012. The Company did not recognize any tax benefit in fiscal 2013 for federal taxes since the Company did not generate taxable income during the two-year carry-back period for the fiscal 2013 NOL. The effective tax rates for fiscal 2013 and 2012 were 0.2% and 2.9%, respectively.
Fiscal 2012 Compared with Fiscal 2011 (53 weeks vs. 52 weeks)
Revenues
Total Revenues
Total revenues increased 5.1% to $181.2 million in fiscal 2012 from $172.3 million in fiscal 2011. Revenues from the retail segment comprised 69.3% of total revenues in fiscal 2012 as compared to 71.5% in fiscal 2011, and revenues from the direct segment comprised 30.7% of total revenues in fiscal 2012 as compared to 28.5% in fiscal 2011. The 53rd week of fiscal 2012 added incremental revenues of approximately $2.1 million.
Direct Marketing Revenues
Direct marketing revenues increased 13.2% to $55.6 million in fiscal 2012 from $49.1 million in fiscal 2011. The increase in direct marketing revenues was attributable to an increase in full price selling. The 53rd week of fiscal 2012 added incremental revenues of approximately $1.0 million.
Retail Store Revenues
Retail store revenues increased 1.9% to $125.6 million in fiscal 2012 from $123.2 million in fiscal 2011. The increase in retail store revenues was driven by a comparable store sales increase of 5.2% partially offset by a reduction in store count. The 53rd week of fiscal 2012 added incremental revenues of approximately $1.1 million.
Gross Profit
Total Gross Profit
Gross profit for fiscal 2012 was $56.7 million or 31.3% of revenues, as compared to $48.6 million, or 28.2% of revenues in fiscal 2011. The increase in gross profit percentage was principally due to increased merchandise margins and the leveraging of reduced occupancy costs partially offset by higher shipping costs.
Direct Marketing Gross Profit
Direct marketing gross profit for fiscal 2012 was $24.4 million or 43.9% of revenues, as compared to $21.8 million, or 44.4% of revenues in fiscal 2011. The decrease in gross profit percentage and in dollars was principally due to increased shipping costs, partially offset by increased merchandise margins.
Retail Store Gross Profit
Retail store gross profit for fiscal 2012 was $32.3 million or 25.7% of revenues, as compared to $26.8 million, or 21.8% of revenues in fiscal 2011. The increase in gross profit percentage and in dollars was primarily due to increased merchandise margins and the leveraging of reduced occupancy costs.
Operating Expenses
Total Selling, General and Administrative
As a percentage of total revenues, our SG&A expenses decreased to 42.8% in fiscal 2012 from 44.4% in fiscal 2011. This decrease was primarily attributable to lower selling and depreciation expenses in the retail segment. In total dollars, SG&A expenses increased 1.3% to $77.5 million in fiscal 2012 from $76.5 million in fiscal 2011.
Direct Marketing Selling, General and Administrative
As a percentage of revenues, direct marketing SG&A expenses decreased to 51.9% in fiscal 2012 from 53.4% in fiscal 2011. The decrease in direct marketing SG&A expenses as a percentage of revenues reflects the leveraging of selling and overhead expenses. In dollars, direct marketing SG&A expenses increased 9.9% to $28.8 million in fiscal 2012 from $26.2 million in fiscal 2011. The increase reflects higher selling and overhead expenses.
Retail Store Selling, General and Administrative
As a percentage of revenues, retail store SG&A expenses decreased to 38.8% in fiscal 2012 from 40.8% in fiscal 2011. In dollars, retail store SG&A expenses decreased 3.2% to $48.7 million in fiscal 2012 from $50.3 million in fiscal 2011. The decrease in retail store SG&A expenses in dollars and as a percentage of revenues reflects lower selling and depreciation expenses partially offset by increased overhead costs.
Impairment of Goodwill
As a result of our annual goodwill impairment analysis, we recognized a goodwill impairment charge related to the direct marketing reporting unit of $4.5 million in fiscal 2012 primarily as a result of the current and projected future performance of the direct marketing business.
Impairment of Long-Lived Assets
We recognized impairment of long-lived assets related to under-performing stores of $0.2 million and $0.5 million in fiscal 2012 and fiscal 2011, respectively.
Other Operating Income
Other operating income, which represents breakage income, was $2.6 million for fiscal 2012 compared to $1.2 million in fiscal 2011. The increase was due to reduced redemption rates for gift cards issued in fiscal 2010.
Loss from Operations
Total Loss from Operations
Our total loss from operations before interest expense and income taxes was $22.9 million in fiscal 2012 as compared to a loss of $27.2 million in fiscal 2011.
Loss from Direct Marketing Operations
Direct marketing loss from operations was $6.7 million in fiscal 2012 as compared to a loss of $3.6 million in fiscal 2011. The fiscal 2012 loss included the goodwill impairment charge of $4.5 million noted above.
Loss from Retail Store Operations
Our loss from retail store operations was $16.2 million in fiscal 2012, as compared to $23.7 million in fiscal 2011. This decrease was primarily attributable to increased sales and higher merchandise margins as well as decreased occupancy costs and depreciation expense.
Interest Expense, Net
We recognized net interest expense of $0.7 million and $0.6 million in fiscal 2012 and fiscal 2011, respectively. Interest expense was related to costs from our credit facility with GE Capital and our previous credit facility with Wells Fargo Retail Finance II, LLC (“Wells Fargo”). Interest income was earned from cash balances in banks.
Income Tax Benefit
We recorded an income tax benefit of $0.7 million in fiscal 2012, compared with a benefit of $2.3 million in fiscal 2011. The Company recorded a tax benefit for continuing operations offsetting the impact resulting from taxes charged to discontinued operations. The Company did not recognize any additional tax benefit in fiscal 2012 for federal taxes therefore the valuation allowance increased accordingly. The fiscal 2012 effective rate is also lower due to the goodwill impairment charge which is non-deductible for tax purposes. The fiscal 2011 benefit included adjustments related to the filing of our fiscal 2010 income tax return. The effective tax rates for fiscal 2012 and 2011 were 2.9% and 8.4%, respectively.
Liquidity and Capital Resources
Our cash requirements are primarily for working capital, operating expenses and capital expenditures including maintenance and remodeling for existing stores, information technology, distribution and other infrastructure related investments, and construction, fixture and inventory costs related to the opening of any new retail stores. Future capital requirements will depend on many factors, including, but not limited to, additional investments in infrastructure and technology, the pace of new store openings, the availability of suitable locations for new stores, the size of the specific stores we open and the nature of arrangements negotiated with landlords. In that regard, our net investment to open new stores is likely to vary significantly in the future.
Credit Facility
The Company and certain of its wholly-owned subsidiaries were parties to a credit agreement (the “GE Agreement”) with GE Capital, as a lender and as agent for the financial institutions from time to time party to the GE Agreement (together with GE Capital in its capacity as a lender, the “GE Lenders”). The GE Agreement provided for a total aggregate commitment of the GE Lenders of $25 million, including a $15 million sublimit for the issuance of letters of credit and a swingline loan facility of $5 million. The GE Agreement had a term of five years and was to mature on May 26, 2016. The obligations of the borrowers under the GE Agreement were secured by substantially all property and assets of the Company and certain of its subsidiaries.
The GE Agreement called for the payment by the Company of a fee of 0.375% per annum on the average unused portion of the GE Agreement, a letter of credit fee calculated using a per annum rate equal to the Applicable Margin with respect to letters of credit (as defined in the GE Agreement) multiplied by the average outstanding face amount of letters of credit issued under the GE Agreement, as well as other customary fees and expenses. Interest accrued on the outstanding principal amount of the revolving credit loans at an annual rate equal to LIBOR (as defined in the GE Agreement) or the Base Rate (as defined in the GE Agreement), plus an applicable margin which was subject to periodic adjustment based on average excess availability under the GE Agreement. Interest on each swingline loan was calculated using the Base Rate. The GE Agreement did not contain any financial covenants with which the Company or any of its subsidiaries or affiliates had to comply during the term of the GE Agreement.
The GE Agreement contained customary representations and warranties, as well as customary covenants that, among other things, restricted the ability of the Company and its subsidiaries to incur liens, consolidate or merge with other entities, incur certain additional indebtedness and guaranty obligations, pay dividends or make certain other restricted payments. The GE Agreement also contained customary events of default, including payment defaults, breaches of representations and warranties and covenants, cross defaults to other material indebtedness, and bankruptcy and insolvency matters.
On June 14, 2013, the Company and certain of its wholly-owned subsidiaries entered into the Credit Agreement with Salus, as a lender and as agent for the financial institutions from time to time party to the Credit Agreement (together with Salus in its capacity as a lender, the “Lenders”). The Credit Agreement provides for a total aggregate commitment of the Lenders of $30 million. The Credit Agreement has a term of four years and matures on June 14, 2017. The obligations of the borrowers under the Credit Agreement are secured by substantially all property and assets of the Company and certain of its subsidiaries.
The Credit Agreement calls for the payment by the Company of a fee of 0.375% per annum on the average unused portion of the Credit Agreement as well as other customary fees and expenses. Interest accrues on the outstanding principal amount of the revolving credit loans at an annual rate equal to the greater of (a) the Base Rate (as defined in the Credit Agreement) plus 3% and (b) 6.25%. The Credit Agreement does not contain any financial covenants with which the Company or any of its subsidiaries or affiliates has to comply during the term of the Credit Agreement.
The Credit Agreement contains customary representations and warranties, as well as customary covenants that, among other things, restricts the ability of the Company and its subsidiaries to incur liens, consolidate or merge with other entities, incur certain additional indebtedness and guaranty obligations, pay dividends or make certain other restricted payments. The Credit Agreement also contains customary events of default, including payment defaults, breaches of representations and warranties and covenants, cross defaults to other material indebtedness, and bankruptcy and insolvency matters.
Concurrently with the execution of the Credit Agreement, the GE Agreement was terminated and replaced with a letter of credit agreement with GE Capital (“Letter of Credit Agreement”). The Letter of Credit Agreement provides for a maximum aggregate face amount of letters of credit that may be issued, to be the lesser of (a) $15 million or (b) an amount equal to a specified percentage of cash collateral held by GE Capital. The cash collateral is required in an amount equal to 105% of the face amount of outstanding letters of credit issued. The Letter of Credit Agreement calls for a payment by the Company of a fee of 0.375% per annum on the average unused portion of the Letter of Credit Agreement, a letter of credit fee of 1.75% per annum on the average outstanding face amount of letters of credit issued under the Letter of Credit Agreement, as well as other customary fees and expenses. None of the other assets or properties of the Company, or any of its subsidiaries or affiliates, were pledged as collateral for these obligations. The Letter of Credit Agreement does not contain any financial covenants with which the Company or any of its subsidiaries or affiliates has to comply during the term of the Letter of Credit Agreement.
As of February 1, 2014, availability under the Credit Agreement was $1.3 million, net of $14.5 million in borrowings. The Credit Agreement requires the Company to have a blocked account arrangement, whereby all cash received is deposited into the blocked account and used to pay down the loan. As a result, the loan payable is classified as a current liability in the accompanying consolidated balance sheet. In addition, the Company had $8.9 million in letters of credit outstanding under the Letter of Credit Agreement and the cash collateral required to secure the Company’s obligations under the Letter of Credit Agreement was approximately $9.4 million, which is shown as restricted cash in the accompanying condensed consolidated balance sheet.
On February 4, 2014, there was an amendment to the Credit Agreement which lowered the total aggregate commitment from $30 million to $25 million. On February 18, 2014, there was another amendment which allows the Company to make dividend payments to its shareholders with respect to holders of Preferred Stock, on a quarterly basis, provided that availability (as defined in the Credit Agreement) is equal to or greater than (1) $5,000,000 immediately prior to such payment and (2) $3,500,000 immediately after giving effect to such payment.
A significant portion of our vendor base is factored, which means our vendors have sold their accounts receivable to specialty lenders known as factors. Approximately 65% of our merchandise payments are made to factors. The credit extended by these factors is enhanced by standby letters of credit that we provide as collateral for our obligations to our vendors.
Other Sources of Capital
On June 20, 2012, the Company filed a Registration Statement on Form S-3 using a “shelf” registration process, which became effective on September 7, 2012. Under this shelf registration, the Company may issue up to $30 million of its common stock, preferred stock, warrants, rights, units or preferred stock purchase rights in one or more offerings, in amounts, at prices, and terms that will be determined at the time of the offering. Because the publicly-traded float of the Company’s shares of common stock is less than $75 million, unless and until the Company’s public float exceeds $75 million, the Company will be restricted to issuing securities registered under the shelf registration equal to no more than one-third of the value of its public float in any consecutive 12-month period.
On July 31, 2013, the Company closed on an underwritten public offering of 15,025,270 shares of its common stock at an offering price of $1.05 per share, resulting in gross proceeds of $15.8 million pursuant to the shelf registration statement. The Company used the net proceeds, after issuance costs, of $13.9 million to repay a portion of the outstanding amounts under the existing revolving Credit Agreement.
Concurrently with the closing of the underwritten public offering mentioned above, the Company sold $21.8 million in principal amount of 7.25% convertible notes in a private placement. The convertible notes were scheduled to automatically convert into 20,738,100 shares of dELiA*s common stock immediately upon ratification by the Company’s stockholders of the issuance of the convertible notes and approval by the Company’s stockholders of the issuance of the 20,738,100 shares of common stock into which the convertible notes were automatically convertible. The Company could not use the proceeds from the sale of the convertible notes until receiving stockholder approval. The proceeds from the sale of the convertible notes were held in an interest bearing deposit account at a financial institution. As collateral security for the Company’s obligations under the convertible notes, we granted to the lead investor in the private placement, on behalf of itself and the other investors, a continuing, first priority, perfected, security interest in this deposit account, all funds in the account, and all cash and non-cash proceeds of the account. The security interest in this collateral remained in effect until all of our obligations to the holders of the convertible notes were fully paid and satisfied. On October 24, 2013, the Company’s stockholders ratified the issuance of the convertible notes and approved the issuance of the shares of common stock into which the convertible notes were automatically converted. The Company used the net proceeds, after costs and expenses, of $20.0 million for the repayment of outstanding amounts under its Credit Agreement with Salus.
Since the market price of the Company’s common stock on the date of conversion exceeded the $1.05 conversion price, the Company recorded $2.9 million in non-cash charges. A $0.5 million charge related to the participation of certain insiders in the convertible note offering was included in stock-based compensation expense, while the remaining $2.4 million was included in interest expense.
Subsequent Event-February 2014 Private Placement
On February 18, 2014, we sold and issued in a Private Placement (i) 199,834 shares of Preferred Stock for an aggregate purchase price of $19,983,400, and (ii) an aggregate of $24,116,600 in principal amount of Notes. The Preferred Stock has a stated value of $100 per share and is convertible at the option of the holder into shares of our common stock at a conversion price of $0.80 per share (subject to adjustment), plus an amount in cash per share of Preferred Stock equal to accrued but unpaid dividends on such shares through but excluding the applicable conversion date. The Notes are mandatorily convertible into 241,166 shares of Preferred Stock upon Stockholder Approval. The proceeds from the sale of the notes are currently in an interest bearing account and
may not be used by the Company until we obtain Stockholder Approval. If we obtain Stockholder Approval, we will receive proceeds from the sale of the Notes of approximately $24,116,600, subject to the deduction of placement agent fees and expenses. The Notes mature on the earlier of (i) August 18, 2014 and (ii) the trading day after Stockholder Approval is not obtained at the Stockholder Meeting. If Stockholder Approval is not obtained, the Notes will mature, we will be required to repay the Notes, together with interest at a rate of 7.25% per annum, and we will not have use of these funds. Based on the $0.75 closing sale price of our common stock on February 18, 2014, the total value of the shares of our common stock issuable upon conversion of the Preferred Stock, and the shares of our common stock issuable upon conversion of the Preferred Stock issuable upon conversion of the Notes is $41,343,750.
Holders of Preferred Stock are entitled to receive, when, as and if declared by the board of directors of the Company, out of any funds legally available therefore, dividends per share of Preferred Stock in an amount equal to 6.0% per annum of the stated value per share. The first date on which dividends are payable is February 18, 2015, and, thereafter, dividends are payable semi-annually in arrears on February 18 and August 18 of each year. Dividends, whether or not declared, begin to accrue and be cumulative from February 18, 2014. If we do not pay any dividend in full on any scheduled dividend payment date, then dividends thereafter will accrue at an annual rate of 8.0% of the stated value of the Preferred Stock from such scheduled dividend payment date to the date that all accumulated dividends on the Preferred Stock have been paid in cash in full. In addition, if we do not meet minimum borrowing availability tests under our Credit Agreement with Salus, we may not pay dividends on the Preferred Stock.
We have agreed to use our commercially reasonable efforts to provide each stockholder entitled to vote at a Stockholder Meeting a proxy statement soliciting each such stockholder’s affirmative vote at the Stockholder Meeting for approval of the Charter Amendment to the certificate of incorporation of the Company to increase the number of authorized and unissued shares of our common stock by an amount not less than the maximum number of shares of our common stock issuable upon conversion of the Preferred Stock (x) as of February 18, 2014, the closing date of the Private Placement, upon conversion of the shares of Preferred Stock and (y) thereafter upon conversion of shares of Preferred Stock issuable upon conversion of the Notes. The Company has agreed to use its commercially reasonable efforts to hold the Stockholder Meeting within 120 days of the closing of the Private Placement. Each investor in the Private Placement has agreed to vote all shares of our common stock it beneficially owns on the record date applicable to the Stockholder Meeting that are eligible to vote in favor of the Charter Amendment.
Based on our current and anticipated future results of operations and the proceeds we received from the Private Placement, we believe that our current cash balance, cash flow from operations and availability under our Credit Agreement will be sufficient to meet our cash requirements for operations and planned capital expenditures at least through the end of our current fiscal year. However, if cash balances, cash flow from operations and availability under our Credit Agreement are not sufficient to meet our capital requirements, then we may be required to obtain additional equity or debt financing in the future. Such equity or debt financing may not be available to us when we need it or, if available, may not be on terms that will be satisfactory to us or may be dilutive to our stockholders. If financing is not available when required or is not available on acceptable terms, we may be unable to take advantage of business opportunities or respond to competitive pressures, and may not be able to operate our business as planned which could lead to a reduction in capital expenditures. Any of these events could have a material and adverse effect on our business, results of operations and financial condition.
Net cash used in operating activities of continuing operations was $59.4 million for fiscal 2013 compared to $9.2 million in fiscal 2012 and net cash provided by operating activities of $3.6 million in fiscal 2011. Cash used in operating activities in fiscal 2013 was mainly due to the funding of the net operating loss, payment of restricted cash to support letters of credit and timing of payments to vendors. Cash used in operating activities in fiscal 2012 was mainly due to the funding of the net operating loss. Cash provided by operating activities in fiscal 2011 was due to the receipt of an income tax refund, receipt of restricted cash which previously supported our outstanding letters of credit under a credit facility with Wells Fargo and the timing of vendor payments, offset by the funding of the net operating loss.
Net cash used in investing activities of continuing operations was $2.8 million in fiscal 2013, $3.9 million in fiscal 2012, and $4.0 million in fiscal 2011. The $2.8 million used in fiscal 2013 was due primarily to capital expenditures associated with investments in technology, the construction of new retail stores, and store refurbishing projects. The $3.9 million used in fiscal 2012 was due primarily to capital expenditures associated with investments in technology , the construction of a new retail store, and store refurbishing projects. The $4.0 million used in fiscal 2011 was due primarily to capital expenditures associated with the construction of new retail stores, store refurbishing projects and investments in technology. During fiscal 2014, we expect capital expenditures to be approximately $3.5 to $4.0 million, net of tenant allowances.
Net cash provided by financing activities of continuing operations was $47.4 million in fiscal 2013 compared to -0- in fiscal 2012 and net cash used in financing activities of $0.9 million in fiscal 2011. Cash provided by financing activities in fiscal 2013 related to proceeds received from the private placement and proceeds from the Credit Agreement offset by costs to obtain the Credit Agreement. Cash used in financing activities in fiscal 2011 related to costs incurred to obtain the GE Agreement.
Contractual Obligations
The following table presents our significant contractual obligations as of February 1, 2014:
(1) Our operating lease obligations are primarily related to dELiA*s retail stores and our corporate headquarters.
(2) Our purchase obligations are primarily related to inventory commitments and service agreements.
(3) Our future severance-related payments provide for cash severance to certain senior executives of up to one times base salary plus bonus, and certain other payments and benefits following any termination without cause or for “good reason.” As of February 1, 2014, these cash severance benefits approximated $2.6 million. In the event of a termination following a change in control of the Company, these senior executives will receive, in the aggregate, approximately $2.8 million of cash severance benefits.
We have long-term noncancelable operating lease commitments for retail stores and office space.
Critical Accounting Estimates
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses, among other things, our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Our significant accounting policies are more fully described in Note 2 to our consolidated financial statements. We believe, however, the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
Direct marketing revenues are recognized at the time of shipment to customers. These revenues are net of any promotional price discounts and an allowance for sales returns. The allowance for sales returns is estimated based upon our direct marketing return policy, historical experience and evaluation of current sales and returns trends. Direct marketing revenues also include shipping and handling billed to customers.
Retail store revenues are recognized at the point of sale, net of any promotional price discounts and an allowance for sales returns. The allowance for sales returns is estimated based upon our retail return policy, historical experience and evaluation of current sales and returns trends.
The Company’s policy with respect to gift certificates and gift cards is to record revenue as they are redeemed for merchandise. Prior to their redemption, these gift certificates and gift cards are recorded as a liability. The liability remains on the Company’s books until the earlier of redemption (recognized as revenue) or when the Company determines the likelihood of redemption is remote (recognized as other operating income). The Company determines the probability of the gift card being redeemed to be remote based on historical redemption patterns. For those gift cards that we determine redemption to be remote, we reverse our liability and record breakage income. The Company recorded $1.2 million, $2.6 million and $1.2 million of breakage income in fiscal 2013, fiscal 2012 and fiscal 2011, respectively.
While the Company will continue to honor all gift certificates and gift cards presented for payment, management reviews unclaimed property laws to determine gift certificate and gift card balances required for escheatment to the appropriate government agency.
Catalog Costs
Catalog costs consist of catalog production and mailing costs. These costs are capitalized and expensed over the expected future revenue stream, which is customarily two to four months from the date the catalogs are mailed.
An estimate of the future sales dollars to be generated from each individual catalog mailing serves as the foundation for our catalog costs policy. The estimate of future sales is calculated for each mailing using historical trends for catalogs mailed in similar prior periods as well as the overall current sales trend for each individual direct marketing brand. This estimate is compared with the actual sales generated-to-date for the catalog mailing to determine the percentage of total catalog costs to be capitalized as prepaid expenses on our consolidated balance sheets. Deferred catalog costs as of February 1, 2014 and February 2, 2013 were approximately $1.4 million and $1.0 million, respectively.
Catalog costs expensed for fiscal 2013, 2012, and 2011 were approximately $11.7 million, $12.2 million, and $11.4 million, respectively, and are included within selling, general and administrative expenses in the accompanying consolidated statements of operations.
Inventories
Inventories, which consist of finished goods, including certain expenses capitalized, are stated at the lower of cost (first-in, first-out method) or market value. Inventories may include items that have been written down to our best estimate of their net realizable value. Our decisions to write-down and establish valuation allowances against our merchandise inventories are based on our current and projected rate of sale, the age of the inventory and other factors such as brand appropriateness, as well as changes in fashion trends and customer preferences. Actual final sales prices to customers may be higher or lower than our estimated sales prices and could result in a fluctuation in gross profit in subsequent periods.
Goodwill and Other Indefinite-Lived Intangible Assets
The Company follows the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 350-10, Intangibles-Goodwill and Other (“ASC 350”), which requires testing for impairment on an annual basis or between annual tests if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying amount. The Company performs its annual impairment test as of the end of its fiscal year unless indicators arise during the year.
Determining the fair value of our direct marketing reporting unit under the first step of the goodwill impairment test and determining the fair value of individual assets and liabilities of that reporting unit (including unrecognized intangible assets) under the second step of the goodwill impairment test is judgmental in nature and often involves the use of significant estimates and assumptions. Similarly, estimates and assumptions are used in determining the fair value of our indefinite-lived intangible assets, primarily trademarks. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and also the magnitude of any such charge.
We perform valuation analyses and consider other market information that is publicly available. Estimates of fair value are primarily determined using discounted cash flows and market comparisons. These approaches use significant estimates and assumptions including projected future cash flows (including timing), discount rates reflecting the risk inherent in future cash flows, revenue growth rates, projected long-term growth rates, royalty rates, determination of appropriate market comparables and the determination of whether a premium or discount should be applied to comparables.
Considerable management judgment is necessary to estimate the fair value of our direct marketing reporting unit and indefinite-lived intangible assets which may be impacted by future actions taken by us or our competitors and the economic environment in which we operate. These estimates affect the balance of goodwill as well as intangible assets on our consolidated balance sheets and operating expenses on our consolidated statements of operations.
We recognized a goodwill impairment charge on the remaining balance of goodwill related to the direct marketing reporting unit of $4.5 million in fiscal 2012 primarily as a result of the current and projected future performance of the direct business. There was no goodwill impairment charge in fiscal 2011. See Note 4 for discussion on the fiscal 2012 goodwill impairment charge with respect to our direct marketing segment.
Impairment of Long-Lived Assets
In accordance with ASC Topic 360, Property, Plant, and Equipment (“ASC 360”), the Company’s management evaluates the value of leasehold improvements and store fixtures associated with retail stores, which have been open for a period of time sufficient to reach maturity. The Company evaluates long-lived assets for impairment at the individual store level, which is the lowest level at which individual cash flows can be identified. Impairment losses are recorded on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of the assets. When events such as these occur, the impaired assets are adjusted to their estimated fair value and an impairment loss is recorded separately as a component of operating income under impairment of long-lived assets.
We measure fair value by discounting estimated future cash flows using an appropriate discount rate. Considerable judgment by us is necessary to estimate the fair value of the assets and accordingly, actual results could vary significantly from such estimates. Our most significant estimates and judgments relating to the long-lived asset impairments include the timing and amount of projected future cash flows and the discount rate selected to measure the risks inherent in future cash flows.
We recorded impairment charges of approximately $3.5 million, $0.2 million and $0.5 million for fiscal 2013, fiscal 2012 and fiscal 2011, respectively, related to under-performing stores.
Income taxes
Income taxes are calculated in accordance with ASC Topic 740-10, Income Taxes (“ASC 740-10”), which requires the use of the asset and liability method. Deferred tax assets and liabilities are recognized based on the difference between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using current enacted tax rates in effect in the years in which those temporary differences are expected to reverse. Inherent in the measurement of deferred balances are certain judgments and interpretations of enacted tax law and published guidance with respect to applicability to the Company’s operations. The effective tax rate utilized by the Company reflects management’s judgment of the expected tax liabilities within the various taxing jurisdictions.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, net operating loss carryback potential, and tax planning strategies in making these assessments.
The Company adopted amendments to ASC 740-10 which clarified the accounting for uncertainty in income taxes recognized in the financial statements. These amendments prescribe a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by the taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate audit settlement.
The Company recognizes interest accrued for increases in the net liability for unrecognized income tax benefits in interest expense and any related penalties in income tax expense.
The Company’s U.S. subsidiaries join in the filing of a U.S. federal consolidated income tax return. The U.S. federal statute of limitations remains open for the fiscal years 2010, 2011 and 2012. State income tax returns are generally subject to examination for a period of 3 to 5 years after filing of the respective returns. The state impact of any federal changes remains subject to examination by various states for a period of up to one year after formal notification to the states.
Recently Adopted Standards
In July 2012, the FASB issued Accounting Standards Update (“ASU”) 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment (“ASU 2012-02”), which amends ASC 350, to permit an entity to first assess qualitative factors to determine if it is more likely than not that an indefinite-lived intangible asset is impaired and whether it is necessary to perform the impairment test of comparing the carrying amount with the recoverable amount of the indefinite-lived intangible asset. This guidance is effective for interim and annual impairment tests performed in fiscal years beginning after September 15, 2012, with early adoption permitted. The Company adopted ASU 2012-02 in the first quarter of fiscal 2013 with no impact on its consolidated financial statements.
Recently Issued Standards
In July 2013, the FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (“ASU 2013-11”), which requires that an unrecognized tax benefit, or portion of an unrecognized tax benefit, be presented as a reduction of a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. If an applicable deferred tax asset is not available or a company does not expect to use the applicable deferred tax asset, the unrecognized tax benefit should be presented as a liability in the financial statements and should not be combined with an unrelated deferred tax asset. ASU 2013-11 is effective for annual
reporting periods, and interim periods within those years, beginning after December 15, 2013. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date; however, retrospective application is permitted. The Company will adopt ASU 2013-11 in the first quarter of 2014 and is not expected to have a material impact on its consolidated financial statements.
Off-Balance Sheet Arrangements
We enter into letters of credit issued under the Letter of Credit Agreement to facilitate the purchase of merchandise.
dELiA*s Brand, LLC, one of our subsidiaries, entered into a license agreement in 2003 with JLP Daisy that grants JLP Daisy exclusive rights (except for our rights) to use the dELiA*s trademarks and copyrightable artwork to advertise, promote and market the licensed products, and to sublicense to permitted sublicensees the right to use the trademarks and artwork in connection with the manufacture, sale and distribution of the licensed products to approved wholesale customers. See Note 12 to the consolidated financial statements for further discussion of this license agreement.
We do not maintain any other off-balance sheet transactions, arrangements, obligations or other relationships with unconsolidated entities or others that are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Guarantees
We have no significant financial guarantees.
Inflation
In general, our costs, some of which include postage, paper, cotton, freight and energy costs, are affected by inflation and we may experience the effects of inflation in future periods. We believe, however, that such effects have not been material to us during the past year.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
From time to time, we have significant amounts of cash and cash equivalents invested in deposit accounts at FDIC-insured financial institutions that are in excess of the federally insured limit. We cannot be assured that we will not experience losses with respect to cash on deposit in excess of the federally insured limits. As of February 1, 2014, we did not hold any marketable securities and do not own any derivative financial instruments in our portfolio, thus we do not believe there is any material market risk exposure with respect to these items.
As at February 1, 2014, we had $14.5 million of outstanding borrowings under our Credit Agreement, thus we are exposed to market risk related to changes in interest rates. Loans under our Credit Agreement bear interest based at variable rates. Accordingly, any increase or decrease in the applicable interest rate on our borrowings under the Credit Agreement would increase or decrease interest expense and, accordingly, affect our net income or loss.
We are also indirectly exposed to market risk with respect to changes in the global price level of certain commodities used in the production of our products. Changes in the cost of fabrics or other raw materials used to manufacture our merchandise may be passed on to us, in whole or in part, in the form of changes in our cost of goods, and, if so, would affect our cost of goods and our results of operations.
Item 8.
Item 8. Financial Statements and Supplementary Data
The consolidated financial statements, financial statement schedule and notes to the consolidated financial statements of dELiA*s, Inc. and subsidiaries are annexed to and made part of this Annual Report on Form 10-K as pages through. An index of such materials appears on page.
Item 9.
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of February 1, 2014. Based upon such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, February 1, 2014, our disclosure controls and procedures were effective to ensure both that (i) information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Exchange Act, and (ii) information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management as appropriate to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Securities Exchange Act Rule 13a-15(f). Our system of internal control is evaluated on a cost benefit basis and is designed to provide reasonable, not absolute, assurance that reported financial information is materially accurate.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the design and effectiveness of our internal control over financial reporting based on the criteria set forth in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control-Integrated Framework (1992), our Chief Executive Officer and Chief Financial Officer concluded that our internal control over financial reporting was effective as of February 1, 2014.
Limitations of the Effectiveness of Internal Control
A control system, no matter how well conceived and operated, can only provide reasonable, not absolute, assurance that the objectives of the internal control system are met. Because of the inherent limitations of any internal control system, no evaluation of controls can provide absolute assurance that all control issues, if any, have been detected.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended February 1, 2014 identified in connection with the evaluation thereof by our management, including the Chief Executive Officer and Chief Financial Officer, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
On April 17, 2014, the Company and American Stock Transfer and Trust Company, LLC entered into the Second Amendment to the Rights Agreement (the “Rights Amendment”), which amended that certain Stockholder Rights Agreement, dated as of December 19, 2005, as amended by the First Amendment to the Rights Agreement, dated as of February 18, 2014 (as amended, the “Rights Agreement”). The Rights Amendment further clarifies that no Valinor Shareholder (as defined in the Rights Amendment) or Flatbush Shareholder (as defined in the Rights Amendment) shall be deemed to be an “Acquiring Person” by virtue of or as a result of (1) the execution and delivery of that certain Securities Purchase Agreement dated February 18, 2014 by and among the Company and the investors to be identified on the signature pages thereto (the “Securities Purchase Agreement”), (2) the sale by the Company of its securities to, and the purchase from the Company of its securities by, any Valinor Shareholder or Flatbush Shareholder, (3) the conversion at any time and from time to time of any such securities into any other securities of the Company, or (4) the other transactions contemplated by the Securities Purchase Agreement.
The foregoing description of the terms of the Rights Amendment does not purport to be complete and is subject to, and qualified in its entirety by, the full text of the Rights Amendment which is attached hereto as Exhibit 10.18.2, and is incorporated herein by reference.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Except for information with respect to our executive officers set forth in Part I of this Annual Report on Form 10-K under the caption “Executive Officers of the Registrant,” the 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
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 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 Schedule
FINANCIAL STATEMENTS, SCHEDULE AND EXHIBITS
(1) Consolidated Financial Statements.
The financial statements required by this item are set forth on pages through of this Annual Report on Form 10-K, and are incorporated by reference herein.
(2) Financial Statement Schedule.
The schedule required by this item is set forth on page of this Annual Report on Form 10-K, and is incorporated by reference herein.
(3) Exhibits.
The exhibit list required by this item is set forth under the caption “Exhibit Index” in this Annual Report on Form 10-K, and is incorporated by reference herein.
dELiA*s, Inc. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
Page
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Changes in Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Financial Statement Schedule
The following financial statement schedule is included herein:
Schedule II-Valuation and Qualifying Accounts
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of
dELiA*s, Inc.
New York, New York
We have audited the accompanying consolidated balance sheets of dELiA*s, Inc. (the “Company”) as of February 1, 2014 and February 2, 2013 and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the three years in the period ended February 1, 2014. In connection with our audits of the financial statements, we have also audited the financial statement schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of dELiA*s, Inc. at February 1, 2014 and February 2, 2013, and the results of its operations and its cash flows for each of the three years in the period ended February 1, 2014, in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the 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.
/s/BDO USA, LLP
New York, NY
April 17, 2014
dELiA*s, Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value and share data)
See accompanying notes to consolidated financial statements
dELiA*s, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
See accompanying notes to consolidated financial statements
dELiA*s, Inc.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(in thousands, except share data)
See accompanying notes to consolidated financial statements
dELiA*s Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying notes to consolidated financial statements
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In these Notes to Consolidated Financial Statements, when we refer to “Alloy, LLC” we are referring to Alloy, LLC, our former parent corporation, and when we refer to “Alloy” we are referring to the Alloy-branded direct marketing and merchandising business that we previously operated. Similarly, when we refer to “dELiA*s” we are referring to the dELiA*s-branded direct marketing, merchandising and retail store business that we operate, when we refer to “dELiA*s, Inc.,” the “Company,” “we,” “us,” or “our,” we are referring to dELiA*s, Inc. and its subsidiaries. When we refer to “the Spinoff,” we are referring to the December 19, 2005 spinoff of the outstanding common shares of dELiA*s, Inc. to the Alloy, LLC shareholders.
1. Business and Basis of Presentation
Business
We are a multi-channel retail company primarily marketing to teenage girls. We generate revenues by selling to consumers through the integration of our e-commerce website, direct mail catalogs and mall-based retail stores. Through our e-commerce website and catalogs, we sell our own proprietary brand products, together with brand name products, in key spending categories directly to consumers, including apparel and accessories. Our mall-based retail stores derive revenues primarily from the sale of proprietary apparel and accessories and, to a lesser extent, branded apparel.
See Note 10 for a private placement transaction which occurred subsequent to our fiscal year end February 1, 2014.
Fiscal Year
The Company’s fiscal year ends on the Saturday closest to January 31st, typically resulting in a 52-week year, but occasionally giving rise to an additional week, resulting in a 53-week year. We refer to the 52-week year ended February 1, 2014 as “fiscal 2013,” and to the 53-week fiscal year ended February 2, 2013 as “fiscal 2012,” and to the 52-week fiscal year ended January 28, 2012 as “fiscal 2011.”
Reclassifications
Certain reclassifications have been made to prior year amounts to conform with current year presentation. The effect of these reclassifications is not material.
Basis of Presentation
The accompanying consolidated financial statements include the historical financial statements of and transactions applicable to the Company and reflect its assets, liabilities, results of operations and cash flows.
2. Discontinued Operations and Assets Held for Sale
On June 4, 2013, A Merchandise, LLC (formerly Alloy Merchandise, LLC), a wholly-owned subsidiary of the Company (“Alloy Merchandising”), and the Company entered into an Asset Purchase Agreement (the “Asset Purchase Agreement”) with HRSH Acquisitions LLC d/b/a Alloy Apparel and Accessories (“Buyer”) and concurrently closed the transaction under the Asset Purchase Agreement. Subject to the terms and conditions of the Asset Purchase Agreement, Alloy Merchandising sold certain assets and transferred certain related liabilities related to its Alloy business to Buyer, and Buyer purchased such assets and assumed certain related liabilities. Upon closing of the transaction, the Company received $3.7 million in cash proceeds, subject to adjustment as provided in the Asset Purchase Agreement, and the Buyer assumed $3.3 million in liabilities. The final purchase
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
price was approximately $3.4 million. The loss on sale from this transaction was immaterial. The Company also agreed to provide certain transition services to Buyer, for up to one year, at specified rates following the consummation of the transaction. The financial impact of the transitional services was not material. In March 2014, the transitional services provided by the Company to the Buyer were extended to December 31, 2014.
Accordingly, the results of the Company’s former Alloy business have been reported as discontinued operations for all periods presented. In discontinued operations, the Company has reversed its allocation of shared services to the Alloy business and has charged discontinued operations with the administrative and distribution expenses that were attributable to Alloy.
(Loss) income from discontinued operations, net of taxes, was ($1.1 million), $1.4 million and $2.8 million for fiscal 2013, fiscal 2012 and fiscal 2011, respectively.
Discontinued operations were comprised of (in thousands):
Assets and liabilities of discontinued operations held for sale included the following (in thousands):
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
3. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of dELiA*s, Inc. and our wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Concentration of Risk
We collect payment for all merchandise, and perform credit card authorizations and check verifications for all customers prior to shipment or delivery. Our cash equivalents include amounts derived from credit card purchases from customers and are typically settled within two to four days. Due to the diversified nature of our client base, we do not believe that we are exposed to a concentration of credit risk.
Fair Value of Financial Instruments
We follow the guidance in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurement Disclosures (“ASC 820”), as it relates to financial and nonfinancial assets and liabilities. We currently have no financial assets or liabilities that are measured at fair value. Our non-financial assets, which include property and equipment, intangibles and goodwill are not required to be measured at fair value on a recurring basis. However, if certain triggering events occur, or if an annual impairment test is required and we are required to evaluate the non-financial asset for impairment, a resulting asset impairment would require that the non-financial asset be recorded at the fair value. ASC 820 prioritizes inputs used in measuring fair value into a hierarchy of three levels: Level 1-quoted prices (unadjusted) in active markets for identical assets or liabilities; Level 2-inputs other than quoted prices included within Level 1 that are either directly or indirectly observable; and Level 3-unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The carrying amounts of our financial instruments, including cash and cash equivalents, receivables, payables and bank loan payable approximated fair value due to the short maturity of these financial instruments.
Self Insurance
The Company uses a combination of insurance and self-insurance for certain losses related to its employee medical plan. Costs for self-insurance claims filed, as well as claims incurred but not reported, are accrued based on management’s estimates, using information received from plan administrators, historical analysis and other relevant data. Management believes that it has adequately reserved for its self-insurance liability, which is capped through the use of stop loss contracts with insurance companies. However, any significant variation from historical trends in claims incurred but not paid could cause actual expense to differ from the accrued liability.
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and credit card receivables. Credit card receivable balances included in cash and cash equivalents as of February 1, 2014 and February 2, 2013 were approximately $0.8 million and $1.4 million, respectively.
Restricted Cash
Restricted cash consists of cash collateral for letters of credit, and is shown either as current or non-current, depending on the expiration provisions of the letter of credit. As of February 1, 2014, current restricted cash was $8.2 million and non-current restricted cash was $1.2 million. There was no restricted cash as of February 2, 2013.
Inventories
Inventories, which consist of finished goods, including certain expenses capitalized, are stated at the lower of cost (first-in, first out method) or market value. Inventories may include items that have been written down to our best estimate of their net realizable value. Our decisions to write-down and establish valuation allowances against our merchandise inventories are based on our current and projected rate of sale, the age of the inventory and other factors such as brand appropriateness, as well as changes in fashion trends and customer preferences. Actual final sales prices to customers may be higher or lower than our estimated sales prices and could result in a fluctuation in gross profit in subsequent periods.
Prepaid Catalog Costs
Catalog costs consist of catalog production and mailing costs. These costs are capitalized and expensed over the expected future revenue stream, which is customarily two to four months from the date the catalogs are mailed. Deferred catalog costs as of February 1, 2014 and February 2, 2013 were approximately $1.4 million and $1.0 million, respectively. Catalog costs expensed for fiscal 2013, fiscal 2012 and fiscal 2011 were approximately $11.7 million, $12.2 million, and $11.4 million, respectively, and are included within selling, general and administrative expenses in the accompanying consolidated statements of operations.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation. Amortization of leasehold improvements is computed on the straight-line method over the lesser of an asset’s estimated useful life or the life of the related store’s lease (generally seven to 10 years). Depreciation on furniture, fixtures and equipment is computed on the straight-line method over the lives noted below. Maintenance and repairs are expensed as incurred.
The following estimated useful lives are used to determine depreciation or amortization:
Construction in progress
N/A
Leasehold improvements
Life of the lease*
Computer software and equipment
3 to 5 Years
Machinery and equipment
3 to 10 Years
Office furniture and store fixtures
5 to 10 Years
Building
39 Years
Land
N/A
* defined as the lesser of an asset’s estimated life or the life of the related lease
Costs of Computer Software Developed or Obtained for Internal Use
As required by ASC Topic 350-40, Internal-Use Software, the Company capitalizes costs related to internally developed software. Only costs incurred during the development stages, including design, coding,
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
installation and testing are capitalized. These capitalized costs primarily represent internal labor costs for employees directly associated with the software development. Upgrades or modifications that result in additional functionality are capitalized.
Goodwill and Other Indefinite-Lived Intangible Assets
The Company follows the provisions of ASC Topic 350-10, Intangibles-Goodwill and Other (“ASC 350-10”), which requires testing for impairment on an annual basis or between annual tests if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying amount. The Company performs its annual impairment test as of the end of its fiscal year unless indicators arise during the year.
Determining the fair value of our direct marketing reporting unit under the first step of the goodwill impairment test and determining the fair value of individual assets and liabilities of that reporting unit (including unrecognized intangible assets) under the second step of the goodwill impairment test is judgmental in nature and often involves the use of significant estimates and assumptions. Similarly, estimates and assumptions are used in determining the fair value of our indefinite-lived intangible assets, primarily trademarks. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and also the magnitude of any such charge.
We perform valuation analyses and consider other market information that is publicly available. Estimates of fair value are primarily determined using discounted cash flows, market comparisons as well as a cost approach. These approaches use significant estimates and assumptions including projected future cash flows (including timing), discount rates reflecting the risk inherent in future cash flows, revenue growth rates, projected long-term growth rates, royalty rates, determination of appropriate market comparables and the determination of whether a premium or discount should be applied to comparables.
Considerable management judgment is necessary to estimate the fair value of our direct marketing reporting unit and indefinite-lived intangible assets which may be impacted by future actions taken by us or our competitors and the economic environment in which we operate. These estimates affect the balance of goodwill as well as intangible assets on our consolidated balance sheets and operating expenses on our consolidated statements of operations.
In fiscal 2012, we recognized a goodwill impairment charge related to the direct marketing reporting unit of $4.5 million, resulting in the full write-off goodwill as of February 2, 2013. See Note 5 for discussion on the fiscal 2012 goodwill impairment charge with respect to our direct marketing segment.
Impairment of Long-Lived Assets
In accordance with ASC Topic 360, Property, Plant, and Equipment, the Company’s management evaluates the value of leasehold improvements and store fixtures associated with retail stores, which have been open for a period of time sufficient to reach maturity. The Company evaluates long-lived assets for impairment at the individual store level, which is the lowest level at which individual cash flows can be identified. Impairment losses are recorded on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of the assets. When events such as these occur, the impaired assets are adjusted to their estimated fair value and an impairment loss is recorded separately as a component of operating income under impairment of long-lived assets.
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
We measure fair value by discounting estimated future cash flows using an appropriate discount rate. Considerable judgment by us is necessary to estimate the fair value of the assets and accordingly, actual results could vary significantly from such estimates. Our most significant estimates and judgments relating to the long-lived asset impairments include the timing and amount of projected future cash flows and the discount rate selected to measure the risks inherent in future cash flows.
We recorded impairment charges of approximately $3.5 million, $0.2 million and $0.5 million for fiscal 2013, fiscal 2012 and fiscal 2011, respectively, related to under-performing stores (see Note 4).
Sales and Use Tax
In accordance with ASC Topic 605-40, Revenue Recognition, the Company records sales tax charged on merchandise sales on a net basis (excluded from revenue).
Revenue Recognition
Direct marketing revenues are recognized at the time of shipment to customers. These revenues are net of any promotional price discounts and an allowance for sales returns. The allowance for sales returns is estimated based upon our direct marketing return policy, historical experience and evaluation of current sales and returns trends. Direct marketing revenues also include shipping and handling billed to customers.
Retail store revenues are recognized at the point of sale, net of any promotional price discounts and an allowance for sales returns. The allowance for sales returns is estimated based upon our retail return policy, historical experience and evaluation of current sales and returns trends.
We recognize other revenues that consist primarily of advertising provided for third parties in our catalogs, on our e-commerce website, in our outbound packages, and in our retail stores pursuant to specific pricing arrangements with Alloy, LLC. Alloy, LLC arranges these advertising services on our behalf pursuant to a media services agreement entered into in connection with the Spinoff which was amended and restated effective December 2010 (see Note 12 to our financial statements). We believe that the terms and conditions of this relationship are similar to those that we could obtain in the marketplace. We also recognize revenue from the sale of offline magazine subscriptions to our telephone direct marketing customers at the time of purchase. The revenue from third-party advertising and offline magazine subscription sales was approximately $0.1 million, $0.2 million, and $0.3 million for fiscal 2013, fiscal 2012 and fiscal 2011, respectively.
The Company’s policy with respect to gift certificates and gift cards is to record revenue as they are redeemed for merchandise. Prior to their redemption, these gift certificates and gift cards are recorded as a liability. The liability remains on the Company’s books until the earlier of redemption (recognized as revenue) or when the Company determines the likelihood of redemption is remote (recognized as other operating income). The Company determines the probability of the gift card being redeemed to be remote based on historical redemption patterns. For those gift cards that the Company determines redemption to be remote, we reverse our liability and record breakage income. The Company recognized approximately $1.2 million, $2.6 million and $1.2 million of breakage income in fiscal 2013, fiscal 2012 and fiscal 2011, respectively, which is recorded in other operating income in the consolidated financial statements.
While the Company will continue to honor all gift certificates and gift cards presented for payment, management reviews unclaimed property laws to determine gift certificate and gift card balances required for escheatment to the appropriate government agency.
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Cost of Goods Sold
Cost of goods sold consists of the cost of merchandise sold to customers, inbound freight costs, shipping and handling costs, buying and merchandising costs, certain distribution costs and store occupancy costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of catalog production and mailing costs; certain fulfillment and distribution costs; store personnel wages and benefits; other store expenses, including supplies, maintenance and visual programs; administrative staff and infrastructure expenses; depreciation; amortization and facility expenses. Credit card fees, insurance and other miscellaneous operating costs are also included in selling, general and administrative expenses.
Store Pre-Opening Costs
Store pre-opening costs consist primarily of rent, supplies and payroll expenses. These costs are expensed as incurred.
Stock-Based Compensation
The Company accounts for stock-based awards in accordance with ASC Topic 718-10, Compensation-Stock Compensation, which requires the measurement and recognition of stock-based compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service period. For awards with performance conditions, an evaluation is made at the grant date and future periods as to the likelihood of the performance criteria being met. Compensation expense is adjusted in future periods for subsequent changes in the expected outcome of the performance conditions until the vesting date. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
Interest Expense (Income), Net
Interest income and expense is presented net in the consolidated statements of operations. Interest income is derived from cash in bank accounts. Interest income for fiscal 2013, fiscal 2012, and fiscal 2011 was $-0-, $-0-, and $3,000, respectively. Interest expense primarily relates to the credit facilities with Salus, GE Capital and Wells Fargo (which was terminated in May 2011). Interest expense for fiscal 2013, fiscal 2012, and fiscal 2011 was $4.7 million, $0.7 million, and $0.6 million, respectively. Included in fiscal 2013 was interest expense related to the conversion of notes payable to equity (see Note 10).
Net (Loss) Income Per Share
We have outstanding restricted stock grants that contain nonforfeitable rights to dividends (whether paid or unpaid) which qualify these shares as participating securities, requiring them to be included in the computation of earnings per share pursuant to the two-class method. Under the two-class method, all earnings (distributed and undistributed) are allocated to common shares and participating securities based on their respective rights to receive dividends. In periods of loss, the unvested restricted stock are not considered participating securities as they are not obligated to fund losses. Basic earnings per common share is calculated by dividing earnings allocated to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect, in periods in which they have a dilutive effect, the effect of unvested
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
restricted stock not classified as participating securities and common shares issuable upon exercise of stock options or warrants. The difference between reported basic and diluted weighted-average common shares results from the assumption that all dilutive stock options and warrants outstanding were exercised and all outstanding restricted shares have vested as determined by applying the “treasury stock” method. For all periods presented in which there were losses, fully diluted losses per share do not differ from basic earnings per share.
The total number of potential common shares with an anti-dilutive impact, excluded from the calculation of diluted net (loss) income per share, is detailed in the following table:
Operating Leases
The Company leases property for its stores and its corporate headquarters under operating leases. Operating lease agreements typically contain construction allowances, rent escalation clauses and/or contingent rent provisions.
For construction allowances, the Company records a deferred lease credit on the consolidated balance sheet and amortizes the deferred lease credit as a reduction of rent expense on the consolidated statement of operations over the terms of the leases. For scheduled rent escalation clauses during the lease terms, the Company records minimum rental expenses on a straight-line basis over the terms of the leases on the consolidated statement of operations. The term of the lease over which the Company amortizes construction allowances and minimum rental expenses on a straight-line basis begins on the date of initial possession, which is generally when the Company enters the space and begins to make improvements in preparation for its intended use, not necessarily the cash rent commencement date.
Certain store leases provide for contingent rents, which are determined as a percentage of gross sales in excess of specified levels. The Company records a contingent rent liability in accrued expenses on the consolidated balance sheets and the corresponding rent expense when management determines that achieving the specified levels during the fiscal year is probable.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Income Taxes
Income taxes are calculated in accordance with ASC Topic 740-10, Income Taxes (“ASC 740-10”), which requires the use of the asset and liability method. Deferred tax assets and liabilities are recognized based on the difference between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using current enacted tax rates in effect in the years in which those temporary differences are expected to reverse. Inherent in the measurement of deferred balances are certain judgments and interpretations of enacted tax law and published guidance with respect to applicability to the Company’s operations. The effective tax rate utilized by the Company reflects management’s judgment of the expected tax liabilities within the various taxing jurisdictions.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion of all of the deferred tax assets will not be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, net operating loss carryback potential, and tax planning strategies in making these assessments.
The Company adopted amendments to ASC 740-10 which clarified the accounting for uncertainty in income taxes recognized in the financial statements. These amendments prescribe a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by the taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate audit settlement.
The Company recognizes interest accrued for increases in the net liability for unrecognized income tax benefits in interest expense and any related penalties in income tax expense.
Recently Adopted Standards
In July 2012, the FASB issued Accounting Standards Update (“ASU”) 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment (“ASU 2012-02”), which amends ASC 350-10 to permit an entity to first assess qualitative factors to determine if it is more likely than not that an indefinite-lived intangible asset is impaired and whether it is necessary to perform the impairment test of comparing the carrying amount with the recoverable amount of the indefinite-lived intangible asset. This guidance is effective for interim and annual impairment tests performed in fiscal years beginning after September 15, 2012, with early adoption permitted. The Company adopted ASU 2012-02 in the first quarter of fiscal 2013 with no impact on its consolidated financial statements.
Recently Issued Standards
In July 2013, the FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (“ASU 2013-11”), which requires that an unrecognized tax benefit, or portion of an unrecognized tax benefit, be presented as a reduction of a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. If an applicable deferred tax asset is not available or a company does not expect to use the applicable deferred tax asset, the unrecognized tax benefit should be presented as a liability in the financial statements and should not be combined with an unrelated deferred tax asset. ASU 2013-11 is effective for annual reporting periods, and interim periods within those years, beginning after December 15, 2013. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date; however, retrospective application is permitted. The Company will adopt ASU 2013-11 in the first quarter of 2014 and is not expected to have a material impact on its consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
4. Property and Equipment, net
Property and equipment (net) consisted of the following:
Depreciation and amortization expense related to property and equipment was approximately $8.2 million, $9.6 million (including $0.7 million of accelerated depreciation on early lease terminations), and $11.4 million for fiscal 2013, fiscal 2012, and fiscal 2011, respectively. In fiscal 2013 and fiscal 2012, approximately $3.3 million and $5.9 million, respectively, of fully depreciated assets no longer in use were written off.
Based upon our impairment analysis of long-lived assets during fiscal 2013, fiscal 2012 and fiscal 2011, we recognized impairment charges of approximately $3.5 million, $0.2 million and $0.5 million, respectively, related to under-performing stores. Impairment charges were primarily related to revenues and margins not meeting targeted levels at the respective stores as a result of macroeconomic conditions, location related conditions and other factors that are negatively impacting the sales and cash flows of these locations.
5. Goodwill and Intangible Assets
The Company’s intangible assets consisted of the following:
The Company performed its annual goodwill impairment test as of February 2, 2013, and concluded that the carrying value of its direct marketing reporting unit goodwill exceeded the implied fair value based on the estimated fair value of the direct marketing reporting unit. Accordingly, the Company recorded a pre-tax non-cash impairment charge of $4.5 million for fiscal 2012 primarily as a result of the current and projected future performance of the direct marketing business. As a result of this impairment charge, goodwill was fully written off as of February 2, 2013. There was no impairment charge in fiscal 2011.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Additionally, based on the annual impairment test performed as of February 1, 2014, the Company concluded that its indefinite-lived intangible assets were not impaired. There were no impairment charges as a result of the 2012 or 2011 impairment analysis for indefinite-lived intangible assets.
Refer to Note 3, “Summary of Significant Accounting Policies, Goodwill and Other Indefinite-Lived Intangible Assets and Impairment of Long Lived Intangible Assets,” for further details regarding our procedure for evaluating goodwill and other intangible assets for impairment.
6. Credit Facility
The Company and certain of its wholly-owned subsidiaries were parties to a credit agreement (the “GE Agreement”) with General Electric Capital Corporation (“GE Capital”), as a lender and as agent for the financial institutions from time to time party to the GE Agreement (together with GE Capital in its capacity as a lender, the “GE Lenders”). The GE Agreement provided for a total aggregate commitment of the GE Lenders of $25 million, including a $15 million sublimit for the issuance of letters of credit and a swingline loan facility of $5 million. The GE Agreement had a term of five years and was to mature on May 26, 2016. The obligations of the borrowers under the GE Agreement were secured by substantially all property and assets of the Company and certain of its subsidiaries.
The GE Agreement called for the payment by the Company of a fee of 0.375% per annum on the average unused portion of the GE Agreement, a letter of credit fee calculated using a per annum rate equal to the Applicable Margin with respect to letters of credit (as defined in the GE Agreement) multiplied by the average outstanding face amount of letters of credit issued under the GE Agreement, as well as other customary fees and expenses. Interest accrued on the outstanding principal amount of the revolving credit loans at an annual rate equal to LIBOR (as defined in the GE Agreement) or the Base Rate (as defined in the GE Agreement), plus an applicable margin which was subject to periodic adjustment based on average excess availability under the GE Agreement. Interest on each swingline loan was calculated using the Base Rate. The GE Agreement did not contain any financial covenants with which the Company or any of its subsidiaries or affiliates had to comply during the term of the GE Agreement.
The GE Agreement contained customary representations and warranties, as well as customary covenants that, among other things, restricted the ability of the Company and its subsidiaries to incur liens, consolidate or merge with other entities, incur certain additional indebtedness and guaranty obligations, pay dividends or make certain other restricted payments. The GE Agreement also contained customary events of default, including payment defaults, breaches of representations and warranties and covenants, cross defaults to other material indebtedness, and bankruptcy and insolvency matters.
On June 14, 2013, the Company and certain of its wholly-owned subsidiaries entered into a new credit agreement (the “Credit Agreement”) with Salus Capital Partners, LLC (“Salus”), as a lender and as agent for the financial institutions from time to time party to the Credit Agreement (together with Salus in its capacity as a lender, the “Lenders”). The Credit Agreement provides for a total aggregate commitment of the Lenders of $30 million. The Credit Agreement has a term of four years and matures on June 14, 2017. The obligations of the borrowers under the Credit Agreement are secured by substantially all property and assets of the Company and certain of its subsidiaries.
The Credit Agreement calls for the payment by the Company of a fee of 0.375% per annum on the average unused portion of the Credit Agreement as well as other customary fees and expenses. Interest accrues on the outstanding principal amount of the revolving credit loans at an annual rate equal to the greater of (a) the Base Rate (as defined in the Credit Agreement) plus 3% and (b) 6.25%. The Credit Agreement does not contain any financial covenants with which the Company or any of its subsidiaries or affiliates has to comply during the term of the Credit Agreement.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The Credit Agreement contains customary representations and warranties, as well as customary covenants that, among other things, restrict the ability of the Company and its subsidiaries to incur liens, consolidate or merge with other entities, incur certain additional indebtedness and guaranty obligations, pay dividends or make certain other restricted payments. The Credit Agreement also contains customary events of default, including payment defaults, breaches of representations and warranties and covenants, cross defaults to other material indebtedness, and bankruptcy and insolvency matters.
Concurrently with the execution of the Credit Agreement, the GE Agreement was terminated and replaced with a letter of credit agreement with GE Capital (“Letter of Credit Agreement”). The Letter of Credit Agreement provides for a maximum aggregate face amount of letters of credit that may be issued, to be the lesser of (a) $15 million or (b) an amount equal to a specified percentage of cash collateral held by GE Capital. The cash collateral is required in an amount equal to 105% of the face amount of outstanding letters of credit issued. The Letter of Credit Agreement calls for a payment by the Company of a fee of 0.375% per annum on the average unused portion of the Letter of Credit Agreement, a letter of credit fee of 1.75% per annum on the average outstanding face amount of letters of credit issued under the Letter of Credit Agreement, as well as other customary fees and expenses. None of the other assets or properties of the Company, or any of its subsidiaries or affiliates, were pledged as collateral for these obligations. The Letter of Credit Agreement does not contain any financial covenants with which the Company or any of its subsidiaries or affiliates has to comply during the term of the Letter of Credit Agreement.
As of February 1, 2014, availability under the Credit Agreement was $1.3 million, net of $14.5 million in borrowings. The Credit Agreement requires the Company to have a blocked account arrangement, whereby all cash received is deposited into the blocked account and used to pay down the loan. As a result, the loan payable is classified as a current liability in the accompanying consolidated balance sheet. The effective interest rate on the Credit Agreement during fiscal 2013 was 6.25%. In addition, the Company had $8.9 million in letters of credit outstanding under the Letter of Credit Agreement and the cash collateral required to secure the Company’s obligations under the Letter of Credit Agreement was approximately $9.4 million, which is shown as restricted cash in the accompanying consolidated balance sheet.
The Company had a previous letter of credit agreement, as amended, with Wells Fargo Retail Finance II, LLC (“Wells Fargo”) (the “Wells Fargo Agreement”) which was terminated on May 26, 2011, that provided for a maximum aggregate face amount of letters of credit that may be issued, to be the lesser of (a) $10 million or (b) an amount equal to a specified percentage of cash collateral held by Wells Fargo. The cash collateral was required in an amount equal to 105% of the face amount of outstanding letters of credit issued. None of the other assets or properties of the Company, or any of its subsidiaries or affiliates, were pledged as collateral for these obligations.
7. Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consisted of the following:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
8. Long-Term Liabilities
Deferred Credits
Deferred credits consist primarily of long-term portions of deferred rent and tenant allowances. We occupy our retail stores and home office under operating leases generally with terms of seven to ten years. Some of these leases have early cancellation clauses, which permit the lease to be terminated if certain sales levels are not met in specific periods. Most of the store leases require payment of a specified minimum rent, plus a contingent rent based on a percentage of the store’s net sales in excess of a specified threshold. Most of the lease agreements have defined escalating rent provisions, which are reported as a deferred rent liability and expensed on a straight-line basis over the term of the related lease, commencing with date of possession. This includes any lease renewals deemed to be probable. In addition, we receive cash allowances from our landlords on certain properties and have reported these amounts as tenant allowances which are amortized to rent expense over the term of the lease, also commencing with date of possession. Included in deferred credits at February 1, 2014 and February 2, 2013 was $4.1 million and $5.0 million, respectively, of deferred rent liability, and $3.2 million and $3.5 million, respectively, of tenant allowances.
9. Stock-Based Compensation
Under the dELiA*s, Inc. Amended and Restated 2005 Stock Incentive Plan (the “2005 Plan”), we may grant incentive stock options, nonqualified stock options and restricted stock to employees (including officers), non-employee directors and consultants. Grants for stock options generally vest and become exercisable annually in equal installments over a four-year period and expire 10 years after the grant date, while restricted stock generally vests and becomes exercisable annually in equal installments over a three-year period. Shares available for future equity grants at February 1, 2014 and February 2, 2013 totaled 2.0 million and 4.0 million, respectively.
The Company accounts for share-based compensation under the provisions of ASC Topic 718, Compensation-Stock Compensation, which requires share-based compensation for equity awards to be measured based on estimated fair values at the date of grant.
The Company recorded stock-based compensation expense (including expense for common and restricted stock awards) of $2.1 million, $0.7 million, and $0.7 million for fiscal 2013, fiscal 2012 and fiscal 2011, respectively, related to employee and non-employee directors share-based awards and such expense is included in selling, general and administrative expense in our consolidated statements of operations. Included in fiscal 2013 was $0.5 million of stock-based compensation expense related to the conversion of the notes payable to equity as more fully disclosed in Note 10.
Stock Options
The Company estimates the fair value of stock options granted using the Black-Scholes option-pricing model, which requires the Company to estimate the expected term of stock option grants and expected future stock price volatility over the expected term.
Amounts included in stock-based compensation expense related to stock option awards were $0.6 million, $0.4 million, and $0.5 million for fiscal 2013, fiscal 2012 and fiscal 2011, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The per share weighted average fair value of stock options granted during fiscal 2013, fiscal 2012, and fiscal 2011 were $0.60, $0.81, and $0.93, respectively. The fair value of each option grant was estimated using the following weighted average assumptions:
The following table summarizes stock option activity during fiscal 2013:
The intrinsic value of stock options exercised during fiscal 2013, fiscal 2012, and fiscal 2011 was approximately $0.1 million, $-0-, and $-0-, respectively. There were no aggregate intrinsic values of stock options outstanding and stock options exercisable at February 1, 2014.
As of February 1, 2014, there was approximately $0.9 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements. That cost is expected to be recognized over a weighted average period of 1.6 years.
Restricted Stock
The fair value of restricted stock awards is calculated based on the stock price on the date of the grant. The weighted average grant date fair values for restricted stock issued during fiscal 2013, fiscal 2012, and fiscal 2011 were $0.91, $1.17, and $1.02, respectively.
Amounts included in stock-based compensation expense related to restricted stock awards were $0.7 million, $0.3 million, and $0.2 million for fiscal 2013, fiscal 2012 and fiscal 2011, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table summarizes restricted stock activity during fiscal 2013:
As of February 1, 2014, there was approximately $1.1 million of total unrecognized compensation cost related to restricted stock, which is expected to be recognized over a weighted average period of 1.8 years.
10. Stockholders’ Equity
Rights Offering
On December 30, 2005, we filed a prospectus under which we distributed at no charge to persons who were holders of our common stock on December 28, 2005 transferable rights to purchase up to an aggregate of 2,691,790 shares of our common stock at a cash subscription price of $7.43 per share (the “rights offering”). The rights offering was made to help fund the costs and expenses of our retail store expansion plan and to provide funds for general corporate purposes following the Spinoff. MLF Investments, LLC (“MLF”), which was controlled by Matthew L. Feshbach, our former Chairman of the Board, agreed to backstop the rights offering, meaning MLF agreed to purchase all shares of our common stock that remained unsold upon completion of the rights offering at the same $7.43 subscription price per share. The rights offering was completed in February 2006 with approximately $20 million of gross proceeds. Our stockholders exercised subscription rights to purchase 2,040,570 shares of dELiA*s common stock, of the 2,691,790 shares offered in the rights offering, raising a total of $15.2 million. On February 24, 2006, MLF purchased the remaining 651,220 shares for a total of $4.8 million. MLF received as compensation for its backstop commitment a nonrefundable fee of $50,000 and ten-year warrants to purchase 215,343 shares of our common stock at an exercise price of $7.43 per share. The warrants had a grant date fair value of approximately $0.9 million and were recorded as a cost of raising capital. The MLF warrants were subsequently split so that MLF Offshore Portfolio Company, LP owned warrants to purchase 206,548 shares of our common stock and MLF Partners 100, LP owned warrants to purchase 8,795 shares of our common stock. Such warrants were distributed on a pro-rata basis to investors as part of the winding up of operations of MLF and its affiliated funds. All 215,343 warrants were outstanding as of February 1, 2014 and February 2, 2013.
Common Stock
In fiscal 2013, the Company issued shares of common stock in lieu of cash payments as follows: (a) 86,450 shares, valued at $0.1 million, of common stock to members of the Board of Directors for directors’ fees; and (b) 138,610 shares of common stock, valued at $0.2 million (88,803 shares net of 49,807 of shares withheld) to certain employees of the Company in lieu of cash compensation. The 49,807 shares withheld are recorded as treasury stock in the accompanying consolidated balance sheets.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Preferred Stock
We are authorized to issue, without stockholder approval, up to 25,000,000 shares of preferred stock, $0.001 par value per share, having rights senior to those of our common stock. In addition, we have 1,000,000 shares of series A junior participating preferred stock authorized, none of which are outstanding as of February 1, 2014. See Note 16 regarding a private placement transaction whereby the Company sold and issued series B preferred stock subsequent to February 1, 2014.
Shelf Registration Statements
On June 20, 2012, the Company filed a Registration Statement on Form S-3 using a “shelf” registration process, which became effective on September 7, 2012. Under this shelf registration, the Company may issue up to $30 million of its common stock, preferred stock, warrants, rights, units or preferred stock purchase rights in one or more offerings, in amounts, at prices, and terms that will be determined at the time of the offering. Because the publicly-traded float of the Company’s shares of common stock is less than $75 million, unless and until the Company’s public float exceeds $75 million, the Company will be restricted to issuing securities registered under the shelf registration equal to no more than one-third of the value of its public float in any consecutive 12-month period.
On July 31, 2013, the Company closed on an underwritten public offering of 15,025,270 shares of its common stock at an offering price of $1.05 per share, resulting in gross proceeds of $15.8 million pursuant to the shelf registration statement. The Company used the net proceeds, after issuance costs, of $13.9 million to repay a portion of the outstanding amounts under the existing revolving Credit Agreement.
Private Placement of Convertible Notes
Concurrently with the closing of the underwritten public offering mentioned above, the Company sold $21.8 million in principal amount of 7.25% convertible notes in a private placement. The convertible notes were scheduled to automatically convert into 20,738,100 shares of dELiA*s common stock immediately upon ratification by the Company’s stockholders of the issuance of the convertible notes and approval by the Company’s stockholders of the issuance of the 20,738,100 shares of common stock into which the convertible notes were automatically convertible. The Company could not use the proceeds from the sale of the convertible notes until receiving stockholder approval. The proceeds from the sale of the convertible notes were held in an interest bearing deposit account at a financial institution. As collateral security for our obligations under the convertible notes, we granted to the lead investor in the private placement, on behalf of itself and the other investors, a continuing, first priority, perfected, security interest in this deposit account, all funds in the account, and all cash and non-cash proceeds of the account. The security interest in this collateral remained in effect until all of our obligations to the holders of the convertible notes were fully paid and satisfied. On October 24, 2013, the Company’s stockholders ratified the issuance of the convertible notes and approved the issuance of the shares of common stock into which the convertible notes were automatically converted. The Company used the net proceeds, after costs and expenses, of $20.0 million for the repayment of outstanding amounts under its Credit Agreement with Salus.
Since the market price of the Company’s common stock on the date of conversion exceeded the $1.05 conversion price, the Company recorded $2.9 million in non-cash charges. A $0.5 million charge related to the participation of certain insiders in the convertible note offering was included in stock-based compensation expense, while the remaining $2.4 million was included in interest expense.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
11. Income Taxes
The components of the benefit for income taxes consist of the following:
The reconciliation between the statutory income tax rate and the effective tax rate is as follows:
The types of temporary differences that give rise to our deferred tax assets and liabilities are set out as follows at:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
For federal income tax purposes, we have unused net operating loss (“NOL”) carry forwards of approximately $203 million at February 1, 2014, expiring through January 31, 2034. The U.S. Tax Reform Act of 1986 contains provisions that limit the NOL carry forwards available to be used in any given year upon the occurrence of certain events, including a significant change of ownership. We have experienced such ownership changes in the past and we believe that we may experience another ownership change, assuming stockholder approval, as a result of the Private Placement and both the public offering and private placement we completed on July 31, 2013. As a result of these transactions, we may be further limited in our ability to utilize our NOLs as an offset against future taxable income. Currently, $106 million of our federal NOL carry forwards are limited to $22 million due to previous change in ownership events. In addition, the annual limitations may result in the expiration of net operating losses before utilization. For state tax purposes, we have unused NOL carry forwards of approximately $161 million at February 1, 2014 which have expiration dates that vary by jurisdiction.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, net operating loss carryback potential, and tax planning strategies in making these assessments.
Based upon the above criteria, the Company does not believe that it is more-likely-than-not that the remaining net deferred tax assets will be realized. For fiscal 2013, fiscal 2012 and fiscal 2011, the valuation allowance increased by $22.6 million, $6.6 million, and $8.7 million, respectively, primarily related to increased federal and state tax NOL carry forwards.
The net deferred tax liability relates to an indefinite-lived intangible asset acquired at the time of the Spinoff.
At February 1, 2014 and February 2, 2013, the Company had a liability for unrecognized tax benefits of $0.5 million and $0.5 million, respectively, both of which would have favorably affected the Company’s effective tax rate if recognized. Included within the $0.5 million, as of February 1, 2014, is an accrual of $0.2 million for the payment of related interest and penalties. The Company does not believe there will be any material changes in the unrecognized tax positions over the next 12 months.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
The Company recognizes interest related to unrecognized tax benefits in interest expense and any related penalties in income tax expense. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheet. The Company recorded an additional $10,700, $11,400 and $4,700 in interest, and a reduction in penalties of $677 for fiscal 2013, and increases in penalties of $19,400 and $4,500, for fiscal 2012 and fiscal 2011, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The Company’s subsidiaries join in the filing of a U.S. federal consolidated income tax return. The U.S. federal statute of limitations remains open for the fiscal years 2010, 2011 and 2012. State income tax returns are generally subject to examination for a period of 3 to 5 years after filing of the respective returns. The state impact of any federal changes remains subject to examination by various states for a period of up to one year after formal notification to the states.
12. Spinoff Related Transactions
Services and Revenues
We recognize other revenues that consist primarily of advertising provided for third parties in our catalogs, on our e-commerce web pages, in our outbound packages, and in our retail stores pursuant to specific pricing arrangements with Alloy, LLC. Alloy, LLC originally arranged these advertising services on our behalf through a Media Services Agreement (the “Original Agreement”) entered into in connection with the Spinoff. Revenue under these arrangements was recognized, net of commissions and agency fees, when the underlying advertisement is published or otherwise delivered pursuant to the terms of each arrangement.
On November 16, 2010, the Company entered into an Amended and Restated Media Services Agreement (the “A/R Media Services Agreement”) with Alloy, LLC. The A/R Media Services Agreement replaces the Original Agreement, which expired by its terms on December 19, 2010, and became effective on December 20, 2010, upon expiration of the Original Agreement. The A/R Media Services Agreement provides, among other things, that Alloy, LLC will serve as our exclusive sales agent for the purpose of providing the following media and marketing related services to the Company and its subsidiaries: license of websites, internet advertising, direct segment upsell arrangements, catalog advertisements and insertions, sampling and in-store promotions, and database collection and marketing. The A/R Media Services Agreement expires on December 20, 2015. Effective May 6, 2011, the Company and Alloy, LLC amended the A/R Media Services Agreement to remove the sampling and in-store promotion services therefrom. In addition, as part of the transaction described under Note 1 “Discontinued Operations and Assets Held for Sale,” we further amended the A/R Media Services Agreement to assign the provisions of such agreement related to our former Alloy business to the purchaser of such business.
Prior to the Spinoff, we and Alloy, LLC entered into the following agreements that were to define our ongoing relationships after the Spinoff: a distribution agreement, tax separation agreement, trademark agreement, information technology and intellectual property agreement, and an On Campus Marketing call center agreement. The On Campus Marketing call center agreement was terminated July 16, 2012. In addition, as part of the transaction involving the sale of our former CCS business, we entered into a Media Placement Services Agreement with Alloy, LLC pursuant to which we agreed to purchase specified media services over a three year period for $3.3 million. The Media Placement Services Agreement expired on February 1, 2012.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
13. Commitments and Contingencies
Leases
We lease dELiA*s retail stores and office space under noncancelable operating leases with various expiration dates through January 2025. As of February 1, 2014, future net minimum lease payments are as follows:
Most of the dELiA*s retail store leases require payment of a specified minimum rent, plus a contingent rent based on a percentage of the store’s net sales in excess of a specified threshold. Most of the lease agreements have defined escalating rent provisions, which are expensed over the term of the related lease on a straight-line basis commencing with the date of possession, including any lease renewals deemed to be probable. In addition, most of the leases require payment of real estate taxes, certain common area and maintenance costs (“CAM”) and other related charges in addition to the future minimum operating lease payments. We sublease a portion of our office space. The minimum lease payments presented above do not include real estate taxes, CAM or other related charges. Total real estate taxes, CAM and other related charges for fiscal 2013, fiscal 2012 and fiscal 2011 were $10.9 million, $11.2 million and $11.6 million, respectively.
Total rent expense, excluding real estate taxes, CAM and other related charges, during fiscal 2013, fiscal 2012 and fiscal 2011 was $16.3 million, $17.6 million, and $18.2 million, respectively. There were no contingent excess rent payments made during these periods.
Sales Tax
With respect to the dELiA*s website and catalogs, sales or other similar taxes are collected primarily in states where we have dELiA*s retail stores, another physical presence or other personal property. However, various other states may seek to impose sales tax obligations on such shipments in the future. A number of proposals have been made at the state and local levels that would impose additional taxes on the sale of goods and services through the internet. A successful assertion by one or more states that we should have collected or be collecting sales taxes on the sale of products could have a material adverse effect on our results of operations.
License Agreement
In February 2003, dELiA*s Brand, LLC, a wholly-owned subsidiary of the Company, entered into a master license agreement with JLP Daisy to license our dELiA*s brand on an exclusive basis for wholesale distribution in certain product categories, primarily in mid- and upper-tier department stores, in exchange for an up-front payment from JLP Daisy of $16.5 million, which is applied against royalties otherwise due from JLP Daisy for sales of dELiA*s branded merchandise. The initial term of the master license agreement was approximately 10
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
years, which was extended and, at our option, (i) will remain in effect until JLP Daisy recoups its advance and preferred return or (ii) the term will immediately expire and JLP Daisy will be entitled to be paid the balance of any unrecouped advance and a preferred return calculated at 6% per year (if not already received). As of February 1, 2014, JLP Daisy has not recouped its advance and preferred return and therefore the master license agreement remains in effect. As part of the master license agreement, dELiA*s Brand, LLC granted to JLP Daisy a security interest in the dELiA*s trademarks and copyrightable artwork, although the only event that would entitle JLP Daisy to exercise its rights in respect of the lien is a termination or rejection of the license or the master license agreement in a bankruptcy proceeding. We have not recorded any amounts associated with the master license agreement.
Employment Agreements
The Company has entered into an employment agreement with our Chief Executive Officer and offer letters with certain senior executives of the Company. The agreement and offer letters specify various employment-related matters, including annual compensation, performance incentive bonuses, and severance benefits in the event of termination with or without cause and in the event of a change in control of the Company. As of February 1, 2014, the aggregate cash severance benefit was approximated $2.6 million in the event of termination with or without cause and $2.8 million in the event of a termination following the change in control of the Company.
Benefit Plan
All employees who meet eligibility requirements may participate in the dELiA*s Inc. 401(k) Profit Sharing Plan (the “Plan”). Under the Plan, employees can defer 1% to 75% of compensation as defined. The Company’s matching contribution is at a rate of $0.50 per employee contribution dollar on up to the first 5% of employee contribution and is immediately vested. Employee contributions are always 100% vested. The Company’s matching contributions were $0.3 million, $0.3 million, and $0.1 million for fiscal years 2013, 2012 and 2011, respectively.
Litigation
The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. Although the amount of any liability that could arise with respect to these actions cannot be determined with certainty, in the Company’s opinion, any such liability will not have a material adverse effect on its consolidated financial position, consolidated results of operations or liquidity.
14. Segment Reporting
The Company’s executive management, being its chief operating decision makers, works together to allocate resources and assess the performance of the Company’s business. All of the Company’s operations are in the U.S. The Company’s executive management manages the Company as two distinct operating segments, direct marketing and retail stores.
The Company’s executive management assesses the performance of each operating segment based on operating income/loss, which is defined as net sales less the cost of goods sold and selling, general and administrative (“SG&A”) expenses both directly identifiable and allocable. For the direct segment, these SG&A expenses primarily consist of catalog development, production and circulation costs, order processing costs, direct personnel costs and allocated overhead expenses. For the retail segment, these SG&A expenses primarily consist of store selling expenses, direct labor costs and allocated overhead expenses. Allocated overhead expenses are costs associated with general corporate expenses and shared departmental services (e.g., executive, finance, information technology, legal and human resources).
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Operating segment assets are those directly used in or clearly allocable to an operating segment’s operations. For the retail segment, these assets primarily include inventory, fixtures and leasehold improvements. For the direct segment, these assets primarily include inventory and prepaid catalog costs (excluding the Assets Held for Sale). Corporate and other assets include corporate headquarters, warehouse and fulfillment facilities, shared technology infrastructure as well as corporate cash and cash equivalents and prepaid expenses. Operating segment depreciation and amortization and capital expenditures incurred are recorded directly to each operating segment. Corporate assets and other depreciation and amortization and capital expenditures are allocated to each reportable segment. The accounting policies of the segments are the same as those described in Note 3. Reportable data for our reportable segments were as follows (reflects continuing operations only):
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
15. Quarterly Results (Unaudited)
The following table sets forth unaudited quarterly financial data for each of our last two fiscal years:
(1) Included in the third quarter of fiscal 2013 is an impairment of long-lived assets charge of $3.3 million, see Note 4 for further discussion. Included in the fourth quarter of fiscal 2012 is a goodwill impairment charge of $4.5 million, see Note 5 for further discussion.
(2) (Loss) income per share calculations for each quarter include the appropriate weighted average effect for the quarter; therefore, the sum of quarterly (loss) income per share amounts may not equal year-to-date (loss) income per share amounts, which reflect the weighted average effect on a year-to-date basis.
16. Subsequent Events
On February 4, 2014, there was an amendment to the Credit Agreement which lowered the total aggregate commitment from $30 million to $25 million. On February 18, 2014, there was another amendment which allows the Company to make dividend payments to its shareholders with respect to holders of Preferred Stock (as defined below), on a quarterly basis, provided that availability (as defined in the Credit Agreement) is equal to or greater than (1) $5,000,000 immediately prior to such payment and (2) $3,500,000 immediately after giving effect to such payment.
On February 18, 2014, the Company sold and issued in a private placement transaction (the “Private Placement”) (i) 199,834 shares of series B preferred stock (“Preferred Stock”) for an aggregate purchase price of $19,983,400, and (ii) an aggregate of $24,116,600 in principal amount of notes (the “Notes”). The Preferred Stock has a stated value of $100 per share and is convertible at the option of the holder into shares of our common stock at a conversion price of $0.80 per share (subject to adjustment), plus an amount in cash per share of Preferred Stock equal to accrued but unpaid dividends on such shares through but excluding the applicable
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
conversion date. The Notes are mandatorily convertible into 241,166 shares of Preferred Stock upon Stockholder Approval (as defined below). If at the time of the conversion of the Notes, the market price of our common stock is above the conversion price of the Notes, the Company will incur a non-cash charge in the amount equal to the difference between the market price of the Company’s common stock at the time of conversion and the conversion price of the Notes. The proceeds from the sale of the Notes are currently in an interest bearing account and may not be used by the Company until it obtains Stockholder Approval. If the Company obtains Stockholder Approval, it will receive proceeds from the sale of the Notes of approximately $24,116,600, subject to the deduction of placement agent fees and expenses. The Notes mature on the earlier of (i) August 18, 2014 and (ii) the trading day after Stockholder Approval is not obtained at the Stockholder Meeting (as defined below). If Stockholder Approval is not obtained, the Notes will mature, the Company will be required to repay the Notes, together with interest at a rate of 7.25% per annum, and the Company will not have use of the funds. Based on the $0.75 closing sale price of our common stock on February 18, 2014, the total value of the shares of our common stock issuable upon conversion of the Preferred Stock, and the shares of our common stock issuable upon conversion of the Preferred Stock issuable upon conversion of the Notes is $41,343,750.
Holders of Preferred Stock are entitled to receive, when, as and if declared by the board of directors of the Company, out of any funds legally available therefore, dividends per share of Preferred Stock in an amount equal to 6.0% per annum of the stated value per share. The first date on which dividends are payable is February 18, 2015, and, thereafter, dividends are payable semi-annually in arrears on February 18 and August 18 of each year. Dividends, whether or not declared, begin to accrue and be cumulative from February 18, 2014. If the Company does not pay any dividend in full on any scheduled dividend payment date, then dividends thereafter will accrue at an annual rate of 8.0% of the stated value of the Preferred Stock from such scheduled dividend payment date to the date that all accumulated dividends on the Preferred Stock have been paid in cash in full. In addition, if the Company does not meet minimum borrowing availability tests under our Credit Agreement with Salus, it may not pay dividends on the Preferred Stock.
The Company has agreed to use its commercially reasonable efforts to provide each stockholder entitled to vote at a special meeting of its stockholders (the “Stockholder Meeting”) a proxy statement soliciting each such stockholder’s affirmative vote at the Stockholder Meeting for approval of an amendment (the “Charter Amendment”) to the certificate of incorporation of the Company to increase the number of authorized and unissued shares of common stock by an amount not less than the maximum number of shares of common stock issuable upon conversion of the Preferred Stock (x) as of February 18, 2014, the closing date of the Private Placement, upon conversion of the shares of Preferred Stock and (y) thereafter upon conversion of shares of Preferred Stock issuable upon conversion of the Notes (such affirmative approval being referred to herein as the “Stockholder Approval,” and the date such Stockholder Approval is obtained, the “Stockholder Approval Date”). The Company has agreed to use its commercially reasonable efforts to hold the Stockholder Meeting within 120 days of the closing of the Private Placement. Each investor in the Private Placement has agreed to vote all shares of our common stock it beneficially owns on the record date applicable to the Stockholder Meeting that are eligible to vote in favor of the Charter Amendment.
On April 2, 2014, the Company issued approximately 1.3 million shares of restricted stock to certain employees of the Company under the 2005 Plan.
On April 2, 2014, the Board of Directors approved the dELiA*s, Inc. 2014 Stock Incentive Plan (the “2014 Plan”) which will replace the 2005 Plan, subject to stockholder approval. If stockholder approval is obtained, no additional options will be granted under the 2005 Plan, although all options outstanding under the 2005 Plan would remain outstanding in accordance with their terms and the terms of the 2005 Plan. A total of 8,000,000 shares of common stock will be subject to the 2014 Plan. The 2014 Plan is intended to permit the grant of stock options, stock appreciation rights and stock awards, including restricted stock awards and restricted stock units.
dELiA*s, Inc.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
INDEX TO EXHIBITS
* Filed herewith
** Furnished with this report
# Management contract or compensatory plan or arrangement