Item 1. Business
In this Form 10-K , when we refer to “Alloy, Inc.” we are referring to Alloy, Inc., our former parent corporation, and when we refer to “Alloy” we are referring to the Alloy-branded direct marketing and merchandising business that we operate. Similarly, when we refer to “dELiA*s” we are referring to the dELiA*s-branded direct marketing, merchandising and retail store business that we operate, when we refer to “dELiA*s, Inc.”, the “Company”, “we”, “us”, or “our”, we are referring to dELiA*s, Inc. and its subsidiaries. When we refer to “the Spinoff”, we are referring to the December 19, 2005 spinoff of the outstanding common shares of dELiA*s, Inc. to the Alloy, Inc. shareholders.
Overview
We are a multi-channel retail company comprised of two lifestyle brands marketing to teenage girls and young women. We generate revenue by selling to consumers through websites, direct mail catalogs, and retail stores. We operate two brands-dELiA*s and Alloy-each of which we believe are well-established, differentiated, lifestyle brands. Through our e-commerce webpages, catalogs and retail stores, dELiA*s (the brand) offers a wide variety of product categories to teenage girls to cater to an entire lifestyle. Alloy is a prominent branded junior apparel catalog and e-commerce site for young women.
Through our e-commerce webpages and catalogs, we sell many name brand products along with our own proprietary brand products in key spending categories directly to consumers, including apparel and accessories. Our mall-based dELiA*s retail stores derive revenue primarily from the sale of proprietary apparel and accessories and, to a lesser extent, branded apparel to teenage girls.
Our focus on a diverse collection of name brands and proprietary brands allows us to adjust our merchandising strategy quickly as fashion trends change. In addition, we strive to keep our merchandise mix fresh by regularly introducing new trends and styles. Our proprietary brands provide us an opportunity to broaden our customer base by offering merchandise of comparable quality to brand name merchandise, at a lower price, while permitting improved gross profit margins. Our proprietary brands also allow us to capitalize on emerging fashion trends when branded merchandise is not available in sufficient quantities, and to exercise a greater degree of control over the flow of our merchandise from our vendors to us, and from us to our customers.
We have built comprehensive databases that together include information such as name, mailing and email addresses and amounts and dates of purchases in our direct and retail businesses. In addition to helping us target consumers directly, our databases provide us with access to important demographic information.
We refer to the 53-week fiscal year ended February 2, 2013 as “fiscal 2012”, the 52-week fiscal year ended January 28, 2012 as “fiscal 2011”, and the 52-week fiscal year ended January 29, 2011 as “fiscal 2010”. We also refer to the 52-week fiscal year ending February 1, 2014 as “fiscal 2013”.
Recent Developments
On March 28, 2013, we announced that we had retained Janney Montgomery Scott LLC (“Janney”), as strategic advisor to our Board of Directors with an initial focus on the potential disposition of the Company’s Alloy brand. We believe this potential disposition will allow management to concentrate its efforts on the dELiA*s business. Our Board of Directors has not set a definitive timetable for any transaction, and there can be no assurance that Janney’s retention will result in any specific action or transaction. We do not intend to disclose or comment on developments until such time as our Board of Directors takes action, if any, or otherwise considers disclosure appropriate or required.
On March 28, 2013, we also announced that Walter Killough, our chief executive officer, who we previously announced would leave the Company at or about April 1, 2013, has agreed to continue to serve as our chief executive officer on a month-to-month basis as our search for a permanent chief executive officer continues.
On March 28, 2013, we further announced that Dyan Jozwick, President, dELiA*s Brand, had resigned from the Company. The Company has retained a senior merchandise consultant with relevant experience to oversee our merchandising functions on an interim basis.
The Brands
dELiA*s
dELiA*s develops, markets and sells primarily its own lifestyle brand, and to a lesser extent third-party brands, in its retail stores, as well as via catalogs and the internet. The dELiA*s brand is a distinctive collection of apparel, dresses, swimwear, footwear, outerwear and accessories marketing primarily to trend-setting, fashion-aware teenage girls. While dELiA*s markets to teenage girls, we focus marketing efforts on potential customers who we believe fit the profile and have the interests of fashion-forward high-school teens. In fiscal 2012, dELiA*s circulated approximately 20.0 million catalogs.
dELiA*s retail stores sell a distinctive collection of lifestyle-oriented apparel and accessories for trend-setting, fashion-aware teenage girls primarily via mall-based retail stores. The majority of dELiA*s’ merchandise is privately branded and sold under the dELiA*s label. As of February 2, 2013, we operated 104 dELiA*s retail stores. These stores range in size from approximately 2,600 to 5,000 square feet with an average size of approximately 3,800 square feet.
Alloy
Alloy markets and sells branded junior apparel (including extended sizes and inseams), dresses, accessories, swimwear, footwear and outerwear marketing to young women via catalogs and the internet. Alloy offers a wide selection of well-known, juniors-targeted name brands, such as Truck Jeans, Spoon Jeans, Soprano, Pinky, Angie, Blue Heaven and Lily White. In fiscal 2012, Alloy circulated approximately 16.5 million catalogs.
Business Strengths
We believe our principal business strengths include:
Broad Access to Teenage and Young Women Consumers
In fiscal 2012, we reached a significant portion of teenage and young women consumers in the United States by:
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circulating approximately 36.5 million direct mail catalogs for our two brands, with an average of one new book per brand being mailed each month;
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communicating with select segments of our database by sending, on average, 8.3 million emails per week to those of our target audience who have opted in to receiving such emails;
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engaging our customer through the internet, social media and mobile commerce; and
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owning and operating 104 dELiA*s retail stores in 33 states as of February 2, 2013.
Comprehensive Databases
Our dELiA*s and Alloy databases contain information about a significant number of households who have purchased products online or requested catalogs directly from us as of February 2, 2013, including approximately 3.3 million households who have purchased merchandise or requested a catalog within the last two years. In addition to names and addresses, our databases give us the ability to review a variety of valuable information that may include age range, purchasing history, stated interests, online behavior, educational level and socioeconomic
factors. We continually refresh and grow our databases with information we gather through direct marketing programs and purchased customer lists. We analyze this data in detail, which we believe enables us to improve response rates from our direct sales efforts. We also use selected retail transactions that are added to our databases to help identify potential new customers for our direct business.
Operating Flexibility
We attempt to maintain significant flexibility in the operation of our business so that we can react quickly to changes in customer preferences. We regularly review the sales performance of our merchandise in an effort to identify and respond to changing trends and consumer preferences. When purchasing merchandise from our vendors, we pursue a strategy that is designed to maximize our speed to market. We strive to establish strong and loyal relationships with our suppliers which we believe allows us to quickly obtain merchandise and ship it to our distribution center for direct sales or our retail stores for retail sales. Currently, we are able to replenish a majority of our merchandise within 60 days. Our e-commerce webpages and databases allow us to quickly update our merchandise presentations, promotions, and display of offerings in an effort to create excitement for our customers.
Experienced Management Team
Our senior management has significant retail and direct marketing experience, with an average of over 20 years in the retail, catalog and e-commerce apparel businesses. Please see the information set forth above under the caption “Recent Developments” for additional information concerning our management team.
Our Business Strategy
Our strategy is to improve upon our position as a multi-channel retail company, to improve the productivity in our dELiA*s retail stores, and to carry out such strategy while controlling costs. In addition, our strategy includes strengthening the dELiA*s brand through alignment across all channels of our business while continuing extended offerings online and in our catalogs. The key elements of our strategy are as follows:
Direct Marketing Strategy
Our direct marketing strategy is designed to minimize our exposure to risks associated with rapidly changing fashion trends and facilitate speed to market and the flexibility with which we are able to purchase and stock a wide assortment of merchandise. Our primary objective is to reflect, rather than shape, styles and tastes while maintaining a specific focus on our customer. We develop exclusive merchandise and select name brand merchandise from what we believe are quality manufacturers and name brands. Our buyers and merchandisers work closely with our many suppliers to develop products to our specifications. This speed to market gives us flexibility to incorporate the latest trends into our product mix and to better serve the evolving tastes of customers. Through this strategy, we believe we are able to minimize design risk and make final product selections only two to seven months before the products are brought to market. We believe this allows us to stay current with the tastes of the market, and unlike others in our industry that require a longer lead time to bring goods to the market, we believe our strategy enables us to receive a continuous allotment of goods from our suppliers and carry the proper amount of inventory.
Our direct marketing strategy also enables us to manage our inventory levels efficiently once consumer demand patterns have emerged. We attempt to limit the size of our initial merchandise orders and rely on quick reorder ability. Because we generally do not make aggressive initial orders, we believe we are able to limit our risk of excess inventory. Additionally, we have several methods for clearing slow moving inventory, ranging from clearance media and internet offers to tent sales and third-party liquidators.
Our merchandise selection includes products from many leading suppliers and name brands. dELiA*s primarily carries its own branded merchandise, though it also carries third-party branded merchandise from well-
known name brands such as Converse and Sperry. Brands currently offered through Alloy include nationally-recognized names such as Vigold Premium by Vigoss, Truck Jeans, Paris Blues, MIA, Jalate, Celebrity Pink and Unionbay, as well as smaller, niche labels, including Necessary Objects and Standards and Practices.
Our database management and mailing strategy is designed to efficiently gather, maintain and utilize the information collected within our databases. Our databases are maintained by a third-party vendor providing address hygiene, duplicate identification and modeling capabilities. The databases enable detailed selections based on general industry practices, but enable greater specificity when required, based on maintaining any transactional history, plus the ability to overlay demographic information to the extent provided to us, for selected individuals and households listed in the databases.
Our catalog mailing program, coupled with our e-mail marketing program, seeks to maximize profitability with a continual testing and monitoring program designed to provide our customers with offers and promotions that will be of interest to them.
We believe that high levels of customer service and support are critical to the value of our brands and to retaining and expanding our customer base. We consistently monitor customer service calls, through our third party call center provider (we outsourced this function during fiscal 2012), for quality assurance purposes. Additionally, we review our call and distribution centers’ policies and procedures on a regular basis. A majority of our catalog and internet orders are shipped within 48 hours of credit approval. In cases in which the order is placed using another person’s credit card and exceeds a specified threshold, the order is shipped only after we have received confirmation from the cardholder. Customers generally receive orders within three to ten business days after shipping. Our shipments are generally carried to customers by the United States Postal Service and United Parcel Service.
Trained personnel are available for the dELiA*s and Alloy brands 24 hours a day, 7 days per week through multiple toll-free telephone numbers, via our third party provider.
Retail Strategy
Our current strategy is to concentrate on improving productivity in our existing store base while keeping store growth relatively flat. We monitor the performance of our existing retail stores and may from time-to-time close underperforming stores as appropriate. When we determine to close a retail store, we typically exercise a sales volume based termination right or negotiate with landlords to determine the quickest and most cost-effective way to exit such location. Store activity for the past two fiscal years follows:
* Totals include one store that was closed and relocated to an alternative site in the same mall during fiscal 2012.
** Totals include two stores that were closed, remodeled and reopened during fiscal 2011, and one store that was closed and relocated to an alternative site in the same mall during fiscal 2011.
*** Totals include one store that was closed, remodeled and reopened during fiscal 2010, and one store that was closed and relocated to an alternative site in the same mall during fiscal 2010.
We plan our new stores to have a four-wall cash contribution margin of at least 15% in the first full year and to have a net build-out cost, including inventory, of approximately $0.6 million. We define contribution margin as store gross profit less direct cash costs of operating the store.
The stores currently average approximately 3,800 square feet, though individual stores may be smaller or larger than the averages. Our stores are designed to look upscale, appealing to what we believe to be our database customer demographics.
In addition to strong customer demographics, we look for high traffic malls, high economic growth areas and/or high income demographics in selecting new retail store locations. We believe that over half our dELiA*s direct customers come from households with incomes of over $75,000 per year and over 20% come from households with income over $125,000 per year.
Each store is open during mall shopping hours and has a store management team that always includes a store manager, and depending on the sales volume of the store, one or more of the following additional management: a co-manager, one or more assistant managers and one or more customer experience supervisors, as well as eight to twenty part-time sales associates. Currently, district managers supervise seven to eleven stores, with twelve district managers reporting to two regional managers, who in turn report to a Vice President of Stores.
Our goal is to hire and retain experienced sales associates, store managers and district managers and establish clear performance goals, objectives and related corresponding incentives which are based on planned sales. District managers, store managers, co-managers and assistant store managers participate in an incentive program which is based on achieving predetermined sales-related and customer conversion goals in their respective stores or districts. We have well-established store operating policies and procedures, and emphasize our loss prevention program in order to control inventory shrinkage and ensure policy and procedure compliance.
In addition, we have traffic counters and related software in our retail locations in order to evaluate store by store customer conversion rates. We utilize this system in evaluating and managing store performance, establishing effective staffing models and focusing our training efforts.
Segments
We generate net sales from two reportable segments-direct marketing and retail stores. Net sales, by segment, are as follows:
Direct Marketing Segment
Our direct marketing segment, which consists of the dELiA*s and Alloy e-commerce webpages and catalogs, derives revenues from sales of merchandise via the internet or catalog directly to consumers and also from advertising. Included in our direct marketing net sales of $97.1 million in fiscal 2012 were approximately $0.3 million of advertising revenues.
In fiscal 2012, each of our catalogs and associated e-commerce webpages targeted a particular segment of the market and offered our own proprietary brands together with many name brands well known by our target customers.
dELiA*s-During fiscal 2012, the dELiA*s catalog ranged from 56 to 84 pages in length. We mailed seventeen full price versions of the dELiA*s catalog, including remails, and allocated up to two pages per catalog to our advertising clients and marketing partners. The dELiA*s e-commerce webpages (reached through www.delias.com) are designed to complement the catalog and offer the same merchandise as in the catalog, as well as additional products, colors, sizes and special offers.
Alloy-During fiscal 2012, the Alloy catalog ranged in length from 48 to 68 pages. We mailed seventeen full price versions of the Alloy catalog, including remails, and there were no pages allocated for our advertising clients and marketing partners. The Alloy e-commerce webpages (reached through www.alloyapparel.com) offer the same merchandise as in the catalog, as well as additional products, colors, sizes and special offers.
Retail Store Segment
Our retail store segment derives revenue from the sale of apparel and accessories to consumers through dELiA*s stores. dELiA*s mall-based retail stores sell a distinctive collection of lifestyle-oriented apparel and accessories for trend-setting, fashion-aware teenage girls. As of February 2, 2013, we operated 104 dELiA*s stores in 33 states. The majority of merchandise sold in our retail stores is sold under the dELiA*s label. Retail store segment revenues for fiscal 2012 were $125.6 million.
Financial information about our segments is summarized in Note 13 to our consolidated financial statements.
Merchandise Suppliers
Because we sell a number of brand-name products in addition to our own proprietary brands, we obtain products from a wide variety of manufacturers, importers and other suppliers. No single vendor accounted for more than 6.2%, 12.9% and 12.5% of products sold for fiscal 2012, fiscal 2011 and fiscal 2010, respectively. We believe that there are sufficient alternate sources of merchandise at comparable prices for almost all of the products we sell should we decide to or be required to change vendors for any particular product. Therefore, we do not believe that a loss of one or a few vendors would have a material impact on our operations.
Infrastructure, Operations and Technology
Our operations are dependent on our ability to maintain computer and telecommunications systems in effective working order and to protect our systems against damage from fire, natural disaster, power loss, telecommunications failure, unauthorized intrusion or access to confidential information, or similar events. We have implemented, either directly or through other third parties, appropriate security, redundancy and backup programs for our various businesses.
We license commercially available technology whenever possible in lieu of dedicating our financial and human resources to developing proprietary online infrastructure solutions. Currently, most services related to maintenance and operation of our e-commerce webpages are through third-party providers located in Petaluma, CA.
In fiscal 2012, we outsourced our call center function. The transition was completed by the end of the second quarter of fiscal 2012.
In our direct marketing segment, we use third-party licensed software for stockkeeping unit (“SKU”) and classification inventory tracking, purchase order management and merchandise distribution. Sales in our direct
segment, whether through the internet, the call center or the mail, are updated daily and the host system downloads price changes, order status and inventory levels. In addition, we use other licensed software products and services to further supplement our supply chain, for merchandise planning and to analyze customer behavior. In our retail segment, licensed software is used for SKU and classification inventory tracking, purchase order management, merchandise distribution, automated ticket making, and sales audit.
Sales in our retail segment are updated daily in the third-party licensed merchandising reporting systems by the nightly polling of sales information from each store’s point-of-sale (“POS”) terminals. Our POS system consists of registers providing price look-up, time and attendance, inventory management (transfers and distributions), and credit card/check authorization. This host system downloads price changes and inventory movements (store-to-store transfers and warehouse merchandise distributions). We evaluate information obtained through the nightly polling to implement merchandising decisions, planning and determining the open-to-buy, processing and managing of product purchasing/reorders, managing markdowns and allocating merchandise on a daily basis. For both the direct marketing and retail store segments, we use centralized financial systems for general ledger and accounts payable.
During fiscal 2013, we plan to move our data center which is currently outsourced in Sterling, Virginia, to an outsourced data center in the New York/New Jersey area.
Competition
The retail and direct businesses are each highly competitive. Our retail stores compete on the basis of, among other things, the location of our stores, the breadth, quality, style, and availability of merchandise, the level of customer service offered and merchandise price. Although we feel the eclectic mix of products offered in our retail stores helps differentiate us, it also means that we compete against a wide variety of smaller, independent specialty stores, as well as department stores and national specialty chains. Many of our competitors have substantially greater name recognition as well as financial, marketing and other resources. Our retail stores also face competition from small boutiques that offer an individualized shopping experience similar to the one we strive to provide to our target customers.
Along with certain retail segment factors noted above, other key competitive factors for our direct-segment operations include the success or effectiveness of customer mailing lists, response rates, catalog presentation, merchandise delivery and web site design and availability. Our direct-segment operations compete against numerous catalogs and web sites, which may have a greater volume of circulation and web traffic.
Seasonality
Our historical revenues and operating results have varied significantly from quarter to quarter due to seasonal fluctuations in consumer purchasing patterns. Sales of apparel, accessories and footwear through our e-commerce webpages, catalogs and retail stores have generally been higher in our third and fourth fiscal quarters, which contain the key back-to-school and holiday selling seasons, as compared to our first and second fiscal quarters. During the second, third and the beginning of our fourth fiscal quarters, our working capital requirements increase and may be funded by our cash balances and utilization of our existing Credit Agreement with General Electric Capital Corporation (“GE Capital”). Quarterly results of operations may also fluctuate significantly as a result of a variety of factors, including the timing of store openings and the relative proportion of our new stores to mature stores, fashion trends and changes in consumer preferences, calendar shifts of holiday or seasonal periods, changes in merchandise mix, timing of promotional events, general economic conditions, competition and weather conditions.
Intellectual Property
We and Alloy, Inc. have registered various trademarks and servicemarks used in our business operations with the United States Patent and Trademark Office (the “PTO”). With respect to certain Alloy trademarks and
servicemarks covering goods and services, we and Alloy, Inc. are joint owners by assignment of these trademarks and servicemarks. We and Alloy, Inc. filed instruments with the PTO to request that the PTO divide these jointly owned trademarks and servicemarks between us such that we each would own the registrations for those trademarks and servicemarks for the registration classes covering the goods and services applicable to our respective businesses and the PTO has honored such request. Applications for the registration of certain of our other trademarks and servicemarks are currently pending. We also use trademarks, tradenames, logos and endorsements of our suppliers and partners with their permission. We are not aware of any pending material conflicts concerning our marks or our use of others’ intellectual property.
Government Regulation
We are subject, directly and indirectly, to various laws and governmental regulations relating to our business. The internet continues to rapidly evolve and several laws or regulations directly apply to online commerce and community websites. However, due to the increasing popularity and use of the internet, governmental authorities in the United States and abroad may adopt additional laws and regulations to govern internet activities. Laws with respect to online commerce, including social media, may cover issues such as pricing, taxing, distribution, unsolicited email (“spamming”), content, intellectual property, defamation, privacy and data security, product endorsements, online behavioral advertising and characteristics and quality of products and services. Laws with respect to community websites may cover content, copyrights, libel, obscenity and personal privacy. Any new legislation or regulation or the application of existing laws and regulations to the internet could have a material and adverse effect on our business, results of operations and financial condition.
Governments of other states or foreign countries might attempt to regulate our transmissions or levy sales or other taxes relating to our activities even though we do not have a physical presence or operations in those jurisdictions. As our products and advertisements are available over the internet anywhere in the world, and we conduct marketing programs in numerous states, multiple jurisdictions may claim that we are required to register to do business as a foreign corporation in each of those jurisdictions. Our failure to register as a foreign corporation in a jurisdiction where we are required to do so could subject us to taxes and penalties.
It is possible that state and foreign governments might also attempt to regulate our transmissions of content on our e-commerce webpages or prosecute us for violations of their laws. For example, a French court has ruled that a website operated by a United States company must comply with French laws regarding content, and an Australian court has applied the defamation laws of Australia to the content of a U.S. publisher posted on the company’s website. We cannot assure you that state or foreign governments will not charge us with violations of local laws or that we might not unintentionally violate these laws in the future, or that foreign citizens will not obtain jurisdiction over us in a foreign country, subjecting us to litigation in that country under the laws of that country.
The United States Congress enacted the Children’s Online Privacy Protection Act of 1999 (“COPPA”) and the Federal Trade Commission (“FTC”) promulgated implementing regulations, which became effective in 2000. The principal COPPA requirements apply to websites, or those portions of websites, directed to children under age 13. COPPA mandates that individually identifiable information about minors under the age of 13 not be collected, used or displayed without first obtaining informed parental consent that is verifiable in light of present technology, subject to certain limited exceptions. As a part of our efforts to comply with these requirements, we do not knowingly collect personally identifiable information from any person under 13 years of age and have implemented age screening mechanisms on certain areas of our websites in an effort to prohibit persons under the age of 13 from registering. This may have the effect of dissuading some percentage of our customers from using our e-commerce webpages, which may adversely affect our business. While we use our commercially reasonable efforts to ensure that we are compliant with COPPA, our efforts may not be successful. If it turns out that our activities are not COPPA compliant, we may face litigation with the FTC or individuals or face a civil penalty, which could adversely affect our business. The FTC has revised its COPPA regulations and the Company plans to continue to comply with COPPA including upon the effectiveness of such revised regulations.
A number of government authorities both in the United States and abroad, as well as private parties, are increasing their focus on privacy issues and the use of personal information. The FTC and attorneys general in several states have investigated the use of personal information by some internet companies. In particular, an attorney general may examine privacy policies to ensure that a company fully complies with representations in the policies regarding the manner in which the information provided by consumers and other visitors to a website is used and disclosed by the company. As a result, we periodically review our privacy policies, and we believe we are in compliance with relevant federal and state laws. However, our business could be adversely affected if new regulations or decisions regarding the use and disclosure of personal information are made, or if government authorities or private parties challenge our privacy practices.
In December 2003, the Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003 (“CAN-SPAM”) was enacted by the United States Congress. This legislation regulates “commercial electronic mail messages,” (i.e., email) the primary purpose of which is to promote a product or service. Among its provisions are ones requiring specific types of disclosures in covered emails, requiring specific opt-out mechanisms and prohibiting certain types of deceptive headers. Violations of its provisions may result in civil money penalties and criminal liability. CAN-SPAM further authorizes the FTC to establish a national “Do-Not-E-Mail” registry akin to the recently-adopted Do Not Call Registry. Any entity that sends commercial email messages, such as our various subsidiaries, and those who re-transmit such messages, must adhere to the CAN-SPAM requirements. Compliance with these provisions may limit our ability to send certain types of emails on our own behalf, which may adversely affect our business. While we intend to operate our businesses in a manner that complies with the CAN-SPAM provisions, we may not be successful in so operating. If it turns out we have violated the provisions of CAN-SPAM, we may face litigation with the FTC or face civil penalties, which could adversely affect our business.
The European Union Directive on the Protection of Personal Data may affect our ability to make our websites available in Europe if we do not afford adequate privacy to European users. Similar legislation was recently passed in other jurisdictions and may have a similar effect. Legislation governing privacy of personal data provided to internet companies is in various stages of development and implementation in other countries around the world and could affect our ability to make our e-commerce webpages available in those countries as future legislation is made effective.
Relationship with JLP Daisy LLC
In February 2003, dELiA*s Brand LLC, a wholly-owned subsidiary of the Company, entered into a master license agreement with JLP Daisy to license the dELiA*s brand on an exclusive basis for wholesale distribution in certain product categories, primarily in mid- and upper-tier department stores. dELiA*s Brand LLC received a $16.5 million cash advance against future royalties from the licensing ventures. The master license agreement provides that JLP Daisy is entitled to retain all of the royalty income generated from the sale of licensed products until JLP Daisy recoups its advance plus one-third of a preferred return of 18% per year on the unrecouped advance, if ever. Thereafter, we will receive an increasing share of the royalties until JLP Daisy recoups its advance plus a preferred return of 18% per year on the unrecouped advance, at which time we will receive a majority of the royalty stream after brand management fees. The initial term of the master license agreement is approximately 10 years, which is subject to an automatic extension of five years under specified circumstances and, at our option, (i) the term will remain in effect until JLP Daisy recoups its advance and preferred return or (ii) the term will immediately expire and JLP Daisy will be entitled to be paid the balance of any unrecouped advance and a preferred return calculated at 6% per year (if not received already). As of February 2, 2013, JLP Daisy has not recouped its advance and preferred return and therefore the master license agreement remains in effect. The master license agreement provides that the advance will be recoupable by JLP Daisy solely out of its share of the royalty payments and not through recourse against dELiA*s Brand LLC, us or any of our properties or assets. The master license agreement may be terminated early under certain circumstances, including, at our option, upon payment to JLP Daisy of an amount based upon royalties received from the sale of the licensed products during a specified period. In addition, dELiA*s Brand LLC granted to JLP Daisy a security interest in
the dELiA*s trademarks and copyrightable artwork, although the only event that would entitle JLP Daisy to exercise its rights in respect of the lien is a termination or rejection of the license or master license agreement in a bankruptcy proceeding. We have not recorded any amounts associated with the master license agreement.
Employees
As of February 2, 2013, we had 588 full-time and 1,452 part-time employees. Of the 588 full-time employees, 106 worked in warehouse/fulfillment/customer service; 164 worked in executive, finance, information technology and other corporate and division management and 318 were employed by our dELiA*s retail stores. Of the 1,452 part-time employees, 33 were warehouse/fulfillment/customer service staff; 11 were in executive, finance, information technology and other corporate and division management and 1,408 were part-time associates at dELiA*s retail stores. None of our employees are covered by a collective bargaining agreement. We consider relations with our employees to be good.
Website Access to Reports
Our corporate website is www.deliasinc.com. Our periodic and current reports are available free of charge on the “Investor Relations” page of this website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC.
Item 1A.
Item 1A. Risk Factors
Risks Related to Our Business
We have a history of operating losses.
We incurred losses from continuing operations for the last five fiscal years. Although we expect to report net profits in the future, our expectations may not be realized and we may continue to experience losses. If our revenue grows more slowly than we anticipate, or if our operating expenses are higher than we expect, or if we continue to incur operating losses, we may not be able to become profitable, in which case our financial condition would be adversely affected and our stock price could decline.
Our ability to achieve profitability will also depend on our ability to manage and control operating expenses and to generate and sustain increased levels of revenue. We expect to incur significant operating expenses and capital expenditures, including general and administrative costs to support our operations and the costs of being a public company.
Additionally, we base our expenses in large part on our operating plans, current business strategies and future revenue projections. Many of our expenses, such as our retail store lease expenses, are fixed in the short term, and we may not be able to quickly reduce expenses and spending if our revenues are lower than we project. In addition, we may find that our costs to maintain or expand our operations, and in particular the costs to purchase inventory, produce our catalogs and build, outfit and employ personnel for our new retail stores, are more expensive than we currently anticipate. Therefore, the magnitude and timing of these expenses may contribute to fluctuations in our quarterly operating results.
Our success depends largely on the value of our brands, and if the value of our brands were to diminish, our sales are likely to decline.
The prominence of our catalogs and e-commerce webpages and our dELiA*s retail stores among our teenage target market are integral to our business as well as to the implementation of our strategies for expanding our business.
Maintaining, promoting and positioning our brands will depend largely on the success of our marketing and merchandising efforts and our ability to provide a consistent, high quality customer experience. Moreover, we anticipate that we will continue to increase the number of customers we target, through means that could include broadening the intended audience of our existing brands. Misjudgments by us in this regard could damage our existing or future brands. Any adverse affects on our current or future brands could result in decreases in sales.
If we fail to anticipate, identify and respond to changing fashion trends, customer preferences and other fashion-related factors, our sales are likely to decline.
Customer tastes and fashion trends are volatile and tend to change rapidly. Our success depends in part on our ability to effectively predict and respond to changing fashion tastes and consumer demands, and to translate market trends into appropriate, saleable product offerings in a timely manner. If we are unable to successfully predict or respond to changing styles or trends and misjudge the market for our products, our sales may be lower, and we may be faced with unsold inventory. In response, we may be forced to rely on additional markdowns or promotional sales to dispose of excess or slow-moving inventory, which may have a material adverse effect on our financial condition or results of operations.
Our ability to attract customers to our retail stores depends heavily on the success of the shopping malls and other retail centers in which our stores are located. Any decrease in customer traffic in those shopping centers could negatively impact our sales.
Customer traffic in our retail stores depends heavily on locating our stores in prominent locations within successful shopping malls or other retail centers. Sales are derived, in part, from the volume of traffic in those
shopping centers. Our stores benefit from the ability of other tenants to generate consumer traffic in the vicinity of our stores and the continuing popularity of the shopping centers as shopping destinations. Our sales volume and customer traffic generally may be adversely affected by, among other things, economic downturns in a particular area, competition from internet retailers, non-mall retailers and other shopping destinations, and the closing or decline in popularity of other stores in the shopping centers in which our retail stores are located. A reduction in customer traffic for any reason could have a material adverse effect on our business, results of operations and financial condition. In addition, some malls that were in prominent locations when we opened stores may cease to be viewed as prominent. If this occurs, our sales may be adversely affected.
Internet sales are subject to numerous risks.
We sell merchandise over the internet through our e-commerce websites, www.delias.com and www.alloyapparel.com. Our internet operations are subject to numerous risks, including:
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changing consumer tastes and preferences;
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the successful implementation of new systems and internet or mobile platforms;
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the failure of the computer systems that operate our websites and their related support systems, causing, among other things, website downtimes and other technical failures;
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reliance on third-party computer hardware/software;
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rapid technological change;
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liability for online content;
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violations of state or federal laws, including those relating to online privacy;
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credit card fraud; and
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telecommunications failures and vulnerability to electronic break-ins and similar disruptions.
Our failure to successfully address and respond to these risks could reduce internet sales, increase costs and damage the reputation of our brands.
We depend on our key personnel to operate our business, and we may not be able to hire enough additional management and other personnel to manage our growth. In addition, we may face risks associated with the transition of senior management.
Our performance is substantially dependent on the continued efforts of our executive officers and other key employees. The loss of the services of any of our executive officers or key employees could adversely affect our business. Additionally, we must continue to attract, retain and motivate talented management and other highly skilled employees to be successful. We must also hire and train store managers to support our retail expansion. We may be unable to retain our key employees or attract, assimilate and retain other highly qualified employees in the future. On March 28, 2013, we announced that Walter Killough, our chief executive officer, who we previously announced would leave the Company at or about April 1, 2013, has agreed to continue to serve as our chief executive officer on a month-to-month basis as our search for a permanent chief executive officer continues. On March 28, 2013, we further announced that Dyan Jozwick, President, dELiA*s Brand, had resigned from the Company. We expect to hire new personnel to fill these positions. Once they are hired, we anticipate that we will experience a transition period before they are fully integrated into our organization. If Mr. Killough does not remain as our chief executive officer, we do not find long-term replacements for Mr. Killough and Ms. Jozwick, or the transition period for these replacements is lengthy, our business and results of operations may be adversely affected.
We rely on third parties for some essential business operations and services, and disruptions or failures in service or changes in terms may adversely affect our ability to deliver goods and services to our customers.
We currently depend on third parties for important aspects of our business, such as printing, shipping, paper supplies, operation of our e-commerce webpages, and the outsourcing of our call center function. We have
limited control over these third parties, and we are not their only client. In addition, we may not be able to maintain satisfactory relationships with any of these third parties on acceptable commercial terms. Further, we cannot be certain that the quality or cost of products and services that they provide will remain at current levels or the levels needed to enable us to conduct our business efficiently and effectively.
Postal rate and other shipping rate increases, as well as increases in paper and printing costs, affect the cost of our order fulfillment and catalog mailings. We rely heavily on quantity discounts in these areas. No assurances can be given that we will continue to receive these discounts and that we will not be subject to additional increases in costs in excess of those already announced. Any increases in these costs will have a negative impact on earnings to the extent we are unable or do not pass such increases on directly to customers or offset such increases by raising selling prices or by implementing more efficient printing, mailing and delivery alternatives.
Our ability to meet our cash requirements depends on many factors.
We currently anticipate that operating revenue, cash on hand, and availability under our existing Credit Agreement with GE Capital will be sufficient to cover our operating expenses, including cash requirements in connection with our operations and our projected capital expenditures, through at least the end of our current fiscal year. However, if we do not meet our targets for revenue growth, gross margins, or expenses, or if our costs associated with any retail store expansion plans are not as anticipated, our current sources of funds may be insufficient to meet our cash requirements. We may fail to meet our targets for revenue growth for a variety of reasons, including:
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decreased consumer spending in response to weak economic conditions;
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higher energy prices causing a decreased level of disposable income;
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weakness in the teenage market;
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poor response to our merchandise offerings;
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increased competition from our competitors; and
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our marketing and expansion plans are not as successful as we anticipate.
Additionally, if demand for our products decreases or our retail store plans do not produce the desired sales increases, such developments could reduce our operating revenues. If such funds, together with cash on hand and availability under our Credit Agreement are insufficient to cover our expenses, we could be required to adopt one or more alternatives listed below. For example, we could be required to:
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reduce or delay other capital spending;
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reduce other discretionary spending;
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sell assets or operations; and/or
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sell additional equity or debt securities, which equity securities may be dilutive.
If we are required to take any of the actions in the first three items immediately above, it could have a material adverse effect on our business, financial condition and results of operations, including our ability to grow our business. In addition, we cannot assure you that we would be able to take any of these actions because of (i) a variety of commercial or market factors, or (ii) market conditions being unfavorable for an equity or debt offering. In addition, such actions, if taken, may not enable us to satisfy our cash requirements if the actions do not generate a sufficient amount of additional capital.
We may fail to use our databases and our expertise in marketing to consumers successfully, and we may not be able to maintain the quality and size of our databases.
The effective use of our consumer databases and our expertise in marketing to consumers are important components of our business. If we fail to capitalize on these assets, our business will be less successful.
Currently, we have useful data for only a portion of our targeted market. Additionally, as individuals in our databases age, they are less likely to purchase our products and their data is thus of less value to our business. We must, therefore, continuously obtain data on new potential customers and on those persons who are just entering their teenage years in order to maintain and increase the size and value of our databases. If we fail to obtain sufficient numbers of new names and related information, our business could be adversely affected.
General economic conditions may adversely impact our results of operations.
Our financial performance is subject to world-wide economic conditions and the resulting impact on U.S. consumer confidence and levels of consumer spending, which may remain volatile for the foreseeable future. Some of the factors impacting discretionary consumer spending include general economic conditions, wages and unemployment, consumer debt, reductions in net worth based on market declines, increasing health care costs, residential real estate and mortgage markets, taxation, increases in fuel and energy prices, consumer confidence, failure to increase the debt ceiling in the U.S., and other macroeconomic factors. Consumer purchases of discretionary items, including our merchandise, generally decline during recessionary periods and other periods where disposable income is adversely affected. A downturn in the U.S. economy could affect consumer purchases of our merchandise and adversely impact our results of operations and continued growth.
Our agreement with Alloy, Inc. to license our database information may make that information less valuable to us.
We and Alloy, Inc. have agreed that we will license data collected by dELiA*s and Alloy (excluding credit card data), subject to applicable laws and privacy policies, although Alloy, Inc. has agreed not to provide certain of this data to our competitors, with some limited exceptions. Certain actions that Alloy, Inc. could take, such as breaching its contractual covenants, could result in our losing a significant portion of the competitive advantage we believe our databases provide to us. In such event, our business and results of operations could be adversely affected.
New dELiA*s retail store openings could strain our resources and cause the performance of our existing operations to suffer.
Any dELiA*s retail store expansion will largely depend on our ability to find sites to open and operate new stores successfully. Our ability to open and operate new stores successfully depends on several factors, including, among others, our ability to:
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identify suitable store locations, the availability of which is outside our control;
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negotiate acceptable lease terms;
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prepare stores for opening within budget;
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source sufficient levels of inventory at acceptable costs to meet the needs of new stores;
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hire, train and retain store personnel;
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successfully integrate new stores into our existing operations;
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contain payroll costs; and
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generate sufficient operating cash flows or secure adequate capital on commercially reasonable terms to fund any of our expansion plans.
In addition, any retail store expansion will place increased demands on our operational, managerial and administrative resources. These increased demands could cause us to operate our business less effectively, which, in turn, could cause deterioration in the financial performance of our individual stores and our overall business.
Modifications and/or upgrades to our information technology systems may disrupt our operations.
We regularly evaluate our information technology systems and requirements. Modifications may include replacing existing systems with successor systems, making changes to existing systems, or acquiring new systems with new functionality. We are aware of the inherent risks associated with replacing and modifying these systems, including inaccurate system information, system disruptions and user acceptance and understanding. Information technology system disruptions and inaccurate system information, if not anticipated and appropriately mitigated, could have a material adverse effect on our financial condition and results of operations. Additionally, there is no assurance that a successfully implemented system will deliver the anticipated value to us.
Our catalog response rates may decline.
The number of customers who make purchases from catalogs that we mail to them, which we refer to as “response rates,” may decline due to, among other things, our ability to effectively predict and respond to changing fashion tastes and consumer demands and translate market trends into appropriate, saleable product offerings in a timely manner. Response rates also usually decline when we mail additional catalog editions to the same customers within a short time period. In addition, there can be no assurance that any strategic circulation cuts will enable us to improve or maintain our response rates. We also have mailed our Alloy catalogs to selected dELiA*s catalog customers and our dELiA*s catalogs to selected Alloy catalog customers (which practice we refer to as cross-mailing), which has resulted in generally lower response rates from the dELiA*s catalogs customers who also are sent Alloy catalogs and vice-versa. Additional cross-mailings of such catalogs could result in further such response rate declines. Although it is our expectation that the additional sales generated by such cross-mailing will more than offset the declines in response rate, we can give no assurance that these expectations will be realized. If we are mistaken, these trends in response rates are likely to have a material adverse effect on our rate of sales growth and on our profitability and could have a material adverse effect on our business.
Traffic to our e-commerce webpages may decline, resulting in fewer purchases of our products. Additionally, the number of e-commerce visitors that we are able to convert into purchasers may decline.
In order to generate online customer traffic, we depend heavily on mailed catalogs, outbound emails and an affiliates program in which we pay third parties for traffic referred from their websites to our e-commerce webpages. Our sales volume and e-commerce webpage traffic generally may be adversely affected by, among other things, declines in the number and frequency of our catalog mailings, reductions in outbound emails and declines in referrals from third parties. Our sales volume may also be adversely affected by economic downturns, system failures and competition from other internet and non-internet retailers.
In addition, the number of e-commerce visitors that we are able to convert into purchasers may decline due to, among other things, our inability to effectively predict and respond to changing fashion tastes and consumer demands and translate market trends into appropriate, saleable product offerings in a timely manner and our inability to keep up with new technologies and e-commerce features. The internet and the e-commerce industry are subject to rapid technological change. If competitors introduce new features and website enhancements embodying new technologies, or if new industry standards and practices emerge, our existing e-commerce webpages, the www.delias.com and www.alloyapparel.com websites, and our respective systems may become obsolete or unattractive. Developing our e-commerce webpages and other systems entails significant technical and business risks. We may face material delays in introducing new services, products or enhancements. If this happens, our customers may forego the use of our e-commerce webpages and use websites and e-commerce pages of our competitors. We may use new technologies ineffectively, or we may fail to adequately adapt our website, our transaction processing systems and our computer network to meet customer requirements or emerging industry standards.
We do not own the content websites that direct customers to our e-commerce webpages, and thus have to depend on Alloy, Inc. to maintain those websites as attractive sites for our target customers.
Pursuant to an agreement with Alloy, Inc., it will continue to own both www.delias.com and www.alloy.com websites, the related e-commerce webpages and the related uniform resource locators (“urls”). Alloy, Inc. also operates www.alloy.com. Although we may transition our e-commerce operations to websites that we own, we will be required to maintain links from those websites to Alloy, Inc. owned websites, and Alloy, Inc. will be required to maintain links from those websites to our websites. Alloy, Inc. will continue to provide the community and content on each of those websites, and we will have no control over any of such community or content. Because a significant portion of our direct marketing sales come from our e-commerce sites, if Alloy, Inc. fails to maintain those websites, or fails to maintain those websites as attractive sites for the target audiences, our e-commerce activities may suffer.
Because we experience seasonal fluctuations in our revenues, our quarterly results may fluctuate.
Our business is seasonal, reflecting the general pattern of peak sales for teen clothing and accessories, which provide the majority of our sales during the back-to-school and holiday shopping seasons. Typically, a larger portion of our revenues are obtained during our third and fourth fiscal quarters. Any significant decrease in sales during the back-to-school and winter holiday seasons would have a material adverse effect on our financial condition and results of operations. In addition, in order to prepare for the back-to-school and holiday shopping seasons, we must order and keep in stock significantly more merchandise than we carry during other parts of the year, and we must hire temporary workers and incur additional staffing costs in our warehouse and retail stores to meet anticipated sales demand. If sales for the third and fourth quarters do not meet anticipated levels, then increased expenses may not be offset, which could decrease our profitability. Additionally, any unanticipated decrease in demand for our products during these peak seasons could require us to sell excess inventory at a substantial markdown, which could decrease our profitability.
Our liquidity and ability to raise capital may be limited, and we may be unable to fund any retail store expansion.
We expect that our total capital expenditures, net of landlord allowances, primarily the costs to relocate or remodel existing stores and relocate our data center, will be approximately $1.3 million in fiscal 2013. Although, we currently expect that the sum of our current cash on hand and our current cash flows from operations and availability under our Credit Agreement will be sufficient to fund our near-term operations, including but not limited to, any retail store openings or remodels, our expectations may be wrong. If we are wrong, we may need to obtain additional debt or equity financing in the future to fund fully our operations and any retail store expansion, which equity financing may be dilutive. In addition, if we decide to significantly accelerate growth of our retail operations, additional debt or equity financing may also be required. The type, timing and terms of the financing selected by us would depend on, among other things, our retail growth plans, our cash needs, the availability of other financing sources and prevailing conditions in the financial markets. These sources may not be available to us or, if available, may not be available to us on satisfactory terms.
Competition may adversely affect our business.
The teenage girl and young womens’ retail apparel industry is highly competitive, with fashion, quality, price, location, in-store environment and service being the principal competitive factors. We compete for retail store sales with specialty apparel retailers and certain other youth-focused apparel retailers, such as American Eagle Outfitters, Abercrombie & Fitch, Aeropostale, Hollister, Wet Seal, Forever 21, and H&M. We also compete for retail store sales with full price and discount department stores such as Target, Kohl’s, Nordstrom’s, Macy’s, Bloomingdale’s and others. If we are unable to compete effectively for retail store sales, we may lose market share, which would reduce our revenues and gross profit. In addition, we compete for favorable site locations and lease terms in shopping malls with certain of our competitors as well as numerous other retailers. Many of our competitors are large national chains, which have substantially greater financial, marketing and
other resources than we do. The growth of our retail store business depends significantly on our ability to operate stores in desirable locations with capital investments and lease costs that allow us to earn a return that meets or exceeds our financial projections. Desirable new locations may not be available to us at all or at reasonable costs. In addition, we must be able to renew our existing store leases on terms that meet our financial targets. Our failure to secure favorable real estate and lease terms generally and upon renewal, or even being permitted to renew our expiring leases, could cause us to lose market share which would reduce our revenues and gross profit.
Many of our existing competitors, as well as potential new competitors in our target markets, have longer operating histories, greater brand recognition, larger customer bases and significantly greater financial, technical and marketing resources than we do. These advantages allow our competitors to spend considerably more on marketing and may allow them to use their greater resources more effectively than we can use ours. Accordingly, these competitors may be better able to take advantage of market opportunities and be better able to withstand market downturns than us. If we fail to compete effectively, our business will be materially and adversely affected.
Closing stores could result in significant costs to us.
We could, in the future, decide to close additional dELiA*s retail stores or close or sell businesses or operations that are producing losses or that are not as profitable as we expect. If we decide to close any dELiA*s stores before the expiration of their lease terms, we may incur payments to landlords to terminate or “buy out” the remaining term of the lease. We also may incur costs related to the employees at such stores, whether or not we terminate the leases early. Upon any such closure or sale, the closing costs, fixed assets, and inventory write-downs would adversely affect our results and could adversely affect our cash on hand.
Our dELiA*s exclusive branding activities could lead to increased inventory obsolescence.
Our promotion and sale of dELiA*s branded products increases our exposure to risks of inventory obsolescence. Accordingly, if a particular style of product does not achieve widespread consumer acceptance, we may be required to take significant markdowns, which could have a material adverse effect on our gross profit margin and other operating results. Moreover, dELiA*s exclusive brand development plans may include entry into joint ventures and additional licensing or distribution arrangements, which may also contribute to increased inventory obsolescence as third parties may control more of these operations.
Our master license agreement with JLP Daisy LLC could cause us to lose our trademarks or otherwise adversely affect the value of our dELiA*s brand.
In February, 2003, dELiA*s Brand, LLC, a wholly-owned subsidiary of the Company , entered into a master license agreement with JLP Daisy to license our dELiA*s brand on an exclusive basis for wholesale distribution in certain product categories, primarily in mid and upper-tier department stores, in exchange for an up-front payment from JLP Daisy of $16.5 million, which is applied against royalties otherwise due from JLP Daisy for sales of dELiA*s branded merchandise. The initial term of the master license agreement is approximately 10 years, which is subject to an automatic extension under specified circumstances and, at our option, (i) will remain in effect until JLP Daisy recoups its advance and preferred return or (ii) term will immediately expire and JLP Daisy will be entitled to be paid the balance of any unrecouped advance and a preferred return calculated at 6% per year (if not already received). As of February 2, 2013, JLP Daisy has not recouped its advance and preferred return and therefore the master license agreement remains in effect. As part of the master license agreement, dELiA*s Brand, LLC granted to JLP Daisy a security interest in the dELiA*s trademarks and copyrightable artwork, although the only event that would entitle JLP Daisy to exercise its rights in respect of the lien is a termination or rejection of the license or the master license agreement in a bankruptcy proceeding. If we become subject to a bankruptcy proceeding, we could lose the rights to our dELiA*s trademarks, which could have a material adverse effect on our business and operating results.
Additionally, because sales of dELiA*s branded products by JLP Daisy’s licensees have been significantly less than we and JLP Daisy expected when we entered into the master license agreement, we expect that JLP Daisy may try to increase the sales of the dELiA*s branded products by its licensees, by expanding the number of licensed products their licensees offer, the number and type of stores in which such licensed products are sold, or both, so that they can recoup more of their initial advance. Sales of dELiA*s branded products by JLP Daisy’s licensees may negatively impact our customers’ image of the brand, which could have a material adverse effect on our profit margins and other operating results. Additionally, a change in our customers’ image of the brand due to sales of dELiA*s branded products by JLP Daisy’s licensees to greater numbers of retailers may negatively affect our dELiA*s retail store expansion plans.
We depend largely upon an outsourced call center and a single distribution facility.
The call center function is outsourced to a third party for our dELiA*s and Alloy e-commerce webpages and catalogs. The distribution for our dELiA*s and Alloy e-commerce webpages and catalogs and all our dELiA*s retail stores are handled from a single, owned facility in Hanover, Pennsylvania. Any significant interruption in the operation of the call center function or distribution facility due to natural disasters, accidents, system failures, expansion or other unforeseen causes could delay or impair our ability to receive orders and distribute merchandise to our customers and retail stores, which could cause our sales to decline. This could have a material adverse effect on our operations and results.
We have recorded impairment charges in the past and we may be required to recognize impairment charges in the future.
Pursuant to generally accepted accounting principles, we are required to perform impairment tests on our identifiable intangible assets with indefinite lives, including goodwill, annually or at any time when certain events occur, which could impact the value and earnings of our business segments. Our determination of whether impairment has occurred is based on a comparison of the assets’ fair market values with the assets’ carrying values. Significant and unanticipated changes could require a provision for impairment in a future period that could substantially affect our reported earnings in a period of such change. We recognized a goodwill impairment charge of $4.5 million related to our direct marketing reporting unit in fiscal 2012.
Additionally, pursuant to generally accepted accounting principles, we are required to recognize an impairment loss when circumstances indicate that the carrying value of long-lived tangible and intangible assets with finite lives may not be recoverable. Management’s policy in determining whether an impairment indicator exists (i.e., a triggering event) comprises measurable operating performance criteria as well as qualitative measures. If a determination is made that a long-lived asset’s carrying value is not recoverable over its estimated useful life, the asset is written down to estimated fair value, if lower. The determination of fair value of long-lived assets is generally based on estimated expected discounted future cash flows, which is generally measured by discounting expected future cash flows identifiable with the long-lived asset at our weighted-average cost of capital. We have recognized impairment charges of approximately $0.2 million in fiscal 2012 and $0.5 million in fiscal 2011 related to underperforming store locations. We had no impairment charges related to long-lived assets in fiscal 2010.
If our manufacturers and importers are unable to produce our proprietary-branded goods on time or to our specifications, we could suffer lost sales.
We do not own or operate any manufacturing facilities and, therefore, depend upon independent third party vendors for the manufacture of all of our branded products. Our products are manufactured to our specifications primarily by domestic manufacturers and importers. We cannot control all of the various factors, which include inclement weather, natural disasters, labor disputes and acts of terrorism that might affect the ability of a manufacturer or importer to ship orders of our products in a timely manner or to meet our quality standards. Late delivery of products or delivery of products that do not meet our quality standards could cause us to miss the delivery date requirements of our customers or delay timely delivery of merchandise to our retail stores for those
items. These events could cause us to fail to meet customer expectations, cause our customers to cancel orders or cause us to be unable to deliver merchandise in sufficient quantities or of sufficient quality to our stores, which could result in lost sales.
There are risks of obtaining products from third parties.
Our business depends largely on the ability of third-party vendors and their subcontractors or suppliers to provide us with current-season, brand-name apparel and other merchandise at competitive prices, in sufficient quantities, manufactured in compliance with all applicable laws and of acceptable quality. We do not have any long-term contracts with any vendor and are not likely to enter into these contracts in the foreseeable future. In addition, many of the vendors that we use are factored and have limited resources, production capacities, and operating histories. Additionally, because the fashion market is volatile and customer taste tends to change rapidly, we must, in order to be successful, identify and obtain merchandise from new third-party brands for which our customers show a preference. As a result, we are subject to the following risks:
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our vendors may fail or be unable to expand with us;
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our current vendor terms may be changed to require increased payments or letters of credit in advance of delivery, and we may not be able to fund such payments through our current credit facility, cash balances, or our cash flow;
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we may not be able to identify or obtain products from new “hot” brands preferred by our customers; and
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our ability to procure products in sufficient quantities, at acceptable prices, may be limited.
We believe, based on the country of origin tags that appear on the products we sell, that a substantial portion of the products sold to us by our third-party vendors and domestic importers are produced in factories located in foreign countries, especially in China and other Asian countries. Any event causing a sudden disruption of manufacturing or imports from Asia or elsewhere, including, but not limited to, the imposition of import restrictions, could materially harm our operations. Many of our and our vendor’s imports are subject to existing or potential duties, tariffs or quotas that may limit the quantity of certain types of goods that may be imported into the United States from countries in Asia or elsewhere. We and our vendors compete with other companies for production facilities and import quota capacity. Our and our vendors’ businesses are also subject to a variety of other risks generally associated with doing business abroad, such as political instability, currency and exchange risks, disruption of imports by labor disputes (both in other countries and in the United States) and local business practices.
Ours and our vendors’ foreign sourcing operations may also be hurt by political and financial instability, strikes, health concerns regarding infectious diseases in countries in which our merchandise is produced, adverse weather conditions or natural disasters or acts of war or terrorism. Our future operations and performance will be subject to these factors, which are beyond our control, and these factors could materially hurt our business, financial condition and results of operations or may require us to modify our current business practices and incur increased costs.
Fluctuations in the cost, availability and quality of raw materials, labor and transportation, could increase our costs.
Fluctuations in the cost, availability and quality of the fabrics or other raw materials used to manufacture our merchandise could have a material adverse effect on our cost of goods and, accordingly, on our results of operations. The prices for those fabrics depend largely on the market prices for the raw materials used to produce them, including cotton. The price and availability of these raw materials may fluctuate significantly, depending on many factors, including, among other things, crop yields and weather patterns. In addition, the cost of labor at many of our third-party manufacturers has been increasing as the middle class in developing countries continues
to grow, and we expect this trend to continue. The cost of transportation has been increasing as well and, if the price of oil remains at current levels or increases, that cost pressure will continue. We may not be able to pass all or a portion of higher raw materials prices, labor or transportation costs on to our customers, which could adversely affect our gross margin and our results of operations.
The effects of war or acts of terrorism could have a material adverse effect on our operating results and financial condition.
The continued threat of terrorism and the associated heightened security measures and military actions in response to acts of terrorism have disrupted commerce and have intensified uncertainties in the U.S. economy. Any further acts of terrorism or a future war may disrupt commerce and undermine consumer confidence, which could negatively impact our sales revenue by causing consumer spending and/or mall traffic to decline. Furthermore, an act of terrorism or war, or the threat thereof, or any other unforeseen interruption of commerce, could negatively impact our business by interfering with our ability to obtain merchandise from foreign manufacturers. Our inability to obtain merchandise from our foreign manufacturers or substitute other manufacturers, at similar costs and in a timely manner, could adversely affect our operating results and financial condition.
Weather conditions where our stores are located may impact consumer shopping patterns, which alone or together with natural disasters, particularly in areas where our sales are concentrated, could adversely affect our results of operations.
Uncharacteristic or significant weather conditions can affect consumer shopping patterns, particularly in apparel and seasonal items, which could lead to lost sales or greater than expected markdowns and adversely affect our short-term results of operations. For example, frequent or unusually heavy snowfall, ice storms, rainstorms or other significant weather conditions over a prolonged period could make it difficult for our customers to travel to our stores and thereby reduce our sales and profitability. Our business is also susceptible to unseasonable weather conditions. For example, extended periods of unseasonably warm temperatures during the winter season or cool weather during the summer season could render a portion of our inventory incompatible with those unseasonable conditions. Natural disasters in areas where our sales are concentrated could result in significant physical damage to or closure of one or more of our stores or distribution center, and cause delays in the distribution of merchandise from our vendors to our distribution center and stores, which could adversely affect our results of operations by increasing our costs and lowering our sales.
We must effectively manage our vendors to minimize inventory risk and maintain our margins.
We seek to avoid maintaining high inventory levels in an effort to limit the risk of outdated merchandise and inventory write-downs. If we underestimate quantities demanded by our customers and our vendors cannot restock, then we may disappoint customers who may then turn to our competitors. We require many of our vendors to meet minimum restocking requirements, but if our vendors cannot meet these requirements and we cannot find alternate vendors, we could be forced to carry more inventory than we have in the past or we could have a loss in sales. Our risk of inventory write-downs would increase if we were to hold large inventories of merchandise that prove to be unpopular.
We may be required to collect sales tax on our direct marketing operations.
At present, with respect to sales generated in the direct marketing segment by our Alloy brand, sales tax or other similar taxes on direct shipments of goods to consumers is collected primarily in states where Alloy has a physical presence or personal property. With respect to the dELiA*s direct sales, sales or other similar taxes are collected primarily in states where we have dELiA*s retail stores, another physical presence or personal property. However, various states or foreign countries may seek to impose sales tax collection obligations on out-of-state direct mail companies.
A successful assertion by one or more states that we or one or more of our subsidiaries should have collected or should be collecting sales taxes on the direct sale of our merchandise could have a material adverse effect on our business.
We could face liability from, or our ability to conduct business could be adversely affected by, government and private actions concerning personally identifiable data, including privacy.
Our direct marketing business is subject to federal and state laws regarding the collection, maintenance and disclosure of personally identifiable information we collect and maintain in our databases. If we do not comply, we could become subject to liability. While these provisions do not currently unduly restrict our ability to operate our business, if those regulations become more restrictive, they could adversely affect our business. In addition, laws or regulations that could impair our ability to collect and use user names and other information on the e-commerce webpages may adversely affect our business. For example, COPPA currently limits our ability to collect personal information from website visitors who may be under age 13. Further, claims could also be based on other misuse of personal information, such as for unauthorized marketing purposes. If we violate any of these laws, we could face civil penalties. In addition, the attorneys general of various states review company websites and their privacy policies from time to time. In particular, an attorney general may examine such privacy policies to assure that the policies overtly and explicitly inform users of the manner in which the information they provide will be used and disclosed by the Company. If one or more attorneys general were to determine that our privacy policies fail to conform with state law, we also could face fines or civil penalties, any of which could adversely affect our business.
We could face liability for information displayed in our catalogs or displayed on or accessible via e-commerce webpages and our other websites.
We may be subjected to claims for defamation, negligence, copyright or trademark infringement or based on other theories relating to the information we publish in any of our catalogs, on our e-commerce webpages and on any of our other websites. These types of claims have been brought, sometimes successfully, against similar companies in the past. Based upon links we provide to third-party websites, we could also be subjected to claims based upon online content we do not control that is accessible from our e-commerce webpages.
We may be liable for misappropriation of our customers’ personal information.
If third parties or unauthorized employees of ours are able to penetrate our network security or otherwise misappropriate our customers’ personal information or credit card information, or if we give third parties or our employees improper access to our customers’ personal information or credit card information, we could be subject to claims of liability. These claims could include claims for unauthorized purchases with credit card information, impersonation or other similar fraud claims, or negligence claims. This potential liability could also include claims for other misuse of personal information, including unauthorized marketing purposes. Liability for misappropriation of this information could decrease our profitability.
In addition, the Federal Trade Commission and state agencies have been investigating various internet companies regarding their use of personal information. We could incur additional expenses if new regulations regarding the use of personal information are introduced or if government agencies investigate our privacy practices.
We rely on encryption and authentication technology licensed from third parties to provide the security and authentication necessary to effect secure transmission of confidential information such as customer credit card numbers. Advances in computer capabilities, new discoveries in the field of cryptology or other events or developments may result in a compromise or breach of the algorithms that we use to protect customer transaction data. If any such compromise of our security were to occur, it could subject us to claims of liability, damage our reputation and diminish the value of our brands. A party who is able to circumvent our security measures could
misappropriate proprietary information or cause interruptions in our operations. We may be required to expend significant capital and other resources to protect against such security breaches or to alleviate problems caused by such breaches. Our security measures are designed to significantly reduce the risk of security breaches, but our failure to prevent such security breaches could subject us to claims of liability, damage our reputation and diminish the value of our brands and cause our sales to decline.
Government regulation of the Internet and e-commerce is evolving and unfavorable changes could harm our business.
As noted above in Item 1 under the caption “Governmental Regulation,” we are subject to regulations and laws specifically governing the Internet and e-commerce. Existing and future laws and regulations may impede the growth of our Internet or e-commerce services. These regulations and laws may cover taxation, privacy, data protection, pricing, content, copyrights, distribution, mobile communications, electronic contracts and other communications, consumer protection, the provision of e-commerce payment services, and consumer protection. Unfavorable regulations and laws could diminish the on-line demand for our products and services and increase our costs of doing business.
Many of our vendors utilize factors and therefore require letters of credit.
All or a portion of the credit extended by factors to our vendors often is collateralized by standby letters of credit, which we are required to provide and which we currently obtain under our Credit Agreement with GE Capital. Any increases in the amount of such letters of credit required by such factors reduces the amount of availability we have under our Credit Agreement with GE Capital. Any increase in our vendors’ use of factors or decrease in the amount of credit extended by these factors could require us to provide additional standby letters of credit, thereby reducing further the amount of availability, or require us to obtain increased credit lines which may or may not be readily available to us on acceptable terms. Any such decreases could adversely affect our ability to operate our business, including requiring us to reduce other discretionary spending, such as on advertising. Any such event could result in reduced sales.
Our ability to procure merchandise could be adversely affected by changes in our vendors’ factoring arrangements.
Although we do not have a direct relationship with factors, a portion of our vendors who supply us with merchandise have direct factoring arrangements. Vendors who engage in factoring transactions will typically sell their accounts receivable to a factor at a discount in exchange for cash payments, which can be used to finance the business and operations of the vendors.
If the financial condition of our vendors’ factors were to deteriorate and those vendors were unable to procure alternative factoring arrangements, our ability to timely procure merchandise for our stores could be adversely affected. This also could require the devotion of significant time and attention by our management to adequately resolve such matters. In turn, our results of operations and financial condition could suffer.
Our Credit Agreement with GE Capital includes covenants that impose restrictions on our financial and business operations.
Our Credit Agreement contains covenants that restrict the manner in which we conduct our business under certain circumstances. Subject to certain exceptions, these covenants restrict or limit our ability to, among other things:
•
grant liens on assets;
•
merge, consolidate, dissolve or liquidate;
•
incur or guarantee additional indebtedness;
•
make certain investments or acquisitions;
•
engage in certain sales (including the sale of stock); and
•
pay dividends.
If we fail to comply with the covenants and are unable to obtain a waiver or amendment, an event of default would result, and GE Capital could declare outstanding borrowings immediately due and payable. If that should occur, we cannot guarantee that we would have sufficient liquidity at that time to repay or refinance borrowings under the Credit Agreement.
Our inability or failure to protect our intellectual property or our infringement of other’s intellectual property could have a negative impact on our operating results.
Our trademarks are valuable assets that are critical to our success. The unauthorized use or other misappropriation of our trademarks, or the inability for us to continue to use any current trademarks, could diminish the value of our brands and have a negative impact on our business. We are also subject to the risk that we may infringe on the intellectual property rights of third parties. Any infringement or other intellectual property claim made against us, whether or not it has merit, could be time-consuming, result in costly litigation, cause product delays or require us to pay royalties or license fees. As a result, any such claim could have a material adverse effect on our operating results.
In addition, with respect to certain Alloy trademarks and servicemarks, we and Alloy, Inc. have become joint owners by assignment of such trademarks and servicemarks. We and Alloy, Inc. have filed instruments with the PTO to request that the PTO divide these jointly owned trademarks and servicemarks between us such that we each would own the registrations for those trademarks and servicemarks for the registration classes covering the goods and services applicable to our respective businesses and the PTO has honored such request.
The impact of potential consolidation of commercial and retail landlords.
Continued consolidation in the commercial retail real estate market could affect our ability to successfully negotiate favorable rental terms for our stores in the future. Should significant consolidation continue, a large proportion of our store base could be concentrated with one or a few entities that could then be in a position to dictate unfavorable terms to us due to their significant negotiating leverage. If we are unable to negotiate favorable rental terms with these entities, this could affect our ability to profitably operate our stores, which could adversely impact our business, financial condition and results of operations.
We may have potential business conflicts with Alloy, Inc. with respect to our past and ongoing relationships.
On December 19, 2005, Alloy, Inc. completed the Spinoff of all of the outstanding common stock of dELiA*s, Inc. to its shareholders. In connection with the Spinoff, Alloy, Inc. contributed and transferred to us substantially all of its assets and liabilities related to its direct marketing and retail store segments.
We entered into various agreements with Alloy, Inc. prior to or in connection with the Spinoff. These agreements govern various interim and ongoing relationships between Alloy, Inc. and us following the Spinoff. Certain of these agreements expired by their terms on December 19, 2010. We subsequently entered into certain amended and restated agreements effective December 20, 2010 which expire on December 20, 2015.
Potential business conflicts may arise between Alloy, Inc. and us in a number of areas relating to our past and ongoing relationships, including:
•
labor, tax, employee benefit, pending litigation, indemnification and other matters arising from our separation from Alloy, Inc.;
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intellectual property matters;
•
joint database ownership and management; and
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the nature, quantity, quality, time of delivery and pricing of services we supply to each other under our various agreements with Alloy, Inc.
We may not be able to resolve any potential conflicts. Even if we do so, however, because Alloy, Inc. will be performing a number of services and functions for us, they will have leverage with negotiations over their performance that may result in a resolution of such conflicts that may be less favorable to us than if we were dealing with another third party.
Risks Related to our Common Stock
The price of our common stock may be volatile and you may lose all or a part of your investment.
The price of our common stock may fluctuate widely, depending upon a number of factors, many of which are beyond our control. For instance, it is possible that our future results of operations may be below the expectations of investors and, to the extent our company is followed by securities analysts, the expectations of these analysts. If this occurs, our stock price may decline. Other factors that could affect our stock price include the following:
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the perceived prospects of our business and the teenage market as a whole;
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changes in analysts’ recommendations or projections, if any;
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fashion trends;
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changes in market valuations of similar companies;
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actions or announcements by our competitors;
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actual or anticipated fluctuations in our operating results;
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litigation developments; and
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changes in general economic or market conditions or other economic factors unrelated to our performance.
In addition, the stock markets can experience significant price and trading volume fluctuations. These broad market fluctuations may adversely affect the trading price of our common stock. In the past, following periods of volatility in the market price of a public company’s securities, securities class action litigation has often been instituted against that company. Such litigation could result in substantial costs to us and a likely diversion of our management’s attention.
Provisions of Delaware law and of our charter and by-laws and stockholder rights plan may make a takeover more difficult.
Provisions in our amended and restated certificate of incorporation and by-laws and in the Delaware corporation law may make it difficult and expensive for a third party to pursue a tender offer, change in control or takeover attempt that our management and board of directors oppose. Public stockholders that might wish to
participate in one of these transactions may not have an opportunity to do so. For example, our amended and restated certificate of incorporation and by-laws contain provisions:
•
reserving to our board of directors the exclusive right to change the number of directors and fill vacancies on our board of directors, which could make it more difficult for a third party to obtain control of our board of directors;
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authorizing the issuance of up to 25 million shares of preferred stock which can be created and issued by the board of directors without prior stockholder approval, commonly referred to as “blank check” preferred stock, with rights senior to those of our common stock, which could make it more difficult or expensive for a third party to obtain voting control;
•
establishing advance notice requirements for director nominations or other proposals at stockholder meetings; and
•
generally requiring the affirmative vote of holders of at least 70% of the outstanding voting stock to amend certain provisions of our amended and restated certificate of incorporation and by-laws, which could make it more difficult for a third party to remove the provisions we have included to prevent or delay a change of control.
In addition, we have adopted a stockholder rights plan that may prevent a change in control or sale of us in a manner or on terms not approved by our board of directors. These anti-takeover provisions could substantially impede the ability of public stockholders to benefit from a change in control or to change our management and board of directors.
We have a significant number of options outstanding which, if exercised, would dilute the equity interests of our existing stockholders and adversely affect earnings per share.
As of February 2, 2013, we had outstanding options, of which 2,065,336 were vested, to purchase 3,050,086 shares of common stock at a weighted average exercise price of $3.84 per share. From time to time, we may issue additional options to employees, non-employee directors and consultants pursuant to our equity incentive plans. Our stockholders will experience dilution as these stock options are exercised.
We have a shelf registration statement which, if utilized, may dilute the equity interests of our existing stockholders and adversely affect earnings per share.
We have a shelf registration statement in which the Company may issue up to $30 million of its common stock, preferred stock, warrants, rights, units or preferred stock purchase rights. Our stockholders may experience dilution if an equity transaction is consummated. To date, no securities of the Company have been issued under this shelf registration statement.
If we fail to meet the continued listing standards of Nasdaq, our common stock may be delisted, which may adversely affect the market price and liquidity of our common stock.
Our common stock is currently traded on The Nasdaq Global Market. Nasdaq has requirements we must meet in order to remain listed on The Nasdaq Global Market, including that we maintain a minimum closing bid price of $1.00 per share of our common stock. The closing bid price of our common stock has been below $1.00 per share since April 11, 2013. If the closing bid price of our common stock remains below $1.00 per share for 30 consecutive trading days or we do not meet other listing requirements, we would fail to be in compliance with Nasdaq’s listing standards. If this occurs, we expect that we would receive written notification from Nasdaq and would then have a 180-day period to regain compliance with Nasdaq’s listing requirements by having the closing bid price of our common stock be at least $1.00 per share for at least 10 consecutive trading days. If we are unable to do so, our common stock may be delisted from The Nasdaq Global Market and transferred to a listing on The Nasdaq Capital Market, or delisted from Nasdaq altogether. There can be no assurance that we will be able to maintain or regain compliance with the requirements for listing our common stock on The Nasdaq Global Market, or we would be eligible for transfer to The Nasdaq Capital Market and remain in compliance with the
requirements for listing on that market. The failure to maintain our listing on The Nasdaq Global Market or to qualify for listing on The Nasdaq Capital Market could have an adverse effect on the market price and liquidity of our shares of common stock.
We do not intend to pay dividends on our common stock.
We have never declared or paid any cash dividend on our capital stock. We currently intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future. Further, we are prohibited under the terms of the Credit Agreement from paying dividends. Any determination to pay dividends in the future will be made at the discretion of our board of directors and will depend on our results of operations, financial conditions, contractual restrictions imposed by applicable law and other factors our board deems relevant. Accordingly, investors must be prepared to rely on sales of their common stock after price appreciation to earn an investment return, which may never occur. If our common stock does not appreciate in value, or if our common stock loses value, our stockholders may lose some or all of their investment in our shares.
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2.
Item 2. Properties
The following table sets forth information as of February 2, 2013 regarding the principal facilities that we currently use in our business operations. Except for the property in Hanover, PA, which we own, all such facilities are leased. We believe our facilities are well maintained, in good operating condition and otherwise adequate for our business operations.
The following table sets forth information regarding the states in which we operate retail stores as of February 2, 2013, and the number of stores in each state.
Item 3.
Item 3. Legal Proceedings
The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. Although the amount of any liability that could arise with respect to these actions cannot be determined with certainty, in the Company’s opinion, any such liability will not have a material adverse effect on its consolidated financial position, consolidated results of operations or liquidity.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
Executive Officers of the Registrant
Walter Killough, age 58, has served as our Chief Executive Officer (CEO) since May 2010, and had served as Chief Operating Officer and a director since December 2005. On March 28, 2013, we announced that Mr. Killough, who we previously announced would leave the Company at or about April 1, 2013, has agreed to continue to serve as our chief executive officer on a month-to-month basis as our search for a permanent chief executive officer continues. Mr. Killough joined Alloy, Inc. in March 2003 as a consultant, and served as the Chief Operating Officer of its Retail and Direct Consumer Division from October 2003 until December 2005. Prior to joining Alloy, Inc., Mr. Killough was at J.Crew for 14 years. He was appointed its Chief Operating Officer in 2001, and prior to that served as an executive vice president. As its Chief Operating Officer, he was responsible for all sourcing, catalog circulation and production, warehouse and distribution, retail and direct planning and logistics.
David J. Dick, age 46, has served as our Senior Vice President, Chief Financial Officer and Treasurer since February 2, 2009 and had served as the Company’s Vice President, Controller and Chief Accounting Officer since April 2008. Prior to that, Mr. Dick served as Chief Financial Officer of Charlie Brown’s Acquisition Corp., a multi-concept casual dining restaurant operator, from 2006 to 2007, and from 1993 to 2006, worked for Linens ‘n Things, Inc., a specialty retailer of home furnishings, where he held a number of positions including Vice President, Controller and Treasurer. From 1987 to 1992, Mr. Dick worked for Ernst & Young LLP. He is a certified public accountant.
Marc G. Schuback, age 51, has served as our Senior Vice President, General Counsel and Secretary since August 2007. Prior to that, Mr. Schuback served as Vice President, Assistant General Counsel and Assistant Corporate Secretary of Footstar, Inc., a nationwide footwear retailer, from July 1996 to August 2007.
David Diamond, age 45, has served as our Senior Vice President, Human Resources since January, 2004. Prior to joining dELiA*s, Mr. Diamond worked in executive search focused on the retail industry most recently as a partner with Hudson Highland Partners, a subsidiary of Hudson Highland Group Inc. and was previously with Russell Reynolds Associates Inc., Levy-Kerson Ltd. and Whitehead Mann Plc. Prior to that, Mr. Diamond was a merchant with The May Department Stores Company from 1989 to 1996 working in the G. Fox, Filene’s and Lord & Taylor divisions. Mr. Diamond also currently serves on the Board of Trustees of the Direct Marketing Educational Foundation.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our Common Stock has traded on the NASDAQ Global Market under the symbol “DLIA” since December 20, 2005. The table below sets forth the high and low sale prices for our Common Stock during the periods indicated as reported by the NASDAQ Global Market.
Stockholders
As of April 17, 2013 there were approximately 179 holders of record of the 31,939,615 outstanding shares of our Common Stock.
Dividends
We have never declared or paid cash dividends on our Common Stock. We intend to retain any future earnings to finance the growth and development of our business. We do not anticipate paying cash dividends in the foreseeable future.
Unregistered Sales of Securities
There were no unregistered sales of our securities during fiscal 2012.
Issuer Purchases of Equity Securities
During fiscal 2012, the Company did not purchase any shares of its Common Stock.
Item 6.
Item 6. Selected Financial Data
SELECTED FINANCIAL DATA
The selected statements of operations data for fiscal 2012, fiscal 2011, and fiscal 2010 have been derived from the audited financial statements included elsewhere in this report which have been audited by BDO USA, LLP, independent registered public accountants. Selected balance sheet data as of fiscal 2012 and 2011 has been derived from the audited financial statements included herein. Selected balance sheet data as of January 29, 2011, January 30, 2010 (“fiscal 2009”) and January 31, 2009 (“fiscal 2008”) and the selected statements of operations data for fiscal years 2009 and 2008 have been derived from audited financial statements and not included herein. Our historical results are not necessarily indicative of results to be expected for any future period. The data presented below has been derived from financial statements that have been prepared in accordance with accounting principles generally accepted in the United States of America and should be read with our financial statements, including the related notes, and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report. The amounts specified below are for continuing operations only. Our former CCS business is treated as discontinued operations.
(1) The Company sold its CCS business in November 2008, thus the results of the CCS business have been reported as discontinued operations. See Note 15 to the consolidated financial statements for financial data by reportable segment.
(2) The Company considers a store comparable after it has been open for fifteen full months without closure for more than seven consecutive days and whose square footage has not been expanded or reduced by more than 25% within the past year. If a store is closed during a fiscal quarter, it is removed from the computation of comparable store sales for that fiscal quarter.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial condition and results of operations together with “Selected Financial Data” and our financial statements and related notes appearing elsewhere in this annual report. Descriptions of all documents included as exhibits hereto are qualified in their entirety by reference to the full text of such documents so referenced.
Executive Summary and Overview
dELiA*s, Inc. is a multi-channel retailer of apparel and accessories, comprised of two lifestyle brands-dELiA*s and Alloy. Our merchandise assortment (which includes many name brand products along with our own proprietary brand products), our e-commerce webpages, our catalogs, and our mall-based dELiA*s retail stores are designed to appeal directly to consumers. We reach our customers through our direct marketing segment, which consists of our e-commerce and catalog businesses, and our dELiA*s retail stores.
Our strategy is to improve upon our position as a direct marketing company; to increase productivity in our dELiA*s retail stores; and to carry out such strategy while controlling costs. In addition, our strategy includes strengthening the dELiA*s brand through alignment across all channels of our business while continuing extended offerings online and in our catalogs.
We expect that improved productivity in each segment of our business will be the key element of our overall growth strategy. Our focus is to improve productivity in our current retail store base, to invest in web-based marketing programs to drive additional traffic to our websites and improve the productivity of catalogs distributed. As productivity improves and market conditions allow, we plan to continue to expand the dELiA*s retail store base over the long term. In addition, as store performance and market conditions allow, we may plan on accelerating our growth in gross square footage. Should we accelerate our growth, we may need additional equity or debt financing.
Recent Developments
On March 28, 2013, we announced that we had retained Janney Montgomery Scott LLC (“Janney”), as strategic advisor to our Board of Directors with an initial focus on the potential disposition of the Company’s Alloy brand. We believe this potential disposition will allow management to concentrate its efforts on the dELiA*s business. Our Board of Directors has not set a definitive timetable for any transaction, and there can be no assurance that Janney’s will result in any specific action or transaction. We do not intend to disclose or comment on developments until such time as our Board of Directors takes action, if any, or otherwise considers disclosure appropriate or required.
On March 28, 2013, we also announced that Walter Killough, our chief executive officer, who we previously announced would leave the Company at or about April 1, 2013, has agreed to continue to serve as our chief executive officer on a month-to-month basis as our search for a permanent chief executive officer continues.
On March 28, 2013, we further announced that Dyan Jozwick, President, dELiA*s Brand, had resigned from the Company. The Company has retained a senior merchandise consultant with relevant experience to oversee our merchandising functions on an interim basis.
Goals
We believe that focusing on our brands and implementing the following initiatives should lead to profitable growth and improved results from operations:
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delivering low-to mid-single digit comparable store sales growth in our dELiA*s retail stores over the long term;
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driving low-to mid-single digit top-line growth in direct marketing, through targeted circulation in productive mailing segments, and implementation of web, mobile and social media based initiatives;
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improving gross profit margins each year by 50 basis points;
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developing retail merchandising assortments that emphasize key categories more effectively;
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improving our retail store metrics through increased focus on the selling culture, with emphasis on increased customer conversion, thereby improving productivity;
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implementing profit-improving inventory planning and allocation strategies such as seasonal carry-in reduction, better store-planning, targeted replenishment by size, tactical fashion investment, and to create inventory turn improvement;
•
leveraging our current expense infrastructure and taking additional operating costs out of the business;
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monitoring and opportunistically closing or working with landlords to reduce costs on underperforming stores; and
•
expanding the dELiA’s retail store base over the long-term.
Key Performance Indicators
The following measurements are among the key business indicators that management reviews regularly to gauge the Company’s results:
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store metrics such as comparable store sales, sales per gross square foot, average retail price per unit sold, average transaction values, average units per transaction, traffic conversion rates and store contribution margin (defined as store gross profit less direct costs of running the store);
•
direct marketing metrics such as average order value and demand generated by book, with demand defined as the amount customers seek to purchase without regard to merchandise availability;
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web metrics such as unique site visits, carts opened and carts converted, and site conversion;
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fill rate, which is the percentage of any particular order we are able to ship for our direct marketing business, from available on-hand inventory or future inventory orders;
•
gross profit;
•
operating income;
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inventory turnover and average inventory per store; and
•
cash flow and liquidity determined by the Company’s cash provided by operations.
The discussion below includes references to “comparable stores.” We consider a store comparable after it has been open for fifteen full months without closure for more than seven consecutive days and whose square footage has not been expanded or reduced by more than 25% within the past year. If a store is closed during a fiscal quarter, it is removed from the computation of comparable store sales for that fiscal quarter.
Our fiscal year is on a 52-53 week basis and ends on the Saturday nearest to January 31. The fiscal year ended February 2, 2013 was a 53-week fiscal year, while January 28, 2012, and January 29, 2011 were both 52-week fiscal years. We refer to the extra week in fiscal 2012 as the “53rd week”.
Consolidated Results of Operations
The following table sets forth our statements of operations data for the periods indicated, reflected as a percentage of revenues:
Fiscal 2012 Compared with Fiscal 2011 (53 weeks vs. 52 weeks)
Revenues
Total Revenues
Total revenues increased 2.6% to $222.7 million in fiscal 2012 from $217.2 million in fiscal 2011. Revenue from the retail segment comprised 56.4% of total revenue for fiscal 2012 as compared to 56.7% in fiscal 2011, and revenue from the direct segment comprised 43.6% of total revenue for fiscal 2012 as compared to 43.3% for fiscal 2011. The 53rd week added incremental revenues of approximately $2.9 million.
Direct Marketing Revenues
Direct marketing revenues increased 3.4% to $97.1 million in fiscal 2012 from $93.9 million in fiscal 2011. The increase in revenue is attributable to an increase in full price selling and the 53rd week added incremental revenues of approximately $1.7 million.
Retail Store Revenues
Retail store revenues increased 1.9% to $125.6 million in fiscal 2012 from $123.2 million in fiscal 2011. The increase in revenue was driven by a comparable store sales increase of 5.2% (fiscal 2012 includes a fifty-third week and therefore the fiscal 2012 comparable sales are compared to the fifty-three week period ended February 4, 2012 for the prior year) partially offset by a reduction in store count.
The following table sets forth select operating data in connection with the revenues of our Company:
* Totals include one store that was closed and relocated to an alternative site in the same mall during the first quarter of fiscal 2012.
** Totals include two stores that were closed, remodeled and reopened during fiscal 2011, and one store that was closed and relocated to an alternative site in the same mall during fiscal 2011.
Gross Profit
Total Gross Profit
Gross profit for fiscal 2012 was $73.2 million or 32.8% of revenues, as compared to $68.3 million, or 31.5% of revenues in fiscal 2011. The increase in gross profit percentage was principally due to increased merchandise margins and the leveraging of reduced occupancy costs partially offset by higher shipping costs.
Direct Marketing Gross Profit
Direct marketing gross profit for fiscal 2012 was $40.6 million or 41.9% of revenues, as compared to $41.2 million, or 43.9% of revenues in fiscal 2011. The decrease in gross profit percentage and in dollars was principally due to increased shipping costs.
Retail Store Gross Profit
Retail store gross profit for fiscal 2012 was $32.5 million or 25.9% of revenues, as compared to $27.1 million, or 22.0% of revenues in fiscal 2011. The increase in gross profit percentage and in dollars was primarily due to increased merchandise margins and the leveraging of reduced occupancy costs.
Operating Expenses
Total Selling, General and Administrative
As a percentage of total revenues, our selling, general and administrative (“SG&A”) expenses decreased to 42.0% in fiscal 2012 from 42.7% in fiscal 2011. This decrease was primarily attributable to lower selling and depreciation expenses in the retail segment. In total dollars, SG&A expenses increased 0.7% to $93.4 million in fiscal 2012 from $92.7 million in fiscal 2011.
Direct Marketing Selling, General and Administrative
As a percentage of revenues, SG&A expenses increased to 49.0% in fiscal 2012 from 47.9% in fiscal 2011. The increase in SG&A expenses as a percentage of revenues reflects the deleveraging of selling and overhead expenses. In dollars, direct marketing SG&A expenses increased 5.6% to $47.5 million in fiscal 2012 from $45.0 million in fiscal 2011. The increase reflects higher selling and overhead expenses.
Retail Store Selling, General and Administrative
As a percentage of revenues, SG&A expenses decreased to 36.5% in fiscal 2012 from 38.7% in fiscal 2011. In dollars, retail store SG&A expenses decreased 3.9% to $45.9 million in fiscal 2012 from $47.7 million in fiscal 2011. The decrease in SG&A expenses in dollars and as a percentage of revenues reflects lower selling and depreciation expenses partially offset by increased overhead costs.
Impairment of Goodwill
As a result of our annual goodwill impairment analysis, we recognized a goodwill impairment charge related to the direct marketing reporting unit of $4.5 million in fiscal 2012 primarily as a result of the current and projected future performance of the Alloy business.
Impairment of Long-Lived Assets
We recognized impairment of long-lived assets related to under-performing stores of $0.2 million and $0.5 million in fiscal 2012 and fiscal 2011, respectively.
Other Operating Income
Other operating income, which represents breakage income, was $4.2 million for fiscal 2012 compared to $2.0 million in fiscal 2011. The increase was due to reduced redemption rates for gift cards issued in fiscal 2010.
Loss from Operations
Total Loss from Operations
Our total loss from operations before interest expense and income taxes was $20.8 million in fiscal 2012 as compared to a loss of $22.9 million in fiscal 2011.
Loss from Direct Marketing Operations
Direct marketing loss from operations was $7.6 million in fiscal 2012 as compared to a loss of $2.2 million in fiscal 2011. The fiscal 2012 loss included the goodwill impairment charge of $4.5 million noted above. The remainder of the loss was attributable to increased shipping, selling and overhead costs partially offset by higher breakage income.
Loss from Retail Store Operations
Our loss from retail store operations was $13.1 million in fiscal 2012, as compared to $20.8 million in fiscal 2011. This decrease was primarily attributable to higher merchandise margins as well as decreased occupancy costs and depreciation expense.
Interest Expense, net
We recognized net interest expense of $0.7 million and $0.6 million in fiscal 2012 and fiscal 2011, respectively. Interest expense was related to costs from our credit facilities with GE Capital and Wells Fargo Retail Finance II, LLC (“Wells Fargo”). Interest income was earned from cash balances in banks.
Income Tax Benefit
We recorded income tax expense of $0.1 million in fiscal 2012, compared with a benefit of $0.8 million in fiscal 2011. The fiscal 2011 benefit included adjustments related to the filing of our fiscal 2010 income tax return. The Company did not recognize any tax benefit in fiscal 2012 for federal taxes since the Company did not generate taxable income during the two-year carry-back period for the fiscal 2012 NOL. The effective tax rates for fiscal 2012 and 2011 were 0% and 4%, respectively.
Fiscal 2011 Compared with Fiscal 2010 (52 weeks vs. 52 weeks)
Revenues
Total Revenues
Total revenues decreased 1.6% to $217.2 million in fiscal 2011 from $220.7 million in fiscal 2010. Revenue from the retail segment comprised 56.7% of total revenue for fiscal 2011 as compared to 55.5% in fiscal 2010, and revenue from the direct segment comprised 43.3% of total revenue for fiscal 2011 as compared to 44.5% for fiscal 2010.
Direct Marketing Revenues
Direct marketing revenues decreased 4.4% to $93.9 million in fiscal 2011 from $98.3 million in fiscal 2010. In the direct segment, there were decreases in both the Alloy and dELiA*s brands. The decrease in revenue is attributable to a decrease in clearance and full price selling in both brands.
Retail Store Revenues
Retail store revenues increased 0.6% to $123.2 million in fiscal 2011 from $122.4 million in fiscal 2010. The increase in revenue was driven by the full year impact of the seven stores (net of relocations and remodels) opened in fiscal 2010, and a comparable store sales increase of 0.1%.
Gross Profit
Total Gross Profit
Gross profit for fiscal 2011 was $68.3 million or 31.5% of revenues, as compared to $73.5 million, or 33.3% of revenues in fiscal 2010. The decline in gross profit percentage was principally due to reduced merchandise margins related to markdowns and the deleveraging of occupancy costs on lower overall sales volume.
Direct Marketing Gross Profit
Direct marketing gross profit for fiscal 2011 was $41.2 million or 43.9% of revenues, as compared to $44.0 million, or 44.8% of revenues in fiscal 2010. The decrease in gross profit percentage and in dollars was principally due to reduced merchandise margins and increased shipping costs.
Retail Store Gross Profit
Retail store gross profit for fiscal 2011 was $27.1 million or 22.0% of revenues, as compared to $29.4 million, or 24.0% of revenues in fiscal 2010. The decrease in gross profit percentage and in dollars was primarily due to reduced merchandise margins related to markdowns.
Operating Expenses
Total Selling, General and Administrative
As a percentage of total revenues, our selling, general and administrative (“SG&A”) expenses decreased to 42.7% in fiscal 2011 from 43.4% in fiscal 2010. This decrease was primarily attributable to the leveraging of reduced overhead expenses. In total dollars, SG&A expenses decreased 3.1% to $92.7 million in fiscal 2011 from $95.7 million in fiscal 2010.
Direct Marketing Selling, General and Administrative
As a percentage of revenues, SG&A expenses increased to 47.9% in fiscal 2011 from 47.4% in fiscal 2010. The increase in SG&A expenses as a percentage of revenues reflects the deleveraging of selling expenses on lower sales, partially offset by lower overhead and depreciation expenses. In dollars, direct marketing SG&A expenses decreased 3.3% to $45.0 million in fiscal 2011 from $46.6 million in fiscal 2010. The decrease reflects lower selling, overhead and depreciation expenses.
Retail Store Selling, General and Administrative
As a percentage of revenues, SG&A expenses decreased to 38.7% in fiscal 2011 from 40.2% in fiscal 2010. In dollars, retail store SG&A expenses decreased 3.0% to $47.7 million in fiscal 2011 from $49.2 million in fiscal 2010. The decrease in SG&A expenses in dollars and as a percentage of revenues reflects lower selling and overhead costs.
Impairment of Long-Lived Assets and Goodwill
Impairment of long-lived assets and goodwill was $0.5 million in fiscal 2011 compared to $7.6 million in fiscal 2010. In fiscal 2011, we recognized an impairment of long-lived assets related to under-performing stores of $0.5 million, and in fiscal 2010, we recognized a goodwill impairment charge related to the direct marketing segment of $7.6 million.
Other Operating Income
Other operating income, which represents breakage income, was $2.0 million for fiscal 2011 compared to $0.5 million in fiscal 2010.
Loss from Operations
Total Loss from Operations
Our total loss from operations before interest expense and income taxes was $22.9 million in fiscal 2011 as compared to a loss of $29.4 million in fiscal 2010.
Loss from Direct Marketing Operations
Direct marketing loss from operations was $2.2 million in fiscal 2011 as compared to a loss of $9.9 million in fiscal 2010. The fiscal 2010 loss included the goodwill impairment charge of $7.6 million noted above.
Loss from Retail Store Operations
Our loss from retail store operations was $20.8 million in fiscal 2011, as compared to $19.5 million in fiscal 2010. This increase was primarily attributable to lower merchandise margins, increased occupancy costs, and the impairment of long-lived assets related to under-performing stores noted above.
Interest Expense, net
We recognized net interest expense of $0.6 million and $0.4 million in fiscal 2011 and fiscal 2010, respectively. Interest expense was related to costs from our credit facilities with GE Capital and Wells Fargo. Interest income was earned from cash balances in money market accounts.
Income Tax Benefit
We recorded an income tax benefit of $0.8 million in fiscal 2011, compared with a benefit of $8.1 million in fiscal 2010. The fiscal 2011 benefit included adjustments related to the filing of our fiscal 2010 income tax return. The Company did not recognize any additional tax benefit in fiscal 2011 for federal taxes since the Company did not generate taxable income during the two-year carry-back period for the fiscal 2011 NOL. The effective tax rates for fiscal 2011 and 2010 were 4% and 27%, respectively.
Liquidity and Capital Resources
Our capital requirements include maintenance and remodeling expenditures for existing stores, information technology, distribution and other infrastructure related investments, and construction, fixture and inventory costs related to the opening of any new retail stores. Future capital requirements will depend on many factors, including, but not limited to, additional investments in infrastructure and technology, the pace of new store openings, the availability of suitable locations for new stores, the size of the specific stores we open and the nature of arrangements negotiated with landlords. In that regard, our net investment to open new stores is likely to vary significantly in the future.
On May 26, 2011, the Company and certain of its wholly-owned subsidiaries entered into a new credit agreement (the “Credit Agreement”) with General Electric Capital Corporation (“GE Capital”), as a lender and as agent for the financial institutions from time to time party to the Credit Agreement (together with GE Capital in its capacity as a lender, the “Lenders”), which replaced the Company’s previous letter of credit agreement, as amended, with Wells Fargo Retail Finance II, LLC (“Wells Fargo”) (the “Wells Fargo Agreement”). The Credit Agreement provides for a total aggregate commitment of the Lenders of $25 million, including a $15 million sublimit for the issuance of letters of credit and a swingline loan facility of $5 million. Under the Credit Agreement, the Company has the right to request, subject to the agreement of the Lenders, that the Lenders increase their revolving commitments up to an additional $25 million. The Credit Agreement has a term of five years and matures on May 26, 2016. The obligations of the borrowers under the Credit Agreement are secured by substantially all property and assets of the Company and certain of its subsidiaries.
As of February 2, 2013, availability under the Credit Facility was $5.1 million, net of outstanding letters of credit of $11.9 million.
The Credit Agreement calls for the payment by the Company of a fee of 0.375% per annum on the average unused portion of the Credit Agreement, a letter of credit fee calculated using a per annum rate equal to the Applicable Margin with respect to letters of credit (as defined in the Credit Agreement) multiplied by the average outstanding face amount of letters of credit issued under the Credit Agreement, as well as other customary fees and expenses. Interest accrues on the outstanding principal amount of the revolving credit loans at an annual rate equal to LIBOR (as defined in the Credit Agreement) or the Base Rate (as defined in the Credit Agreement), plus an applicable margin which is subject to periodic adjustment based on average excess availability under the Credit Agreement. Interest on each swingline loan is calculated using the Base Rate. The Credit Agreement does not contain any financial covenants with which the Company or any of its subsidiaries or affiliates has to comply during the term of the Credit Agreement.
The Credit Agreement contains customary representations and warranties, as well as customary covenants that, among other things, restricts the ability of the Company and its subsidiaries to incur liens, consolidate or merge with other entities, incur certain additional indebtedness and guaranty obligations, pay dividends or make
certain other restricted payments. The Credit Agreement also contains customary events of default, including payment defaults, breaches of representations and warranties and covenants, cross defaults to other material indebtedness, and bankruptcy and insolvency matters.
The Wells Fargo Agreement, which was terminated on May 26, 2011, provided for a maximum aggregate face amount of letters of credit that may be issued, to be the lesser of (a) $10 million or (b) an amount equal to a specified percentage of cash collateral held by Wells Fargo. The cash collateral was required in an amount equal to 105% of the face amount of outstanding letters of credit issued. None of the other assets or properties of the Company, or any of its subsidiaries or affiliates, were pledged as collateral for these obligations.
A significant portion of our vendor base is factored, which means our vendors have sold their accounts receivable to specialty lenders known as factors. Approximately 70% of our merchandise payments are made to factors. The credit extended by these factors is enhanced by standby letters of credit that we provide as collateral for our obligations to our vendors, which directly reduce the amount available to us under our Credit Agreement.
We expect our current cash balance, cash flow from operations and availability under our Credit Agreement will be sufficient to meet our cash requirements for operations and planned capital expenditures at least through the end of our current fiscal year. However, if cash balances, cash flow from operations and availability under our Credit Agreement are not sufficient to meet our capital requirements, then we may be required to obtain additional equity or debt financing in the future. Such equity or debt financing may not be available to us when we need it or, if available, may not be on terms that will be satisfactory to us or may be dilutive to our stockholders. If financing is not available when required or is not available on acceptable terms, we may be unable to take advantage of business opportunities or respond to competitive pressures, and may not be able to operate our business as planned which could lead to a reduction in capital expenditures. Any of these events could have a material and adverse effect on our business, results of operations and financial condition.
Net cash used in operating activities was $7.1 million for fiscal 2012 compared to net cash provided by operating activities of $5.3 million in fiscal 2011 and net cash used in operating activities of $7.8 million in fiscal 2010. Cash used in operating activities in fiscal 2012 was mainly due to the funding of the net operating loss. Cash provided by operating activities in fiscal 2011 was due to the receipt of an income tax refund, receipt of restricted cash which previously supported our outstanding letters of credit under the Wells Fargo Agreement and the timing of vendor payments, offset by the funding of the net operating loss. Cash used in operating activities in fiscal 2010 was primarily due to the funding of the net operating loss and the timing of vendor payments.
Net cash used in investing activities was $4.5 million in fiscal 2012, $4.0 million in fiscal 2011, and $5.8 million in fiscal 2010. The $4.5 million used in fiscal 2012 was due primarily to capital expenditures associated with investments in technology , the construction of a new retail store, and store refurbishing projects. The $4.0 million used in fiscal 2011 was due primarily to capital expenditures associated with the construction of our new retail stores, store refurbishing projects and investments in technology. The $5.8 million used in fiscal 2010 was due primarily to capital expenditures associated with the construction of new retail stores. During fiscal 2013, we expect capital expenditures to be approximately $1.3 million, net of tenant allowances.
Net cash provided by financing activities was $0- in fiscal 2012 compared to net cash used in financing activities of $0.9 million in fiscal 2011 and net cash provided by financing activities of $12,000 in 2010. Cash used in financing activities in fiscal 2011 related to costs incurred to obtain the Credit Agreement. Cash provided by financing activities in fiscal 2010 related to proceeds received from the exercise of employee stock options.
Contractual Obligations
The following table presents our significant contractual obligations as of February 2, 2013:
(1) Our operating lease obligations are primarily related to dELiA*s retail stores and our corporate headquarters.
(2) Our purchase obligations are primarily related to inventory commitments and service agreements.
(3) Our future severance-related payments primarily consist of severance agreements with existing employees.
We have long-term noncancelable operating lease commitments for retail stores and office space.
Critical Accounting Estimates
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses, among other things, our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.
Our significant accounting policies are more fully described in Note 2 to our consolidated financial statements. We believe, however, the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
Direct marketing revenues are recognized at the time of shipment to customers. These revenues are net of any promotional price discounts and an allowance for sales returns. The allowance for sales returns is estimated based upon our direct marketing return policy, historical experience and evaluation of current sales and returns trends. Direct marketing revenues also include shipping and handling billed to customers.
Retail store revenues are recognized at the point of sale, net of any promotional price discounts and an allowance for sales returns. The allowance for sales returns is estimated based upon our retail return policy, historical experience and evaluation of current sales and returns trends.
The Company’s policy with respect to gift certificates and gift cards is to record revenue as they are redeemed for merchandise. Prior to their redemption, these gift certificates and gift cards are recorded as a liability. The liability remains on the Company’s books until the earlier of redemption (recognized as revenue) or when the Company determines the likelihood of redemption is remote (recognized as other operating income). The Company determines the probability of the gift card being redeemed to be remote based on historical redemption patterns. For those gift cards that we determine redemption to be remote, we reverse our liability and record breakage income. The Company recorded $4.2 million, $2.0 million and $0.5 million of breakage income in fiscal 2012, fiscal 2011 and fiscal 2010, respectively.
While the Company will continue to honor all gift certificates and gift cards presented for payment, management reviews unclaimed property laws to determine gift certificate and gift card balances required for escheatment to the appropriate government agency.
Catalog Costs
Catalog costs consist of catalog production and mailing costs. These costs are capitalized and expensed over the expected future revenue stream, which is customarily two to four months from the date the catalogs are mailed.
An estimate of the future sales dollars to be generated from each individual catalog mailing serves as the foundation for our catalog costs policy. The estimate of future sales is calculated for each mailing using historical trends for catalogs mailed in similar prior periods as well as the overall current sales trend for each individual direct marketing brand. This estimate is compared with the actual sales generated-to-date for the catalog mailing to determine the percentage of total catalog costs to be capitalized as prepaid expenses on our consolidated balance sheets. Deferred catalog costs as of February 2, 2013 and January 28, 2012 were approximately $1.7 million and $2.1 million, respectively.
Catalog costs expensed for fiscal 2012, 2011, and 2010 were approximately $21.5 million, $21.2 million, and $22.8 million, respectively, and are included within selling, general and administrative expenses in the accompanying consolidated statements of operations.
Inventories
Inventories, which consist of finished goods, including certain expenses capitalized, are stated at the lower of cost (first-in, first-out method) or market value. Inventories may include items that have been written down to our best estimate of their net realizable value. Our decisions to write-down and establish valuation allowances against our merchandise inventories are based on our current rate of sale, the age of the inventory and other factors. Actual final sales prices to customers may be higher or lower than our estimated sales prices and could result in a fluctuation in gross profit in subsequent periods.
Goodwill and Other Indefinite-Lived Intangible Assets
The Company follows the provisions of ASC-350-10, Intangibles-Goodwill and Other, which requires testing for impairment on an annual basis or between annual tests if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying amount. The Company performs its annual impairment test as of the end of its fiscal year unless indicators arise during the year.
Determining the fair value of our direct marketing reporting unit under the first step of the goodwill impairment test and determining the fair value of individual assets and liabilities of that reporting unit (including unrecognized intangible assets) under the second step of the goodwill impairment test is judgmental in nature and often involves the use of significant estimates and assumptions. Similarly, estimates and assumptions are used in determining the fair value of our indefinite-lived intangible assets, primarily trademarks. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and also the magnitude of any such charge.
We perform valuation analyses and consider other market information that is publicly available. Estimates of fair value are primarily determined using discounted cash flows and market comparisons. These approaches use significant estimates and assumptions including projected future cash flows (including timing), discount rates reflecting the risk inherent in future cash flows, revenue growth rates, projected long-term growth rates, royalty rates, determination of appropriate market comparables and the determination of whether a premium or discount should be applied to comparables.
Considerable management judgment is necessary to estimate the fair value of our direct marketing reporting unit and indefinite-lived intangible assets which may be impacted by future actions taken by us or our competitors and the economic environment in which we operate. These estimates affect the balance of goodwill as well as intangible assets on our consolidated balance sheets and operating expenses on our consolidated statements of operations.
As a result of our annual goodwill impairment analysis, we recognized a goodwill impairment charge related to the direct marketing reporting unit of $4.5 million in fiscal 2012 primarily as a result of the current and projected future performance of the Alloy business. There was no goodwill impairment charge in fiscal 2011 and a $7.6 million charge in fiscal 2010. See Note 4 for discussion on the fiscal 2012 and fiscal 2010 goodwill impairment charges with respect to our direct marketing segment.
Impairment of Long-Lived Assets
In accordance with ASC 360, Property, Plant, and Equipment, the Company’s management evaluates the value of leasehold improvements and store fixtures associated with retail stores, which have been open for a period of time sufficient to reach maturity. The Company evaluates long-lived assets for impairment at the individual store level, which is the lowest level at which individual cash flows can be identified. Impairment losses are recorded on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of the assets. When events such as these occur, the impaired assets are adjusted to their estimated fair value and an impairment loss is recorded separately as a component of operating income under impairment of long-lived assets.
We measure fair value by discounting estimated future cash flows using an appropriate discount rate. Considerable judgment by us is necessary to estimate the fair value of the assets and accordingly, actual results could vary significantly from such estimates. Our most significant estimates and judgments relating to the long-lived asset impairments include the timing and amount of projected future cash flows and the discount rate selected to measure the risks inherent in future cash flows.
We recorded impairment charges of approximately $0.2 million and $0.5 million for fiscal 2012 and fiscal 2011, respectively, related to under-performing stores. There were no impairment charges recorded for fiscal 2010.
Income taxes
Income taxes are calculated in accordance with ASC 740-10, Income Taxes, which require the use of the asset and liability method. Deferred tax assets and liabilities are recognized based on the difference between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using current enacted tax rates in effect in the years in which those temporary differences are expected to reverse. Inherent in the measurement of deferred balances are certain judgments and interpretations of enacted tax law and published guidance with respect to applicability to the Company’s operations. The effective tax rate utilized by the Company reflects management’s judgment of the expected tax liabilities within the various taxing jurisdictions.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, net operating loss carryback potential, and tax planning strategies in making these assessments.
The Company adopted amendments to ASC 740-10 which clarified the accounting for uncertainty in income taxes recognized in the financial statements. These amendments prescribe a recognition threshold and a
measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by the taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate audit settlement.
The Company recognizes interest accrued for increases in the net liability for unrecognized income tax benefits in interest expense and any related penalties in income tax expense.
The Company’s U.S. subsidiaries join in the filing of a U.S. federal consolidated income tax return. The U.S. federal statute of limitations remains open for the fiscal years 2008, 2009, 2010 and 2011. State income tax returns are generally subject to examination for a period of 3 to 5 years after filing of the respective returns. The state impact of any federal changes remains subject to examination by various states for a period of up to one year after formal notification to the states.
Recently Adopted Standard
In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment (“ASU 2011-08”). ASU 2011-08 permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. ASU 2011-08 applies to all companies that have goodwill reported in their financial statements. The provisions of ASU 2011-08 were effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The Company adopted this guidance in the first quarter of fiscal 2012 with no impact on its consolidated financial statements.
Recently Issued Standards
In July 2012, the FASB issued guidance that will allow an entity to first assess qualitative factors to determine whether it is necessary to perform a quantitative impairment test for indefinite-lived intangible assets. If entities determine, based on qualitative factors, the fair value of the asset is more likely than not less than the carrying value, the two-step impairment test would be required. This guidance is effective for fiscal years beginning after September 15, 2012, with early adoption permitted. The Company will adopt this guidance for the fiscal year beginning February 3, 2013 and does not expect the adoption will have a material impact on its consolidated financial statements.
Off-Balance Sheet Arrangements
We enter into letters of credit issued under the Credit Agreement to facilitate the purchase of merchandise.
dELiA*s Brand, LLC, one of our subsidiaries, entered into a license agreement in 2003 with JLP Daisy that grants JLP Daisy exclusive rights (except for our rights) to use the dELiA*s trademarks and copyrightable artwork to advertise, promote and market the licensed products, and to sublicense to permitted sublicensees the right to use the trademarks and artwork in connection with the manufacture, sale and distribution of the licensed products to approved wholesale customers. See Note 12 to the consolidated financial statements for further discussion of this license agreement.
We do not maintain any other off-balance sheet transactions, arrangements, obligations or other relationships with unconsolidated entities or others that are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Guarantees
We have no significant financial guarantees.
Inflation
In general, our costs, some of which include postage, paper, cotton, freight and energy costs, are affected by inflation and we may experience the effects of inflation in future periods. We believe, however, that such effects have not been material to us during the past year.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
From time to time, we have significant amounts of cash and cash equivalents invested in deposit accounts at FDIC-insured financial institutions that are in excess of the federally insured limit. Since expanded deposit protection under the Dodd-Frank Wall Street Reform Act expired on December 31, 2012, we cannot be assured that we will not experience losses with respect to cash on deposit in excess of the federally insured limits. As of February 2, 2013, we did not hold any marketable securities and do not own any derivative financial instruments in our portfolio, thus we do not believe there is any material market risk exposure with respect to these items.
As at February 2, 2013, we had no outstanding borrowings under our Credit Agreement. However, to the extent that we borrow under our Credit Agreement, we are exposed to market risk related to changes in interest rates. Loans under our Credit Agreement bear interest based at variable rates. Accordingly, any increase or decrease in the applicable interest rate on our borrowings under the Credit Agreement would increase or decrease interest expense and, accordingly, affect our net income or loss.
We are also indirectly exposed to market risk with respect to changes in the global price level of certain commodities used in the production of our products. Changes in the cost of fabrics or other raw materials used to manufacture our merchandise may be passed on to us, in whole or in part, in the form of changes in our cost of goods, and, if so, would affect our cost of goods and our results of operations.
Item 8.
Item 8. Financial Statements and Supplementary Data
The consolidated financial statements, financial statement schedule and notes to the consolidated financial statements of dELiA*s, Inc. and subsidiaries are annexed to and made part of this Annual Report on Form 10-K as pages through. An index of such materials appears on page.
Item 9.
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of February 2, 2013. Based upon such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, February 2, 2013, our disclosure controls and procedures were effective to ensure both that (i) information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Exchange Act, and (ii) information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management as appropriate to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Securities Exchange Act Rule 13a-15(f). Our system of internal control is evaluated on a cost benefit basis and is designed to provide reasonable, not absolute, assurance that reported financial information is materially accurate.
Under the supervision and with the participation of our management, including our principal executive officers, we conducted an evaluation of the design and effectiveness of our internal control over financial reporting based on the criteria set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our evaluation under the framework in Internal Control-Integrated Framework, our Chief Executive Officer and Chief Financial Officer concluded that our internal control over financial reporting was effective as of February 2, 2013.
Limitations of the Effectiveness of Internal Control
A control system, no matter how well conceived and operated, can only provide reasonable, not absolute, assurance that the objectives of the internal control system are met. Because of the inherent limitations of any internal control system, no evaluation of controls can provide absolute assurance that all control issues, if any, have been detected.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended February 2, 2013 identified in connection with the evaluation thereof by our management, including the Chief Executive Officer and Chief Financial Officer, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Except for information with respect to our executive officers set forth in Part I of this Form 10-K under the caption “Executive Officers of the Registrant,” the response to this item is incorporated by reference from the discussion responsive thereto under the captions “CORPORATE GOVERNANCE AND INFORMATION ABOUT DIRECTORS AND EXECUTIVE OFFICERS”-“The Board of Directors,”-“Corporate Governance and Nominating Committee, “ Codes of Business Conduct and Ethics” and “Information About Directors and Executive Officers, “ and “OTHER MATTERS”-in our definitive Proxy Statement for our 2013 Annual Meeting of Stockholders, which is expected to be filed with the SEC within 120 days after the close of our fiscal year ended February 2, 2013.
Item 11.
Item 11. Executive Compensation
The response to this item is incorporated by reference from the discussion responsive thereto under the caption “EXECUTIVE COMPENSATION” in our definitive proxy statement for our 2013 Annual Meeting of Stockholders, which is expected to be filed with the SEC within 120 days after the end of our fiscal year ended February 2, 2013, except that the section in the definitive proxy statement entitled “EXECUTIVE COMPENSATION”-“Compensation Committee Report” shall not be deemed incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The response to this item is incorporated by reference from the discussion responsive thereto under the caption “INFORMATION ABOUT DELIA*S SECURITY OWNERSHIP” and “EXECUTIVE COMPENSATION”-“Equity Compensation Plan Information” in our definitive proxy statement for our 2013 Annual Meeting of Stockholders, which is expected to be filed with the SEC within 120 days after the end of our fiscal year ended February 2, 2013.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The response to this item is incorporated by reference from the discussion responsive thereto under the caption “CORPORATE GOVERNANCE AND INFORMATION ABOUT DIRECTORS AND EXECUTIVE OFFICERS”-“The Board of Directors” and “CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS” in our definitive proxy statement for our 2013 Annual Meeting of Stockholders, which is expected to be filed with the SEC within 120 days after the end of our fiscal year ended February 2, 2013.
Item 14.
Item 14. Principal Accountant Fees and Services
The response to this item is incorporated by reference from the discussion responsive thereto under the captions “Audit Fees,” Policy of Audit Committee on Pre-Approval of Audit and Permissible Non-Audit Services of Independent Auditors” and “Percentage of Audit Services Pre-Approved” in our definitive proxy statement for our 2013 Annual Meeting of Stockholders, which is expected to be filed with the SEC within 120 days after the end of our fiscal year ended February 2, 2013.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedule
FINANCIAL STATEMENTS, SCHEDULE AND EXHIBITS
(1) Consolidated Financial Statements.
The financial statements required by this item are set forth on pages through of this Annual Report on Form 10-K, and are incorporated by reference herein.
(2) Financial Statement Schedule.
The schedule required by this item is set forth on page of this Annual Report on Form 10-K, and is incorporated by reference herein.
(3) Exhibits.
The exhibit list required by this item is set forth under the caption “Exhibit Index” in this Annual Report on Form 10-K, and is incorporated by reference herein.
dELiA*s, Inc. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
Page
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Changes in Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Financial Statement Schedule
The following financial statement schedule is included herein:
Schedule II-Valuation and Qualifying Accounts
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of
dELiA*s, Inc.
New York, New York
We have audited the accompanying consolidated balance sheets of dELiA*s, Inc. (the “Company”) as of February 2, 2013 and January 28, 2012 and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the three years in the period ended February 2, 2013. In connection with our audits of the financial statements, we have also audited the financial statement schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of dELiA*s, Inc. at February 2, 2013 and January 28, 2012, and the results of its operations and its cash flows for each of the three years in the period ended February 2, 2013, in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/BDO USA, LLP
New York, NY
April 23, 2013
dELiA*s, Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value and share data)
See accompanying notes to consolidated financial statements
dELiA*s, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
See accompanying notes to consolidated financial statements
dELiA*s, Inc.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(in thousands, except share data)
See accompanying notes to consolidated financial statements
dELiA*s Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying notes to consolidated financial statements
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In these Notes to Consolidated Financial Statements, when we refer to “Alloy, Inc.” we are referring to Alloy, Inc., our former parent corporation, and when we refer to “Alloy” we are referring to the Alloy-branded direct marketing and merchandising business that we operate. Similarly, when we refer to “dELiA*s” we are referring to the dELiA*s-branded direct marketing, merchandising and retail store business that we operate, when we refer to “dELiA*s, Inc.”, the “Company”, “we”, “us”, or “our”, we are referring to dELiA*s, Inc. and its subsidiaries. When we refer to “the Spinoff”, we are referring to the December 19, 2005 spinoff of the outstanding common shares of dELiA*s, Inc. to the Alloy, Inc. shareholders.
1. Business and Basis of Presentation
Business
We are a multi-channel retail company comprised of two lifestyle brands primarily marketing to teenage girls and young women. Our two lifestyle brands-dELiA*s and Alloy-generate revenue by selling to consumers through the integration of e-commerce websites, direct mail catalogs and, for dELiA*s, mall-based retail stores. Through our e-commerce webpages and catalogs, we sell many name brand products along with our own proprietary brand products in key spending categories directly to consumers, including apparel and accessories. Our mall-based retail stores derive revenue primarily from the sale of apparel and accessories to teenage girls.
On March 28, 2013, we announced that we have retained Janney Montgomery Scott LLC as strategic advisor to the Board of Directors with an initial focus on the potential disposition of our Alloy brand. We believe this potential disposition will allow management to concentrate its efforts on the dELiA*s business.
Fiscal Year
The Company’s fiscal year ends on the Saturday closest to January 31st, typically resulting in a fifty-two week year, but occasionally giving rise to an additional week, resulting in a fifty-three week year. We refer to the 53-week year ended February 2, 2013 as “fiscal 2012”, and to the 52-week fiscal year ended January 28, 2012 as “fiscal 2011”, and to the 52-week fiscal year ended January 29, 2011 as “fiscal 2010”.
Reclassifications
Certain reclassifications have been made to prior year amounts to conform with current year presentation. The effect of these reclassifications is not material.
Basis of Presentation
The accompanying consolidated financial statements include the historical financial statements of and transactions applicable to the Company and reflect its assets, liabilities, results of operations and cash flows.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of dELiA*s, Inc. and our wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.
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Concentration of Risk
We collect payment for all merchandise, and perform credit card authorizations and check verifications for all customers prior to shipment or delivery. Our cash equivalents include amounts derived from credit card purchases from customers and are typically settled within two to four days. Due to the diversified nature of our client base, we do not believe that we are exposed to a concentration of credit risk.
Fair Value of Financial Instruments
We follow the guidance in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurement Disclosures” (“ASC 820”) as it relates to financial and nonfinancial assets and liabilities. We currently have no financial assets or liabilities that are measured at fair value. Our non-financial assets, which include property and equipment, intangibles and goodwill are not required to be measured at fair value on a recurring basis. However, if certain triggering events occur, or if an annual impairment test is required and we are required to evaluate the non-financial asset for impairment, a resulting asset impairment would require that the non-financial asset be recorded at the fair value. ASC 820 prioritizes inputs used in measuring fair value into a hierarchy of three levels: Level 1-quoted prices (unadjusted) in active markets for identical assets or liabilities; Level 2-inputs other than quoted prices included within Level 1 that are either directly or indirectly observable; and Level 3-unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The carrying amounts of our financial instruments, including cash and cash equivalents, receivables and payables approximated fair value due to the short maturity of these financial instruments.
Self Insurance
The Company uses a combination of insurance and self-insurance for certain losses related to its employee medical plan. Costs for self-insurance claims filed, as well as claims incurred but not reported, are accrued based on management’s estimates, using information received from plan administrators, historical analysis and other relevant data. Management believes that it has adequately reserved for its self-insurance liability, which is capped through the use of stop loss contracts with insurance companies. However, any significant variation from historical trends in claims incurred but not paid could cause actual expense to differ from the accrued liability.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and credit card receivables. Credit card receivable balances included in cash and cash equivalents as of February 2, 2013 and January 28, 2012 were approximately $1.4 million and $1.6 million, respectively.
Inventories
Inventories, which consist of finished goods, including certain expenses capitalized, are stated at the lower of cost (first-in, first out method) or market value. Inventories may include items that have been written down to our best estimate of their net realizable value. Our decisions to write-down and establish valuation allowances against our merchandise inventories are based on our current rate of sale, the age of the inventory and other factors. Actual final sales prices to customers may be higher or lower than our estimated sales prices and could result in a fluctuation in gross profit in subsequent periods.
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Prepaid Catalog Costs
Catalog costs consist of catalog production and mailing costs. These costs are capitalized and expensed over the expected future revenue stream, which is customarily two to four months from the date the catalogs are mailed. Deferred catalog costs as of February 2, 2013 and January 28, 2012 were approximately $1.7 million and $2.1 million, respectively. Catalog costs expensed for fiscal 2012, fiscal 2011 and fiscal 2010 were approximately $21.5 million, $21.2 million, and $22.8 million, respectively, and are included within selling, general and administrative expenses in the accompanying consolidated statements of operations.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation. Amortization of leasehold improvements is computed on the straight-line method over the lesser of an asset’s estimated useful life or the life of the related store’s lease (generally 7-10 years). Depreciation on furniture, fixtures and equipment is computed on the straight-line method over the lives noted below. Maintenance and repairs are expensed as incurred.
The following estimated useful lives are used to determine depreciation or amortization:
Construction in progress
N/A
Leasehold improvements
Life of the lease*
Computer software and equipment
3 to 5 Years
Machinery and equipment
3 to 10 Years
Office furniture and store fixtures
5 to 10 Years
Building
39 Years
Land
N/A
* defined as the lesser of an asset’s estimated life or the life of the related lease
Costs of Computer Software Developed or Obtained for Internal Use
As required by ASC 350-40, Internal-Use Software, the Company capitalizes costs related to internally developed software. Only costs incurred during the development stages, including design, coding, installation and testing are capitalized. These capitalized costs primarily represent internal labor costs for employees directly associated with the software development. Upgrades or modifications that result in additional functionality are capitalized.
Goodwill and Other Indefinite-Lived Intangible Assets
The Company follows the provisions of ASC-350-10, Intangibles-Goodwill and Other, which requires testing for impairment on an annual basis or between annual tests if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying amount. The Company performs its annual impairment test as of the end of its fiscal year unless indicators arise during the year.
Determining the fair value of our direct marketing reporting unit under the first step of the goodwill impairment test and determining the fair value of individual assets and liabilities of that reporting unit (including unrecognized intangible assets) under the second step of the goodwill impairment test is judgmental in nature and often involves the use of significant estimates and assumptions. Similarly, estimates and assumptions are used in determining the fair value of our indefinite-lived intangible assets, primarily trademarks. These estimates and
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assumptions could have a significant impact on whether or not an impairment charge is recognized and also the magnitude of any such charge.
We perform valuation analyses and consider other market information that is publicly available. Estimates of fair value are primarily determined using discounted cash flows, market comparisons as well as a cost approach. These approaches use significant estimates and assumptions including projected future cash flows (including timing), discount rates reflecting the risk inherent in future cash flows, revenue growth rates, projected long-term growth rates, royalty rates, determination of appropriate market comparables and the determination of whether a premium or discount should be applied to comparables.
Considerable management judgment is necessary to estimate the fair value of our direct marketing reporting unit and indefinite-lived intangible assets which may be impacted by future actions taken by us or our competitors and the economic environment in which we operate. These estimates affect the balance of goodwill as well as intangible assets on our consolidated balance sheets and operating expenses on our consolidated statements of operations.
As a result of our annual goodwill impairment analysis as of February 2, 2013, we recognized a goodwill impairment charge related to the direct marketing reporting unit of $4.5 million in fiscal 2012 primarily as a result of the current and projected future performance of the Alloy business. See Note 4 for discussion on the fiscal 2012 and fiscal 2010 $7.6 million goodwill impairment charges with respect to our direct marketing segment.
Impairment of Long-Lived Assets
In accordance with ASC 360, Property, Plant, and Equipment, the Company’s management evaluates the value of leasehold improvements and store fixtures associated with retail stores, which have been open for a period of time sufficient to reach maturity. The Company evaluates long-lived assets for impairment at the individual store level, which is the lowest level at which individual cash flows can be identified. Impairment losses are recorded on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of the assets. When events such as these occur, the impaired assets are adjusted to their estimated fair value and an impairment loss is recorded separately as a component of operating income under impairment of long-lived assets.
We measure fair value by discounting estimated future cash flows using an appropriate discount rate. Considerable judgment by us is necessary to estimate the fair value of the assets and accordingly, actual results could vary significantly from such estimates. Our most significant estimates and judgments relating to the long-lived asset impairments include the timing and amount of projected future cash flows and the discount rate selected to measure the risks inherent in future cash flows.
We recorded impairment charges of approximately $0.2 million and $0.5 million for fiscal 2012 and fiscal 2011, respectively, related to under-performing stores (see Note 3). There were no impairment charges related to long-lived assets recorded for fiscal 2010.
Sales and Use Tax
In accordance with ASC 605-40, Revenue Recognition, the Company records sales tax charged on merchandise sales on a net basis (excluded from revenue).
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Revenue Recognition
Direct marketing revenues are recognized at the time of shipment to customers. These revenues are net of any promotional price discounts and an allowance for sales returns. The allowance for sales returns is estimated based upon our direct marketing return policy, historical experience and evaluation of current sales and returns trends. Direct marketing revenues also include shipping and handling billed to customers.
Retail store revenues are recognized at the point of sale, net of any promotional price discounts and an allowance for sales returns. The allowance for sales returns is estimated based upon our retail return policy, historical experience and evaluation of current sales and returns trends.
We recognize other revenues that consist primarily of advertising provided for third parties in our catalogs, on our e-commerce webpages, in our outbound packages, and in our retail stores pursuant to specific pricing arrangements with Alloy, Inc. Alloy, Inc. arranges these advertising services on our behalf pursuant to a media services agreement entered into in connection with the Spinoff which was amended and restated effective December 2010 (see Note 11 to our financial statements). We believe that the terms and conditions of this relationship are similar to those that we could obtain in the marketplace. We also recognize revenue from the sale of offline magazine subscriptions to our telephone direct marketing customers at the time of purchase. The revenue from third-party advertising and offline magazine subscription sales was approximately $0.3 million, $0.7 million, and $0.4 million for fiscal 2012, fiscal 2011 and fiscal 2010, respectively.
The Company’s policy with respect to gift certificates and gift cards is to record revenue as they are redeemed for merchandise. Prior to their redemption, these gift certificates and gift cards are recorded as a liability. The liability remains on the Company’s books until the earlier of redemption (recognized as revenue) or when the Company determines the likelihood of redemption is remote (recognized as other operating income). The Company determines the probability of the gift card being redeemed to be remote based on historical redemption patterns. For those gift cards that the Company determines redemption to be remote, we reverse our liability and record breakage income. The Company recorded approximately $4.2 million, $2.0 million and $0.5 million of breakage income in fiscal 2012, fiscal 2011 and fiscal 2010, respectively, which is recorded in other operating income in the consolidated financial statements.
While the Company will continue to honor all gift certificates and gift cards presented for payment, management reviews unclaimed property laws to determine gift certificate and gift card balances required for escheatment to the appropriate government agency.
Cost of Goods Sold
Cost of goods sold consists of the cost of merchandise sold to customers, inbound freight costs, shipping and handling costs, buying and merchandising costs, certain distribution costs and store occupancy costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of catalog production and mailing costs; certain fulfillment and distribution costs; store personnel wages and benefits; other store expenses, including supplies, maintenance and visual programs; administrative staff and infrastructure expenses; depreciation; amortization and facility expenses. Credit card fees, insurance and other miscellaneous operating costs are also included in selling, general and administrative expenses.
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Store Pre-Opening Costs
Store pre-opening costs consist primarily of rent, supplies and payroll expenses. These costs are expensed as incurred.
Stock-based compensation
The Company accounts for stock-based awards in accordance with ASC 718-10, Compensation-Stock Compensation, which requires the measurement and recognition of stock-based compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service period. For awards with performance conditions, an evaluation is made at the grant date and future periods as to the likelihood of the performance criteria being met. Compensation expense is adjusted in future periods for subsequent changes in the expected outcome of the performance conditions until the vesting date. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
Interest Expense (Income), Net
Interest income and expense is presented net in the consolidated statements of operations. Interest income is derived from cash in bank accounts. Interest income for fiscal 2012, fiscal 2011, and fiscal 2010 was $-0-, $3,000, and $17,000, respectively. Interest expense primarily relates to the credit facilities with GE Capital and Wells Fargo (which was terminated in May 2011). Interest expense for fiscal 2012, fiscal 2011, and fiscal 2010 was $0.7 million, $0.6 million, and $0.4 million, respectively.
Net (loss) Income Per Share
We have outstanding restricted stock grants that contain nonforfeitable rights to dividends (whether paid or unpaid) which qualify these shares as participating securities, requiring them to be included in the computation of earnings per share pursuant to the two-class method. Under the two-class method, all earnings (distributed and undistributed) are allocated to common shares and participating securities based on their respective rights to receive dividends. Basic earnings per common share is calculated by dividing earnings allocated to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect, in periods in which they have a dilutive effect, the effect of unvested restricted stock not classified as participating securities and common shares issuable upon exercise of stock options or warrants. The difference between reported basic and diluted weighted-average common shares results from the assumption that all dilutive stock options and warrants outstanding were exercised and all outstanding restricted shares have vested. For all periods presented in which there were losses, fully diluted losses per share do not differ from basic earnings per share.
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The total number of potential common shares with an anti-dilutive impact, excluded from the calculation of diluted net (loss) income per share, is detailed in the following table:
Operating leases
The Company leases property for its stores and its corporate headquarters under operating leases. Operating lease agreements typically contain construction allowances, rent escalation clauses and/or contingent rent provisions.
For construction allowances, the Company records a deferred lease credit on the consolidated balance sheet and amortizes the deferred lease credit as a reduction of rent expense on the consolidated statement of operations over the terms of the leases. For scheduled rent escalation clauses during the lease terms, the Company records minimum rental expenses on a straight-line basis over the terms of the leases on the consolidated statement of operations. The term of the lease over which the Company amortizes construction allowances and minimum rental expenses on a straight-line basis begins on the date of initial possession, which is generally when the Company enters the space and begins to make improvements in preparation for its intended use, not necessarily the cash rent commencement date.
Certain store leases provide for contingent rents, which are determined as a percentage of gross sales in excess of specified levels. The Company records a contingent rent liability in accrued expenses on the consolidated balance sheets and the corresponding rent expense when management determines that achieving the specified levels during the fiscal year is probable.
Income Taxes
Income taxes are calculated in accordance with ASC 740-10, Income Taxes, which require the use of the asset and liability method. Deferred tax assets and liabilities are recognized based on the difference between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using current enacted tax rates in effect in the years in which those temporary differences are expected to reverse. Inherent in the measurement of deferred balances are certain judgments and interpretations of enacted tax law and published guidance with respect to applicability to the Company’s operations. The effective tax rate utilized by the Company reflects management’s judgment of the expected tax liabilities within the various taxing jurisdictions.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion of all of the deferred tax assets will not be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, net operating loss carryback potential, and tax planning strategies in making these assessments.
The Company adopted amendments to ASC 740-10 which clarified the accounting for uncertainty in income taxes recognized in the financial statements. These amendments prescribe a recognition threshold and a
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measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by the taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate audit settlement.
The Company recognizes interest accrued for increases in the net liability for unrecognized income tax benefits in interest expense and any related penalties in income tax expense.
Recently Adopted Standard
In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment (“ASU 2011-08”). ASU 2011-08 permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. ASU 2011-08 applies to all companies that have goodwill reported in their financial statements. The provisions of ASU 2011-08 were effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The Company adopted this guidance in the first quarter of fiscal 2012 with no impact on its consolidated financial statements.
Recently Issued Standards
In July 2012, the FASB issued guidance that will allow an entity to first assess qualitative factors to determine whether it is necessary to perform a quantitative impairment test for indefinite-lived intangible assets. If entities determine, based on qualitative factors, the fair value of the asset is more likely than not less than the carrying value, the two-step impairment test would be required. This guidance is effective for fiscal years beginning after September 15, 2012, with early adoption permitted. The Company will adopt this guidance for the fiscal year beginning February 3, 2013 and does not expect the adoption will have a material impact on its consolidated financial statements.
3. Property and Equipment, net
Property and equipment (net) consisted of the following:
Depreciation and amortization expense related to property and equipment (including capitalized leases) was approximately $9.6 million (including $0.7 million of accelerated depreciation on early lease terminations),
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$11.4 million, and $10.7 million for fiscal 2012, fiscal 2011, and fiscal 2010, respectively. In fiscal 2012, approximately $5.9 million of fully depreciated assets no longer in use were written off.
Based upon our impairment analysis of long-lived assets during fiscal 2012 and 2011, we recognized impairment charges of approximately $0.2 million and $0.5 million, respectively, related to under-performing stores. There were no long-lived asset impairment charges recognized for fiscal 2010.
4. Goodwill and Intangible Assets
The Company’s intangible assets consisted of the following:
The Company performed its annual goodwill impairment test as of February 2, 2013, and concluded that the carrying value of its direct marketing reporting unit goodwill exceeded the implied fair value based on the estimated fair value of the direct marketing reporting unit. Accordingly, the Company recorded a pre-tax non-cash impairment charge of $4.5 million for fiscal 2012 primarily as a result of the current and projected future performance of the Alloy business. In fiscal 2010, the Company recorded a pre-tax non-cash impairment charge of $7.6 million and there was no impairment charge in fiscal 2011.
Additionally, based on the annual impairment test performed as of February 2, 2013, the Company concluded that its indefinite-lived intangible assets were not impaired. There were no impairment charges as a result of the 2011 or 2010 impairment analysis for indefinite-lived intangible assets.
Refer to Note 2, “Summary of Significant Accounting Policies, Goodwill and Other Indefinite-Lived Intangible Assets and Impairment of Long Lived Intangible Assets”, for further details regarding our procedure for evaluating goodwill and other intangible assets for impairment.
5. Credit Facility
On May 26, 2011, the Company and certain of its wholly-owned subsidiaries entered into a new credit agreement (the “Credit Agreement”) with General Electric Capital Corporation (“GE Capital”), as a lender and as agent for the financial institutions from time to time party to the Credit Agreement (together with GE Capital in its capacity as a lender, the “Lenders”, currently GE Capital is the only Lender), which replaced the Company’s previous letter of credit agreement, as amended, with Wells Fargo Retail Finance II, LLC (“Wells Fargo”) (the “Wells Fargo Agreement”). The Credit Agreement provides for a total aggregate commitment of the Lenders of $25 million, including a $15 million sublimit for the issuance of letters of credit and a swingline loan facility of $5 million. Under the Credit Agreement, the Company has the right to request, subject to the agreement of the Lenders, that the Lenders increase their revolving commitments up to an additional $25 million. The Credit Agreement has a term of five years and matures on May 26, 2016. The obligations of the borrowers under the Credit Agreement are secured by substantially all property and assets of the Company and certain of its subsidiaries.
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As of February 2, 2013, availability under the Credit Facility was $5.1 million, net of outstanding letters of credit of $11.9 million.
The Credit Agreement calls for the payment by the Company of a fee of 0.375% per annum on the average unused portion of the Credit Agreement, a letter of credit fee calculated using a per annum rate equal to the Applicable Margin with respect to letters of credit (as defined in the Credit Agreement) multiplied by the average outstanding face amount of letters of credit issued under the Credit Agreement, as well as other customary fees and expenses. Interest accrues on the outstanding principal amount of the revolving credit loans at an annual rate equal to LIBOR (as defined in the Credit Agreement) or the Base Rate (as defined in the Credit Agreement), plus an applicable margin which is subject to periodic adjustment based on average excess availability under the Credit Agreement. Interest on each swingline loan is calculated using the Base Rate. The Credit Agreement does not contain any financial covenants with which the Company or any of its subsidiaries or affiliates has to comply during the term of the Credit Agreement.
The Credit Agreement contains customary representations and warranties, as well as customary covenants that, among other things, restricts the ability of the Company and its subsidiaries to incur liens, consolidate or merge with other entities, incur certain additional indebtedness and guaranty obligations, pay dividends or make certain other restricted payments. The Credit Agreement also contains customary events of default, including payment defaults, breaches of representations and warranties and covenants, cross defaults to other material indebtedness, and bankruptcy and insolvency matters.
The Wells Fargo Agreement, which was terminated on May 26, 2011, provided for a maximum aggregate face amount of letters of credit that may be issued, to be the lesser of (a) $10 million or (b) an amount equal to a specified percentage of cash collateral held by Wells Fargo. The cash collateral was required in an amount equal to 105% of the face amount of outstanding letters of credit issued. None of the other assets or properties of the Company, or any of its subsidiaries or affiliates, were pledged as collateral for these obligations.
6. Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consisted of the following:
7. Long-Term Liabilities
Deferred Credits
Deferred credits consist primarily of long-term portions of deferred rent and tenant allowances. We occupy our retail stores and home office under operating leases generally with terms of seven to ten years. Some of these
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leases have early cancellation clauses, which permit the lease to be terminated if certain sales levels are not met in specific periods. Most of the store leases require payment of a specified minimum rent, plus a contingent rent based on a percentage of the store’s net sales in excess of a specified threshold. Most of the lease agreements have defined escalating rent provisions, which are reported as a deferred rent liability and expensed on a straight-line basis over the term of the related lease, commencing with date of possession. This includes any lease renewals deemed to be probable. In addition, we receive cash allowances from our landlords on certain properties and have reported these amounts as tenant allowances which are amortized to rent expense over the term of the lease, also commencing with date of possession. Included in deferred credits at February 2, 2013 and January 28, 2012 was $5.0 million and $6.0 million, respectively, of deferred rent liability, and $3.5 million and $4.6 million, respectively, of tenant allowances.
8. Stock-Based Compensation
Under the dELiA*s, Inc. Amended and Restated 2005 Stock Incentive Plan, we may grant incentive stock options, nonqualified stock options and restricted stock to employees (including officers), non-employee directors and consultants. Grants for stock options generally vest and become exercisable annually in equal installments over a four-year period and expire 10 years after the grant date, while restricted stock generally vests and becomes exercisable annually in equal installments over a three-year period. Shares available for future equity grants at February 2, 2013 and January 28, 2012 totaled 4.0 million and 3.9 million, respectively.
The Company accounts for share-based compensation under the provisions of ASC 718 Compensation-Stock Compensation, which requires share-based compensation for equity awards to be measured based on estimated fair values at the date of grant.
The Company recorded stock-based compensation expense (including expense for restricted stock) of $0.7 million, $0.7 million, and $0.8 million for fiscal 2012, fiscal 2011 and fiscal 2010, respectively, related to employee and non-employee directors share-based awards and such expense is included in selling, general and administrative expense in our consolidated statements of operations.
Stock Options
The Company estimates the fair value of stock options granted using the Black-Scholes option-pricing model, which requires the Company to estimate the expected term of stock option grants and expected future stock price volatility over the expected term.
The per share weighted average fair value of stock options granted during fiscal 2012, fiscal 2011, and fiscal 2010 were $0.81, $0.93, and $1.14, respectively. The fair value of each option grant was estimated using the following weighted average assumptions:
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The following table summarizes stock option activity during fiscal 2012:
The intrinsic value of stock options exercised during fiscal 2012, fiscal 2011, and fiscal 2010 was approximately $-0-, $-0-, and $2,000, respectively. There were no aggregate intrinsic values of stock options outstanding and stock options exercisable at February 2, 2013.
As of February 2, 2013, there was approximately $0.4 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements. That cost is expected to be recognized over a weighted average period of 1.5 years.
Restricted Stock
The fair value of restricted stock awards is calculated based on the stock price on the date of the grant. The weighted average grant date fair values for restricted stock issued during fiscal 2012, fiscal 2011, and fiscal 2010 were $1.17, $1.02, and $1.74, respectively.
The following table summarizes restricted stock activity during fiscal 2012:
There were 42,258 restricted shares canceled during fiscal 2012 as a result of a former board member not standing for re-election to the board.
As of February 2, 2013, there was approximately $0.4 million of total unrecognized compensation cost related to restricted stock, which is expected to be recognized over a weighted average period of 1.7 years.
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9. Stockholders’ equity
Rights Offering
On December 30, 2005, we filed a prospectus under which we distributed at no charge to persons who were holders of our common stock on December 28, 2005 transferable rights to purchase up to an aggregate of 2,691,790 shares of our common stock at a cash subscription price of $7.43 per share (the “rights offering”). The rights offering was made to help fund the costs and expenses of our retail store expansion plan and to provide funds for general corporate purposes following the Spinoff. MLF Investments, LLC (“MLF”), which was controlled by Matthew L. Feshbach, our former Chairman of the Board, agreed to backstop the rights offering, meaning MLF agreed to purchase all shares of our common stock that remained unsold upon completion of the rights offering at the same $7.43 subscription price per share. The rights offering was completed in February 2006 with approximately $20 million of gross proceeds. Our stockholders exercised subscription rights to purchase 2,040,570 shares of dELiA*s common stock, of the 2,691,790 shares offered in the rights offering, raising a total of $15.2 million. On February 24, 2006, MLF purchased the remaining 651,220 shares for a total of $4.8 million. MLF received as compensation for its backstop commitment a nonrefundable fee of $50,000 and ten-year warrants to purchase 215,343 shares of our common stock at an exercise price of $7.43 per share. The warrants had a grant date fair value of approximately $0.9 million and were recorded as a cost of raising capital. The MLF warrants were subsequently split so that MLF Offshore Portfolio Company, LP owned warrants to purchase 206,548 shares of our common stock and MLF Partners 100, LP owned warrants to purchase 8,795 shares of our common stock. Such warrants were distributed on a pro-rata basis to investors as part of the winding up of operations of MLF and its affiliated funds. All 215,343 warrants were outstanding as of February 2, 2013 and January 28, 2012.
Preferred Stock
We are authorized to issue, without stockholder approval, up to 25,000,000 shares of preferred stock, $0.001 par value per share, having rights senior to those of our common stock. In addition, we have 1,000,000 shares of series A junior participating preferred stock authorized, none of which are outstanding as of February 2, 2013.
Shelf Registration Statement
On June 20, 2012, the Company filed a registration statement on Form S-3 using a “shelf” registration process, which became effective on September 7, 2012. Under this shelf registration, the Company may issue up to $30 million of its common stock, preferred stock, warrants, rights, units or preferred stock purchase rights in one or more offerings, in amounts, at prices, and terms that will be determined at the time of the offering. Because the publicly-traded float of the Company’s shares of common stock is less than $75 million, unless and until the Company’s public float exceeds $75 million, the Company will be restricted to issuing securities registered under the shelf registration equal to no more than one-third of the value of its public float in any consecutive twelve month period. If any securities are sold by the Company under the shelf registration, we expect the net proceeds will be added to general corporate funds and may be used for general corporate purposes. To date, no securities of the Company have been issued under this shelf registration statement.
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10. Income Taxes
The components of the benefit for income taxes consist of the following for fiscal:
The reconciliation between the statutory income tax rate and the effective tax rate is as follows:
The types of temporary differences that give rise to our deferred tax assets and liabilities are set out as follows at:
For federal income tax purposes, we have unused net operating loss (“NOL”) carry forwards of approximately $150 million at February 2, 2013, expiring through January 31, 2033. The U.S. Tax Reform Act of
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
1986 contains provisions that limit the NOL carry forwards available to be used in any given year upon the occurrence of certain events, including a significant change of ownership. We have experienced such ownership changes and may experience such future changes. As a result, $106 million of our federal NOL carry forwards are limited to $22 million due to this change in ownership event. In addition, the annual limitations may result in the expiration of net operating losses before utilization. For state tax purposes, we have unused NOL carry forwards of approximately $118 million at February 2, 2013 which have expiration dates that vary by jurisdiction.
In fiscal 2010, we recorded an adjustment of $1.0 million to properly present our deferred tax liability, which is included in deferred credits and other long-term liabilities, as related to an indefinite-lived intangible asset acquired at the time of the Spinoff, with a corresponding decrease to additional paid-in capital. This adjustment had no material impact on prior years’ consolidated financial statements.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, net operating loss carryback potential, and tax planning strategies in making these assessments.
Based upon the above criteria, the Company does not believe that it is more-likely-than-not that the remaining net deferred tax assets will be realized. For fiscal 2012, the valuation allowance increased by $6.6 million related to increased federal and state tax NOL carry forwards. For fiscal 2011, the valuation allowance increased by $8.7 million related to increased federal and state tax NOL carry forwards. For fiscal 2010, the valuation allowance increased by $1.0 million related to the adjustment for the deferred tax liability noted above, and $0.7 million related to increased state tax NOL carry forwards.
At February 2, 2013 and January 28, 2012, the Company had a liability for unrecognized tax benefits of $0.5 million and $0.4 million, respectively, both of which would have favorably affected the Company’s effective tax rate if recognized. Included within the $0.5 million, as of February 2, 2013, is an accrual of $0.2 million for the payment of related interest and penalties. The Company does not believe there will be any material changes in the unrecognized tax positions over the next twelve months.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
The Company recognizes interest related to unrecognized tax benefits in interest expense and any related penalties in income tax expense. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheet. The Company recorded an additional $11,400, $5,000 and $5,000 in interest, and $19,400, $5,000 and $10,000 in penalties, for the fiscal 2012, fiscal 2011 and fiscal 2010, respectively.
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The Company’s subsidiaries join in the filing of a U.S. federal consolidated income tax return. The U.S. federal statute of limitations remains open for the fiscal years 2008, 2009, 2010 and 2011. State income tax returns are generally subject to examination for a period of 3 to 5 years after filing of the respective returns. The state impact of any federal changes remains subject to examination by various states for a period of up to one year after formal notification to the states.
11. Spinoff Related Transactions
Services and Revenues
We recognize other revenues that consist primarily of advertising provided for third parties in our catalogs, on our e-commerce web pages, in our outbound packages, and in our retail stores pursuant to specific pricing arrangements with Alloy, Inc. Alloy, Inc. originally arranged these advertising services on our behalf, through a Media Services Agreement (the “Original Agreement”) entered into in connection with the Spinoff. Revenue under these arrangements was recognized, net of commissions and agency fees, when the underlying advertisement is published or otherwise delivered pursuant to the terms of each arrangement.
On November 16, 2010, the Company entered into an Amended and Restated Media Services Agreement (the “A/R Media Services Agreement”) with Alloy, Inc. The A/R Media Services Agreement replaced the Original Agreement, which expired by its terms on December 19, 2010, and became effective on December 20, 2010, upon expiration of the Original Agreement. The A/R Media Services Agreement provides, among other things, that Alloy, Inc. will serve as our exclusive sales agent for the purpose of providing the following media and marketing related services to the Company and its subsidiaries: license of websites, internet advertising, direct segment upsell arrangements, catalog advertisements and insertions, sampling and in-store promotions, and database collection and marketing. The A/R Media Services Agreement expires on December 20, 2015. Effective May 6, 2011, the Company and Alloy, Inc. amended the A/R Media Services Agreement to remove the sampling and in-store promotion services therefrom.
We recorded revenues of approximately $0.3 million, $0.6 million, and $0.4 million for fiscal 2012, fiscal 2011, and fiscal 2010, respectively, in our consolidated financial statements in accordance with the terms of the A/R Media Services Agreement.
We recorded expenses of approximately $0.5 million, $0.7 million, and $0.2 million for fiscal 2012, fiscal 2011, and fiscal 2010, respectively, in our consolidated financial statements in accordance with the terms of the A/R Media Services Agreement.
Prior to the Spinoff, we and Alloy, Inc. entered into the following agreements that were to define our ongoing relationships after the Spinoff: a distribution agreement, tax separation agreement, trademark agreement, information technology and intellectual property agreement, and an On Campus Marketing call center agreement. The On Campus Marketing call center agreement was terminated July 16, 2012.
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
12. Commitments and Contingencies
Leases
We lease dELiA*s retail stores and office space under noncancelable operating leases with various expiration dates through February 2023. As of February 2, 2013, future net minimum lease payments are as follows:
Most of the dELiA*s retail store leases require payment of a specified minimum rent, plus a contingent rent based on a percentage of the store’s net sales in excess of a specified threshold. Most of the lease agreements have defined escalating rent provisions, which are expensed over the term of the related lease on a straight-line basis commencing with the date of possession, including any lease renewals deemed to be probable. In addition, most of the leases require payment of real estate taxes, certain common area and maintenance costs (“CAM”) and other related charges in addition to the future minimum operating lease payments. We sublease a portion of our office space. The minimum lease payments presented above do not include real estate taxes, CAM or other related charges. Total real estate taxes, CAM and other related charges for fiscal 2012, fiscal 2011 and fiscal 2010 were $11.2 million, $11.6 million and $11.6 million, respectively.
Total rent expense, excluding real estate taxes, CAM and other related charges, during fiscal 2012, fiscal 2011 and fiscal 2010 was $17.6 million, $18.2 million, and $17.7 million, respectively. There were no contingent excess rent payments made during these periods.
Sales Tax
At present, with respect to Alloy, sales or other similar taxes are collected in respect of direct shipments of goods to consumers located primarily in states where Alloy has a physical presence or personal property. With respect to the dELiA*s website and catalogs, sales or other similar taxes are collected primarily in states where we have dELiA*s retail stores, another physical presence or other personal property. However, various other states may seek to impose sales tax obligations on such shipments in the future. A number of proposals have been made at the state and local levels that would impose additional taxes on the sale of goods and services through the internet. A successful assertion by one or more states that we should have collected or be collecting sales taxes on the sale of products could have a material adverse effect on our results of operations.
License Agreement
In February 2003, dELiA*s Brand LLC, a wholly-owned subsidiary of the Company, entered into a master license agreement with JLP Daisy to license the dELiA*s brand on an exclusive basis for wholesale distribution
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
in certain product categories, primarily in mid- and upper-tier department stores. dELiA*s Brand LLC received a $16.5 million cash advance against future royalties from the licensing ventures. The master license agreement provides that JLP Daisy is entitled to retain all of the royalty income generated from the sale of licensed products until JLP Daisy recoups its advance plus one-third of a preferred return of 18% per year on the unrecouped advance, if ever. Thereafter, we will receive an increasing share of the royalties until JLP Daisy recoups its advance plus a preferred return of 18% per year on the unrecouped advance, at which time we will receive a majority of the royalty stream after brand management fees.
The initial term of the master license agreement is approximately 10 years, which is subject to an automatic extension of five years under specified circumstances and, at our option, (i) the term will remain in effect until JLP Daisy recoups its advance and preferred return or (ii) the term will immediately expire and JLP Daisy will be entitled to be paid the balance of any unrecouped advance and a preferred return calculated at 6% per year (if not received already). As of February 2, 2013, JLP Daisy has not recouped its advance and preferred return and therefore the master license agreement remains in effect. The master license agreement provides that the advance will be recoupable by JLP Daisy solely out of its share of the royalty payments and not through recourse against dELiA*s Brand LLC, us or any of our properties or assets. The master license agreement may be terminated early under certain circumstances, including, at our option, upon payment to JLP Daisy of an amount based upon royalties received from the sale of the licensed products during a specified period. In addition, dELiA*s Brand LLC granted to JLP Daisy a security interest in the dELiA*s trademarks and copyrightable artwork, although the only event that would entitle JLP Daisy to exercise its rights in respect of the lien is a termination or rejection of the license or master license agreement in a bankruptcy proceeding. We have not recorded any amounts associated with the master license agreement.
Employment Agreements
The Company has entered into employment agreements with certain key executives. The agreements specify various employment-related matters, including annual compensation, performance incentive bonuses, and severance benefits in the event of termination with or without cause.
In addition, there are other executives of the Company with severance agreed to in offer letters depending on various circumstances.
Benefit Plan
All employees who meet eligibility requirements may participate in the dELiA*s Inc. 401(k) Profit Sharing Plan (the “Plan”). Under the Plan, employees can defer 1% to 75% of compensation as defined. The Company temporarily suspended its matching contribution to the Plan in early fiscal 2009. The Company reinstated its matching contribution in April 2010 at a rate of $0.25 per employee contribution dollar on up to the first 5% of employee contribution. Employee contributions are always 100% vested. Until December 31, 2011, any Company matching contribution vested at 20% per year of employee service. Effective January 1, 2012, the matching contribution was increased from $0.25 to $0.50 per employee contribution dollar, and all past and future matching contributions are immediately vested. The Company’s matching contributions were $0.3 million, $0.1 million, and $0.1 million for fiscal years 2012, 2011 and 2010, respectively.
Litigation
The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. Although the amount of any liability that could arise with respect to these actions cannot be determined
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
with certainty, in the Company’s opinion, any such liability will not have a material adverse effect on its consolidated financial position, consolidated results of operations or liquidity.
13. Segment Reporting
The Company’s executive management, being its chief operating decision makers, works together to allocate resources and assess the performance of the Company’s business. All of the Company’s operations are in the U.S. The Company’s executive management manages the Company as two distinct operating segments, direct marketing and retail stores. Although offering customers substantially similar merchandise, the Company’s direct and retail operating segments have distinct management, marketing and operating strategies and processes.
The Company’s executive management assesses the performance of each operating segment based on operating income/loss, which is defined as net sales less the cost of goods sold and selling, general and administrative (“SG&A”) expenses both directly identifiable and allocable. For the direct segment, these SG&A expenses primarily consist of catalog development, production and circulation costs, order processing costs, direct personnel costs and allocated overhead expenses. For the retail segment, these SG&A expenses primarily consist of store selling expenses, direct labor costs and allocated overhead expenses. Allocated overhead expenses are costs associated with general corporate expenses and shared departmental services (e.g., executive, finance, information technology, legal and human resources).
Operating segment assets are those directly used in or clearly allocable to an operating segment’s operations. For the retail segment, these assets primarily include inventory, fixtures and leasehold improvements. For the direct segment, these assets primarily include inventory and prepaid catalog costs. Corporate and other assets include corporate headquarters, warehouse and fulfillment and contact center facilities (the contact center facility is no longer in use as that function has been outsourced to a third party), shared technology infrastructure as well as corporate cash and cash equivalents and prepaid expenses. Operating segment depreciation and amortization and capital expenditures incurred are recorded directly to each operating segment. Corporate assets and other depreciation and amortization and capital expenditures are allocated to each reportable segment. The accounting policies of the segments are the same as those described in Note 2. Reportable data for our reportable segments were as follows (reflects continuing operations only):
dELiA*s, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
14. Quarterly Results (Unaudited)
The following table sets forth unaudited quarterly financial data for each of our last two fiscal years:
(1) Included in the fourth quarter of fiscal 2012 is a goodwill impairment charge of $4.5 million. See Note 4 for further discussion.
(2) (Loss) income per share calculations for each quarter include the appropriate weighted average effect for the quarter; therefore, the sum of quarterly (loss) income per share amounts may not equal year-to-date (loss) income per share amounts, which reflect the weighted average effect on a year-to-date basis.
dELiA*s, Inc.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
INDEX TO EXHIBITS
* Filed herewith.
** Furnished with this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.