Item 1. Business.
Our Company
rue21, inc. and subsidiaries (rue21,inc.) was originally incorporated in Pennsylvania in October 1976. We changed our name to rue21, inc. in May 2003 and reincorporated in Delaware on October 30, 2009. rue21 is a fast growing specialty apparel retailer offering the newest fashion trends at every day great value. At the end of fiscal year 2011, we operated 755 stores in 46 states. Many of our stores are located in small- and middle-market communities that we believe have been underserved by traditional specialty apparel retailers.
We offer a broad selection of merchandise for anyone who wants to look and feel 21. Over the last few years, rue21 has expanded and developed a number of product categories to complement our extensive apparel offerings, including rue21 etc!, our girls jewelry and accessories, tarea by rue21, our intimate apparel, Carbon Elements, our guys accessories, and a full line of fragrances and beauty products. Our coordinated merchandise assortment allows our customer to create a complete look from head to toe, and our merchandising model allows us to quickly identify and respond to trends and bring proven concepts and styles to our customers every day at great value. We believe that the mix of fashion and key items we offer at attractive price points allows us to compete effectively against all of our competitors, from traditional specialty retailers to larger department stores and mass merchant discount retailers.
Our principal executive offices are located at 800 Commonwealth Drive, Warrendale, Pennsylvania, 15086. Our telephone number is 724-776-9780.
Our internet address is www.rue21.com. We make available through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (“Exchange Act”), as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission (“SEC”).
Our Business Strategy
We pursue a three-pronged business strategy that focuses on diversification and growth. The key elements of our strategy are:
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Diversified Product - girls, guys, rue21 etc! We offer a broad range of girls and guys apparel and accessories, including footwear, jewelry and fragrances.
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Flexible Real Estate - strip centers, regional malls, outlet centers. As of January 28, 2012 approximately 52% of our 755 stores were located in strip centers, 33% in regional malls and 15% in outlet centers. With low build-out costs, competitive lease terms and a low-cost operating model, our stores generate a consistently strong return on investment in all three types of shopping centers.
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Balanced Sales Growth - new stores, store conversions, comparable store sales. We drive sales growth through opening new stores, converting existing stores into our new, larger rue21 etc! layout, and increasing our comparable store sales. In fiscal year 2012, we plan to open 120 new stores, including 18 new stores opened as of March 15, 2012. We also plan to convert approximately 30 stores to the rue21 etc! format in 2012, including 2 stores converted as of March 15, 2012.
We believe our business strategy presents us with significant opportunities to increase net sales and net income, and we continue to invest capital to build the infrastructure necessary to support our growth. This includes investments in systems designed to drive sales and improve merchandise margins and new in-store technology that will allow us to streamline tasks and optimize customer service. Strategies that we believe will continue to generate earnings growth for the Company include the opportunity to:
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Increase Square Footage. We intend to drive our square footage growth by opening new stores and converting existing stores to our larger rue21 etc! layout. Following a disciplined real estate strategy, we have increased our geographic presence by opening 120 new retail stores in fiscal 2011. We operated 755 locations as of January 28, 2012, and believe there is significant opportunity to expand to 1,500 stores. Most of our new stores will be opened in strip centers and regional malls in small and middle market communities where there are few competitors offering similar fashion merchandise. In addition, we plan to continue to convert our existing stores into the larger rue21 etc! format that features an expanded area for our higher margin etc! categories, which include accessories, intimate apparel, footwear, jewelry and beauty/fragrances. As of January 28, 2012, approximately 80% of our store base was in the rue21 etc! layout. We converted 38 stores to the rue21 etc! layout in fiscal year 2011 and plan to convert 30 stores in fiscal year 2012. Historically, these conversions result in increased store profitability and generate return on investment.
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Drive Comparable Store Sales. We seek to maximize our comparable store sales by continuing to expand the depth of our fashion offerings, adding impact with strong point-of-sale events in key volume sales categories, and growing our high margin accessories categories. We believe marketing and operational initiatives will also increase our brand loyalty, and our efforts to streamline our in-store processes and reduce tasks will give our associates the ability to focus on providing supreme customer service, resulting in increased transactions. The Company plans to continue to reach our customers through social media channels and by executing our successful bounce back coupon programs, which we believe will drive repeat business and grow sales.
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Improve Profit Margins. We believe we have the opportunity to continue to drive margin expansion through scale efficiencies, implementation of technology and business processes, continued cost discipline and changes in merchandise mix. We believe our strong expected store growth will permit us to take advantage of economies of scale in sourcing and to leverage our existing infrastructure, corporate overhead and fixed costs. We are focused on increasing efficiencies in our supply chain and distribution systems to achieve better product flow. We believe the expansion of our higher margin categories, such as accessories and footwear, will increase our overall margins over time.
Our comparable store sales increases were 0.4% in fiscal year 2011 and 2.1% in fiscal year 2010. Our net sales were $760.3 million in fiscal year 2011, which represents a 19.8% increase over fiscal year 2010. Our net income was $39.0 million in fiscal year 2011, which represents a 28.8% increase over fiscal year 2010. We believe our trend-right merchandise assortments, compelling value proposition, and speed-to-market merchandising strategy have contributed to our strong operating results.
Our Stores
As of January 28, 2012, we operated 755 stores in 46 states throughout the United States. Our stores are located in strip centers, regional malls and outlet centers.
Store Locations
The following store list shows the number of stores operated in each state as of January 28, 2012:
See Note 1 to the Consolidated Financial Statements for certain geographic information, which is incorporated by reference.
Distinctive Store Experience
Our stores are designed by our in-house team in partnership with architectural consultants with the goal of creating an exciting and inviting atmosphere for girls and guys to shop and socialize. Our stores feature colorful displays showcasing the latest styles and trends, themed dressing rooms and top-40 music. Girls and guys apparel is located in separate areas with trend walls displaying the newest fashions. We believe that the fun and playful atmosphere in our stores contributes to the overall shopping experience.
Each of our stores is typically led by a manager, a full-time assistant manager, two part-time assistant managers and eight to ten part-time sales associates, depending on store volume.
Store Growth and Store Conversions
Our in-house real estate team works along with our brokerage network to negotiate the leases, lease renewals, and construction costs of every site. We lease all of our stores and determine store locations based on several factors, including geographic location, demographic information and proximity to other value retailers including Walmart, Target and Kohl’s that we believe will drive traffic to a shopping center. Additionally, we analyze factors such as performance of a particular shopping center, the quality and nature of existing shopping center tenants and the configuration of the space and the lease terms being offered.
In fiscal year 2011, we opened 120 new stores. We plan to open a total of 120 stores in fiscal year 2012. We currently expect our store base to grow from 755 stores as of January 28, 2012 to 1,500 stores. Our new store strategy is primarily focused on expanding our presence in small and middle market communities that are starved for fashion. We also see an opportunity to increase our footprint within regional malls.
Converting existing stores to a larger rue21 etc! layout continues to be an integral part of our growth strategy. As of January 28, 2012, 602 of our 755 stores were in the rue21 etc! layout. We have plans to continue to convert additional stores within the next five years to a larger rue 21 etc! layout as opportunities to do so become available. In fiscal year 2012, we have plans to convert 30 stores to the rue21 etc! layout. The table below highlights certain information regarding our new stores opened and existing stores converted to the rue21 etc! layout as of the fiscal year end for each of the years indicated below:
(1) Stores opened during period do not include existing stores that have been converted.
rueCulture and rueCommunity
A key component to our ongoing success has been our ability to preserve and continue to build our deep rooted corporate and customer culture. The passion and commitment fostered by rueCulture enables us to connect with our employees and customers, to differentiate our customers’ shopping experience and to ultimately drive our growth and profitability.
Customer Connection
We create a fun and exciting fashion destination for our customers both in the store, through our themed dressing rooms and our top-40 music selection, and on the internet via our website, the rueCommunity blog and other social networking sites such as Facebook, Twitter and YouTube. We consult a panel of teen advisors who regularly provide us with feedback on products and trends. By carrying the newest styles and regularly updating floor sets, we encourage our customers to shop our stores frequently. Our store associates share the rue21 excitement and deliver a memorable, high energy in-store experience to our customers. Our stores have become a community destination of choice where customers can meet and socialize with friends.
Associate Development
rueCulture emphasizes exceptional people, and we believe that the passion and commitment of our managers, assistant managers and sales associates are key to our past and future success. We are intensely focused on fostering the talents of our employees, and are committed to providing sales associates and managers with career advancement opportunities. We endeavor to promote a large portion of store managers and district managers from within our company. We emphasize clear communication throughout the company, and routinely hold store manager conference calls and store level, district, and regional management meetings to keep our employees focused, informed and involved. In addition, we provide continuing education and training through our Management Advancement Development training program and our “rueniversity” assistant manager training program, which promote building effective management skills and reinforce the rueCulture.
Our Products and Brands
We offer a complete assortment of fashion apparel and accessories for girls and guys, including graphic t-shirts, denim, dresses, shirts, hoodies, belts, jewelry, handbags, footwear, intimate apparel and other accessories at every day great value. We seek to identify the most current fashion trends in the market and utilize our product and sourcing teams to quickly introduce these fashions to our stores. All our brands are sold exclusively through our own stores. Our apparel and accessory brands include rue21 (Girls apparel), rue21 etc! (Girls accessories), tarea by rue21 (Girls intimate apparel), Carbon and CJ Black (Guys apparel), and Carbon Elements (Guys accessories). In addition, we sell our own line of fragrances under names of rue by rue21, revert eco rue21, CJ Black, sparkle rue21, Pink Ice by rue21, MetroBlack rue21, tarea by rue21, twentyone black, runway21 by rue21, Carbon Elements, Intense by rue21, and rue21 etc!.
The table below indicates our product mix as a percentage of our net sales derived from our product categories, based on our internal merchandising system, as of fiscal year end for each of the years indicated:
Our product mix may change based on the growth rate of each product category, although an increase in net sales in one of our product categories may not necessarily decrease net sales in our other product categories. Our diversified product assortment allows us to benefit from increased sales in all categories.
Merchandising and Sourcing
Our flexible, fast fashion model allows us to quickly identify and respond to trends and bring the newest, tested concepts and styles to our stores. We strive to offer a compelling product selection for our customers by regularly editing our merchandise assortment to reflect key fashion trends and by shipping daily deliveries of new merchandise to our stores.
Merchandising
Our merchandise buying teams, led by our General Merchandise Manager and Merchandising Directors, are responsible for identifying emerging fashion trends, reviewing merchandise lines from new and existing vendors, and selecting merchandise for our stores that will resonate with our customers. The merchants are responsible for developing seasonal strategies, as well as buying, editing and pricing our merchandise on an ongoing basis based on customer demand. Our marketing, product development and visual teams work with the merchandise team to coordinate color and trends across the product assortments to ensure trend right merchandise that encourages
multiple unit and outfit purchases. Our merchants are dedicated to consistently delivering high quality fashion assortments at every day great value.
Sourcing
We do not own or operate any manufacturing facilities. We purchase all of our merchandise from a network of domestic based importers and domestic vendors. We believe our lack of dependence on any one vendor enhances our flexibility and minimizes product risk. In addition, we believe our long-term relationships with many of our vendors enable us to benefit from quick deliveries as well as very competitive pricing.
Although all of our vendors are based in the United States, the majority source our products from overseas. Our vendors are responsible for importing products. We do not directly import any of our merchandise. A small portion of our merchandise is manufactured domestically.
Our vendors are required to sign our vendor agreement that incorporates a comprehensive vendor compliance manual, which is updated regularly. The vendor compliance manual details our packing, shipping and production requirements, as well as our legal requirements, professional and ethical standards and payment terms. We typically transact business on an order-by-order basis. Each purchase order also incorporates and references the requirements, standards and terms described in the preceding sentence. The purchase orders, vendor agreement and vendor compliance manual all are designed to ensure that our vendors operate in compliance with all applicable rules and regulations, including labor, customs and consumer protection laws. We do not control or audit the vendors that produce the merchandise we sell. We do reserve the right to conduct random testing of products and use a third party resource to conduct such random testing on designated categories of items to further address our concern for customer safety. Our national freight consolidator ships to our distribution facility in Weirton, West Virginia from both the west coast and east coast.
Marketing and Advertising
We believe that girls and guys rely heavily on the opinions of their peers, often expressed through social media, websites and blogs, to determine whether a retailer is relevant to them. As a result, we do not depend on conventional advertising, but instead employ a viral approach to marketing that is designed to capture the interest of our customers and drive them into our stores. For example, product knowledge, trend statements and fashion blogs are posted daily through Facebook, Twitter and YouTube. Our rue21.com website reinforces our brand image and allows us to reach our customers in a fun and interactive environment. Website promotions and contests are an added incentive to motivate teens to share their voice. In addition, email campaigning is used to send “e-blasts” and coupons. The “e-blasts” highlight key trends, new products and promotional events to drive our customer back to our stores.
In addition to using our website and social networking to promote our brand image, we employ a community-based marketing approach to building brand awareness and customer loyalty. We often initiate marketing efforts in concert with the local shopping center management in advance of opening our stores. At a store level, we reinforce our brands through in-store signage, events, and product labeling, and by hiring diverse, energetic and enthusiastic individuals who exemplify our brand. Our coupon programs encourage repeat business from our customers. We have built an extensive coupon program which is strategically planned during select times of the year to maximize sales, traffic and customer loyalty.
Distribution
We distribute all of our merchandise from our recently expanded 378,000 square foot distribution and office facility located in Weirton, West Virginia. Substantially all merchandise arrives at our distribution facility pre-ticketed by our vendors, which allows for a quick turn around time and reduced internal labor. In general, the merchandise is received, sorted and packed in to shipments for each store based on a predetermined allocation plan. The distribution facility then uses an automated sorting system for separating shipments by store. Merchandise is shipped to our stores daily via a third-party delivery service to ensure a steady flow of new products to our stores.
Management Information Systems
Our management information systems provide a full range of business process support and information to our store, merchandising, financial and real estate business teams. We believe the combination of our business processes and systems provide us with improved operational efficiencies, scalability, increased management control and timely reporting that allow us to identify and respond to trends in our business.
Competition
Although the retail industry is highly competitive, we believe rue21 is specialized in its ability to operate successfully in many different types of markets. Although large value retailers, including Walmart, Target and Kohl’s, sell merchandise at comparable price points, our store format and in-store shopping experience is distinctive, with an exciting and inviting atmosphere offering trend-right fashions and our exclusive brands. Large value retailers may only have a small part of their store and total product selection dedicated to apparel and accessories. Department stores, including Dillard’s and JC Penney, or other junior retailers may be located in proximity to us in regional malls or outlet centers; however we believe that we have been successful competing against all types of competition based on our product assortment, exclusive brands, ability to respond to changing trends, and our distinctive combination of fashion and value.
Intellectual Property
We have registered numerous trademarks, trade names and logos with the United States Patent and Trademark Office. We believe that the recognition associated with these trademarks makes them extremely valuable and, therefore, we intend to use and renew our trademarks in accordance with our business plans. In addition we own domain names, including www.rue21.com, for our primary trademarks and own unregistered copyright rights in our website content. We also rely on a variety of intellectual property rights that we license from third parties. We expect to continually grow our merchandise assortment and strengthen our brands, and we will continue to file new applications as appropriate to protect our intellectual property rights. In addition, we will continue to register and renew indefinitely applicable foreign trademarks.
Regulation and Legislation
We are subject to labor and employment laws, laws governing advertising and promotions, privacy laws, safety regulations and other laws, including consumer protection regulations that regulate retailers and/or govern the promotion and sale of merchandise and the operation of stores and warehouse facilities. We monitor changes in these laws and believe that we are in material compliance with applicable laws.
Employees
As of January 28, 2012, we had 9,196 employees of which 6,856 were part-time employees. None of our employees is represented by a union and we have had no labor-related work stoppages. Our rueCulture emphasizes teamwork and the belief that everyone can make a difference. The value we place on our employees is one of the keys to our success, and as a result we believe our relationship with our employees is strong.
Seasonality
Our operations are seasonal in nature and consist of two principal selling seasons: Spring (the first and second quarters) and Fall (the third and fourth quarters). Generally, our highest sales volume occurs in the fourth quarter, which includes the holiday selling season. Accordingly, cash requirements are highest in the third quarter as our inventories build in advance of the holiday season. In addition, our quarterly results can be affected by the timing of new store openings and store closings, the amount of sales contributed by new and existing stores, as well as the timing of certain holidays.
Available Information
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports and the proxy statement for our annual meeting of stockholders are made available, free of charge, on our corporate website, www.rue21.com, as soon as reasonably practicable after such reports have been filed with or furnished to the SEC.
Our Code of Business Conduct and Ethics (the “Code”) and Board of Directors Committee Charters (for each of our Audit, Compensation and Corporate Governance and Nominating Committees) are also available on our website. The Committee Charters and the Code can be found at www.rue21.com, under the “Investor Relations, Corporate Governance” tab. Any amendments and waivers to the Code will also be available on our website.
All of these documents are available in print to any stockholder who requests them via our website or by writing to rue21, inc., c/o Vice President and General Counsel, 800 Commonwealth Dr., Warrendale, PA 15086.
The public may also read and copy any materials that we have filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. In addition, these materials may be obtained at the website maintained by the SEC at www.sec.gov. The public may obtain information on the operation of the SEC’s Public Reference room by calling the SEC at 1-800-SEC-0330.
The content of our website (www.rue21.com) is not intended to be incorporated by reference in this Annual Report on Form 10-K.
Item 1A.
Item 1A. Risk Factors.
Our business is highly dependent upon our ability to identify and respond to new and changing fashion trends, customer preferences and other related factors.
Fashion trends and customer tastes are volatile and can change rapidly. Our success depends in large part upon our ability to effectively identify and respond to changing fashion trends and consumer demands, and to translate market trends into appropriate, saleable product offerings in a timely manner. A small number of our employees, including our divisional merchandise managers, our Senior Vice President and General Merchandise Manager and our President and Chief Executive Officer, are primarily responsible for performing this analysis and making related product purchase decisions. Failure of these employees to identify and react appropriately to new and changing trends or tastes or to accurately forecast demand for certain product offerings could lead to, among other things, excess inventories, markdowns and write-offs, which could have a material adverse effect on our business plan, results of operations and financial condition.
Our square footage growth strategy depends upon our ability to successfully open and operate a significant number of new stores and convert existing stores to our larger etc! format each year in a timely and cost-effective manner.
Our square footage growth strategy depends on our ability to open new stores in new markets each year and convert existing stores to the rue21 etc! format. The success of the strategy depends on many factors including, among others, our ability to:
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identify suitable store locations primarily in strip centers and regional malls, the availability of which is largely outside of our control;
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negotiate acceptable lease terms, desired tenant allowances and assurances from operators and developers that they can complete the project, which depend in part on the financial resources of the operators and developers;
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obtain or maintain adequate capital resources on acceptable terms;
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source sufficient levels of inventory at acceptable costs;
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hire, train and retain an expanded workforce of store managers and other personnel;
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successfully integrate new stores into our existing control structure and operations, including information system integration;
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maintain adequate distribution facility, information system and other operational system capabilities;
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identify and satisfy the merchandise and other preferences of our customers in new geographic areas and markets; and
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address competitive, merchandising, marketing, distribution and other challenges encountered in connection with expansion into new geographic areas and markets.
Our failure to effectively address challenges such as these could adversely affect our ability to successfully open and operate new stores or convert existing stores to the etc! format in a timely and cost-effective manner.
In addition, as the number of our stores increases, we may face risks associated with market saturation of our product offerings or operating complexity as our store base grows. To the extent our new store openings are in markets where we have existing stores, we may experience reduced net sales in existing stores in those markets. Finally, there can be no assurance that any newly opened stores will be received as well as, or achieve net sales or profitability levels comparable to those of, our existing stores in the time periods estimated by us, or at all. If our stores fail to achieve, or are unable to sustain, acceptable net sales and profitability levels, our business may be materially harmed and we may incur significant costs associated with closing those stores.
Our growth strategy depends on strategic initiatives designed to increase sales and improve the efficiencies, costs and effectiveness of our operations, and failure to achieve or sustain our strategic initiatives may have an adverse impact on our business and financial results.
There is no assurance that we will be able to implement important strategic initiatives in accordance with our expectations, which may result in an adverse impact on our business and financial results. These strategic initiatives are designed to improve our results of operations and drive long-term shareholder value, and include expanding into new geographic markets, reducing shrink, adding technology to our stores in order to improve efficiency, and developing and expanding our merchandise assortments and selling methods. There can be no assurance we will be able to successfully integrate the planned initiatives into our existing operations profitably. These risks could have a material adverse effect on our results of operations, financial condition and cash flows.
We currently have several strategies planned to improve sales and merchandise margins. There is no guarantee that the shift to new business processes will result in higher sales in our stores or improved margins for our business as a whole. Moreover, implementation of these strategies could increase costs and place a strain on our management, operational resources, and information systems. The failure of our strategies to improve sales and merchandise margins could have a material adverse impact on our business or our stock price.
We experience fluctuations in our comparable store sales.
Our success depends in part on our ability to improve sales. A variety of factors affect comparable store sales, including fashion trends, competition, current economic conditions, the timing of new merchandise releases and promotional events, changes in our merchandise mix, timing and location in the opening of stores, and weather conditions. These factors may cause our comparable store sales results to differ materially from prior periods and from expectations. Our comparable store sales have fluctuated in the past on an annual, quarterly, and monthly basis. Failure to meet the expectations of investors or securities analysts in one or more future periods could reduce the market price of our common stock.
Our business is sensitive to global, national and regional consumer spending and economic conditions.
Consumer purchases of discretionary retail items and specialty retail products, including our products, may be affected by economic conditions such as employment levels, salary and wage levels, the availability of consumer credit, inflation, high interest rates, high tax rates, high fuel prices and consumer confidence in future economic
conditions. Purchases of fashion apparel, beauty products and accessories often decline during periods when economic or market conditions are unsettled or weak. In such circumstances, we may increase the number of promotional sales, which could have a material adverse effect on our results of operations, financial condition and cash flows.
Continued challenging macroeconomic conditions and rising raw material costs, such as the price of cotton, could negatively impact our vendors, which, in turn, could have an adverse impact on our business. Some of our vendors are small and specialized with limited resources, production capacities and operating histories. Rising costs of raw materials, fuel, or labor shortages could cause our vendors to slow or cease shipments or require or condition their sale of merchandise on more stringent payment terms, which could result in lost sales, cancellation charges, or excessive markdowns.
Our failure to protect our reputation could have a material adverse effect on our brand image.
Our ability to maintain our reputation is critical to our brand image and any negative publicity may reduce demand for our merchandise. If we or our business partners fail to comply with local laws or regulations, ethical, social, product, labor and environmental standards it could jeopardize our reputation and potentially lead to various adverse consumer actions or loss of business. Damage to our reputation or loss of consumer confidence for any reason could have a material adverse effect on our competitive position, results of operations, financial condition and cash flows, as well as require additional resources to rebuild our reputation.
We could face increased competition from other retailers that could adversely affect us and our growth strategy.
The specialty retail industry is highly competitive. We compete for sales with a broad range of other retailers, including individual and chain specialty stores, department stores and discount retailers. In addition to the traditional store-based retailers, we also compete with direct marketers or retailers that sell similar lines of merchandise online and who target customers through the internet. Brand image, marketing, design, price, service, quality, image presentation and fulfillment are all competitive factors in both the store-based and internet channels.
Many of our competitors have substantially greater name recognition as well as financial, marketing and other resources and therefore may be able to adapt to changes in customer preferences more quickly, devote greater resources to marketing and sale of their products, generate national brand recognition or adopt more aggressive pricing policies than we can. Many of our competitors also utilize traditional forms of advertising and marketing media which we do not, including advertising through use of newspapers, magazines, billboards, television and radio, which may provide them with greater brand recognition than we have.
Our competitors may also sell certain products or substantially similar products through the internet or through outlet centers or discount stores, increasing the competitive pricing pressure for those products. We cannot assure you that we will continue to be able to compete successfully against existing or future competitors. Our expansion into markets served by our competitors and entry of new competitors or expansion of existing competitors into our markets could have a material adverse effect on us. Competitive forces and pressures may intensify as our presence in the retail marketplace grows.
We do not possess exclusive rights to many of the elements that comprise our in-store experience and product offerings. Our competitors may seek to emulate facets of our business strategy and in-store experience, which could result in a reduction of any competitive advantage or special appeal that we might possess. In addition, some of our product offerings are sold to us on a nonexclusive basis. As a result, our current and future competitors may be able to duplicate or improve upon some or all of our in-store experience or product offerings that we believe are important in differentiating our stores and our customers’ shopping experience, especially those competitors with significantly greater financial, marketing and other resources than ours. If our competitors were to duplicate or improve upon some or all of our in-store experience or product offerings, our competitive position and our business could suffer.
We depend on key personnel and may not be able to retain or replace these individuals or recruit additional personnel, which could harm our business.
Much of our future success depends on the continued availability and service of senior management personnel. The loss of any of our executive officers or other key senior management personnel may have a material adverse effect on our business and prospects, as we may not be able to find suitable individuals to replace such personnel on a timely basis. In addition, any such departure could be viewed in a negative light by investors and analysts, which could cause our common stock price to decline.
Failure to attract and retain qualified field and store management and to control labor costs, as well as other labor issues, could adversely affect our financial performance.
Our success depends in part upon our ability to attract, motivate and retain a sufficient number of store employees, including store managers, who understand and appreciate our corporate culture and customers, and are able to adequately and effectively represent our culture and establish credibility with our customers. If we are unable to hire and retain store personnel capable of consistently providing a high level of customer service, our ability to open new stores may be impaired, the performance of our existing and new stores could be materially adversely affected and our brand image may be negatively impacted. We are also dependent upon temporary personnel to adequately staff our stores and distribution facility. Any failure to meet our staffing needs or any material increases in employee turnover rates could have a material adverse effect on our business or results of operations.
Currently, none of our employees is represented by a union. However, our employees have the right at any time under the National Labor Relations Act to form or affiliate with a union. If some or all our workforce were to become unionized and the terms of the collective bargaining agreement were significantly different from our current compensation arrangements, it could increase our costs and adversely impact our profitability. In addition, we are evaluating the potential future impact of recently enacted comprehensive healthcare reform legislation, which will likely cause our healthcare costs to increase.
Our ability to attract customers to our stores that are located in strip centers, regional malls and outlet centers depends heavily on the success of the shopping centers in which our stores are located, and any decrease in customer traffic in these shopping centers could cause our net sales to be less than expected.
Our sales are derived, to a significant degree, from the volume of traffic in the shopping centers where our stores are located. We benefit from the ability of other shopping centers’ tenants, particularly anchor stores such as Walmart, Target and Kohl’s, to generate consumer traffic in the vicinity of our stores and the continuing popularity of the strip centers, regional malls and outlet centers as shopping destinations. Our sales volume and traffic may be adversely affected by, among other things, economic downturns nationally or regionally, high fuel prices, increased competition, changes in consumer demographics, a decrease in popularity of shopping centers or of stores in the shopping centers in which our stores are located, the closing of anchor stores important to our business, or a deterioration in the financial condition of shopping center operators or developers which could, for example, limit their ability to finance shopping center improvements for us and other retailers. A reduction in consumer traffic as a result of any of these or other factors could have a material adverse effect on us.
We plan to use cash from operations to fund our expanding business and execute on our growth strategy and risks associated with leasing substantial amounts of space, including future increases in occupancy costs, could have a negative impact on our cash flow.
To support our expanding business and execute our growth strategy, we will need significant amounts of cash from operations, including funds to pay our lease obligations, build out new store space, purchase inventory, pay personnel, further invest in our infrastructure and facilities, and pay for the increased costs associated with operating as a public company. In particular, payments under the operating leases associated with our stores and our distribution facility account for a significant portion of our operating expenses.
Our substantial operating lease obligations could have significant negative consequences, including:
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requiring that a substantial portion of our available cash be applied to pay our rental obligations, thus reducing cash available for other purposes;
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increasing our vulnerability to general adverse economic and industry conditions;
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limiting our flexibility in planning for or reacting to changes in our business or in the industry in which we compete; and
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limiting our ability to obtain additional financing.
Any of these consequences could place us at a disadvantage with respect to our competitors. We depend on cash flow from operations to pay our lease expenses and to fulfill our other cash needs. If our business does not generate sufficient cash flow from operations to fund these activities or we experience working capital leverage deterioration, and sufficient funds are not otherwise available to us under our senior secured credit facility, we may need additional equity or debt financing. If such financing is not available to us on satisfactory terms, our ability to run and expand our business or to respond to competitive pressures would be limited and we could be required to delay, significantly curtail or eliminate planned store openings or operations or other elements of our growth strategy.
Additional sites that we lease may be subject to long-term non-cancelable leases if we are unable to negotiate our current standard lease terms. If an existing or future store is not profitable, and we decide to close it, we may nonetheless be committed to perform our obligations under the applicable lease including, among other things, paying the base rent for the balance of the lease term. Moreover, even if a lease has an early cancellation clause, we may not satisfy the contractual requirements for early cancellation under that lease. Our inability to enter into new leases or renew existing leases on terms acceptable to us or be released from our obligations under leases for stores that we close would materially adversely affect us.
Accounting regulatory authorities have indicated that they may begin to require lessees to capitalize operating leases in their financial statements in the next few years. If adopted, such a change would require us to record a significant amount of lease related assets and liabilities on our balance sheet and make other changes to the recording and classification of lease related expenses on our statement of operations and cash flows. This and other future changes to accounting rules or regulations or the questioning of current accounting practices in regard to leases may materially impact the presentation of our results of operations.
Our ability to obtain merchandise at competitive prices depends primarily on our sourcing relationships and the ability of our vendors to manufacture and supply us with merchandise, and any events that adversely affect our vendors or their ability to obtain financing for their operations could disrupt merchandise deliveries and result in lost sales and profitability.
We do not own or operate any manufacturing facilities. We purchase all of our merchandise from third-party vendors. There can be no assurance that we will be able to acquire desired merchandise in sufficient quantities on acceptable terms or at all in the future, especially if we need significantly greater amounts of inventory in connection with the growth of our business. Any inability to acquire suitable merchandise in sufficient quantities and at acceptable prices, in particular exclusive merchandise, due to the loss of or deterioration or change in our relationship with one or more key vendors, or events harmful to our vendors, may materially adversely affect us. In addition, increased orders may negatively impact our approach of generally striving to minimize the time from purchase order to product delivery, and may increase our markdown risk.
We generally have no long-term purchase contracts or other contractual assurances of continued supply, pricing or access to new products. Any of our vendors could discontinue supplying us with desired products in sufficient quantities for a variety of reasons. The benefits we currently experience from our vendor relationships could be adversely affected if our vendors:
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choose to discontinue selling non-exclusive or exclusive products to us;
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refuse to allow us to return merchandise purchased from them;
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raise the prices they charge us;
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sell similar or identical products to certain of our competitors, many of whom purchase products in significantly greater volume and, in some cases, at lower prices than we do;
•
enter into arrangements with competitors that could impair our ability to sell their products, including by giving our competitors exclusive licensing arrangements or exclusive access to styles, brands and products or limiting our access to such arrangements or styles, brands or products;
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initiate or expand sales of their products through their own stores or through the Internet to the retail market and therefore compete with us directly; or
•
sell their products through outlet centers or discount stores, increasing the competitive pricing pressure we face.
So long as we purchase merchandise from domestic vendors who source products overseas, any event causing a sudden disruption of manufacturing or imports from Asia, Central America or elsewhere, including the imposition of additional import restrictions, could materially harm our operations. Many of our 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, Central America or elsewhere. We compete with other companies for production facilities and import quota capacity. New initiatives may be proposed impacting the trading status of certain countries and may include retaliatory duties or other trade sanctions which, if enacted, would limit or reduce the products purchased from suppliers in such countries.
Our vendors’ sourcing operations may also be hurt by political and financial instability, strikes, health concerns regarding infectious diseases in countries in which our merchandise is produced, adverse weather conditions or natural disasters that may occur in Asia, Central America or elsewhere or acts of war or terrorism in the United States or worldwide, to the extent these acts affect the production, shipment or receipt of merchandise. 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 or incur increased costs.
We may suffer risks if our vendors fail to follow our vendor guidelines, including the risk that a vendor or a manufacturer may fail to use acceptable labor practices or comply with other applicable laws.
Many of the products sold in our stores are manufactured outside of the United States, which may increase the risk that the labor, manufacturing safety and other practices followed by the manufacturers of these products may differ from those generally accepted in the United States. Although we require each of our vendors to sign a purchase order and vendor agreement that requires adherence to accepted labor practices and compliance with labor, manufacturing safety and other laws, we do not supervise, control or audit our vendors or the manufacturers that produce the merchandise we sell to our customers, and we have no direct relationship and very limited contact with any of the manufacturers. The violation of such labor, manufacturing safety or other laws by any of our vendors or these manufacturers, or the divergence of the labor practices followed by any of our vendors or these manufacturers from those generally accepted in the United States, could interrupt, or otherwise disrupt, the shipment of finished products to us or damage our brand image and/or subject us to boycotts by our customers or activist groups.
Our net sales and inventory levels fluctuate on a seasonal basis or due to store events or promotions, leaving our operating results particularly susceptible to changes in seasonal shopping patterns and related risks.
Our net sales are typically disproportionately higher during the back-to-school and winter holiday seasons. Any significant decrease in net sales during the back-to-school or winter holiday seasons would have a material adverse effect on us. In addition, in order to prepare for these seasons, we must order and keep in stock significantly more merchandise than we carry during other parts of the year. This inventory build-up may require us to expend cash faster than is generated by our operations during this period. Any unanticipated decrease in demand for our products during these peak shopping seasons could require us to sell excess inventory at a substantial markdown, which could have a material adverse effect on our business, profitability, ability to repay any indebtedness and our brand image.
In addition, we may experience variability in net sales as a result of a variety of other factors, including the timing of new store openings, store events, promotions or other marketing activities, which may cause our results of operations to fluctuate on a quarterly basis and relative to corresponding periods in prior years.
A significant disruption to our distribution network or to the timely receipt of inventory could adversely impact sales or increase our transportation costs, which would decrease our profits.
Our only distribution facility is located in Weirton, West Virginia. Our distribution facility supports our entire business. All of our merchandise is shipped to the distribution facility from our vendors, and then packaged and shipped from our distribution facility to our stores. The success of our stores depends on their timely receipt of merchandise. The efficient flow of our merchandise requires that we have adequate capacity and fulfillment in our distribution facility to support our current level of operations, and the anticipated increased levels that may follow from our growth plans. If we encounter difficulties associated with our distribution facility or if it were to shut down for any reason, including by fire, natural disaster, or a prolonged shutdown, we could face shortages of inventory, resulting in “out-of-stock” conditions in our stores, and incur significantly higher costs and longer lead times associated with distributing merchandise to our stores. This could have a material adverse effect on our business and harm our reputation. In addition, our failure to provide adequate order fulfillment and secure additional distribution capacity when necessary could impede our growth plans, and the further increase of this capacity would increase our costs.
We currently rely upon independent third-party transportation providers for substantially all of our product shipments, including shipments to all of our stores. Our utilization of their delivery services for shipments, or those of any other shipping companies we may elect to use, is subject to risks, including increases in fuel prices, which would increase our shipping costs, and employee strikes and inclement weather, which may impact the shipping company’s abilities to provide delivery services that adequately meet our shipping needs. If we change shipping companies, we could face logistical difficulties that could adversely affect deliveries and we would incur costs and expend resources in connection with such change. Moreover, we may not be able to obtain terms as favorable as those received from the independent third-party transportation providers we currently use, which in turn would increase our costs.
We rely heavily on information technology systems and any failure, inadequacy, or interruption of those systems could harm our ability to effectively operate our business.
We rely heavily on information technology systems across our operations, including for management of our supply chain, point-of-sale processing in our stores, our financial accounting and reporting, compensating our employees, managing our website and various other processes and transactions. See “Business - Management Information Systems.” Our ability to effectively manage our business and coordinate the sourcing, distribution and sale of our merchandise depends significantly on the reliability and capacity of these systems.
System security risk issues could disrupt our information technology services, and any such disruption could harm our net sales, increase our expenses, and harm our reputation and stock price.
Through our operations, we collect and store certain personal information that our customers provide to enroll in promotional programs, register on our website, or otherwise communicate and interact with us. We may request customer zip codes to assist in site selection or place customers on email distribution lists at their request. In addition, we rely on third party technology and systems in certain aspects of our businesses, including to securely transmit confidential information. Despite instituted safeguards for the protection of such information, security could be compromised and confidential customer or business information misappropriated. Loss of customer or business information could disrupt our operations, damage our reputation, and expose us to claims from customers, financial institutions, payment card associations and other persons, any of which could have an adverse effect on our business, financial condition and results of operations. In addition, compliance with more stringent privacy and information security laws and standards may result in significant expense due to increased investment in technology and the development of new operational processes.
There are claims made against us from time to time that can result in litigation or regulatory proceedings which could distract management from our business activities and result in significant liability or damage to our brand image.
As a growing company with expanding operations, we increasingly face the risk of litigation and other claims against us. Our business is subject to the risk of litigation by employees, consumers, suppliers, competitors, shareholders, government agencies and others through private actions, class actions, administrative proceedings, regulatory actions or other litigation. The number of employment-related class actions filed each year has continued to increase, and recent changes and proposed changes in Federal and state laws may cause claims to rise even more. The outcome of litigation, particularly class action lawsuits, regulatory actions and intellectual property claims, is difficult to assess or quantify. Plaintiffs in these types of lawsuits may seek recovery of very large or indeterminate amounts, and the magnitude of the potential loss relating to these lawsuits may remain unknown for substantial periods of time. In addition, certain of these lawsuits, if decided adversely to us or settled by us, may result in liability material to our financial statements as a whole or may negatively affect our operating results if changes to our business operation are required. The cost to defend future litigation may be significant. There also may be adverse publicity associated with litigation that could negatively affect customer perception of our business, regardless of whether the allegations are valid or whether we are ultimately found liable. We cannot predict or determine the ultimate outcome of any legal or administrative proceedings to which we are now subject or may become subject in the future or quantify the loss, expense or other amounts attributable to any such matter. The resolution of any future legal claims and administrative proceedings, if unfavorable, could have a material adverse affect on our business and results of operations.
We may be subject to liability if we infringe upon the trademarks or other intellectual property rights of third parties.
We sometimes purchase merchandise from vendors who hold manufacturing and distribution rights under the terms of certain licenses or who themselves own intellectual property rights to the merchandise. In addition, we purchase merchandise that may be subject to design copyrights, design patents, or otherwise may incorporate protected intellectual property. We rely upon vendors’ representations set forth in our purchase orders and vendor agreements concerning their right to sell us the products that we purchase from them. If a third party claims to have licensing rights with respect to merchandise we purchased from a vendor, or we acquire unlicensed merchandise, we could be obligated to remove such merchandise from our stores, incur costs associated with destruction of such merchandise if the distributor or vendor is unwilling or unable to reimburse us, and be subject to liability under various civil and criminal causes of action, including actions to recover unpaid royalties and other damages and injunctions. Although our purchase orders and vendor agreement with each vendor require the vendor to indemnify us against such claims, a vendor may not have the financial resources to defend us, in which case we may have to pay the costs and expenses associated with defending such claim. Any of these results could harm our brand image and have a material adverse effect on our business and growth
If we were to be found liable for any infringement, we could be required to pay substantial damages and could be subject to injunctions preventing further infringement. Such infringement claims could harm our brand image. In addition, any payments we are required to make and any injunctions we are required to comply with as a result of such infringement actions could adversely affect our financial results.
Failure to comply with existing laws or regulations, or changes in such laws and regulations, including employment laws and laws related to our merchandise, could make conducting our business more expensive or otherwise change the way we do business.
We are subject to numerous laws and regulations, including labor and employment, customs, truth-in-advertising, consumer protection and zoning and occupancy laws and ordinances that regulate retailers generally and/or govern the importation, promotion and sale of merchandise and the operation of stores and warehouse facilities. Our policies, procedures and internal controls are designed to comply with all applicable laws and regulations, including those imposed by the Sarbanes-Oxley Act of 2002, the Securities Exchange Act of 1934,
Payment Card Industry Data Security Standards (PCI/DSS) and the NASDAQ stock market rules. Failure to comply
with such laws and regulations could have a material adverse impact on our financial condition or the price of our common stock.
Changes in international, federal, state or local laws, rules or regulations, including but not limited to laws, rules or regulations related to employment, wages, data privacy, information security, intellectual property, taxes, products, product safety, health and safety, and imports and exports, could increase the Company’s costs of doing business or otherwise impact the Company’s business. These laws and regulations are complex, continuously evolving and the related enforcement is increasingly aggressive, particularly in the state of California, which has increased the cost of compliance. If these laws and regulations were to change or were violated by our management, employees, vendors, buying agents or trading companies, the costs of certain goods could increase, we could be subject to damage to our reputation, class action lawsuits, legal and settlement costs, civil and criminal liability, restatements of our financial statements, disruption of our business and loss of customers which could hurt our business and results of operations. Any required changes to our employment practices could result in increased payroll costs, the loss of employees, reduced sales, low employee morale and harm to our business and results of operations. It is often difficult for us to plan and prepare for potential changes to applicable laws and future actions or payments related to such changes could be material to us.
We may be unable to protect our trademarks or other intellectual property rights.
We are not aware of any claims of infringement upon or challenges to our right to use any of our brand names or trademarks in the United States. Nevertheless, there can be no assurance that the actions we have taken to establish and protect our trademarks will be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products as a violation of the trademarks or proprietary rights of others. Also, others may assert rights in, or ownership of, our trademarks and other proprietary rights or claim that we are infringing on their proprietary rights, and we may not be able to successfully resolve these types of conflicts to our satisfaction. In addition, upon registration of our marks internationally, the laws of certain foreign countries may not protect proprietary rights to the same extent as do the laws of the United States.
Although we have begun to register our trademarks in some foreign countries, international protection of our brand image and the use of these marks could be limited. Other entities may have rights to trademarks that contain portions of our marks or may have registered similar or competing marks for apparel and accessories in foreign countries in which our vendors source our merchandise. There may also be other prior registrations in other foreign countries of which we are not aware. Accordingly, it may be possible for others to enjoin the manufacture, sale or exportation of our branded goods to the United States. If we were unable to reach a licensing arrangement with these parties, our vendors may be unable to manufacture our products in those countries. Our inability to register our trademarks or purchase or license the right to use our trademarks or logos in these jurisdictions could limit our ability to obtain supplies from less costly markets or penetrate new markets should our business plan change to include selling our merchandise in those jurisdictions outside the United States.
Concentration of ownership among our existing executive officers, directors and principal stockholders may prevent new investors from influencing significant corporate decisions.
Our executive officers, directors and our largest stockholder own, in the aggregate, approximately 36.8% of our outstanding common stock and own options that will enable them to own, in the aggregate, approximately 38.2% of our outstanding common stock. As a result, these stockholders will be able to exercise significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions and will have significant influence over our management and policies. Two of the seven members of our board of directors are principals of Apax Partners. Funds advised by Apax Partners can take actions that have the effect of delaying a change in control of us or discouraging others from making tender offers for our shares, which could prevent stockholders from receiving a premium for their shares. These actions may be taken even if other stockholders oppose them. The concentration of voting power among funds advised by Apax Partners may have an adverse effect on the price of our common stock. The interests of these stockholders may not be consistent with your interests as a stockholder.
In addition, our amended and restated certificate of incorporation will provide that the provisions of Section 203 of the Delaware General Corporation Law, or the DGCL, that relate to business combinations with interested stockholders will apply to us. Section 203 of the DGCL prohibits a publicly held Delaware corporation from engaging in a business combination transaction with an interested stockholder for a period of three years after the interested stockholder became such unless the transaction fits within an applicable exemption, such as board approval of the business combination or the transaction which resulted in such stockholder becoming an interested stockholder. The provisions of Section 203 of the DGCL may delay, prevent or deter a merger, acquisition, tender offer or other transaction that might otherwise result in our stockholders receiving a premium over the market price for their common stock.
Our amended and restated certificate of incorporation provides that the doctrine of corporate opportunity does not apply to Apax Partners, funds advised by Apax Partners, or any of our directors who are employees of or affiliated with Apax Partners, acting on Apax Partners’ behalf, or funds advised by Apax Partners, in a manner that would prohibit them from investing or participating in competing businesses. To the extent they invest in such other businesses, Apax Partners or funds advised by Apax Partners may have differing interests than our other stockholders.
Our stock price may be volatile or may decline regardless of our operating performance or other factors.
Our stock price may fluctuate substantially as a result of quarter to quarter variations in our actual or projected performance or the financial performance of other companies in the retail industry. In addition, the stock market has experienced price and volume fluctuations that have affected the market price of many retail and other stocks and that have often been unrelated or disproportionate to the operating performance of these companies.
Anti-takeover provisions in our charter documents and Delaware law might discourage or delay acquisition attempts for us that you might consider favorable.
Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that may make the acquisition of our company more difficult without the approval of our board of directors. These provisions:
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establish a classified board of directors so that not all members of our board of directors are elected at one time;
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authorize the issuance of undesignated preferred stock, the terms of which may be established and the shares of which may be issued without stockholder approval, and which may include super voting, special approval, dividend, or other rights or preferences superior to the rights of the holders of common stock;
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prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders;
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provide that the board of directors is expressly authorized to make, alter, or repeal our amended and restated bylaws; and
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establish advance notice requirements for nominations for elections to our board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings.
These anti-takeover provisions and other provisions under Delaware law could discourage, delay or prevent a transaction involving a change in control of our company, even if doing so would benefit our stockholders. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing and to cause us to take other corporate actions you desire.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
We do not own any real property. Our principal executive office is located in an 84,000 square foot space in Warrendale, Pennsylvania and is leased under a lease agreement expiring in 2021.
Our 378,000 square foot distribution facility is located in Weirton, West Virginia. Our distribution facility is leased under a lease agreement expiring in 2026, with an option to renew for two additional five-year terms.
As of January 28, 2012, we operated 755 stores in 713 cities in 46 states. All of our stores are leased from third parties and the leases typically have terms of five to ten years with options to renew for additional five-year periods thereafter. Most of our leases have early cancellation clauses, which permit the lease to be terminated by us or the landlord if certain sales levels are not met in specific periods or if a shopping center does not meet specified occupancy standards. In addition to future minimum lease payments, most of our store leases provide for additional rental payments based on a percentage of net sales if sales at the respective stores exceed specified levels, as well as the payment of common area maintenance charges, real property insurance and real estate taxes. Many of our lease agreements have defined escalating rent provisions over the initial term and any extensions.
We believe that our facilities are generally adequate for current and anticipated future use.
Item 3.
Item 3. Legal Proceedings.
We are subject to various legal proceedings and claims which arise in the ordinary course of our business. If a potential loss arising from these lawsuits, claims and pending actions is probable and reasonably estimable, we record the estimated liability based on circumstances and assumptions existing at the time. Management does not believe that the outcome of current litigation will have a material adverse effect on our consolidated results of operations or financial condition, and believes that the recorded liabilities are adequate. However, there are inherent limitations in projecting the outcome of these matters and in the estimation process, and should future actual liabilities exceed projected liabilities, it could have a material adverse effect on our consolidated financial condition or on our operations.
Item 4.
Item 4. Mine Safety Disclosures
Not Applicable.
Part II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock has been listed on The NASDAQ Global Select Market under the symbol “rue” since our initial public offering on November 13, 2009. Before then, there was no public market for our common stock. The following table sets forth the high and low sales prices of our common stock per share, as reported by The NASDAQ Global Select Market. The number of holders of record of our stock as of December 31, 2011 was approximately 132.
The following table sets forth the high and low sales prices of our common stock per share, as reported by The NASDAQ Global Select Market.
Dividends
The continued operation and expansion of our business will require substantial funding. Accordingly, we do not anticipate that we will pay any cash dividends on shares of our common stock for the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our board of directors and will depend upon results of operations, financial condition, contractual restrictions, including our senior secured credit facility and other indebtedness we may incur, restrictions imposed by applicable law and other factors our board of directors deems relevant.
Securities Authorized for Issuance Under Equity Compensation Plans
The information incorporated by reference in Item 12 of this Annual Report from our 2012 Proxy Statement under the heading “Equity Compensation Plan Information” is hereby incorporated by reference into this Item 5.
Stock Price Performance Graph
The following graph compares the cumulative stockholder return on our common stock from November 13, 2009 (the date of our initial public offering) through January 28, 2012 with the return on the Total Return Index for the NASDAQ Stock Market (US securities only) and the NASDAQ Retail Trade Stocks. The graph assumes $100 invested on November 13, 2009, in the stock of rue21, inc. the NASDAQ Global Stock Market (US securities only), and the NASDAQ Retail Trade Stocks. It also assumes that all dividends are reinvested.
Comparison of 27 Month Cumulative Total Return
Assumes Initial Investment of $100
January 2012
Comparison of Cumulative Total Return
Assumes Initial Investment of $100
January 2012
(1) Returns are based upon the premise that $100 is invested in each of (a) our common stock, (b) NASDAQ Stock Market (US securities only), and (c) the index of NASDAQ Retail Trade Stocks on November 13, 2009, and that all dividends (if any) were reinvested. Stockholder returns over the indicated period should not be considered indicative of future stockholder returns.
Unregistered Sales of Equity Securities
Not applicable.
Item 6.
Item 6. Selected Consolidated Financial Data.
The following selected financial data are derived from the Consolidated Financial Statements of the Company. We have also included certain non-financial operating data to enhance your understanding of our business. The data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion together with “Selected Consolidated Financial Data,” and the historical consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. The statements in this discussion regarding industry outlook, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements in this discussion are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in Part I - Item 1A “Risk Factors”. Our actual results may differ materially from those contained in or implied by any forward-looking statements.
We operate on a fiscal calendar widely used by the retail industry that results in a given fiscal year consisting of a 52- or 53-week period ending on the Saturday closest to January 31 of the following year. For example, references to “fiscal year 2011” refer to the fiscal year ended January 28, 2012.
Overview
rue21 is a fast growing specialty apparel retailer offering the newest fashion trends for girls and guys at every day great value. We were originally founded in 1976 as a value-focused specialty apparel retailer. In 1998, we were acquired by certain funds now advised by Apax Partners, through SKM Equity Fund II, L.P. and SKM Investment Fund II. In 2001, our current President and Chief Executive Officer, Bob Fisch, joined us. Upon his hiring, Bob Fisch began repositioning our company by aligning our stores under one brand name, strengthening our management team, honing our fashion value merchandise approach and refocusing our store growth strategy. In late 2006, we introduced our larger rue21 etc! store layout, which averages approximately 5,000 square feet and features a separate store-in-store for our rue21 etc! girls jewelry and accessories category. As of January 28, 2012, we operated 755 stores in 46 states, 602 of which featured the larger rue21 etc! store layout.
Our strong growth and operating results reflect the initiatives taken by our management team, as well as the increasing acceptance of our brand and merchandise. Our net sales increased from $296.9 million in fiscal year 2007 to $760.3 million in fiscal year 2011, a compound annual growth rate of 26.5%. Over the same period, we grew income from operations from $17.5 million to $62.8 million, a compound annual growth rate of 37.7%. Since the beginning of fiscal year 2007, we have increased our store base from 278 stores to 755 stores as of January 28, 2012. Our total square footage growth has outpaced our total store growth over this same period, reflecting the increasing size of our average store.
We expect to continue our strong growth in the future. We believe there is a significant opportunity to grow our store base to 1,500 stores. We plan to open 120 stores in fiscal year 2012. We also plan to continue to convert our existing stores into the larger rue21 etc! layout, which allows us to offer an increased proportion of higher margin categories, such as accessories, intimate apparel, footwear and fragrances. We converted 38 stores to the rue21 etc! layout in fiscal year 2011 and plan to convert 30 stores in fiscal year 2012. We expect to continue to drive our comparable store sales by increasing the penetration of our newer product categories, increasing our brand awareness, continuing to provide our distinctive in-store experience and converting stores to the rue21 etc! layout.
Our growth in total square footage is supported by our store economics, which we believe to be very attractive. As a result of our low store build-out costs, favorable lease terms and low-cost operating model, our stores generate strong returns on investment. We focus our real estate strategy on strip centers, regional malls and outlet centers, primarily in small and middle market communities, which we believe are underserved by traditional junior and young men’s specialty apparel retailers. Our typical new store investment is approximately $170,000, which includes build-out costs, net of landlord tenant allowances and initial inventory, net of payables. New stores generate on average between $900,000 and $1.1 million in net sales per store in the first twelve months.
We continue to invest the capital necessary to build our infrastructure and support our future growth. In 2011 we completed expansion plans at our corporate headquarters in Warrendale, Pennsylvania, and expanded the footprint of our distribution facility in Weirton, West Virginia. We also continue to invest in our systems infrastructure, including implementation of the latest store merchandising, supply chain, financial and real estate applications.
How We Assess the Performance of Our Business
In assessing the performance of our business, we consider a variety of performance and financial measures. The key measures for determining how our business is performing are net sales, comparable store and non-comparable store sales, gross profit margin and selling, general and administrative expense.
Net Sales
Net sales constitute gross sales net of any returns and merchandise discounts. Net sales consist of sales from comparable stores and non-comparable stores.
Comparable Store Sales
A store is included in comparable store sales on the first day of the sixteenth month after its opening, as new stores generally open with above run-rate sales volumes, which usually extend for a period of at least three months, and comparability generally is achieved twelve months after the initial three-month period after store opening. Comparable store sales include existing stores that have been converted to our rue21 etc! layout. When a store that is included in comparable store sales is in the process of being converted to our rue21 etc! layout, net sales from that store remain in comparable store sales. There may be variations in the way in which some of our competitors and other apparel retailers calculate comparable or “same store” sales. As a result, data in this Annual Report on Form 10-K regarding our comparable store sales may not be comparable to similar data made available by other retailers. Non-comparable store sales include sales not included in comparable store sales and sales from closed stores.
Measuring the change in year-over-year comparable store sales allows us to evaluate how our store base is performing. Various factors affect comparable store sales, including:
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consumer preferences, buying trends and overall economic trends;
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our ability to identify and respond effectively to fashion trends and customer preferences;
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competition;
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changes in our merchandise mix;
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pricing;
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the timing of our releases of new merchandise and promotional events;
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the level of customer service that we provide in our stores;
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our ability to source and distribute products efficiently; and
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the number of stores we open, close and convert in any period.
As we continue to pursue our store growth strategy, we expect that a significant percentage of our net sales increase will continue to come from non-comparable store sales. Opening new stores is an important part of our growth strategy. Accordingly, comparable store sales is only one element we use to assess the success of our growth strategy.
The retail apparel industry is cyclical, and consequently our net sales are affected by general economic conditions. Purchases of apparel and accessories are sensitive to a number of factors that influence the levels of consumer spending, including economic conditions and the level of disposable consumer income, consumer debt, interest rates and consumer confidence.
Gross Profit
Gross profit is equal to our net sales minus our cost of goods sold. Gross margin measures gross profit as a percentage of our net sales. Cost of goods sold includes the direct cost of purchased merchandise, distribution center costs, all freight costs incurred to get merchandise to our stores, store occupancy costs and buying costs. The components of our cost of goods sold may not be comparable to those of other retailers.
Our cost of goods sold is substantially higher in higher volume quarters because cost of goods sold generally increases as net sales increase. Changes in the mix of our products, such as changes in the proportion of accessories, may also impact our overall cost of goods sold. We review our inventory levels on an ongoing basis in order to identify slow-moving merchandise, and generally use markdowns to clear that merchandise. The timing and level of markdowns are not seasonal in nature but are driven by customer acceptance of our merchandise. If we misjudge the market for our products, we may be faced with significant excess inventories for some products and be required to mark down those products in order to sell them. Significant markdowns have reduced our gross profit in some prior periods and may have a material adverse impact on our earnings for future periods depending on the amount of the markdowns and the amount of merchandise affected.
Selling, General and Administrative Expense
Selling, general and administrative expense includes administration, stock-based compensation and store expenses but excludes store occupancy costs and freight to stores. These expenses do not generally vary proportionally with net sales. As a result, selling, general and administrative expense as a percentage of net sales is usually higher in lower volume quarters and lower in higher volume quarters. The components of our selling, general and administrative expense may not be comparable to those of other retailers. Selling, general and administrative expense has increased significantly since fiscal 2009 due to additional legal, accounting, insurance and other expenses we incurred as a result of being a public company and compliance with the Sarbanes-Oxley Act and related rules and regulations and we expect it will increase in future periods due to our continuing store growth.
Results of Operations
The following tables summarize key components of our consolidated results of operations for the periods indicated, both in dollars and as a percentage of net sales:
The following table summarizes the number of stores open at the beginning of the period and at the end of the period.
(1) Stores opened during period do not include existing stores that have been converted to our rue21 etc! layout.
Fiscal Year 2011 Compared to Fiscal Year 2010
Net Sales
In fiscal year 2011, our net sales increased 19.8%, or $125.6 million, to $760.3 million from $634.7 million in fiscal year 2010. This increase in net sales was due to an increase of approximately 14.7% in the number of transactions and an increase in the average dollar transaction of approximately 4.2%. The average dollar value of transactions increased due to a higher average unit retail slightly offset by a decrease in units per transaction. During fiscal year 2011, we opened 120 new stores and closed 3 stores compared to 105 new stores and 2 store closures in fiscal year 2010. Our comparable store sales increased 0.4% in fiscal year 2011 compared to an increase of 2.1% in fiscal year 2010. There were 611 comparable stores and 144 non-comparable stores open at January 28, 2012 compared to 523 and 115, respectively, at January 29, 2011.
In fiscal year 2011, net sales of girls apparel, girls accessories and guys apparel and accessories represented 55.2%, 26.4% and 18.4%, respectively, of total net sales compared to 55.9%, 25.7% and 18.4%, respectively, for fiscal year 2010. For fiscal year 2011, the girls apparel, girls accessories and guys apparel and accessories categories grew by approximately 18.1%, 22.7% and 19.8%, respectively, as compared to fiscal year 2010.
Gross Profit
Gross profit increased 22.1%, or $51.8 million, in fiscal year 2011 to $286.6 million from $234.8 million in fiscal year 2010. Gross margin increased 70 basis points to 37.7% for fiscal year 2011 from 37.0% for fiscal year 2010. This increase was attributable to a 70 basis point increase in merchandise margin, primarily due to an improvement in our initial mark-up rate in fiscal year 2011. Gross margin as a percent of sales was not impacted by store occupancy, distribution and buying costs, as these costs were flat as a rate to net sales in fiscal year 2011 compared to fiscal year 2010.
Selling, General and Administrative Expense
Selling, general and administrative expense increased 21.0%, or $34.2 million to $197.2 million in fiscal year 2011 from $163.0 million in fiscal year 2010. As a percentage of net sales, selling, general and administrative expense increased 20 basis points to 25.9% in fiscal year 2011 as compared to 25.7% in fiscal year 2010.
Store operating expenses increased 30 basis points as a percentage of sales primarily due to salary and related expenses. Corporate administrative and general expenses decreased 10 basis points primarily due to a decrease to salary and related expenses offset by a 30 basis point increase in stock based compensation.
Depreciation and Amortization Expense
Depreciation and amortization expense was flat as a percentage of net sales at 3.5% in fiscal year 2011 and fiscal year 2010, respectively. Depreciation and amortization expense increased 21.1%, or $4.6 million, in fiscal year 2011 to $26.6 million from $22.0 million and was primarily due to the continued opening of new stores and conversions, investments in information technology and the completion of the home office expansion during fiscal year 2011.
Provision for Income Taxes
The increase in provision for income taxes of $4.4 million in fiscal year 2011 from fiscal year 2010 was due primarily to a $13.1 million increase in pre-tax income. The effective tax rate was at 38.0% in fiscal year 2011 as compared to 39.2% in fiscal year 2010. This rate decrease was primarily the result of corporate restructuring and discrete events in fiscal year 2011.
Net Income
Net income increased 28.8%, or $8.8 million, to $39.0 million in fiscal year 2011 from $30.2 million in fiscal year 2010. This increase was due to the factors discussed above.
Fiscal Year 2010 Compared to Fiscal Year 2009
Net Sales
In fiscal year 2010, our net sales increased 20.8%, or $109.1 million, to $634.7 million from $525.6 million in fiscal year 2009. This increase in net sales was due to an increase of approximately 20.3% in the number of transactions, primarily driven by new store openings. During fiscal year 2010, we opened 105 new stores and closed 2 stores compared to 88 new stores and 2 store closures in fiscal year 2009. Our comparable store sales increased 2.1% in fiscal year 2010 compared to an increase of 7.8% in fiscal year 2009. Comparable store sales increased by $115.6 million and non-comparable store sales decreased by $6.5 million for fiscal year 2010 compared to fiscal year 2009. There were 523 comparable stores and 115 non-comparable stores open at January 29, 2011 compared to 417 and 118, respectively, at January 30, 2010.
In fiscal year 2010, net sales of girls apparel, girls accessories and guys apparel and accessories represented 55.9%, 25.7% and 18.4%, respectively, of total net sales compared to 56.7%, 24.3% and 19.0%, respectively, for fiscal year 2009. For fiscal year 2010, the girls apparel, girls accessories and guys apparel and accessories categories grew by approximately 19.0%, 27.8% and 17.1%, respectively, as compared to fiscal year 2009.
Gross Profit
Gross profit increased 25.0%, or $46.9 million, in fiscal year 2010 to $234.8 million from $187.9 million in fiscal year 2009. Gross margin increased 120 basis points to 37.0% for fiscal year 2010 from 35.8% for fiscal year 2009. This increase was attributable to a 120 basis point increase in merchandise margin, primarily due to an improvement in our initial mark-up rate in fiscal year 2010. Gross margin as a percent of sales was not impacted by store occupancy, distribution and buying costs, as these costs were flat as a rate to net sales in fiscal year 2010 compared to fiscal year 2009.
Selling, General and Administrative Expense
Selling, general and administrative expense increased 21.6%, or $28.9 million to $163.0 million in fiscal year 2010 from $134.1 million in fiscal year 2009. As a percentage of net sales, selling, general and administrative expense increased 20 basis points to 25.7% in fiscal year 2010 as compared to 25.5% in fiscal year 2009. In fiscal year 2010, we incurred $3.1 million in public company expenses and stock-based compensation expense of $2.2 million. In fiscal year 2009, we incurred $2.5 million in public company expenses and stock-based compensation expense of $0.4 million. In November 2009, we and Apax Partners, L.P (Apax) agreed to terminate the letter agreement relating to financial advisory services provided to the Company. As part of termination agreement, we were required to pay Apax a one-time termination fee of $1.5 million, which is included as a component of public company expenses in fiscal year 2009. Excluding the impact of these items, selling, general and administrative expenses as a percentage of net sales, would have leveraged 10 basis points in fiscal year 2010.
Store operating expenses increased by $20.4 million primarily resulting from the operation of 638 stores as of January 29, 2011 compared to the operation of 535 stores as of January 30, 2010. As a percentage of net sales, store operating expenses were flat at 18.6% in each of fiscal year 2010 and fiscal year 2009.
Administrative and general expenses increased as a percentage of net sales to 7.1% in fiscal year 2010 as compared to 6.9% in fiscal year 2009 due primarily to the incremental public company and stock-based compensation expenses as discussed above. Excluding the impact of the incremental public company and stock-based compensation expenses, administrative and general expenses as a percentage of net sales, would have decreased to 6.2% in fiscal year 2010 as compared to 6.3% in fiscal year 2009.
Depreciation and Amortization Expense
Depreciation and amortization expense increased as a percentage of net sales to 3.5% in fiscal year 2010 from 3.2% in fiscal year 2009, or $5.0 million. The increase in depreciation and amortization expense was primarily due to the continued opening of new stores and conversions, investments in information technology and the completion of the distribution center expansion during fiscal year 2010.
Provision for Income Taxes
The increase in provision for income taxes of $5.1 million in fiscal year 2010 from fiscal year 2009 was due primarily to a $13.4 million increase in pre-tax income. The effective tax rate was at 39.2% in fiscal year 2010 as compared to 39.5% in fiscal year 2009. This rate decrease was the result of state tax credits offset by non-deductible expenses in fiscal year 2010.
Net Income
Net income increased 37.4%, or $8.2 million, to $30.2 million in fiscal year 2010 from $22.0 million in fiscal year 2009. This increase was due to the factors discussed above.
Liquidity and Capital Resources
Our primary source of liquidity is cash flows from operations. Our primary cash needs are generally for capital expenditures incurred in connection with the opening of new stores, the conversion of existing stores, and for the related increase in merchandise inventories. Cash is also required for investment in information technology, home office and distribution facility infrastructure and funding normal working capital requirements. The most significant components of our working capital are cash and cash equivalents, merchandise inventories, accounts payable and other current liabilities. Our working capital position benefits from the fact that we generally collect cash from sales to customers the same day or, in the case of credit or debit card transactions, within several days of the related sale, and we typically have up to 75 to 90 days to pay our vendors.
As of January 28, 2012, we had cash, cash equivalents and short term investments totaling $72.0 million. Our cash and cash equivalents consist of cash on deposit and investments with a maturity of 90 days or less. Our cash, cash equivalents and short term investments balance at January 28, 2012 increased by $21.9 million from $50.1 million at January 29, 2011. Components of this change in cash for fiscal year 2011, as well as for change in cash for the fiscal years 2010 and 2009, are provided below in more detail.
A summary of operating, investing and financing activities are shown in the following table:
Operating Activities
Operating activities consist primarily of net income adjusted for non-cash items, including depreciation and amortization, deferred taxes, the effect of working capital changes and tenant allowances received from landlords.
During fiscal year 2011, we generated $74.2 million in cash from operating activities. Our major source of cash from operations was attributable to net income of $39.0 million and an increase in accounts payable of $22.3 million. Net cash was reduced for additional merchandise inventory required by operations of $35.1 million.
During fiscal year 2010, we generated $61.6 million in cash from operating activities. Our major source of cash from operations was attributable to net income of $30.2 million and an increase in accounts payable of $21.8 million. Net cash was reduced for additional merchandise inventory required by operations of $23.4 million.
During fiscal year 2009, we generated $48.8 million in cash from operating activities. This increase in cash from operating activities was primarily attributable to net income of $22.0 million. Other working capital components increased by $14.2 million due to increases in accrued expenses and in tenant allowances received from landlords as a result of new store openings.
Investing Activities
Investing activities consist of capital expenditures for new and converted stores, as well as investment in information technology and our distribution and headquarter facility expansions. Additionally, the company purchased short term investments during fiscal year 2011.
In fiscal year 2011, capital expenditures, net of tenant allowances increased $8.7 million as compared to fiscal year 2010. Capital expenditures, net of tenant allowances, for the opening of new stores and conversions were $15.7 million, $16.2 million and $11.5 million in fiscal years 2011, 2010 and 2009, respectively. The remaining capital expenditures in fiscal year 2011 were primarily due to increases in fixture refreshes, headquarters expansion and information technology infrastructure investments.
While there can be no assurance that current expectations will be realized, the Company expects capital expenditures, net of tenant allowances to be approximately $38.0 to $40.0 million in fiscal year 2012.
Purchases of short term investments consisted of highly liquid, money market funds with a maturity in excess of 90 days and less than 365 days.
Financing Activities
Financing activities consist principally of proceeds from the exercise of employee stock options and excess tax benefits from share-based award activities, proceeds from our initial public offering in fiscal year 2009, along with net borrowings under our credit facilities.
Net cash of $1.2 million was provided by financing activities in fiscal year 2011, which was primarily utilized to fund general corporate activities. During fiscal year 2011, we received $0.6 million for the exercise of stock options, and we recognized a $0.6 million excess tax benefit related to share based award activities.
We completed our initial public offering (IPO) on November 13, 2009, which resulted in net proceeds to us of $29.2 million after deducting underwriters’ discounts and commissions. We incurred legal and other costs related to our IPO of approximately $3.0 million, which is included as a reduction of additional paid-in capital. We used the net proceeds to us from the IPO to repay the $25.8 million outstanding under the senior secured credit facilities.
Senior Secured Credit Facility
Effective April 10, 2008, we established a five-year $60.0 million senior secured credit facility with Bank of America, N.A., which was amended on November 24, 2009. Key provisions of the amendment included an increase in the borrowing ceiling to $85 million from $60 million, which is further expandable at our option in increments of $5 million up to a maximum of $100 million under certain defined conditions. On November 18, 2011 a second amendment was executed. The key provision of the second amendment allows the Company to provide guarantees to third party lenders in connection with purchase orders in the ordinary course of business if such guarantees are considered necessary by the Company. Interest accrues at the higher of the Federal Funds rate plus .50%, the prime rate or the adjusted LIBOR rate plus 1.00% plus the applicable margin which ranges from 1.25% to 3.00%. Availability under our senior secured credit facility is collateralized by a first priority interest in all of our assets. As of January 28, 2012 and January 29, 2011, there was no amount outstanding under the senior secured credit facility.
Our senior secured credit facility includes a fixed charge covenant applicable only if net availability falls below a 10% threshold. We are in compliance with all covenants under our senior secured credit facility as of January 28, 2012 and expect to remain in compliance for the next twelve months.
We believe that our cash position, net cash provided by operating activities and availability under our senior secured credit facility will be adequate to finance working capital needs and planned capital expenditures for at least the next twelve months.
Off Balance Sheet Arrangements
We are not a party to any off balance sheet arrangements.
Contractual Obligations
The following table summarizes our contractual obligations as of January 28, 2012 and the effect such obligations are expected to have on our liquidity and cash flows in future periods.
(1) Excludes common area maintenance (CAM) charges, real estate taxes and certain other expenses which amounted to approximately 19% of minimum lease obligations in fiscal year 2011 which we expect to be consistent for the next three years.
Impact of Inflation
Our results of operations and financial condition are presented based on historical cost. While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we believe the effects of inflation, if any, on our consolidated results of operations and financial condition have been immaterial.
Critical Accounting Policies
Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires estimates and judgments that affect the reported amounts of our assets, liabilities, net sales and expenses. Management bases estimates on
historical experience and other assumptions it believes to be reasonable given the circumstances and evaluates these estimates on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.
We believe that the following critical accounting policies involve a higher degree of judgment and complexity. See Note 1 to our consolidated financial statements for the fiscal year ended January 28, 2012 for a complete discussion of our significant accounting policies. The following reflect the significant estimates and judgments used in the preparation of our consolidated financial statements.
Revenue Recognition
Revenue is recognized upon purchase of merchandise by customers. Allowances for sales returns are recorded as a reduction of sales in the periods in which the sales are recognized. Deferred revenue is established upon the purchase of gift cards by customers, and revenue is recognized upon redemption of gift cards for merchandise.
Inventory Valuation
We value merchandise inventory at the lower of cost (first-in, first-out basis) or market using the retail inventory method. We record merchandise receipts at the time they are delivered to our consolidator, as we do not directly import any merchandise. This is the point at which title and risk of loss transfer to us.
We review our inventory levels to identify slow-moving merchandise and generally use markdowns to clear slow-moving merchandise. We record a markdown reserve based on estimated future markdowns related to current inventory. Each period we evaluate the selling trends experienced and the related promotional events or pricing strategies in place to sell through the current inventory levels. Markdowns may occur when inventory exceeds customer demand for reasons of style, seasonal adaptation, changes in customer preference, lack of consumer acceptance of fashion items, competition, or if it is determined that the inventory in stock will not sell at its currently ticketed price. Such markdowns may have an adverse impact on earnings, depending on the extent and amount of inventory affected. The anticipated deployment of new seasonal merchandise is reflected within the estimated future markdowns reserve used in valuing current inventory, as such new inventory in certain circumstances will displace merchandise units currently on-hand. The markdown reserve is recorded as an increase to cost of goods sold in the consolidated statements of income.
We also estimate a shrinkage reserve for the period of time between the last physical count and the balance sheet date. The estimate for shrinkage reserve can be affected by changes in merchandise mix and changes in actual shrinkage trends.
Asset Impairment
We are exposed to potential impairment if the book value of our assets exceeds their expected future cash flows. The major components of our long-lived assets are store fixtures, equipment and leasehold improvements. We have recognized impairment charges related to store conversions and may recognize impairment charges in the future. The impairment of unamortized costs is measured at the store level and the unamortized cost is reduced to fair value if it is determined that the sum of expected undiscounted future net cash flows estimated to be generated by those assets is less than net book value.
Income Taxes
We account for income taxes in accordance with the authoritative guidance issued by the Financial Accounting Standards Board (FASB), which requires the use of the asset and liability method. Under this method, deferred tax assets and liabilities are recognized based on the difference between our consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the tax rates, based on certain judgments regarding enacted tax laws and published guidance, in effect in the years when those temporary differences are expected to reverse. A valuation allowance is established
against the deferred tax assets when it is more likely than not that some portion or all of the deferred taxes may not be realized. Changes in the level and composition of earnings, tax laws or the deferred tax valuation allowance, as well as the results of tax audits may materially impact our effective tax rate.
We recognize income tax liabilities related to unrecognized tax benefits in accordance with the FASB’s authoritative guidance related to uncertain tax positions and adjust these liabilities when our judgment changes as the result of the evaluation of new information. We classify interest and penalties as an element of tax expense.
The calculation of the deferred tax assets and liabilities, as well as the decision to recognize a tax benefit from an uncertain position and to establish a valuation allowance require management to make estimates and assumptions. We believe that our assumptions and estimates are reasonable, although actual results may have a positive or negative material impact on the balances of deferred tax assets and liabilities, valuation allowances, or net income.
Stock-Based Compensation
We account for stock-based compensation in accordance with the FASB’s authoritative guidance for stock-based compensation. Under this guidance, stock-based compensation cost is estimated at the grant date based on the award’s fair value as calculated by the Black-Scholes option-pricing model and is recognized as expense over the requisite service period. The Black-Scholes model requires various highly judgmental assumptions including volatility, expected option life, risk free interest rate and dividend yield. The expected volatility reflects the application of SAB Topic 14’s interpretive guidance and, accordingly, incorporates historical volatility of similar entities whose share prices are publicly available. The expected option life reflects the application of the simplified method set out in SAB Topic 14. The simplified method defines the life as the average of the contractual term of the options and the weighted-average vesting period for all option tranches. The risk-free interest rate is based on 7-year U.S. Treasury instruments whose maturities are similar to those of the expected term of the award being valued. The expected dividend yield was based on our expectation of not paying dividends on our common stock for the foreseeable future.
If any of the assumptions used in the Black-Scholes model change significantly, stock-based compensation expense may differ materially in the future from that recorded in the current period. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. We estimate the forfeiture rate based on historical experience. Further, to the extent our actual forfeiture rate is different from our estimate; stock-based compensation expense is adjusted accordingly.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Our principal market risk relates to interest rate sensitivity, which is the risk that future changes in interest rates will reduce our net income or net assets. Our senior secured credit facility accrues interest at the Bank of America N.A. base rate, defined at our option as the prime rate or the Eurodollar rate plus applicable margin, which ranges from 1.25% to 3.00% set quarterly dependent upon average net availability under our senior secured credit facility during the previous quarter. Because our senior secured credit facility bears interest at a variable rate, we will be exposed to market risks relating to changes in interest rates, if we have a meaningful outstanding balance. As of January 28, 2012, we had no outstanding borrowings under our senior secured credit facility, nor did we have any borrowings during fiscal year 2011. We had outstanding balances under our senior secured credit facility during fiscal year 2009 prior to our initial public offering, but we do not believe we are significantly exposed to changes in interest rate risk. We currently do not engage in any interest rate hedging activity and currently have no intention to do so in the foreseeable future.
Item 8.
Item 8. Financial Statements and Supplementary Data.
rue21, inc.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of rue21, inc.
We have audited the accompanying consolidated balance sheets of rue21, inc. as of January 28, 2012 and January 29, 2011, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended January 28, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of rue21, inc. at January 28, 2012 and January 29, 2011, and the consolidated results of its operations and its cash flows for each of the three years in the period ended January 28, 2012, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), rue21, inc.’s internal control over financial reporting as of January 28, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 27, 2012 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Pittsburgh, Pennsylvania
March 27, 2012
rue21, inc.
Consolidated Balance Sheets
See accompanying notes to the consolidated financial statements.
rue21, inc.
Consolidated Statements of Income
See accompanying notes to the consolidated financial statements.
rue21, inc.
Consolidated Statements of Stockholders’ Equity
See accompanying notes to the consolidated financial statements
rue21, inc.
Consolidated Statements of Cash Flows
See accompanying notes to the consolidated financial statements
rue21, inc.
Notes to Consolidated Financial Statements
For the Year Ended January 28, 2012
(Dollars in thousands, unless otherwise indicated)
Note 1 - Business and Summary of Significant Accounting Policies
Organization
rue21, inc. (the Company or rue21) is a specialty retailer of junior and young men’s apparel and accessories with 755, 638, and 535 stores as of January 28, 2012, January 29, 2011 and January 30, 2010 respectively, in various strip centers, regional malls and outlet centers throughout the United States. Sales are generally transacted for cash, checks and through the acceptance of third-party credit and debit cards.
On November 13, 2009, the Company completed an initial public offering of 7,780,252 shares of common stock at a price to the public of $19.00 per share, of which 1,650,000 shares were sold by the Company, 6,130,252 were sold by the selling shareholders (including 913,590 by members of the Company’s management). Upon completion of the offering, the Company received proceeds of approximately $29,156, net of underwriters’ discounts and commissions. On February 26, 2010, the Company completed an offering of 6,961,958 shares of common stock, including 908,081 shares of common stock subsequently sold pursuant to the underwriters’ over-allotment option, at a price of $28.50 per share, all of which were sold by funds advised by Apax Partners L.P., the Company’s principal stockholder and certain members of the Company’s management. The Company received no proceeds from the offering and incurred approximately $0.6 million in expense related to the offering.
In conjunction with the initial public offering of common stock, the Company was reincorporated in Delaware. The Company’s authorized capital stock consists of 200,000,000 shares of common stock, par value $0.001 per share, and 10,000,000 shares of preferred stock, par value $0.001 per share. The consolidated financial statements do not reflect the reclassification of the common stock, $0.004 par value to common stock, $0.001 par value, other than the related adjustment to par value and the increase in the number of authorized shares.
Principles of Consolidation
The consolidated financial statements include all the accounts of the Company and its wholly owned subsidiaries “r services, llc” and “rue services corporation”. All intercompany transactions and balances have been eliminated in consolidation. At January 28, 2012, the Company operated as one reporting segment.
Fiscal Year
The Company’s fiscal year is 52 or 53 weeks ending on the Saturday nearest to January 31 of the following year. These consolidated financial statements were prepared for the 52 weeks ended January 28, 2012, “Fiscal Year 2011”. As used herein, “Fiscal Year 2010” and “Fiscal Year 2009” refer to the 52 week period ended January 29, 2011 and January 30, 2010, respectively.
Reclassifications
Certain prior period amounts have been reclassified to conform to the current year presentation.
Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the
rue21, inc. and subsidiary
Notes to Consolidated Financial Statements - (continued)
financial statements and the reported amounts of net sales and expenses during the reporting period. Actual results could differ from those estimates. On an ongoing basis, management reviews its estimates based on currently available information. Changes in facts and circumstances may result in revised estimates.
Seasonality
Our business is seasonal and historically has consisted of two principal seasons: Spring (the first and second quarters) and Fall (the third and fourth quarters). Generally, our highest sales volume occurs in the fourth quarter, which includes the holiday selling season. Our business is also subject, at certain times, to calendar shifts which may occur during key selling times such as school holidays, Easter and regional fluctuations in the calendar during the back-to-school selling season.
Segment Reporting
Business or operating segments are defined as components of an enterprise for which separate financial information is available that is regularly evaluated by the chief operating decision maker in deciding how to allocate resources and assess performance.
The Financial Accounting Standard Board (FASB) has established authoritative guidance for reporting information about a company’s operating segments, including disclosures related to a company’s products and services, geographic areas and major customers. The Company does not have multiple operating segments or business components for which discrete financial information is prepared. The Company operates in and reports as a single operating segment which is the operation of its retail stores which are only located in the United States. The Company’s Chief Executive Officer (CEO) is the chief decision maker. The Company’s CEO utilizes a consolidated approach to assess performance and allocate resources. The Company has no international sales. Net sales are generated through the retail store sale of merchandise to consumers only. All of the Company’s identifiable assets are located in the United States.
Business Concentration
The Company sells a diversified product mix that seeks a complementary balance to attract our core customers. The table below indicates our product mix as a percentage of net sales as of the fiscal year indicated:
Fair Value of Financial Instruments
The FASB has established authoritative guidance that requires management to disclose the estimated fair value of certain assets and liabilities defined as financial instruments. As of January 28, 2012 and January 29, 2011, management believes that the carrying amounts of cash and cash equivalents, receivables, and payables approximate fair value because of the short maturity of these financial instruments.
rue21, inc. and subsidiary
Notes to Consolidated Financial Statements - (continued)
Cash and Cash Equivalents
Cash includes cash equivalents, which includes credit and debit card transactions. Credit and debit card transactions are typically paid to the Company on the next business day. The Company considers all highly liquid investments purchased with an initial maturity of three months or less to be cash equivalents.
Short term investments
As of January 28, 2012, short term investments included deposits primarily held in money market accounts with a maturity greater than three months but less than one year.
Accounts Receivable
Accounts receivable generally represent tenant allowances due from lessors. The Company evaluates collectability and has determined that no allowance is necessary. As of fiscal year end 2011, receivables consisted of: construction allowances - $5,957; third party sell offs - $41; and other - $677. This compares to fiscal year end 2010 of: construction allowances - $5,063; third party sell offs - $928; and other - $294.
Merchandise Inventory
Merchandise inventory is valued at the lower of cost (first-in, first-out basis) or market using the retail inventory method. The Company records merchandise receipts at the time they are delivered to our consolidator, as we are not directly importing any merchandise. This is the point at which title and risk of loss transfer to the Company.
The Company reviews its inventory levels to identify slow-moving merchandise and generally uses markdowns to clear slow-moving merchandise. The Company records a markdown reserve based on estimated future markdowns related to current inventory. Each period the Company evaluates the selling trends experienced and the related promotional events or pricing strategies in place to sell through the current inventory levels. Markdowns may occur when inventory exceeds customer demand for reasons of style, seasonal adaptation, changes in customer preference, lack of consumer acceptance of fashion items, competition, or if it is determined that the inventory in stock will not sell at its currently ticketed price. Such markdowns may have an adverse impact on earnings, depending on the extent and amount of inventory affected. The anticipated deployment of new seasonal merchandise is reflected within the estimated future markdowns reserve utilized in valuing current inventory, as such new inventory in certain circumstances will displace merchandise units currently on-hand. The markdown reserve is recorded as an increase to cost of goods sold in the accompanying Consolidated Statements of Income.
The Company also estimates a shrinkage reserve for the period of time between the last physical count and the balance sheet date. The estimate for shrinkage reserve can be affected by changes in merchandise mix and changes in actual shrinkage trends.
Property and Equipment
Property and equipment are recorded on the basis of cost with depreciation and amortization computed utilizing the straight-line method over the estimated useful lives as follows:
rue21, inc. and subsidiary
Notes to Consolidated Financial Statements - (continued)
In accordance with the FASB’s authoritative guidance related to the impairment or disposal of long-lived assets, impairment losses may be 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 those assets. If such a condition occurs, the assets are adjusted to their estimated fair value. Impairment charges of $325, $221 and $273 were recognized for the fiscal years 2011, 2010, and 2009, respectively, for assets related to stores to be converted and are recorded in selling, general, and administrative expense in the accompanying Consolidated Statements of Income.
Deferred Rent and Tenant Allowances
Deferred rent is recognized when a lease contains a predetermined fixed escalation of minimum rent. The Company recognizes the related rent expense on a straight-line basis from possession date and records the difference between the recognized rental expense and the amounts payable under the lease as deferred rent liability. Also included in deferred rent are tenant allowances received from landlords in accordance with negotiated lease terms. The tenant allowances are amortized as a reduction to rent expense on a straight-line basis over the term of the lease (including the pre-opening build-out period). The short-term portion of deferred rent is recorded in accrued expenses and other current liabilities and the long-term portion is included in deferred rent, tenant allowances and other long-term liabilities in the accompanying Consolidated Balance Sheets.
Insurance and Self-Insurance
The Company uses a combination of insurance and self-insurance for a number of risk management activities including workers’ compensation, general liability, automobile liability, and employee-related health care benefits, a portion of which is paid by the employees. Costs related to claims are accrued based on known claims and historical experiences of incurred but not reported claims received from our insurers. The Company believes that it has adequately reserved for its self-insurance liability, which is capped through the use of stop-loss contracts and specified retentions with insurance companies. However, any significant variation of future claims from historical trends could cause actual results to differ from the accrued liability.
Revenue Recognition
Revenue is recognized upon purchase of merchandise by customers. Allowances for sales returns are recorded as a reduction of net sales in the periods in which the sales are recognized. Consistent with our merchandise return policy of 30 days, the allowance for sales returns at each period end is calculated and recorded based upon an estimate of expected returns over a subsequent 30-day period. The allowance for sales returns was $642, $413, and $349 for the fiscal years 2011, 2010, and 2009, respectively. Sales tax collected from customers is excluded from revenue and is included as part of accrued expenses and other current liabilities on the Company’s Consolidated Balance Sheets.
Deferred revenue is established upon the purchase of gift cards by customers, and revenue is recognized upon redemption of gift cards for merchandise. The Company evaluated unredeemed gift cards and determined that the likelihood of certain gift cards being redeemed by the customer after 18 months was remote, based upon historical redemption patterns of gift cards. We have established a wholly-owned subsidiary to administer the gift card program within a state jurisdiction that does not require remittance of unclaimed property. For those gift cards that were determined redemption would be remote, the Company reversed the liability, and recorded gift card breakage income. Gift card breakage income of $790, $328 and $224 was recognized for the fiscal years 2011, 2010, and 2009, respectively. Gift card breakage income is recorded as reduction to cost of goods sold.
rue21, inc. and subsidiary
Notes to Consolidated Financial Statements - (continued)
Cost of Goods Sold
Cost of goods sold includes costs related to merchandise sold, distribution and warehousing, freight from the distribution center to the stores, store occupancy, and buying and merchandising department expenses. Cost of goods sold is reduced by certain vendor allowances received, primarily for markdowns, merchandise marked out of stock and vendor non-compliance charges.
Selling, General and Administrative Expense
Selling, general and administrative expense includes administration, share-based compensation and store expenses but excludes store occupancy costs and freight to stores.
Income Taxes
The Company accounts for income taxes in accordance with the authoritative guidance issued by the FASB, which requires the use of the asset and liability method. Under this method, deferred tax assets and liabilities are recognized based on the difference between the carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the tax rates, based on certain judgments regarding enacted tax laws and published guidance, in effect in the years when those temporary differences are expected to reverse. A valuation allowance is established against the deferred tax assets when it is more likely than not that some portion or all of the deferred taxes may not be realized. Changes in the level and composition of earnings, tax laws or the deferred tax valuation allowance, as well as the results of tax audits may materially impact the effective tax rate.
The Company recognizes income tax liabilities related to unrecognized tax benefits in accordance with the FASB’s authoritative guidance related to uncertain tax positions and adjust these liabilities when our judgment changes as the result of the evaluation of new information. The Company classifies interest and penalties as an element of tax expense.
The calculation of the deferred tax assets and liabilities, as well as the decision to recognize a tax benefit from an uncertain position and to establish a valuation allowance require management to make estimates and assumptions. The Company believes that its assumptions and estimates are reasonable, although actual results may have a positive or negative material impact on the balances of deferred tax assets and liabilities, valuation allowances, or net income. See Note 8 “Income Taxes”.
Stock Based Compensation
The Company accounts for share based compensation awards in accordance with the FASB’s authoritative guidance, which requires companies recognize all share based payments to employees, including grants of employee stock options, in the consolidated financial statements based on the grant date fair value of the equity or liability instruments issued. The Company recognizes compensation expense for stock option awards on a straight-line basis over the requisite service period of the award. The Company has historically issued new shares of common stock upon the exercise of employee stock options. See Note 5 “Stock-Based Compensation.”
Store Pre-opening Costs
Store pre-opening costs, which consist primarily of occupancy costs and payroll, are expensed as incurred and are included in selling, general and administrative expense in the accompanying Consolidated Statements of Income.
rue21, inc. and subsidiary
Notes to Consolidated Financial Statements - (continued)
Advertising Costs
The Company expenses advertising costs when incurred. Advertising expense, which is classified in selling, general, and administrative expense in the accompanying Consolidated Statements of Income, was $5,104, $3,936 and $3,000 for the fiscal years 2011, 2010, and 2009, respectively.
Repairs and Maintenance
The Company capitalizes costs that extend the life of an asset and that meet certain minimal dollar thresholds depending on asset category. All other costs including maintenance agreements are charged to selling, general and administrative expense in the accompanying Consolidated Statements of Income. Repairs and maintenance expense was $2,112, $1,797 and $1,464 for the fiscal years 2011, 2010, and 2009, respectively. Repairs and maintenance expense does not include any costs for store conversions.
Legal Proceedings and Claims
The Company is subject to certain legal proceedings and claims arising out of the conduct of its business. In accordance with the FASB’s authoritative guidance for contingent losses management records a reserve for estimated losses when the loss is probable and the amount can be reasonably estimated. If a range of possible loss exists and no anticipated loss within the range is more likely than any other anticipated loss, the Company records the accrual at the low end of the range. As the Company believes that it has provided adequate reserves, it anticipates that the ultimate outcome of any matter currently pending against the Company will not materially affect the consolidated financial position or results of operations of the Company.
Reserves are reviewed at least quarterly and are adjusted to reflect the impact and status of settlements, ruling, advice of counsel and other information pertinent to a particular matter. Significant differences could exist between the actual cost required to investigate, litigate and/or settle a claim or the ultimate outcome of a suit and management’s estimate.
Earnings per Share
Basic earnings per common share amounts are calculated using the weighted average number of common shares outstanding for the period. Diluted earnings per common share amounts are calculated using the weighted average number of common shares outstanding plus the additional dilution for all potentially dilutive stock options utilizing the treasury stock method.
The following table shows the amounts used in computing earnings per share and the effect on net income and the weighted average number of shares of potential dilutive common stock (stock options):
rue21, inc. and subsidiary
Notes to Consolidated Financial Statements - (continued)
Equity awards to purchase 699, 340 and 400 shares of common stock for the fiscal years 2011, 2010, and 2009, respectively, were outstanding, but were not included in the computation of weighted average diluted common share amounts as the effect of doing so would have been anti-dilutive.
Note 2 - Fair Value Measurements
The FASB’s authoritative guidelines require the categorization of assets and liabilities into three levels based upon the assumptions (inputs) used to price the assets or liabilities. Level 1 provides the most reliable measure of fair value, whereas Level 3 generally requires significant management judgment. The three levels are defined as follows:
•
Level 1: Unadjusted quoted prices in active markets for identical assets and liabilities. The Company’s cash, cash equivalents and short term investments of $71,960 and $50,111 as of January 28, 2012 and January 29, 2011, respectively, are reported at fair value utilizing Level 1 inputs. The carrying value of these instruments approximate fair value because of their short-term maturity.
•
Level 2: Observable inputs other than those included in Level 1. For example, quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in inactive markets.
•
Level 3: Unobservable inputs reflecting management’s own assumptions about the inputs used in pricing the asset or liability. The Company determined that the fair value measurements related to the impaired long lived assets disclosed in Note 1 are derived from significant unobservable inputs. These non-financial assets are measured on a non-recurring basis when events and circumstances warrant.
In accordance with ASC 820, the following tables represent the fair value hierarchy for the Company’s financial assets (cash equivalents) measured at fair value on a recurring basis as of January 28, 2012 and January 29, 2011:
rue21, inc. and subsidiary
Notes to Consolidated Financial Statements - (continued)
Note 3 - Property and Equipment
Property and equipment consisted of the following:
Depreciation and amortization expense was $26,618, $21,980, and $16,994 for fiscal years 2011, 2010 and 2009, respectively.
Note 4 - Long-Term Debt
Effective April 10, 2008, the Company established a five-year $60,000 senior secured revolving credit facility (the Senior Secured Credit Facility) with Bank of America N.A. The ceiling is expandable at the Company’s option in increments of $5,000 up to a limit of $85,000 under certain defined conditions. The Senior Secured Credit Facility initial borrowing was $27,217. Proceeds from the initial borrowing were used for the extinguishment of all of the Company’s existing long-term debt facilities and the Bank of America N.A. commitment fee. Availability under the Senior Secured Credit Facility is collateralized by a first priority interest in all the Company’s assets. On November 24, 2009, the Company amended its Senior Secured Credit Facility with Bank of America, N.A. Key provisions of the amendment include an increase in the borrowing ceiling to $85,000 from $60,000, which is further expandable at the Company’s option in increments of $5,000 up to a limit of $100,000 under certain defined conditions. Interest accrues at the higher of the Federal Funds rate plus 0.50%, the prime rate or the adjusted LIBOR rate plus the applicable margin which ranges from 1.25% to 3.00% set quarterly dependent upon average net availability on the facility during the previous quarter. As of January 28, 2012 and January 2011, there were no outstanding borrowings under the Senior Secured Credit Facility. Accordingly, the weighted-average interest rate under the Senior Secured Credit Facility was nil for both of the fiscal years ended January 28, 2012 and January 29, 2011. The Senior Secured Credit Facility includes a fixed charge covenant applicable only if net availability falls below thresholds of 10%. The Company is in compliance with all covenants under the Senior Secured Credit Facility at January 28, 2012. The Senior Secured Credit Facility matures in April 2013.
Note 5 - Stock-Based Compensation
In November 2009, the Company adopted the 2009 Omnibus Incentive Plan (the 2009 Plan) in connection with the Company’s initial public offering, pursuant to which key employees, officers, and directors shall be eligible to receive grants of stock options, stock appreciation rights, restricted stock or restricted stock units to purchase or receive, as applicable, up to an aggregate of 3,626,000 shares of common stock based on eligibility, vesting, and performance standards established by the board of directors. Stock options granted are generally exercisable ratably over 3 or 4 years, subject to certain employment terms and conditions. The stock options generally expire ten years from the date of issuance. To date, 777,378 stock options have been granted, 174,298 restricted stock units have been granted and no stock appreciation rights or restricted stock have been issued under the 2009 Plan.
Effective May 15, 2003, the Company adopted the 2003 Ownership Incentive Plan (the 2003 Plan) pursuant to which key employees, officers, and directors were eligible to receive options to purchase common stock for an aggregate of up to 19.8% of the number of shares of the common stock outstanding upon adoption of the 2003 Plan
rue21, inc. and subsidiary
Notes to Consolidated Financial Statements - (continued)
based on eligibility, vesting, and performance standards established by the board of directors. Upon adopting the 2009 Plan, the Company discontinued use of the 2003 Plan and no further option grants will be made under the 2003 Plan.
On November 11, 2011, the Compensation Committee approved a new form of Restricted Stock Unit Award Agreement (the “RSU Agreement”) for the 2009 Plan, which replaces the prior form of Restricted Stock Award Agreement. The RSU agreement clarifies delivery procedures and withholding treatment for stock to be received upon vesting of awards. The material terms of an award of restricted stock units, including applicable vesting terms, the treatment of awards upon termination of employment and potential tax consequences, were not affected by approval of the Committee’s approval of the RSU Agreement.
Stock Option Activity
The following table represents stock options granted, vested, and expired under the existing share based compensation plans for fiscal year ended January 28, 2012.
As of January 28, 2012, the Company had 2,674,324 shares available for stock grants. The Company recognized $4,943, $2,240 and $410 in compensation expense related to stock options for the fiscal years 2011, 2010, and 2009, respectively. The weighted-average fair value of stock options at the grant date was $16.13, $17.37 and $6.92 for the fiscal years 2011, 2010, and 2009, respectively. The intrinsic value of options exercised was $2,194, $3,777 and $13,834 for the fiscal years 2011, 2010, and 2009, respectively. All outstanding vested options are currently exercisable as of January 28, 2012.
The fair value of stock options was estimated at the date of grant using a Black-Scholes option pricing model with the following range of weighted-average assumptions:
(1) Based on the U.S. Treasury yield curve in effect at the time of grant with a term consistent with the expected life of stock options.
(2) Expected stock price volatility is based on comparable volatilities of peer companies within rue21’s industry.
rue21, inc. and subsidiary
Notes to Consolidated Financial Statements - (continued)
(3) Represents the period of time options are expected to be outstanding. The weighted-average expected option term was determined using the “simplified method”, as allowed by Staff Accounting Bulletin Topic 14. The expected term used to value a share option grant under the simplified method is the midpoint between the vesting date and the contractual term of the share option.
The following table summarizes information regarding non-vested outstanding stock options as of January 28, 2012:
As of January 28, 2012, there was $11,503 of unrecognized compensation expense related to non-vested stock option awards that is expected to be recognized over a weighted-average period of 1.18 years. The total fair value of shares vested during the fiscal years 2011, 2010, and 2009, was $2,720, $835 and $5,312, respectively.
Restricted Stock Activity
Below is a summary of restricted stock unit activity for the year ended January 28, 2012:
The total fair value of restricted stock units granted during the fifty-two week period ended January 28, 2012, was $4.4 million. As of January 28, 2012, there was $4.8 million of total unrecognized compensation cost related to non-vested restricted stock units. The unrecognized cost is expected to be recognized over a weighted-average period of 1.3 years.
Note 6 - Lease Commitments
All of the Company’s operations are conducted from leased premises. Store leases provide for base rentals, some of which increase over time, and the payment of a percentage of sales as additional rent when sales exceed specified levels; the latter, providing the basis upon which material contingent rental payments are determined. Minimum rentals relating to these leases are recorded on a straight-line basis. Generally, lease terms are five to ten years in length excluding renewal options. In addition, the Company is typically responsible under its leases for maintenance, common area charges, real estate taxes, and certain other expenses. Point of sale equipment is also leased by the Company for a term of four years. All leases are classified as operating leases.
rue21, inc. and subsidiary
Notes to Consolidated Financial Statements - (continued)
A summary of fixed minimum and contingent rent expense for all operating leases follows:
The table below summarizes future annual minimum lease obligations under all operating leases as required by the lease agreements:
Note 7 - 401(k) Profit Sharing Plan
The Company sponsors a qualified 401(k) plan with a contributory profit-sharing feature (the Plan) for eligible employees. Effective January 1, 2010, the Plan was amended to permit participants of the Plan to contribute up to 50% of pretax annual compensation as defined in the Plan, subject to certain limitations. Also, effective January 1, 2010, the Company will match 100% of participant contributions up to 4% of pretax annual compensation as defined in the Plan. Prior to this amendment, participants of the Plan could contribute up to 15% of pretax annual compensation as defined in the Plan, subject to certain limitations and the Company matched 25% of the first 6% of base compensation that a participant contributes to the Plan. Profit-sharing contributions to the Plan, as determined by the Board of Directors, are discretionary, but generally may not exceed 15% of defined annual compensation paid to all participating employees. 401(k) matching contributions and profit-sharing contributions to the Plan were $703, $579 and $184 for the fiscal years ended January 28, 2012, January 29, 2011 and January 30, 2010, respectively, and are included in selling, general, and administrative expense in the Consolidated Statements of Income.
rue21, inc. and subsidiary
Notes to Consolidated Financial Statements - (continued)
Note 8 - Income Taxes
The provision for income taxes at the fiscal years 2011, 2010, and 2009 consists of the current and deferred elements in the table below:
The Company’s income taxes determined at the statutory rate for the fiscal years ended January 28, 2012, January 29, 2011 and January 30, 2010 differ from the actual rate as follows:
As a result of temporary differences, the Company has the following net deferred tax amounts at January 28, 2012, January 29, 2011 and January 30, 2010:
rue21, inc. and subsidiary
Notes to Consolidated Financial Statements - (continued)
The following table summarizes the activity related to our unrecognized tax benefits:
The gross amount of unrecognized tax benefits at fiscal years ended 2011, 2010, and 2009 was $0, $34 and $35, respectively. Over the next 12 months the company believes that there will be no material change in unrecognized tax benefits.
The Company classifies interest and penalties as an element of tax expense. The amount of tax related interest and penalties for fiscal years ended 2011, 2010 and 2009, respectively, was not material.
The Company files a consolidated U.S. Federal Tax returns as well as various state tax returns. The Company’s U.S. Federal tax returns are open for further audit by taxing authorities for the periods of 2007 through 2011. The principal state jurisdictions that remain open to examination for the periods 2007 and forward are: Pennsylvania, Texas, North Carolina, Illinois, and West Virginia.
Note 9 - Commitments and Contingencies
From time to time, the Company is involved in litigation relating to claims arising out of the normal course of business. As of January 28, 2012, the Company believes that a loss is reasonably possible but that such potential losses, individually or in the aggregate, will not have a material adverse effect on its consolidated financial condition, results of operation, or liquidity.
Note 10 - Related Party Transactions
In May 2003, the Company entered into a letter agreement with Apax Partners, L.P. (Apax) as successor to Saunders Karp & Megrue, LLC, relating to financial advisory services to be provided to the Company from time to time. Under the letter agreement, the Company agreed to pay an annual fee of $250 to Apax and to reimburse Apax for all reasonable out-of-pocket expenses incurred in connection with the letter agreement. In addition, the letter agreement provided for customary indemnification provisions and terminates once Apax and its affiliates beneficially own, collectively, less than 25% of the Company’s voting common stock. In November 2009, the letter agreement with Apax was terminated and Apax received a termination fee of $1,500, which was recorded as a component of selling, general and administrative expenses in the accompanying Consolidated Statements of Income. We also reimburse Apax for reasonable expenses incurred to attend board of director meetings. Amounts paid to Apax totaled $9, $35 and $1,696 for fiscal years 2011, 2010, and 2009, respectively.
rue21, inc. and subsidiary
Notes to Consolidated Financial Statements - (continued)
At January 28, 2012, funds advised by Apax owned approximately 29% of the Company’s outstanding common stock.
Note 11 - Selected Quarterly Financial Data (Unaudited)
The following table sets forth certain unaudited quarterly financial information (in thousands, except share and per share amounts):
Item 9.
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Our management has evaluated, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures, as defined in Rule 13(a)-15(e), as of the end of the period covered by this Annual Report on Form 10-K pursuant to Rule 13a-15(b) under the Exchange Act. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K are effective in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance to our management and board of directors regarding the reliability of our financial reporting and the preparation and fair presentation of published financial statements in accordance with accounting principles generally accepted in the United States of America.
Our management assessed the effectiveness of our internal control over financial reporting as of January 28, 2012. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on that assessment, our management concluded that, as of January 28, 2012, our internal control over financial reporting is effective based on those criteria.
The Company’s independent registered public accounting firm that audited the consolidated financial statements included in this Annual Report issued an attestation report on the Company’s internal control over financial reporting.
Changes in Internal Control over Financial Reporting
There was no change in the Company’s internal control over financial reporting that occurred during the Company’s fourth quarter of fiscal year 2011 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of rue21, inc.
We have audited rue21, inc.’s internal control over financial reporting as of January 28, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). rue21, inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, rue21, inc. maintained, in all material respects, effective internal control over financial reporting as of January 28, 2012, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of rue21, inc. and subsidiary as of January 28, 2012 and January 29, 2011 and the related consolidated statements of income, stockholders’ equity and cash flows for each of the three years in the period ended January 28, 2012 of rue21, inc. and our report dated March 27, 2012 expressed an unqualified opinion thereon.
Pittsburgh, Pennsylvania
March 27, 2012
Item 9B.
Item 9B. Other Information.
None.
Part III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
The information required by this item is incorporated herein by reference to the sections entitled “Proposal No. 1-Election of Directors”, “Information Concerning Our Board of Directors - Audit Committee,” “Information Concerning Executive Officers,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Information Concerning Our Board of Directors - Code of Business Conduct and Ethics” in the 2012 Proxy Statement.
The Code applies to all employees including our principal executive officer, principal financial officer, controller and persons performing similar functions. The Code is available on our website, www.rue21.com, under “Investor Relations, Corporate Governance” and in print to any person who requests it. Any amendments to, or waivers from, a provision of our Code that applies to our principal executive officer, principal financial officer or persons performing similar functions and that relates to any element of the Code enumerated in paragraph (b) of Item 406 of Regulation S-K shall be disclosed by posting such information on our website.
Item 11.
Item 11. Executive Compensation.
The information required by this item is incorporated herein by reference to the sections entitled “Information Concerning our Board of Directors - Director Compensation” and “Understanding Our Director Compensation Table,” “Executive Compensation” “Information Concerning our Board of Directors - Compensation Committee - Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report” in the 2012 Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this item is incorporated herein by reference to the sections entitled “Stock Ownership” and “Equity Compensation Plan Information” in the 2012 Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by this item is incorporated herein by reference to the sections “Certain Relationships and Transactions with Related Persons”, “Information Concerning our Board of Directors - Compensation Committee - Compensation Committee Interlocks and Insider Participation” and “Director Independence” in the 2012 Proxy Statement.
Item 14.
Item 14. Principal Accountant Fees and Services.
The information required by this item is incorporated herein by reference to the section entitled “Proposal 3 - Ratification of Independent Registered Public Accounting Firm For Fiscal Year 2012-Audit and Non-Audit Fees and Independent Public Accountants” in the 2012 Proxy Statement.
Part IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules.
(a) The following documents are filed as part of this Form 10-K:
1. Financial Statements: See “Index to Consolidated Financial Statements” in Part II, Item 8 of this Form 10-K for a list of the Financial Statements required to be filed herewith.
2. Financial Statement Schedule: All Schedules are omitted because they are not required or because the information is immaterial or provided elsewhere in the Consolidated Financial Statements or Notes thereto.
3. Exhibits: See Exhibit Index following the signature page of this Annual Report on Form 10-K.
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.
rue21, inc.
By:
/s/ Robert N. Fisch
Name: Robert N. Fisch
Title: President and Chief Executive Officer
Date: March 27, 2012
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.
Exhibit Index
* Filed herewith.