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EX-31.1 - CERTIFICATION OF CEO - SECTION 302 - SEAL123 INCdex311.htm
EX-21.1 - SUBSIDIARIES OF THE REGISTRANT - SEAL123 INCdex211.htm
EX-12.1 - STATEMENT OF COMPUTATION OF RATIOS - SEAL123 INCdex121.htm
EX-32.1 - CERTIFICATION OF CEO - SECTION 906 - SEAL123 INCdex321.htm
EX-32.2 - CERTIFICATION OF CFO - SECTION 906 - SEAL123 INCdex322.htm
EX-31.2 - CERTIFICATION OF CFO - SECTION 302 - SEAL123 INCdex312.htm
EX-23.1 - CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - SEAL123 INCdex231.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended January 30, 2010

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 0-18632

THE WET SEAL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   33-0415940
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
26972 Burbank, Foothill Ranch, CA   92610
(Address of principal executive offices)   (Zip Code)

(949) 699-3900

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Class A Common Stock, $0.10 par value per share   NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  þ

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a nonaccelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act:

Large accelerated filer:  ¨        Accelerated filer:  þ        Nonaccelerated filer:  ¨        Smaller reporting company:  ¨

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  þ

The aggregate market value of voting stock held by nonaffiliates of the registrant as of August 1, 2009 was approximately $320,398,000 based on the closing sale price of $3.30 per share as reported on the NASDAQ Global Market on July 31, 2009.

The number of shares outstanding of the registrant’s Class A common stock, par value $0.10 per share, at March 26, 2010, was 96,994,139. There were no shares outstanding of the registrant’s Class B common stock, par value $0.10 per share, at March 26, 2010.

DOCUMENTS INCORPORATED BY REFERENCE

PART III of this Annual Report incorporates information by reference from the registrant’s definitive Proxy Statement for its Annual Meeting of Stockholders to be filed with the SEC within 120 days of January 30, 2010.

 

 

 


Table of Contents

THE WET SEAL, INC.

Annual Report on Form 10-K

For the Fiscal Year Ended January 30, 2010

TABLE OF CONTENTS

 

          Page
Part I   

Item 1.

  

Business

   1

Item 1A.

  

Risk Factors

   11

Item 1B.

  

Unresolved Staff Comments

   18

Item 2.

  

Properties

   18

Item 3.

  

Legal Proceedings

   20
Part II   

Item 4.

  

Reserved

   22

Item 5.

  

Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

   22

Item 6.

  

Selected Financial Data

   25

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   26

Item 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

   49

Item 8.

  

Financial Statements and Supplementary Data

   49

Item 9.

  

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

   50

Item 9A.

  

Controls and Procedures

   50

Item 9B.

  

Other Information

   51
Part III   

Item 10.

  

Directors, Executive Officers, and Corporate Governance of the Registrant

   52

Item 11.

  

Executive Compensation

   52

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   52

Item 13.

  

Certain Relationships and Related Transactions, and Director Independence

   53

Item 14.

  

Principal Accountant Fees and Services

   53
Part IV   

Item 15.

  

Exhibits and Financial Statement Schedules

   54

Signatures

   58


Table of Contents

PART I

 

Item 1. Business

Statement Regarding Forward-Looking Disclosure and Risk Factors

Certain sections of this Annual Report on Form 10-K (the “Annual Report”), including “Item 1. Business” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contain various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”), which represent our expectations or beliefs concerning future events.

Forward-looking statements include statements that are predictive in nature, which depend upon or refer to future events or conditions, and/or which include words such as “believes,” “plans,” “anticipates,” “estimates,” “expects,” “may,” “will,” or similar expressions. In addition, any statements concerning future financial performance, ongoing strategies or prospects, and possible future actions, which may be provided by our management, are also forward-looking statements. Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties, and assumptions about our company, economic and market factors, and the industry in which we do business, among other things. These statements are not guarantees of future performance and we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events, or otherwise.

Actual events and results may differ materially from those expressed or forecasted in forward-looking statements due to a number of factors. Factors that could cause our actual performance, future results, and actions to differ materially from any forward-looking statements include, but are not limited to, those discussed in “Item 1A. Risk Factors” below and discussed elsewhere in this Annual Report.

General

We are a national specialty retailer operating stores selling fashionable and contemporary apparel and accessory items designed for female customers aged 13 to 35 years old. As of January 30, 2010, we operated 504 retail stores in 47 states, Puerto Rico and Washington D.C. Our products can also be purchased online.

All references to “we,” “our,” “us,” and “our company” in this Annual Report mean The Wet Seal, Inc. and its wholly owned subsidiaries. All references in this Annual Report to “fiscal 2010,” “fiscal 2009,” “fiscal 2008,” “fiscal 2007,” “fiscal 2006,” “fiscal 2005,” and “fiscal 2004” mean the fiscal year ending January 29, 2011, and the fiscal years ended January 30, 2010, January 31, 2009, February 2, 2008, February 3, 2007, January 28, 2006, and January 29, 2005, respectively. Our Annual Report, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports and the proxy statement for our annual meeting of stockholders are made available, free of charge, on our corporate web site, www.wetsealinc.com, as soon as reasonably practicable after such reports have been electronically filed with or furnished to the Securities and Exchange Commission the “SEC”. Our Code of Business Ethics and Conduct is also located within the Corporate Information section of our corporate web site. These documents are also available in print to any stockholder who requests a copy from our Investor Relations department. The public may also read and copy any materials that we have filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. In addition, these materials may be obtained at the web site maintained by the SEC at www.sec.gov. The content of our web sites (www.wetsealinc.com, www.wetseal.com, and www.ardenb.com) is not intended to be incorporated by reference in this Annual Report.

The names “Wet Seal” and “Arden B” (which are registered in the retail store services and other classes) are trademarks and service marks of our company. Each trademark, trade name, or service mark of any other company appearing in this Annual Report belongs to its respective owner.

 

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Business Segments

We operate two nationwide, primarily mall-based, chains of retail stores under the names “Wet Seal” and “Arden B”. Although the two operating segments have many similarities in their products, production processes, distribution methods, and regulatory environment, there are differences in most of these areas and distinct differences in their economic characteristics. As a result, we consider these segments to be two distinct reportable segments.

Wet Seal. Wet Seal is a junior apparel brand for teenage girls who seek trend-focused and value-competitive clothing, with a target customer age of 13 to 19 years old. Wet Seal seeks to provide its customer base with a balance of affordably priced, fashionable and basic apparel and accessories.

Arden B. Arden B is a fashion brand at value price points for the feminine contemporary woman with sex appeal. Arden B targets customers aged 25 to 35 years old and seeks to deliver contemporary collections of fashion and basic separates and accessories for various aspects of the customers’ lifestyles.

We maintain a Web-based store located at www.wetseal.com, offering Wet Seal merchandise comparable to that carried in our stores to customers over the Internet. We also maintain a Web-based store located at www.ardenb.com, offering Arden B apparel and accessories comparable to those carried in our stores to customers over the Internet. Our online stores are designed to serve as an extension of the in-store experience and offer a wide selection of merchandise, which helps expand in-store sales. Internet operations for both Wet Seal and Arden B are included in their respective operating segments. In fiscal 2009, 2008, and 2007, we experienced rapid growth in both visitor traffic and our online sales, and we will continue to develop our Wet Seal and Arden B websites to increase their effectiveness in marketing our brands.

See Note 13 of the notes to consolidated financial statements for financial information regarding segment reporting, which information is incorporated herein by reference.

Our Stores

Wet Seal stores average approximately 3,900 square feet in size and in fiscal 2009 had average sales per square foot of $268. As of January 30, 2010, we operated 424 Wet Seal stores. Arden B stores average approximately 3,100 square feet in size and in fiscal 2009 had average sales per square foot of $339. As of January 30, 2010, we operated 80 Arden B stores.

During fiscal 2007, we opened 71 and closed 10 Wet Seal stores and opened seven and closed four Arden B stores. During fiscal 2008, we opened 13 and closed three Wet Seal stores and closed eight Arden B stores. During fiscal 2009, we opened 17 and closed two Wet Seal stores and opened one and closed eight Arden B stores.

We expect to open 25 to 40 Wet Seal stores, net of closings, during fiscal 2010. We currently expect to have no net change in the number of Arden B stores during fiscal 2010. However, if we sustain recent improved performance in the Arden B business through the first quarter of fiscal 2010, we may begin to pursue growth of the Arden B store base later in the year. We believe future closures for at least the next 12 months following the date of this Annual Report will primarily result from lease expirations where we decide not to extend, or are unable to extend, store leases. We may, however, accelerate the closure of underperforming stores prior to their lease expirations in cases where we can obtain favorable early lease terminations with the landlords or exercise certain rights contained in the leases. We have approximately 38 existing store leases scheduled to expire in fiscal 2010. Additionally, we plan to remodel or relocate approximately 40 Wet Seal and Arden B stores during fiscal 2010 upon lease renewals. We expect to negotiate new leases that will allow us to remain in a substantial majority of these locations. Our ability to increase the number of Wet Seal and Arden B stores in the future will depend, in part, on satisfactory cash flows from existing operations, the demand for our merchandise, our ability to find suitable mall or other locations with acceptable sites, satisfactory terms and satisfactory general business conditions. Our management does not believe there are significant geographic constraints on the locations of future stores.

 

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Competitive Strengths

Experienced Management Team. Although we have recently had changes among our senior management team, the current members have extensive knowledge of our business and operations, which will be instrumental in managing our company through the current difficult economic environment and driving our company into the next phase of its growth cycle. Mr. Edmond S. Thomas, our president and chief executive officer since October 2007, formerly served as the president and chief operating officer of our company from 1992 to 2000. Our Chief Financial Officer, Mr. Steven H. Benrubi, served as our controller for over two years prior to his appointment as chief financial officer in September 2007. Ms. Sharon Hughes, our president and chief merchandise officer for our Arden B division, who most recently served as a consultant to run our Arden B merchandising team starting in February 2008, was an employee of our company from 1990 through 2002, during which period Ms. Hughes was involved in the formation of the Arden B division and held several different merchant roles, including senior vice president of merchandising. Ms. Kim Bajrech and Ms. Debbie Shinn, vice presidents and divisional merchandise managers for our Wet Seal division, joined the company in 2009 and have extensive experience in the junior apparel business. In addition, Ms. Bajrech was an employee of our company from 1990 to 2002. We are currently undergoing a search for a chief merchandise officer for our Wet Seal division.

Merchandising Models at Wet Seal and Arden B are Focused on Fast Fashion at Affordable Prices. At Wet Seal, we have developed considerable expertise in identifying, stocking and selling a broad assortment of fresh and fashionable apparel and accessories at competitive prices to its teenage customers. Since rejoining our company as a consultant in February 2008, and later becoming president and chief merchandise officer at Arden B, Ms. Hughes has also converted Arden B to the fast fashion merchandising model for its young contemporary business. Our buyers work closely with senior management to determine the optimal product selection and promotion and pricing strategies. A significant portion of our merchandise is sourced domestically or from domestic importers. This sourcing strategy enables us to ship new merchandise to the stores with high frequency and react quickly to changing fashion trends. We also take regular markdowns to effect the rapid sale of slow-moving inventory.

Improved Financial Condition. Since the completion of a recapitalization of our company in May 2005, our financial condition has improved significantly. From fiscal 2005 through 2007, we experienced positive comparable store sales growth, on a consolidated basis, in eight out of 12 fiscal quarters and generated positive cash flows from operations in each of those fiscal years. During fiscal 2008 and fiscal 2009, due in part to an extremely challenging economic environment, we experienced comparable store sales declines on a consolidated basis. However, in spite of these declines, as a result of our taking actions to reduce costs and more conservatively manage inventories, as well as significant recovery in the financial performance of our Arden B division beginning in fiscal 2009, we continue to experience strong cash flows from operations.

In recent years, we have increased our cash position and continue to maintain a low level of indebtedness. Through fiscal 2009, $51.3 million in principal amount of our convertible notes and $23.0 million in face amount of our convertible preferred stock had been converted into shares of our Class A common stock. Also, in fiscal 2009, 2007, and 2006, we repurchased 2.0 million, 3.6 million, and 2.4 million shares of our Class A common stock for $7.3 million, $20.1 million, and $15.1 million, respectively. We repurchased no common stock during fiscal 2008. As of January 30, 2010, our cash and cash equivalents were $161.7 million; total debt, net of discount, was $3.5 million; and stockholders’ equity was $266.7 million.

Strategy

As part of a strategic review of business operations, we have identified what we believe are significant opportunities to improve our business trends and drive sales improvement. The key elements of our opportunities are to:

Manage Business Conservatively in the Near Term Through the Difficult Economic Environment. We have taken many actions to ensure we remain financially strong through a difficult economic environment over the near term and to position ourselves to capitalize on the company’s growth and operating leverage

 

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opportunities when such environment improves. In anticipation of a continuing difficult retail environment, our near term goals include preserving a strong balance sheet, resuming moderate growth of our Wet Seal division store base, ensuring our capital expenditure investments made are accretive or provide efficiencies to the business, maintaining clean inventory levels and reducing costs opportunistically. As part of our cost-cutting initiatives, in January 2008 and January 2009, we eliminated 49 and 37 positions, respectively, in our corporate offices, and two and four positions, respectively, in our field operations, across numerous functional areas. We ended fiscal 2009 with an improved balance sheet, including a substantial cash position and nominal debt. We plan to open 25 to 40 Wet Seal stores, net of closings, during fiscal 2010. Additionally, we will continue to leverage our improved inventory management processes implemented in fiscal 2008 and new systems recently implemented and expected to be implemented in fiscal 2010; and plan to closely monitor inventory positions during fiscal 2010. Lastly, we will continue to operate with a much more cost-efficient, streamlined management organization by maintaining our past cost reductions and continuing to identify any new cost reduction opportunities across all areas of our business.

Improve Merchandise Margin. In our Wet Seal division, we identified and began acting upon opportunities to improve our planning and allocation function, merchandise mix, and markdown cadence in response to declining merchandise margin performance over the course of fiscal 2009. During fiscal 2010, we will leverage our previously enhanced merchandising profiles of each Wet Seal store and further integrate them into our planning and allocation function. We will also continue to improve upon our markdown cadence and size offerings by fully utilizing our markdown and size optimization systems, continue our focus on key merchandise item categories, further develop branded and private label assortments, and further optimize our expanded bottoms offerings in the merchandise mix. In our Arden B division, we will further improve our inventory management, merchandise mix and sourcing, and enhance our planning of promotional strategies across all product categories in order to build upon significant merchandise margin improvement generated in this division during fiscal 2009. We will stay focused on maintaining a merchandise mix balanced with customer needs and continue to make improvements to our sourcing processes and expand our sourcing base.

Improve Store Operations. Our store operation opportunities include improving customer service through continuing to obtain customer feedback and acting upon it to improve our business, continued simplification and/or elimination of nonselling activities, and improved performance in underperforming stores. We will continue to evaluate store activities to determine if excess tasks can be eliminated to facilitate greater focus on sales, and we plan to employ more detailed analysis and monitoring of the operating results of underperforming stores.

Improve Real Estate. We will continue to seek to improve our new and remodeled store economics and address pressure from rising occupancy and store construction costs. We will continue to rollout our new Wet Seal store prototype and enhanced fixturing to take advantage of a more attractive store design and enhance ease of merchandising to produce a more shopper-friendly environment. Additionally, we will test off-mall locations by opening a small number of Wet Seal stores in regional “power centers” during fiscal 2010. We will continue to build the pipeline for store growth and will begin moderately growing our store base, which we estimate will result in fiscal 2010 store openings of approximately 25 to 40 new Wet Seal stores, net of store closings, and may possibly begin to pursue growth of the Arden B store base starting in late fiscal 2010. Additionally, we plan to remodel or relocate approximately 40 Wet Seal and Arden B stores during fiscal 2010 upon lease renewals.

Improve Marketing. We believe we have the opportunity to continue to improve our marketing planning and our divisional merchandising strategies. We are developing specific plans for each division for fiscal 2010. We intend to place more emphasis on Internet marketing, including social networking, and will continue leveraging visual merchandising, celebrity-related promotions, and direct and grass roots marketing. Additionally, we will enhance our focus on marketing our frequent buyer and loyalty programs to drive sales and increase store traffic.

Improve Information Systems. We will complete implementation of a new point-of-sale system in all stores during fiscal 2010, which will improve system reliability and increase store operational efficiency when

 

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processing promotional transactions. We will also complete implementation of an updated retail merchandising system in fiscal 2010, which will improve merchandising decision support and increase efficiency of inventory management practices. Additionally, we will update short-term and long-term information systems strategies that will provide further efficiencies and cost controls.

Improve Physical Distribution and Transport. We will reconfigure and automate our existing distribution center, which will produce increased efficiencies and lead to cost savings. We began this project in late fiscal 2009 and estimate completion by July 2010.

Resume Our Positive Comparable Store Sales Trend. From fiscal 2005 through fiscal 2007, we experienced eight out of 12 quarters of positive comparable store sales results, on a consolidated basis. This resulted primarily from increased transaction counts and the number of items purchased per customer, partially offset by a decrease in average retail price per item sold due to a transition of the Wet Seal business to a “fast fashion” merchandising model and an accompanying change in pricing strategy. After positive comparable store sales results in the first quarter of fiscal 2007, we experienced three consecutive quarters of comparable store sales declines, on a consolidated basis, in the low single digits. As a result, consolidated comparable store sales for fiscal 2007 declined 1.1%, with the comparable sales at the Wet Seal stores increasing 1.2% and at the Arden B stores declining 8.2%. In fiscal 2008, as a result of an extremely challenging economic environment and continued deterioration of the Arden B business, we experienced an 8.5% decrease in comparable store sales, with the comparable sales at the Wet Seal stores declining 4.5% and at the Arden B stores declining 23.5%. In fiscal 2009, resulting from a continuation of a challenging economic environment and some merchandising misses, we experienced a 7.1% decrease in comparable stores sales, with the comparable sales at the Wet Seal stores declining 8.5%, partially offset by a 0.2% increase at the Arden B stores as we began to experience success in the second half of the year from the conversion of the Arden B business to a lower-priced fast fashion merchandising model.

LOGO

 

 
Total Company Monthly Comparable Store Sales

Jan-05

   8.2%    Jan-06    51.4%    Jan-07    3.6%    Jan-08    -5.7%    Jan-09    -14.7%    Jan-10    -3.7%

Feb-05

   16.4%    Feb-06    29.3%    Feb-07    5.0%    Feb-08    -8.2%    Feb-09    -6.6%        

Mar-05

   36.3%    Mar-06    16.2%    Mar-07    10.9%    Mar-08    -10.8%    Mar-09    -11.4%        

Apr-05

   35.7%    Apr-06    17.0%    Apr-07    -9.6%    Apr-08    -1.9%    Apr-09    -2.2%        

May-05

   56.9%    May-06    -8.3%    May-07    1.9%    May-08    -2.0%    May-09    -8.4%        

Jun-05

   59.3%    Jun-06    -4.0%    Jun-07    0.7%    Jun-08    -2.9%    Jun-09    -11.1%        

Jul-05

   50.9%    Jul-06    6.4%    Jul-07    -7.2%    Jul-08    -8.2%    Jul-09    -12.1%        

Aug-05

   48.3%    Aug-06    8.7%    Aug-07    1.7%    Aug-08    -8.7%    Aug-09    -11.2%        

Sep-05

   44.9%    Sep-06    5.8%    Sep-07    -7.0%    Sep-08    -7.5%    Sep-09    -4.5%        

Oct-05

   46.6%    Oct-06    7.5%    Oct-07    -5.4%    Oct-08    -6.2%    Oct-09    -1.3%        

Nov-05

   51.5%    Nov-06    5.5%    Nov-07    -1.7%    Nov-08    -13.9%    Nov-09    -5.0%        

Dec-05

   38.5%    Dec-06    1.3%    Dec-07    0.6%    Dec-08    -12.5%    Dec-09    -4.6%          

 

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LOGO

 

 
Wet Seal Monthly Comparable Store Sales

Jan-05

   18.9%    Jan-06    83.7%    Jan-07    5.8%    Jan-08    -1.1%    Jan-09    -12.1%    Jan-10    -6.7%

Feb-05

   27.1%    Feb-06    47.9%    Feb-07    5.2%    Feb-08    -3.6%    Feb-09    -5.6%        

Mar-05

   51.9%    Mar-06    26.0%    Mar-07    14.0%    Mar-08    -7.3%    Mar-09    -12.5%        

Apr-05

   55.7%    Apr-06    20.1%    Apr-07    -10.0%    Apr-08    3.1%    Apr-09    -4.0%        

May-05

   79.2%    May-06    -5.0%    May-07    3.1%    May-08    1.8%    May-09    -12.4%        

Jun-05

   95.4%    Jun-06    -4.0%    Jun-07    2.8%    Jun-08    -0.8%    Jun-09    -11.3%        

Jul-05

   89.9%    Jul-06    8.1%    Jul-07    -6.0%    Jul-08    -6.2%    Jul-09    -12.3%        

Aug-05

   74.8%    Aug-06    8.6%    Aug-07    5.4%    Aug-08    -5.4%    Aug-09    -12.6%        

Sep-05

   81.0%    Sep-06    8.3%    Sep-07    -4.7%    Sep-08    -3.1%    Sep-09    -5.3%        

Oct-05

   91.3%    Oct-06    8.7%    Oct-07    -3.7%    Oct-08    0.9%    Oct-09    -3.1%        

Nov-05

   89.0%    Nov-06    7.3%    Nov-07    0.0%    Nov-08    -9.7%    Nov-09    -5.8%        

Dec-05

   69.4%    Dec-06    2.1%    Dec-07    4.8%    Dec-08    -6.6%    Dec-09    -7.3%          

LOGO

 

 
Arden B Monthly Comparable Store Sales

Jan-05

   -4.5%    Jan-06    5.2%    Jan-07    -2.7%    Jan-08    -21.2%    Jan-09    -27.0%    Jan-10    15.7%

Feb-05

   0.6%    Feb-06    -4.6%    Feb-07    4.2%    Feb-08    -23.9%    Feb-09    -11.5%        

Mar-05

   11.0%    Mar-06    -4.8%    Mar-07    1.8%    Mar-08    -23.0%    Mar-09    -6.3%        

Apr-05

   -0.1%    Apr-06    8.7%    Apr-07    -8.3%    Apr-08    -17.2%    Apr-09    6.0%        

May-05

   17.8%    May-06    -16.9%    May-07    -1.7%    May-08    -15.1%    May-09    11.0%        

Jun-05

   1.9%    Jun-06    -4.1%    Jun-07    -6.0%    Jun-08    -10.7%    Jun-09    -10.3%        

Jul-05

   -8.2%    Jul-06    0.8%    Jul-07    -11.4%    Jul-08    -16.2%    Jul-09    -11.2%        

Aug-05

   -2.4%    Aug-06    9.1%    Aug-07    -12.0%    Aug-08    -24.7%    Aug-09    -1.8%        

Sep-05

   -4.3%    Sep-06    -0.7%    Sep-07    -13.6%    Sep-08    -21.7%    Sep-09    -1.1%        

Oct-05

   -8.2%    Oct-06    4.5%    Oct-07    -10.3%    Oct-08    -29.4%    Oct-09    8.2%        

Nov-05

   2.0%    Nov-06    0.8%    Nov-07    -6.7%    Nov-08    -27.9%    Nov-09    -1.5%        

Dec-05

   -5.0%    Dec-06    -0.7%    Dec-07    -12.7%    Dec-08    -36.9%    Dec-09    14.1%          

 

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In fiscal 2010, we plan to improve comparable store sales with the implementation of strategic initiatives noted above, which, among other things, includes continued focus on key trends, increased efficiencies in our planning and allocation functions from markdown and size optimization systems, improved promotional planning, ensuring inventory is maintained at sufficient levels to maximize business, and implementation of enhanced merchandising and point-of-sale systems.

Build Upon and Sustain Arden B Recovery. In February 2008, we engaged Ms. Hughes as a consultant to serve as the chief merchandise officer for Arden B under the direction and supervision of Mr. Thomas. In November 2009, Ms. Hughes was appointed president and chief merchandise officer for our Arden B division. Since her arrival, we have significantly reduced the size and cost of the Arden B merchandising organization, refined the product development and sourcing processes to include more partnering with merchandise suppliers, and adjusted our merchandise mix and our pricing and promotional strategies. Our new pricing and promotional strategies at Arden B included significant reductions in price points across all categories. As a result, during the third and fourth quarters of fiscal 2009, Arden B experienced positive comparable store sales results. However, we believe Arden B has yet to achieve its full potential with its target young contemporary customers. We aim to drive further sales and profitability improvement at Arden B through our distinctive, quality merchandise, unified apparel and accessory assortments, our value-pricing strategy, new fixturing to increase store capacity, and continually improving the in-store customer experience.

Expand our Online Business. We plan to continue to grow our Internet business through several initiatives, including expanding our customer databases by leveraging social networks and by more targeted Internet marketing programs. Although our Internet sales are modest compared to consolidated net sales, we experienced substantial growth in fiscal 2009. We believe our focus on introducing new channels to capture customers, continuing to increase Internet marketing, maintaining a consistent brand message across both channels, and being more focused with targeted marketing will allow us to continue to grow our online business. We are optimizing inventory allocated to the Internet business to better meet the demand of our Internet customers and have strengthened our buying and planning staff fully to meet the anticipated sales growth in this area. We also plan to continue to grow our Internet business through continued improvements to inventory planning, fulfillment, and customer service. The growth in our website traffic continues to be substantial, and the Internet is a key component for driving store traffic. Prior to the 2007 holiday season, we launched new website platforms for both divisions. The new websites support advanced merchandising capabilities, personalization based on browsing behavior and past purchase history, and testing tools to measure and determine the most effective content and promotional strategies. In fiscal 2009, we launched website features that allow for selling to countries outside the U.S., customers to search for and reserve denim at stores near them, customers to invite friends to shop with them online whereby each person can control and see the same screen, customers to shop online from their mobile devices and other features that continue to enhance our website and customer experience.

Design and Buying

Our design and buying teams are responsible for identifying evolving fashion trends and developing themes to guide our merchandising strategy. Each retail division has a separate buying team. The merchandising teams for each retail division develop fashion themes and strategies by assessing customer responses to current trends, shopping international and appropriate domestic markets, using fashion services, and gathering references from industry publications. After selecting fashion themes, the design and buying teams work closely with vendors to use colors, materials, and designs that create images consistent with the themes for our product offerings.

Since fiscal 2004 for our Wet Seal division, and beginning in fiscal 2008 for our Arden B division, we have decreased our dependency on internally designed merchandise. This allows us more flexibility to respond to the changing fashion trends of our target customers, to buy in smaller lots, and to reduce sourcing lead times. See also “Allocation and Distribution” below.

 

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Marketing, Advertising, and Promotion

We believe that our brands are among our most important assets. Our ability to successfully increase brand awareness is dependent upon our ability to address the changing needs and priorities of each brand’s target customers. To that end, we will continue our emphasis on visual merchandising, celebrity-related promotions, and direct and grass roots marketing. Additionally, we will build marketing strategies based on past successes of our frequent buyer and loyalty programs and will place more focus on building these programs. We will also be more aggressive with customer acquisition and increase our use of Internet marketing to drive increased store traffic.

During fiscal 2009, 2008, and 2007, we spent 0.4%, 0.5%, and 1.1%, respectively, of net sales on advertising. The decreases in fiscal 2009 and fiscal 2008 were primarily due to the elimination of print advertising programs and the decision not to execute certain advertising activities at our Arden B division due to merchandise content issues in fiscal 2008. In fiscal 2009, our primary marketing focus was on in-store promotion programs and Internet marketing for both Wet Seal and Arden B stores.

As discussed further in Note 1 of the notes to consolidated financial statements, we offer a frequent buyer program in our Wet Seal stores in order to build loyalty to the brand, increase the frequency of visits, promote multiple item purchases, and gain direct access to the customer. As part of this program, we send e-mails to participants to notify them of special in- store promotions. Our Arden B division also offers a loyalty program, “B Rewarded,” designed for the same purposes as that of our Wet Seal division.

Sourcing and Vendor Relationships

We purchase our merchandise from both domestic and foreign vendors. For fiscal 2009, approximately 18% of our retail merchandising receipts were directly imported from foreign vendors. Although in fiscal 2009 no single vendor provided more than 10% of our merchandise, management believes we are one of the largest customers of many of our smaller vendors. Quality control is monitored at the distribution points of our largest vendors and manufacturers, and merchandise is inspected upon arrival at our Foothill Ranch, California, facility.

We do not maintain any long-term or exclusive commitments or arrangements to purchase merchandise from any single supplier, and there are many vendors who could supply our merchandise.

Allocation and Distribution

Our merchandising effort primarily focuses on maintaining a regular flow of fresh, fashionable merchandise into our stores. Successful execution depends largely on our integrated planning, allocation, and distribution functions. By working closely with store operations management and merchandise buyers, our teams of planners and allocators manage inventory levels and coordinate allocation of merchandise to each of our stores based on sales volume and store size, demographics, climate, and other factors that may influence an individual store’s product mix. During fiscal 2008, we implemented merchandise planning software that assists us in streamlining the planning process. In fiscal 2009, we began and completed implementation of size optimization software that will improve our allocation of sizes to better align with each store’s needs.

All merchandise is received from vendors at our Foothill Ranch, California distribution center, where items are inspected and prepared for shipping to our stores. We ship all of our merchandise to our stores by common carrier. Consistent with our goal of maintaining the freshness of our product offerings, we frequently ship new merchandise to stores, and markdowns are taken regularly to effect the rapid sale of slow-moving inventory. In fiscal 2009, we implemented markdown optimization at our Wet Seal division to improve the speed of moving slow product and improve merchandise margins. Marked-down merchandise that remains unsold is either sent to clearance centers for deep discounting and sale, sent to the Internet store for selling, sold to an outside clearance company, or given to charity. The fulfillment process and distribution of merchandise for our online business is performed at our Foothill Ranch, California, distribution center.

 

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Information and Control Systems

Our merchandise, financial, and store computer systems are integrated and operate using primarily Oracle® technology. We have invested in a large data warehouse that provides management, buyers, and planners comprehensive data that helps us identify emerging trends and manage inventories. The core merchandise system is frequently enhanced to support strategic business initiatives.

All of our stores have a point-of-sale system operating on software provided by a leading provider of specialty retailing point-of-sale systems. This system facilitates bar-coded ticket scanning, automatic price lookups, and centralized credit authorizations. All stores are networked to the corporate office via a centrally managed virtual private network. We utilize a store portal that is integrated with the corporate merchandise ERP system to provide the stores and corporate staff with current information regarding sales, promotions, inventory, and shipments, and enables more efficient communications with the corporate office. In fiscal 2007, we installed new wide area networking hardware at all stores, which incorporated upgrades to guard against security breaches to our stores point-of-sale system, completed our merchandise allocation system, upgraded our financial system, and launched new website platforms for the online businesses. In fiscal 2009, in order to further improve gross margin through the use of technology, we completed implementation of Oracle Markdown Optimization for our Wet Seal stores and began implementation of SAS Size Optimization. To enhance store efficiency, we began implementation activities for Oracle Retail Point-of-Sale that will be completed in fiscal 2010. A major upgrade to the Oracle Retail Merchandising system will also be fully implemented in fiscal 2010.

Seasonality and Inflation

Our business is seasonal in nature, with the Christmas season, beginning the week of Thanksgiving and ending the first Saturday after Christmas, and the back-to-school season, beginning the last week of July and ending during September, historically accounting for a large percentage of our sales volume. For the past three fiscal years, the Christmas and back-to-school seasons together accounted for an average of slightly less than 30% of our annual sales. Our profitability depends, to a significant degree, on the sales generated during these peak periods. We do not believe that inflation has had a material effect on our results of operations during the past three years. However, we cannot be certain that our business will not be affected by inflation in the future. Any decrease in sales or margins during these periods, whether as a result of economic conditions, poor weather, or other factors, could have a material adverse effect on our company.

Trademarks

Our primary trademarks and service marks are WET SEAL and ARDEN B, which are registered in the United States Patent and Trademark Office. We also have registered, or have applications pending for, a number of other trademarks including, but not limited to, ACCOMPLICE, B. FIRST, B. REWARDED, ENR EVOLUTION NOT REVOLUTION, FASHION INSIDER, FIT IN. STAND OUT., GET IT. WEAR IT. FLAUNT IT., SEAL STASH, BLUE ASPHALT, CONTEMPO CASUALS, TREND SPOT, STYLIZER, REBELLIOUS, REBELLIOUS BY WET SEAL, A. AUBREY, and URBAN VIBE. In general, the registrations for these trademarks and service marks are renewable indefinitely as long as the marks are used as required under applicable regulations. We are not aware of any adverse claims or infringement actions relating to our trademarks or service marks.

Competition

The women’s retail apparel industry is highly competitive, with fashion, quality, price, location, and service being the principal competitive factors. Our Wet Seal and Arden B stores compete with specialty apparel retailers, department stores, and certain other apparel retailers, including Aeropostale, Anthropologie, Abercrombie & Fitch, Charlotte Russe, Gap, Banana Republic, H&M, Old Navy, Pacific Sunwear, American Eagle, Target, Urban Outfitters, Forever 21, Express, J.C. Penney, Nordstrom, bebe, Zara, Guess?, BCBG, Rue 21, and other regional retailers. Many of our competitors are large national chains that have substantially greater

 

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financial, marketing, and other resources than we do. While we believe we compete effectively for favorable site locations and lease terms, competition for prime locations within malls is intense, and we cannot ensure that we will be able to obtain new locations on terms favorable to us, if at all.

Customers

Our company’s business is not dependent upon a single customer or small group of customers.

Environmental Matters

We are not aware of any federal, state, or local environmental laws or regulations that will materially affect our earnings or competitive position, or result in material capital expenditures. However, we cannot predict the effect on our operations of possible future environmental legislation or regulations. During fiscal 2009, there were no material capital expenditures for environmental control facilities and no such material expenditures are anticipated for fiscal 2010.

Government Regulation

Our company is subject to various federal, state, and local laws affecting our business. Each of our company’s stores must comply with licensing and regulation by a number of governmental authorities in jurisdictions in which the store is located. To date, our company has not been significantly affected by any difficulty, delay, or failure to obtain required licenses or approvals.

Our company is also subject to federal and state laws governing such matters as employment and pay practices, overtime, and working conditions. The bulk of our company’s employees are paid on an hourly basis at rates related to the federal and state minimum wages. In the past, we have been assessed penalties or paid settlements to gain dismissal of lawsuits for noncompliance with certain of these laws, and future noncompliance could result in a material adverse effect on our company’s operations. In July 2006, May 2007, September 2008 and March 2009, we were served with class action complaints alleging violations under certain State of California labor laws. In November 2006, we reached an agreement to settle the July 2006 class action complaint for approximately $0.3 million, and as of February 2, 2008, we had accrued within accrued liabilities in our consolidated balance sheet an amount equal to this settlement amount. We have continued to retain this accrued amount within accrued liabilities in our consolidated balance sheet as of January 30, 2010. In February 2008, the court issued its order granting final approval of the class action settlement, subject to appeal. On April 28, 2008, a notice of appeal of the judgment was filed. On May 6, 2009, the Court reversed and remanded the case to the Superior Court to re-evaluate the fairness of the settlement, and a final hearing will take place in April 2010. We anticipate receiving the appellate decision by March 2010. In October 2009, we reached an agreement to settle the March 2009 complaint for approximately $0.2 million, subject to Superior Court approval, and as of January 30, 2010, we had accrued within accrued liabilities in our consolidated balance sheet an amount equal to this settlement. The Court has preliminarily approved the settlement and set a final approval hearing for June 3, 2010. We are vigorously defending the May 2007 and September 2008 complaints and are unable to predict the likely outcomes and whether such outcomes may have a material adverse effect on our results of operations or financial condition. Accordingly, no provisions for loss contingencies for the May 2007 and September 2008 complaints have been accrued as of January 30, 2010.

We continue to monitor our facilities for compliance with the Americans with Disabilities Act, or the ADA, in order to conform to its requirements. Under the ADA, we could be required to expend funds to modify stores to better provide service to, or make reasonable accommodation for the employment of, disabled persons. We believe that expenditures, if required, would not have a material adverse effect on our company’s operations.

 

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Employees

As of January 30, 2010, we had 6,148 employees, consisting of 1,897 full-time employees and 4,251 part-time employees. Full-time personnel consisted of 630 salaried employees and 1,267 hourly employees. All part-time personnel are hourly employees. Of all employees, 5,824 were sales personnel and 324 were administrative and distribution center personnel. Personnel at all levels of store operations are provided various opportunities for cash and/or other incentives based upon various individual store sales and other performance targets. All of our employees are nonunion, and, in management’s opinion, are paid competitively at current industry standards. We believe that our relationship with our employees is good.

 

Item 1A. Risk Factors

Risks Related to our Business

General economic conditions, perceptions of such conditions by our customers and the impact on consumer confidence and consumer spending have adversely impacted our results of operations and may continue to do so.

Our performance is subject to general economic conditions and their impact on levels of consumer confidence and consumer spending, and we believe the decline in comparable store sales in fiscal 2008 and fiscal 2009 was due at least in part to continued difficult economic conditions. Consumer purchases of discretionary items, including our merchandise, generally decline during periods when disposable income is adversely affected or there is economic uncertainty. As a result of the continued difficult economic conditions, we may face risks that will impact many facets of our operations, including, among other things, the ability of one or more of our vendors to deliver their merchandise in a timely manner or otherwise meet their obligations to us. If the conditions in the U.S. and world economic markets remain uncertain or continue to be volatile, or if they deteriorate further, our business, financial condition, and results of operations may be adversely affected.

We may be unable to reverse declines in comparable store sales in our Wet Seal division.

Our comparable store sales results in our Wet Seal division have declined in each of the past two years, and we cannot assure you that comparable store sales will not continue to decline in the future. In order to improve comparable store sales results, we will need to focus on a variety of factors, including fashion trends, our merchandise mix, holiday periods, actions of competitors, weather conditions and general economic conditions.

Improving comparable store sale results has been further challenged following the resignation of Ms. Maria Comfort, our former president and chief merchandise officer of the Wet Seal division, in November 2009. We have a search underway to find a replacement for Ms. Comfort, but competition for qualified employees is intense and we may have difficulty attracting individuals to serve in the role of senior management of the Wet Seal division. In addition, our search may divert the attention of senior management from the business and operations of our company. Once we identify and attract a suitable replacement for Ms. Comfort, we anticipate that we will experience a transition period before the successor is fully integrated into the Wet Seal division.

Our improvements in comparable store sales and operating results of our Arden B division in fiscal 2009 may not be indicative of our future performance trends, and we cannot assure you that we will be able to sustain such rate of improvement.

Previously, we experienced poor financial performance in our Arden B division. Following efforts by our Board of Directors and our senior management team, including the hiring of Sharon Hughes as president and chief merchandise officer, the closing or rebranding of underperforming stores, and changes to promotional and pricing strategies, comparable store sales and operating results of our Arden B division have improved. However, there can be no guarantee that this improvement of our Arden B division will continue.

 

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Our company’s ability to attract customers to our stores depends heavily on the success of the shopping centers in which many of our stores are located.

Substantially all of our stores are located in shopping centers. Factors beyond our control impact shopping center traffic, such as general economic conditions and consumer spending levels. Accordingly, consumer spending and reduced shopping center traffic remain depressed due to the continued difficult economic conditions. As a result, mall operators have been facing increasing operational and financial difficulties. The increasing inability of mall “anchor” tenants and other area attractions to generate consumer traffic around our stores, the increasing inability of mall operators to attract “anchor” tenants and maintain viable operations and the increasing departures of existing “anchor” and other mall tenants due to declines in the sales volume and in the popularity of malls as shopping destinations, have reduced and will continue to reduce our sales volume and, consequently, adversely affect our financial condition, results of operations and/or cash flows.

Our ability to procure merchandise could be adversely affected by changes in our vendors’ factoring arrangements.

Changes in our vendors’ factoring arrangements may threaten the factors’ financial viability and ability to provide factoring services to its customers. Although we do not have a direct relationship with factors, a portion of our vendors who supply our company 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 certain of our vendors were unable to procure alternative factoring arrangements from competitors of their factor on the same or substantially similar terms, our ability to timely procure merchandise for our stores could be adversely affected. This could require the devotion of significant time and attention by our management to adequately resolve such matters. In turn, our results of operation and financial condition could suffer.

Our ability to use net operating loss carryforwards to offset future taxable income for U.S. federal income tax purposes is subject to limitation.

In general, Section 382 of the Internal Revenue Code, or Section 382, contains provisions that may limit the availability of federal net operating loss carryforwards, or NOLs, to be used to offset taxable income in any given year upon the occurrence of certain events, including significant changes in ownership interests. Under Section 382, potential limitations on NOLs are triggered when there has been an “ownership change” (generally defined as a greater than 50% change (by value) in our stock ownership over a three-year period).

Our ownership changes in April 2005 and December 2006 resulted in Section 382 limitations applying to NOLs generated prior to those dates, which were approximately $172.1 million. As a result of these ownership changes, of our $116.6 million NOLs as of January 30, 2010, we may utilize up to $62.4 million of our NOLs to offset taxable income in fiscal 2010. Future transactions involving the sale or other transfer of our stock may result in additional ownership changes for purposes of Section 382. The occurrence of such additional ownership changes could limit our ability to utilize our remaining NOLs and possibly other tax attributes. Limitations imposed on our ability to use NOLs and other tax attributes to offset future taxable income could cause us to pay U.S. federal income taxes earlier than we otherwise would if such limitations were not in effect. Any further ownership change also could cause such NOLs and other tax attributes to expire unused, thereby reducing or eliminating the benefit of such NOLs and other tax attributes to us and adversely affecting our future cash flows.

If we are unable to anticipate and react to new fashion trends, our financial condition and results of operations could be adversely affected.

We rely on a limited demographic customer base for a large percentage of our sales. Our brand image is dependent upon our ability to anticipate, identify and provide fresh inventory reflecting current fashion trends.

 

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Furthermore, the continued difficult economic conditions make it increasingly difficult for us to accurately predict product demand trends. If we fail to anticipate, identify or react appropriately or in a timely manner to these fashion trends, we could experience reduced consumer acceptance of our products, a diminished brand image and higher markdowns. These factors could adversely affect our financial condition and results of operations.

If we decrease the price that we charge for our products or offer extensive, continued promotions on our products, we may earn lower gross margins and our revenues and profitability may be adversely affected.

The prices that we are able to charge for our products depend on the type of product offered, the consumer and retailer response to the product and the prices charged by our competitors. To the extent that we are forced to lower our prices, our gross margins will be lower and our revenues and profitability may be adversely affected.

We depend upon a single center for our corporate offices and distribution activities, and any significant disruption in the operation of this center could harm our business, financial condition, results of operations and/or cash flows.

Our corporate offices and the distribution functions for all of our stores and Internet business are handled from a single, leased facility in Foothill Ranch, California. In general, this area of California is subject to earthquakes and wildfires. Any significant interruption in the operation of this facility due to a natural disaster, arson, accident, system failure or other unforeseen event could delay or impair our ability to distribute merchandise to our stores and, consequently, lead to a decrease in sales. The financial losses incurred may exceed our insurance for earthquake damages and business interruption costs related to any such disruption. As a result, our business, financial condition, results of operations and/or cash flows could be adversely affected. Furthermore, we have little experience operating essential functions away from our main corporate offices and are uncertain what effect operating satellite facilities might have on our business, personnel and results of operations.

Fluctuations in our results of operations for the third fiscal quarter and the fourth fiscal quarter have a disproportionate effect on our overall financial condition, results of operations and/or cash flows.

We experience seasonal fluctuations in revenues and operating income, with a disproportionate amount of our revenues and a majority of our income being generated in the third fiscal quarter “back-to-school” season, which begins the last week of July and ends during September, and the fourth fiscal quarter “holiday” season. Our revenues and income are generally lower during the first and second fiscal quarters. In addition, any factors that harm our third and fourth fiscal quarter operating results, including adverse weather or unfavorable economic conditions, could have a disproportionate effect on our results of operations for the entire fiscal year.

In order to prepare for our peak shopping seasons, we must order and keep in stock significantly more merchandise than we would carry at other times of the year. An unanticipated decrease in demand for our products during our peak shopping seasons could require us to sell excess inventory at a substantial markdown, which could reduce our net sales and gross profit. Alternatively, an unanticipated increase in demand for certain of our products could leave us unable to fulfill customer demand and result in lost sales and customer dissatisfaction.

Our quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including the merchandise mix and the timing and level of inventory markdowns. As a result, historical period-to-period comparisons of our revenues and operating results are not necessarily indicative of future period-to-period results. You should not rely on the results of a single fiscal quarter, particularly the third fiscal quarter “back-to-school” season or fourth fiscal quarter “holiday” season, as an indication of our annual results or our future performance.

 

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Our failure to effectively compete with other retailers for sales and locations could have a material adverse effect on our financial condition, results of operations and/or cash flows.

The women’s retail apparel industry is highly competitive, with fashion, quality, price, location and service being the principal competitive factors. Our Wet Seal and Arden B stores compete with specialty apparel retailers, department stores and certain other apparel retailers, including Aeropostale, Anthropologie, Abercrombie & Fitch, Charlotte Russe, Gap, Banana Republic, H&M, Old Navy, Pacific Sunwear, American Eagle, Target, Urban Outfitters, Forever 21, Express, J.C. Penney, Nordstrom, bebe, Zara, Guess?, BCBG, Rue 21, and other regional retailers. Many of our competitors are large national chains that have substantially greater financial, marketing and other resources than we do. We face a variety of competitive challenges, including:

 

   

anticipating and quickly responding to changing consumer demands;

 

   

maintaining favorable brand recognition and effectively marketing our products to consumers in narrowly-defined market segments;

 

   

developing innovative, high-quality products in sizes, colors and styles that appeal to consumers in our target markets and maintaining a sufficient quantity of these items for which there is the greatest demand;

 

   

obtaining favorable site locations within malls on reasonable terms;

 

   

sourcing merchandise efficiently;

 

   

pricing our products competitively and achieving customer perception of value;

 

   

offering attractive promotional incentives while maintaining profit margins; and

 

   

withstanding periodic downturns in the apparel industry.

Our industry has low barriers to entry that allow the introduction of new products or new competitors at a fast pace. Any of these factors could result in reductions in sales or the prices of our products which, in turn, could have a material adverse effect on our financial condition, results of operations and/or cash flows.

Furthermore, competition for prime locations and lease terms within shopping malls, in particular, is intense, and we may not be able to obtain new locations or maintain our existing locations on terms favorable to us. We expect to open 25 to 40 Wet Seal stores, net of closures, in fiscal 2010. At this time, we do not expect to open a significant number of Arden B stores in fiscal 2010, aside for replacing closures, but may possibly decide to begin growing the Arden B store base starting late fiscal 2010. While we believe we compete effectively for favorable site locations and lease terms, competition for prime locations within malls, in particular, and within other locations is intense and we cannot assure you that we will be able to obtain new locations on terms favorable to us, if at all.

In addition, actions of our competitors, particularly increased promotional activity, can negatively impact our business. In light of the continued difficult economic conditions, pricing is a significant driver of consumer choice in our industry and we regularly engage in price competition, particularly through our promotional programs. To the extent that our competitors lower prices, through increased promotional activity or otherwise, our ability to maintain gross profit margins and sales levels may be negatively impacted. There can be no assurance that our competitors’ increased promotional activity will not negatively impact our business

The upcoming expiration of leases for approximately 38 of our existing stores could lead to increased costs associated with renegotiating our leases and/or relocating our stores.

We have approximately 38 existing store leases scheduled to expire in fiscal 2010. In connection with the expiration of these leases, we will have to renegotiate new leases, which could result in higher rental amounts for each store and landlord requirements to remodel existing locations as a condition for renewal. We may not be

 

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able to obtain new terms that are favorable to us. In addition, as a result of renewal negotiations, we may be required by the landlord to remodel, which could result in significant capital expenditures. In addition, some landlords may refuse to renew our leases due to our lower sales per square foot as compared with other prospective tenants. If we are unable to agree to new terms with our landlords, we will have to close or relocate these stores, which could result in a significant expenditure and could lead to an interruption in the operation of our business at the affected stores, and we could be required to relocate to less desirable locations or may not be able to find viable locations at all.

Because of the importance of our brand names, we may lose market share to our competitors if we fail to adequately protect our intellectual property rights.

We believe that our trademarks and other proprietary rights are important to our success and our competitive position. We have registered trademarks for Wet Seal and Arden B (which are registered in the retail store services and other classes). We take actions to establish and protect our intellectual property. However, others may infringe on our intellectual property rights or seek to block the sale of our products as violative of their intellectual property rights. If we are required to stop using any of our registered or nonregistered trademarks, our sales could decline and, consequently, our business and results of operations could be adversely affected.

Covenants contained in agreements governing our senior credit facility restrict the manner in which we conduct our business, and our failure to comply with these covenants could result in a default under these agreements, which would have a material adverse effect on our business, financial condition, growth prospects and ability to procure merchandise for our stores.

Our senior revolving credit facility contains covenants that restrict the manner in which we conduct our business. Subject to certain exceptions, these covenants restrict or limit our ability to, among other things:

 

   

incur or guarantee additional indebtedness or refinance our existing indebtedness;

 

   

make certain investments or acquisitions;

 

   

merge, consolidate, dissolve or liquidate;

 

   

engage in certain asset sales (including the sale of stock);

 

   

repurchase stock;

 

   

grant liens on assets;

 

   

pay dividends; and

 

   

close stores.

A breach of any of these covenants could result in a default under the agreements governing our existing indebtedness, acceleration of any amounts then outstanding, the foreclosure upon collateral securing the debt obligations, or the unavailability of the lines of credit. While as of the date of this Annual Report there are not any secured convertible notes outstanding, we have not completed the satisfaction and discharge of our obligations under the indenture governing such notes. We anticipate completing the satisfaction and discharge process promptly.

We do not authenticate the license rights of our suppliers.

We purchase merchandise from a number of vendors who purport to hold manufacturing and distribution rights under the terms of license agreements or that assert that their products are not subject to any restrictions as to distribution. We generally rely upon each vendor’s representation concerning those manufacturing and distribution rights and do not independently verify whether each vendor legally holds adequate rights to the licensed properties they are manufacturing or distributing. If we acquire unlicensed merchandise or merchandise violating a registered trademark, we could be obligated to remove it from our stores, incur costs associated with

 

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destruction of the merchandise if the vendor is unwilling or unable to reimburse us and be subject to civil and criminal liability. The occurrence of any of these events could adversely affect our financial condition, results of operations and/or cash flows.

We are subject to risks associated with our procurement of products from non-U.S. based vendors and U.S. vendors that purchase products internationally, any of which could have a material adverse effect on our business, financial condition, results of operations and/or cash flows.

A portion of our products is manufactured outside the U.S. As a result, we are susceptible to greater losses as a result of a number of risks inherent in doing business in international markets and from a number of factors beyond our control, any of which could have a material adverse effect on our business, financial condition, results of operations and/or cash flows.

These factors include:

 

   

import or trade restrictions (including increased tariffs, customs duties, taxes or quotas) imposed by the U.S. government in respect of the foreign countries in which our products are currently manufactured or any of the countries in which our products may be manufactured in the future;

 

   

political instability or acts of terrorism, significant fluctuations in the value of the U.S. dollar against foreign currencies, restrictions on the transfer of funds between the U.S. and foreign jurisdictions, and/or potential disruption of imports due to labor disputes at U.S. ports, any of which could adversely affect our merchandise flow and, consequently, cause our sales to decline; and

 

   

local business practices that do not conform to our legal or ethical guidelines.

The U.S. and the countries in which our products are produced or sold may also, from time to time, impose new quotas, duties, tariffs or other restrictions, or adversely adjust prevailing quota, duty or tariff levels. In addition, none of our international suppliers or international manufacturers supplies or manufactures our products exclusively. As a result, we compete with other companies for the production capacity of independent manufacturers and import quota capacity. If we were unable to obtain our raw materials and finished apparel from the countries where we wish to purchase them, either because room under the necessary quotas was unavailable or for any other reason, or if the cost of doing so should increase, it could have a material adverse effect on our business, financial condition, results of operations and/or cash flows.

Violation of labor laws and practices by our suppliers could harm our business and results of operations.

Our company’s policy is to use only those sourcing agents and independent manufacturers who operate in material compliance with applicable laws and regulations. The violation of laws, particularly labor laws, by an independent manufacturer, or by one of the sourcing agents, or the divergence of an independent manufacturer’s or sourcing agent’s labor practices from those generally accepted as ethical in the U.S. or in the country in which the manufacturing facility is located, and the public revelation of those illegal or unethical practices, could cause significant damage to our company’s reputation. Although our manufacturer operating guidelines promote ethical business practices, we do not control the business and operations of the manufacturers and cannot guarantee their legal and regulatory compliance.

We are exposed to business risks as a result of our Internet operations.

We operate online stores at www.wetseal.com and www.ardenb.com. Our Internet operations are subject to numerous risks, including unanticipated operating problems, reliance on third-party computer hardware and software providers, system failures and the need to invest in additional computer systems. Specific risks include: (i) diversion of sales from our stores; (ii) rapid technological change; (iii) liability for online content; and (iv) risks related to the failure of the computer systems that operate the website and its related support systems, including computer viruses, telecommunication failures and electronic break-ins and similar disruptions. In addition, Internet operations involve risks which are beyond our control that could have a direct material adverse

 

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effect on our operational results, including: (i) price competition involving the items we intend to sell; (ii) the entry of our vendors into the Internet business in direct competition with us; (iii) the level of merchandise returns experienced by us; (iv) governmental regulation; (v) online security breaches involving unauthorized access to our and/or customer information; (vi) credit card fraud; and (vii) competition and general economic conditions specific to the Internet, online commerce and the apparel industry. Our inability to effectively address these risks and any other risks that we face in connection with our Internet operations could adversely affect the profitability of our Internet operations.

Risks Related to our Common Stock

Our stockholders may experience dilution due to conversions and exercises of outstanding convertible securities and/or the antidilution protection of the securities.

As of January 30, 2010, we have issued 64,484,279 shares of our Class A common stock in connection with prior private placements of Class A common stock and warrants, convertible notes, and shares of preferred stock that are convertible into or exercisable for shares of Class A common stock. An additional 9,740,230 shares of Class A common stock may be issued under the convertible notes, preferred stock, and warrants that remained outstanding as of January 30, 2010, and this number of shares of Class A common stock is subject to antidilution adjustments based upon the antidilution provisions contained in these instruments. The issuance of the additional shares of Class A common stock upon conversion and exercise could cause the market price of our Class A common stock to decline. In March 2010, we completed a series of exercises and conversions of Series E warrants, convertible notes and shares of preferred stock that resulted in the issuance of 4,273,111 shares of our Class A common stock. The Company also repurchased an insignificant remaining convertible note balance from another holder of the convertible notes. As a result of the conversions and repurchase, there are no longer any remaining convertible notes and preferred stock outstanding.

The price of our Class A common stock has fluctuated significantly during the past few years and may fluctuate significantly in the future.

Our Class A common stock, which is traded on the NASDAQ Global Market, has experienced and may continue to experience significant price and volume fluctuations that could adversely affect the market price of our Class A common stock. The market price of our Class A common stock is likely to fluctuate, both because of actual and perceived changes in our operating results and prospects and because of general volatility in the stock market. The market price of our Class A common stock could continue to fluctuate widely in response to factors such as:

 

   

actual or anticipated variations in our results of operations, including comparable store sales;

 

   

the addition or loss of suppliers, customers and other business relationships;

 

   

changes in financial estimates of, and recommendations by, securities analysts;

 

   

conditions or trends in the apparel and consumer products industries;

 

   

additions or departures of key personnel;

 

   

sales of our Class A common stock;

 

   

general market and economic conditions; and

 

   

other events or factors, including the realization of any of the risks described in this risk factors section, many of which are beyond our control.

Fluctuations in the price and trading volume of our Class A common stock in response to factors such as those set forth above could be unrelated or disproportionate to our actual operating performance.

We have never paid dividends on our Class A common stock and do not plan to do so in the future.

Holders of shares of our Class A common stock are entitled to receive any dividends that may be declared by our Board of Directors. However, we have not paid any cash dividends on our Class A common stock and we do not expect to for the foreseeable future. Also, our agreements with our senior lenders restrict the payment of dividends to our stockholders.

 

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Our charter provisions and Delaware law may have anti-takeover effects.

Our certificate of incorporation permits our Board of Directors to designate and issue, without stockholder approval, up to 2,000,000 shares of preferred stock with voting, conversion and other rights and preferences that could differentially and adversely affect the voting power or other rights of the holders of our Class A common stock, which could be used to discourage an unsolicited acquisition proposal. Furthermore, certain provisions of Delaware law applicable to our company could also delay or make more difficult a merger, tender offer or proxy contest involving our company, including Section 203 of the Delaware General Corporation Law, which prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years unless certain conditions are met.

The possible issuance of preferred stock and the application of anti-takeover provisions of Delaware law could each have the effect of delaying, deferring or preventing a change in control of our company, including, without limitation, discouraging a proxy contest, making the acquisition of a substantial block of Class A common stock more difficult and limiting the price that investors might in the future be willing to pay for shares of our Class A common stock.

 

Item 1B. Unresolved Staff Comments

None.

 

Item 2. Properties

Our principal executive offices are located at 26972 Burbank, Foothill Ranch, California, with 301,408 square feet of leased office and distribution facility space. Our principal executive offices contain 215,192 square feet of merchandise handling and storage space in the distribution facility and 86,216 square feet of office space. Our lease for this space runs through December 4, 2017, with the option for us to terminate on December 4, 2014, upon payment by us of an early termination fee of $0.7 million.

We lease all of our stores. Lease terms for our stores typically are 10 years. The leases generally provide for a fixed minimum rental and, on occasion, additional rental based on a percentage of sales once a minimum sales level has been reached. Certain leases include cash reimbursements received from landlords for leasehold improvements and other cash payments received from landlords as lease incentives. When a lease expires, we generally renew that lease at current market terms. However, each renewal is based upon an analysis of the individual store’s profitability and sales potential. At the end of fiscal 2009, we had 1,918,309 square feet of leased space under retail store leases.

 

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The following table sets forth our 504 retail stores by state or territory as of January 30, 2010:

 

State

   Wet Seal    Arden B   

State

   Wet Seal    Arden B

Alabama

   8    1    Nebraska    3    —  

Alaska

   1    —      Nevada    4    1

Arizona

   10    1    New Hampshire    2    1

Arkansas

   4    —      New Jersey    12    4

California

   56    14    New Mexico    3    —  

Colorado

   4    2    New York    14    4

Connecticut

   3    —      North Carolina    9    1

Delaware

   1    —      North Dakota    4    —  

Florida

   29    7    Ohio    19    2

Georgia

   10    2    Oklahoma    3    —  

Hawaii

   5    —      Oregon    4    —  

Idaho

   2    —      Pennsylvania    22    3

Illinois

   19    5    Rhode Island    1    1

Indiana

   10    1    South Carolina    6    —  

Iowa

   4    —      South Dakota    1    —  

Kansas

   6    1    Tennessee    8    1

Kentucky

   4    1    Texas    26    7

Louisiana

   7    —      Utah    5    1

Massachusetts

   13    4    Virginia    11    3

Maryland

   9    2    Washington    12    1

Michigan

   13    2    West Virginia    3    —  

Minnesota

   11    3    Wisconsin    9    —  

Mississippi

   2    —      Washington D.C.    —      1

Missouri

   8    2    Puerto Rico    1    1

Montana

   3    —           

The following table sets forth information with respect to store openings and closings since fiscal 2005:

Total Company

 

     Fiscal Years
   2009    2008    2007    2006    2005

Stores open at beginning of year

   496    494    430    400    502

Stores opened during the year

   18    13    78    38    11

Stores closed during the year

   10    11    14    8    113
                        

Stores open at end of year

   504    496    494    430    400
                        

Wet Seal

 

     Fiscal Years
   2009    2008    2007    2006    2005

Stores open at beginning of year

   409    399    338    308    408

Stores opened during the year

   17    13    71    34    8

Stores closed during the year

   2    3    10    4    108
                        

Stores open at end of year

   424    409    399    338    308
                        

 

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Arden B

 

     Fiscal Years
   2009    2008    2007    2006    2005

Stores open at beginning of year

   87    95    92    92    94

Stores opened during the year

   1    —      7    4    3

Stores closed during the year

   8    8    4    4    5
                        

Stores open at end of year

   80    87    95    92    92
                        

 

Item 3. Legal Proceedings

On July 19, 2006, a complaint was filed in the Superior Court of the State of California for the County of Los Angeles on behalf of certain of our current and former employees that were employed and paid by us on an hourly basis during the four-year period from July 19, 2002 through July 19, 2006. We were named as a defendant. The complaint alleged various violations under the State of California Labor Code, the State of California Business and Professions Code, and orders issued by the Industrial Welfare Commission. On November 30, 2006, we reached an agreement to pay approximately $0.3 million to settle this matter, subject to Superior Court approval. On May 18, 2007, the Superior Court entered an order granting preliminary approval of the class action settlement. On February 29, 2008, the court issued its order granting final approval of the class action settlement, subject to appeal. On April 28, 2008, a notice of appeal of the judgment was filed. On May 6, 2009, the Court reversed and remanded the case to the Superior Court to re-evaluate the fairness of the settlement, and a final hearing will take place in April 2010. As of January 30, 2010, we have accrued an amount equal to the settlement amount in accrued liabilities in our consolidated balance sheet.

On May 22, 2007, a complaint was filed in the Superior Court of the State of California for the County of Orange on behalf of certain of our current and former employees who were employed and paid by us during the four-year period from May 22, 2003 through May 22, 2007. We were named as a defendant. The complaint alleged various violations under the State of California Labor Code, the State of California Business and Professions Code, and orders issued by the Industrial Welfare Commission. Discovery is ongoing and the Court has set a class certification filing deadline of May 21, 2010. We are vigorously defending this litigation and are unable to predict the likely outcome and whether such outcome may have a material adverse effect on our results of operations or financial condition. Accordingly, no provision for a loss contingency has been accrued as of January 30, 2010.

On September 29, 2008, a complaint was filed in the Superior Court of the State of California for the County of San Francisco on behalf of certain of our current and former employees who were employed and paid by us during the four-year period from September 29, 2004 through September 29, 2008. We were named as a defendant. The complaint alleges various violations under the State of California Labor Code and the State of California Business and Professions Code. Plaintiffs recently filed an amended complaint, and we filed a motion to strike positions of the third amended complaint on or about February 16, 2010. The case has been transferred to the complex panel of the San Francisco Superior Court for case management purposes. We are vigorously defending this litigation and are unable to predict the likely outcome and whether such outcome may have a material adverse effect on our results of operations or financial condition. Accordingly, no provision for a loss contingency has been accrued as of January 30, 2010.

On March 18, 2009, a complaint was filed in the Superior Court of the State of California for the County of Orange on behalf of certain of our current and former employees that were employed and paid by us since March 18, 2005. We were named as a defendant. The complaint alleged various violations under the State of California Labor Code, the State of California Business and Professions Code, and orders issued by the Industrial Welfare Commission. On October 23, 2009, we reached an agreement to pay approximately $0.2 million to settle this matter, subject to Superior Court approval. The Court has preliminarily approved the settlement and set a final approval hearing for June 3, 2010. As of January 30, 2010, we had accrued an amount equal to the settlement amount in accrued liabilities on our consolidated balance sheet.

 

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On April 24, 2009 the Pennsylvania Equal Employment Opportunity Commission requested information and records relevant to several charges of discrimination. In the course of this investigation, the EEOC recently served us with a subpoena seeking information related to current and former employees throughout the United States. We have filed a petition to revoke or modify the subpoena and will, if necessary, oppose any attempt by the EEOC to enforce the subpoena in U.S. District Court. We are vigorously defending against the EEOC’s investigation and are unable to predict the likely outcome and whether such outcome may have a material adverse effect on our results of operations or financial condition. Accordingly, no provision for a loss contingency has been accrued as of January 30, 2010.

From time to time, we are involved in other litigation matters relating to claims arising out of our operations in the normal course of business. We believe that, in the event of a settlement or an adverse judgment on certain of these claims arising out of normal course of business, we have insurance coverage to cover a portion of such losses; however, certain other matters may exist or arise for which we do not have insurance coverage. As of January 30, 2010, we were not engaged in any other legal proceedings that are expected, individually or in the aggregate, to have a material adverse effect on our results of operations or financial condition.

 

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PART II

 

Item 4. Reserved

 

Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

We have two classes of common stock: Class A and Class B. Our Class A common stock is listed on the NASDAQ Global Market under the symbol “WTSLA”. As of March 26, 2010, there were 647 stockholders of record of our Class A common stock. The closing price of our Class A common stock on March 26, 2010, was $4.79 per share. As of March 26, 2010, there were no shares of our Class B common stock outstanding.

Price Range of Stock

The following table reflects the high and low closing sale prices of our Class A common stock as reported by NASDAQ for the last two fiscal years:

 

Quarter

   Fiscal 2009    Fiscal 2008
   High    Low    High    Low

First quarter

   $ 4.12    $ 2.02    $ 3.60    $ 2.55

Second quarter

   $ 4.60    $ 2.77    $ 5.50    $ 3.60

Third quarter

   $ 4.07    $ 3.15    $ 5.10    $ 2.33

Fourth quarter

   $ 3.76    $ 2.88    $ 2.97    $ 1.85

Dividend Policy

We have reinvested earnings in the business and have never paid any cash dividends to holders of our common stock. The declaration and payment of future dividends, which are subject to the terms and covenants contained in the agreements governing our existing indebtedness, are at the sole discretion of the Board of Directors and will depend upon our profitability, financial condition, cash requirements, future prospects, and other factors deemed relevant by our Board of Directors. Our senior revolving credit facility limits our ability to declare or pay dividends on any of our shares without consent from the lenders. The Company has no intention of paying cash dividends in the immediate future.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information as of January 30, 2010, about our common stock that may be issued upon the exercise of options, warrants, and rights granted to employees, consultants, or members of our Board of Directors under all of our existing equity compensation plans, including our 1996 Long-Term Incentive Plan, as amended; the 2000 Stock Incentive Plan; and the 2005 Stock Incentive Plan, as amended:

 

Plan category

   (a)     (b)     (c)
   Equity Compensation Plan Information
   Number of securities
to be issued

upon exercise of
outstanding options,
warrants and rights
    Weighted-average
exercise price of
outstanding options,
warrants and rights
    Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in column (a))

Equity compensation plans approved by security holders

   3,831,070 (1)    $ 6.77 (2)    1,745,756

Equity compensation plans not approved by security holders

   166,668     —        —  
                  

Total

   3,997,738      $ 6.77      1,745,756
                  

 

* On October 8, 2007, Mr. Edmond Thomas, our president and chief executive officer, was issued 500,000 restricted shares of our company’s Class A common stock. The restricted shares were not issued pursuant to one of our company’s equity compensation plans. The restricted shares were issued pursuant to Section 4350(l)(1)(A)(iv) of the NASDAQ Marketplace Rules which permits equity incentive compensation to be issued to new employees of a company outside of a shareholder approved plan. The restricted shares vest in three substantially equal tranches on the next three anniversary dates of the original grant. In accordance with this vesting schedule, 166,666 of the restricted shares vested on October 8, 2008, and 166,666 of the restricted shares vested on October 8, 2009.
(1) Includes 2,234,752 outstanding vested and nonvested stock options. Also includes 1,596,318 shares of nonvested restricted common stock and performance shares.
(2) Includes 2,234,752 stock options exercisable at a weighted-average exercise price of $6.77. A weighted-average exercise price is not applied to the 1,596,318 of nonvested restricted common stock and performance shares.

 

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Stock Price Performance Graph

The following graph compares the cumulative stockholder return on our Class A common stock with the return on the Total Return Index for the NASDAQ Stock Market (US) and the NASDAQ Retail Trade Stocks. The graph assumes $100 invested on January 28, 2005, in the stock of Wet Seal, the NASDAQ Global Stock Market (US), and the NASDAQ Retail Trade Stocks. It also assumes that all dividends are reinvested.

Comparison of Cumulative Total Return for the Class A Common Stock

of Wet Seal, January 28, 2005 through January 29, 2010 (1)

LOGO

 

     January 27,
2006*
   February 2,
2007*
   February 1,
2008*
   January 30,
2009*
   January 29,
2010*

The Wet Seal, Inc.

   $ 247    $ 291    $ 139    $ 117    $ 150

NASDAQ Stock Market (US)

   $ 114    $ 123    $ 119    $ 58    $ 84

NASDAQ Retail Trade Stocks

   $ 108    $ 119    $ 105    $ 68    $ 101

 

* Closest preceding trading date to the beginning of our fiscal year.

(1) Returns are based upon the premise that $100 is invested in each of (a) our Class A common stock, (b) NASDAQ Stock Market, and (c) the index of NASDAQ Retail Trade Stocks on January 28, 2005, and that all dividends (if any) were reinvested. Over a five-year period, and based on the actual price movement of these investments, the original $100 would have turned into the amounts shown as of the end of each Wet Seal fiscal year. Stockholder returns over the indicated period should not be considered indicative of future shareholder returns.

The historical stock performance shown on the graph is not necessarily indicative of future price performance.

Unregistered Sales of Equity Securities

(a) None.

(b) None.

 

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(c) Issuer Purchases of Equity Securities

 

Period

   Total Number of
Shares Purchased
   Average Price Paid per
Share
   Total Number of Shares
Purchased as Part of
Publicly Announced Plans
or Programs(1)
   Maximum Number of
Shares that May Yet Be
Purchased Under the
Plans or Programs(2)

January 3, 2010 to January 30, 2010

   2,025,720    $ 3.58    —      1,552,239

 

(1) On November 18, 2009, the Company’s Board of Directors authorized spending of up to $12.5 million to repurchase outstanding shares of the Company’s Class A Common Stock. Pursuant to this plan, during fiscal 2009, the Company repurchased 2,025,720 shares of its Class A common stock at an average market price of $3.58, for a total cost, including commissions, of approximately $7.3 million. Additionally, during February 2010, the Company completed its use of this authority and repurchased the balance of the authorized spending of approximately $5.2 million. As a result this authorized spending plan is now closed.
(2) Calculated as the balance remaining of the authorized spending of approximately $5.2 million divided by the closing price of the Company’s Class A common stock as of January 29, 2010, the last trading day of fiscal 2009.

As of January 30, 2010, 6,019,420 repurchased shares, at a cost of $29.8 million, as well as 2,823,451 shares reacquired by the Company, at no cost, upon employee, director, and consultant forfeitures of stock-based compensation, were not yet retired.

 

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Item 6. Selected Financial Data

The following table sets forth selected consolidated financial and other data as of and for the 2005 through 2009 fiscal years. The following selected financial data has been derived from our audited consolidated financial statements. The data set forth below should be read in conjunction with the consolidated financial statements and notes thereto, which are included elsewhere in this Annual Report.

Five-Year Financial Summary

(In thousands, except per-share and per square foot amounts, ratios, share data, store data, and square footage data)

 

Fiscal Year    2009     2008     2007     2006     2005  

Fiscal Year Ended

   January 30,
2010
    January 31,
2009
    February 2,
2008
    February 3,
2007
    January 28,
2006
 

Operating Results

          

Net sales

   $ 560,918      $ 592,960      $ 611,163      $ 564,324      $ 500,807   

Cost of sales

   $ 394,092      $ 400,521      $ 408,892      $ 370,888      $ 339,483   

Gross margin

   $ 166,826      $ 192,439      $ 202,271      $ 193,436      $ 161,324   

Selling, general, and administrative expenses

   $ 141,633      $ 154,671      $ 177,468      $ 178,703      $ 171,988   

Store closure (adjustments) costs

   $ —        $ —        $ —        $ (730   $ 4,517   

Asset impairment

   $ 2,341      $ 5,611      $ 5,546      $ 425      $ 989   

Operating income (loss)

   $ 22,852      $ 32,157      $ 19,257      $ 15,038      $ (16,170

Income (loss) before (benefit) provision for income taxes

   $ 22,366      $ 31,476      $ 23,610      $ (12,530   $ (29,032

Net income (loss)(1)

   $ 93,430      $ 30,154      $ 23,232      $ (12,838   $ (29,362

Accretion of noncash dividends on convertible preferred stock

   $ —        $ —        $ —        $ —        $ (23,317

Net income (loss) attributable to common stockholders

   $ 93,430      $ 30,154      $ 23,232      $ (12,838   $ (52,679

Per-Share Data

          

Net income (loss) attributable to common stockholders, basic

   $ 0.92      $ 0.30      $ 0.23      $ (0.18   $ (1.19

Net income (loss) attributable to common stockholders, diluted

   $ 0.92      $ 0.30      $ 0.22      $ (0.18   $ (1.19

Weighted-average shares outstanding, basic

     95,685,557        93,172,635        91,154,133        72,577,398        44,340,894   

Weighted-average shares outstanding, diluted

     96,250,188        94,099,234        94,141,019        72,577,398        44,340,894   

Other Financial Information

          

Cash, cash equivalents, and investments

   $ 161,693      $ 142,064      $ 100,618      $ 105,254      $ 96,806   

Working capital

   $ 170,102      $ 130,716      $ 90,236      $ 89,954      $ 65,203   

Ratio of current assets to current liabilities

     4.3        3.7        2.5        2.5        2.0   

Total assets

   $ 354,230      $ 256,659      $ 224,076      $ 208,167      $ 181,055   

Long-term debt, including current portion(2)

   $ 3,540      $ 2,707      $ 3,583      $ 2,739      $ 19,824   

Total stockholders’ equity

   $ 266,699      $ 171,208      $ 127,839      $ 116,797      $ 64,470   

Other Operating Information

          

Number of stores open at year-end

     504        496        494        430        400   

Number of stores opened during the year

     18        13        78        38        11   

Number of stores closed during the year

     10        11        14        8        113   

Square footage of leased store space at year-end:

          

Total Company

     1,918,309        1,879,395        1,863,123        1,612,807        1,498,638   

Wet Seal

     1,674,048        1,612,189        1,568,124        1,316,228        1,205,344   

Arden B

     244,261        267,206        294,999        296,579        293,294   

Average sales per square foot of leased store space(3):

          

Total Company

   $ 277      $ 297      $ 332      $ 348      $ 330   

Wet Seal

   $ 268      $ 292      $ 314      $ 321      $ 297   

Arden B

   $ 339      $ 326      $ 420      $ 459      $ 464   

Average sales per store(3):

          

Total Company

   $ 1,052      $ 1,123      $ 1,248      $ 1,301      $ 1,236   

Wet Seal

   $ 1,056      $ 1,149      $ 1,229      $ 1,253      $ 1,164   

Arden B

   $ 1,035      $ 1,011      $ 1,324      $ 1,467      $ 1,476   

Comparable store sales (decrease) increase(4):

          

Total Company

     (7.1 )%      (8.5 )%      (1.1 )%      6.1     44.7

Wet Seal

     (8.5 )%      (4.5 )%      1.2     8.8     74.1

Arden B

     0.2     (23.5 )%      (8.2 )%      (1.1 )%      0.1

 

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(1) Net income for fiscal 2009 includes the reversal of the valuation allowance against the net deferred tax assets in the amount of $71.3 million, recorded to (benefit) provision for income taxes.
(2) Long-term debt is presented net of unamortized discount of $2.1 million, $2.7 million, $5.5 million, $6.0 million, and $35.6 million for fiscal 2009, fiscal 2008, fiscal 2007, fiscal 2006, and fiscal 2005, respectively.
(3)

Sales during the 53rd week of fiscal 2006 were excluded from “sales” for purposes of calculating “average sales per square foot of leased store space” and “average sales per store” in order to make fiscal 2006 comparable to fiscal 2009, fiscal 2008, fiscal 2007, and fiscal 2005.

(4)

“Comparable store sales” for fiscal 2006 (a 53-week fiscal year) includes a comparison of the 53rd week of comparable store sales in fiscal 2006 to the 1st week of comparable store sales in fiscal 2006. Stores are deemed comparable stores on the first day of the month following the one-year anniversary of their opening or significant remodel/relocation.

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our audited consolidated financial statements and notes thereto included elsewhere in this Annual Report. The following discussion and analysis contains forward-looking statements which involve risks and uncertainties, and our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under the heading “Statement Regarding Forward-Looking Disclosure and Risk Factors” included elsewhere in this Annual Report.

Executive Overview

We are a national specialty retailer operating stores selling fashionable and contemporary apparel and accessory items designed for female customers aged 13 to 35 years old. We operate two nationwide, primarily mall-based, chains of retail stores under the names “Wet Seal” and “Arden B”. At January 30, 2010, we had 504 retail stores in 47 states, Puerto Rico and Washington D.C. Of the 504 stores, there were 424 Wet Seal stores and 80 Arden B stores.

We report our results of operations as two reportable segments representing our two retail divisions (“Wet Seal” and “Arden B”). Internet operations for Wet Seal and Arden B are included in their respective operating segments. Although the two operating segments have many similarities in their products, production processes, distribution methods and regulatory environment, there are differences in most of these areas and distinct differences in their economic characteristics.

Our fiscal year ends on the Saturday closest to the end of January. Fiscal 2009, fiscal 2008, and fiscal 2007 each include 52 weeks of operations.

We consider the following to be key performance indicators in evaluating our performance:

Comparable store sales—For purposes of measuring comparable store sales, sales include merchandise sales as well as membership fee revenues recognized under our Wet Seal division’s frequent buyer program during the applicable period. Stores are deemed comparable stores on the first day of the month following the one-year anniversary of their opening or significant remodel/relocation, which we define to be a square footage increase or decrease of at least 20%. Stores that are remodeled or relocated with a resulting square footage change of less than 20% are maintained in the comparable store base with no interruption. However, stores that are closed for more than three days in a fiscal month, due to remodel, relocation or other reasons, are removed from the comparable store base for that fiscal month as well as for the comparable fiscal month in the following fiscal year. Comparable store sales results are important in achieving operating leverage on certain expenses such as store payroll, occupancy, depreciation and amortization, general and administrative expenses, and other costs that

 

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are at least partially fixed. Positive comparable store sales results generate greater operating leverage on expenses while negative comparable store sales results negatively affect operating leverage. Comparable store sales results also have a direct impact on our total net sales, cash, and working capital.

Average transaction counts—We consider the trend in the average number of sales transactions occurring in our stores to be a key performance metric. To the extent we are able to increase transaction counts in our stores that more than offset any decrease in the average dollar sale per transaction, we will generate increases in our comparable store sales.

Gross margins—We analyze the components of gross margin, specifically cumulative mark-on, markups, markdowns, shrink, buying costs, distribution costs and store occupancy costs. Any inability to obtain acceptable levels of initial markups, a significant increase in our use of markdowns or in inventory shrink, or an inability to generate sufficient sales leverage on other components of cost of sales could have an adverse impact on our gross margin results and results of operations.

Operating income—We view operating income as a key indicator of our financial success. The key drivers of operating income are comparable store sales, gross margins and the changes we experience in operating costs.

Cash flow and liquidity (working capital)—We evaluate cash flow from operations, liquidity and working capital to determine our short-term operational financing needs.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the appropriate application of certain accounting policies, some of which require us to make estimates and assumptions about future events and their impact on amounts reported in our consolidated financial statements. Since future events and their impact cannot be determined with absolute certainty, the actual results will inevitably differ from our estimates.

We believe the application of our accounting policies, and the estimates inherently required therein, are reasonable. Our accounting policies and estimates are reevaluated on an ongoing basis, and adjustments are made when facts and circumstances dictate a change. Our accounting policies are more fully described in Note 1 of notes to consolidated financial statements.

The policies and estimates discussed below involve the selection or application of alternative accounting policies that are material to our consolidated financial statements. Management has discussed the development and selection of these critical accounting policies and estimates with the Audit Committee of our Board of Directors.

We have certain accounting policies that require more significant management judgment and estimates than others. These include our accounting policies with respect to revenue recognition, merchandise inventories, long-lived assets, impairment of goodwill, stock-based compensation, accounting for income taxes and insurance reserves.

Revenue Recognition

Sales are recognized upon purchases by customers at our retail store locations. Taxes collected from our customers are recorded on a net basis. For online sales, revenue is recognized at the estimated time goods are received by customers. Customers typically receive goods within four days of being shipped. Shipping and handling fees billed to customers for online sales are included in net sales. For fiscal 2009, 2008 and 2007, shipping and handling fee revenues were $2.9 million, $2.4 million, and $1.9 million, respectively, within net sales on the consolidated statements of operations.

 

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We have recorded accruals to estimate sales returns by customers based on historical sales return results. Historically, a customer generally could return merchandise within 30 days of the original purchase date. Beginning in the third quarter of fiscal 2008, we modified our sales return policy to allow customers to return merchandise only within 21 days of original purchase. We also modified our sales return policy such that Wet Seal retail store merchandise may be returned for store credit only and Arden B retail store merchandise may be returned for cash refund or store credit within seven days of the original purchase date, and for store credit only thereafter. For Wet Seal and Arden B online sales, merchandise may be returned within 21 days for a full refund. Actual return rates have historically been within management’s estimates and the accruals established. As the accrual for merchandise returns is based on estimates, the actual returns could differ from the accrual, which could impact net sales. The accrual for merchandise returns is recorded in accrued liabilities on the consolidated balance sheets and was $0.3 million and $0.4 million at January 30, 2010, and January 31, 2009, respectively.

We recognize the sales from gift cards, gift certificates, and store credits as they are redeemed for merchandise. Prior to redemption, we maintain an unearned revenue liability for gift cards, gift certificates, and store credits until we are released from such liability. Our gift cards, gift certificates, and store credits do not have expiration dates; however, over time, a percentage of gift cards, gift certificates, and store credits are not redeemed or recovered (“breakage”). Historically, due to the lack of sufficient historical redemption trend data, we had not recognized breakage on gift cards, gift certificates, and store credits. In the fourth quarter of fiscal 2007, we analyzed company-specific historical redemption patterns and determined that the likelihood of redemption of unredeemed gift cards, gift certificates, and store credits three years after their issuance is remote. Beginning in the fourth quarter of fiscal 2007, we adjusted our unearned revenue liability to recognize estimated unredeemed amounts and began to record breakage as additional sales for gift cards, gift certificates, and store credits that remained unredeemed three years after their issuance. Our net sales in the fourth quarter of fiscal 2007 included a benefit of $3.7 million to reduce our unearned revenue liability for estimated unredeemed amounts. Our net sales for fiscal 2008 included a benefit of $0.9 million to reduce our unearned revenue liability for estimated unredeemed amounts. Additionally, based upon an analysis completed by us during the second fiscal quarter of 2009, historical redemption patterns indicated that the likelihood of redemption of unredeemed gift cards, gift certificates, and store credits greater than two years after their issuance is remote. As a result, beginning in the second quarter of fiscal 2009, we adjusted our unearned revenue liability to recognize the change in estimated timing of when breakage of gift cards, gift certificates and store credits is recognized from greater than three years after their issuance dates to greater than two years after their issuance dates. Our net sales in the second quarter of fiscal 2009 included a benefit of $1.2 million due to this change in estimate to reduce our unearned revenue liability for estimated unredeemed amounts. Our net sales for fiscal 2009 included a benefit of $2.2 million to reduce our unearned revenue liability for estimated unredeemed amounts. The unearned revenue for gift cards, gift certificates, and store credits is recorded in accrued liabilities in the consolidated balance sheets and was $5.4 million and $6.5 million at January 30, 2010 and January 31, 2009, respectively. If actual redemptions ultimately differ from the assumptions underlying our breakage adjustments, or our future experience indicates the likelihood of redemption of gift cards, gift certificates, and store credits becomes remote at a different point in time after issuance, we may recognize further significant adjustments to our accruals for such unearned revenue, which could have a significant effect on our net sales and results of operations.

We maintain a frequent buyer program through our Wet Seal division. Under the program, customers receive a 10% to 20% discount on all purchases made during a 12-month period and are provided $5-off coupons that may be used on purchases during such period. The annual membership fee of $20 is nonrefundable. Discounts received by customers on purchases using the frequent buyer program are recognized at the time of such purchases.

We have historically recognized membership fee revenue under the frequent buyer program on a straight-line basis over the 12-month membership period due to a lack of sufficient program history to determine customer usage patterns. During November 2007, we changed from in-store delivery to e-mail delivery of the program’s $5-off coupons, which eliminated the customer’s ability to use such coupons at the time of initial purchases. We believe this change affects customer usage patterns. We also continue to test alternative program structures, and promotions tied to the program, and may decide to further modify the program in ways that could

 

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also affect customer usage patterns. As a result of the program change and potential further modifications, we believe it is appropriate to maintain straight-line recognition of membership fee revenue. We may, in the future, determine that recognition of membership fee revenue on a different basis is appropriate, which would affect net sales. The unearned revenue for this program is recorded in accrued liabilities in the consolidated balance sheets and was $4.7 million and $5.0 million at January 30, 2010, and January 31, 2009, respectively.

We maintain a customer loyalty program through our Arden B division. Under the program, customers accumulate points based on purchase activity. Once a loyalty program member achieves a certain point level, the member earns awards that may be redeemed for merchandise. Merchandise redemptions are accrued as unearned revenue and recorded as a reduction of net sales as points are accumulated by the member.

During fiscal 2007, we modified the terms of the Arden B loyalty program whereby, quarterly, we convert into fractional awards the points accumulated by customers who have not made purchases within the preceding 18 months. Similar to all other awards currently being granted under the program, such fractional awards expire if unredeemed after 60 days.

The unearned revenue for this program is recorded in accrued liabilities on the consolidated balance sheets and was $1.4 million and $1.6 million at January 30, 2010, and January 31, 2009, respectively. If actual redemptions ultimately differ from accrued redemption levels, or if we further modify the terms of the program in a way that affects expected redemption value and levels, we could record adjustments to the unearned revenue accrual, which would affect net sales.

Merchandise Inventories

Merchandise inventories are stated at the lower of cost or market. Market is determined based on the estimated net realizable value, which generally is the merchandise selling price. Cost is calculated using the retail inventory method. Under the retail inventory method, inventory is stated at its current retail selling value and then is converted to a cost basis by applying a cost-to-retail ratio based on beginning inventory and the fiscal year purchase activity. The retail inventory method inherently requires management judgments and estimates, such as the amount and timing of permanent markdowns to clear unproductive or slow-moving inventory, which may impact the ending inventory valuation as well as gross margins.

Markdowns are recorded when the sales value of the inventory has diminished. Factors considered in the determination of permanent markdowns include current and anticipated demand, customer preferences, age of the merchandise and fashion trends. When a decision is made to permanently mark down merchandise, the resulting gross margin reduction is recognized in the period the markdown is recorded. Total markdowns, including permanent and promotional markdowns, on a cost basis in fiscal 2009, 2008 and 2007 were $78.6 million, $77.4 million and $84.5 million, respectively, and represented 14.0%, 13.1% and 13.8% of net sales, respectively. We accrued $2.4 million and $1.8 million for planned but unexecuted markdowns, including markdowns related to slow moving merchandise, as of January 30, 2010, and January 31, 2009, respectively.

To the extent that management’s estimates differ from actual results, additional markdowns may be required that could reduce our gross margin, operating income and the carrying value of inventories. Our success is largely dependent upon our ability to anticipate the changing fashion tastes of our customers and to respond to those changing tastes in a timely manner. If we fail to anticipate, identify or react appropriately to changing styles, trends or brand preferences of our customers, we may experience lower sales, excess inventories and more frequent and extensive markdowns, which would adversely affect our operating results.

Long-Lived Assets

We evaluate the carrying value of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Factors that are considered important that could result in the necessity to perform an impairment review include a current-period operating or

 

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cash flow loss combined with a history of operating or cash flow losses and a projection or forecast that indicates continuing losses or insufficient income associated with the realization of a long-lived asset or asset group. Other factors include a significant change in the manner of the use of the asset or a significant negative industry or economic trend. This evaluation is performed based on estimated undiscounted future cash flows from operating activities compared with the carrying value of the related assets. If the undiscounted future cash flows are less than the carrying value, an impairment loss is recognized, measured by the difference between the carrying value and the estimated fair value of the assets, based on discounted cash flows using our weighted-average cost of capital, currently 12%, with such estimated fair values determined using the best information available. Quarterly, we assess whether events or changes in circumstances have occurred that potentially indicate the carrying value of long-lived assets may not be recoverable.

During fiscal 2009, 2008 and 2007, we determined such events or changes in circumstances had occurred with respect to certain of our retail stores, and that operating losses or insufficient operating income would likely continue. As such, we recorded noncash charges of $2.3 million, $5.6 million and $2.0 million, respectively, in our consolidated statements of operations for fiscal 2009, 2008 and 2007 to write down the carrying value of these stores’ long-lived assets to their estimated fair value.

The estimation of future cash flows from operating activities requires significant estimates of factors that include future sales growth and gross margin performance. If our sales growth, gross margin performance or other estimated operating results are not achieved at or above our forecasted level, or inflation exceeds our forecast and we are unable to recover such costs through price increases, the carrying value of certain of our retail stores may prove to be unrecoverable and we may incur additional impairment charges in the future.

Impairment of Goodwill

We test goodwill for impairment no less frequently than annually, and also may test on an interim basis if an event or circumstance indicates that it is more likely than not impairment may have occurred. The impairment, if any, is measured based on the estimated fair value of a reporting unit. Fair value can be determined based on discounted cash flows, comparable sales or valuations of other retail businesses. Impairment occurs when the carrying amount of the goodwill exceeds its estimated fair value.

The most significant assumptions we use in this analysis are those made in estimating future cash flows. In estimating future cash flows, we use assumptions for items such as comparable store sales, store count growth rates, the rate of inflation and the discount rate we consider to represent our weighted-average cost of capital and/or the market discount rate for acquisitions of retail businesses.

If our assumptions used in performing the impairment test prove inaccurate, the fair value of our goodwill may ultimately prove to be significantly lower, thereby causing the carrying value to exceed the fair value and indicating impairment has occurred. Based on our analysis performed in the fourth quarter of fiscal 2007, which considered the deteriorating operating performance of the Arden B division at that time and our resulting outlook for that business, we wrote off the entire $3.5 million carrying value of our goodwill, which was directly associated with the Arden B division. This charge is included in asset impairment in our consolidated statements of operations. As a result, no goodwill remained on our consolidated balance sheets as of January 30, 2010, and January 31, 2009.

Stock-Based Compensation

We measure and recognize compensation expense for all share-based payment awards to employees and directors based on estimated fair values.

We currently use the Black-Scholes option-pricing model to value stock options granted to employees. We use these values to recognize stock compensation expense for stock options. The Black-Scholes model is complex and requires significant exercise of judgment to estimate future common stock dividend yield, common

 

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stock expected volatility and the expected life of the stock options. These assumptions significantly affect our stock option valuations, and future changes in these assumptions could significantly change valuations of future stock option grants and, thus, affect future stock compensation expense. In addition, if circumstances were to change such that we determined stock options values were better represented by an alternative valuation method, such change could also significantly affect future stock compensation expense.

We also apply the Black-Scholes and Monte-Carlo simulation models to value performance shares granted to employees and consultants. Use of the Black-Scholes model for this purpose requires the same exercise of judgment noted above. The Monte-Carlo simulation model is also complex and requires significant exercise of judgment to estimate expected returns on our common stock, expected common stock volatility and our maximum expected share value during applicable vesting periods. This valuation approach also requires us to estimate a marketability discount in consideration of trading restrictions on performance share grants.

We currently believe Monte-Carlo simulation provides the most relevant value of performance share grants as the simulation allows for vesting throughout the vesting period and includes an assumption for equity returns over time, while the Black-Scholes method does not. As the Monte-Carlo simulation provides a more precise estimate of fair value, we have used that approach to value our performance shares for accounting purposes.

The assumptions we use to value our performance shares significantly affect the resulting values used for accounting purposes. Accordingly, changes in these assumptions could significantly change valuations and, thus, affect future stock compensation expense. In addition, if circumstances were to change such that we determined performance share values were better represented by the Black-Scholes model or an alternative valuation method, and such changes resulted in a significant change in the value of performance shares, such changes could also significantly affect future stock compensation.

The following table summarizes stock-based compensation recorded in the consolidated statements of operations:

 

     Fiscal Year Ended
     January 30,
2010
    January 31,
2009
   February 2,
2008
     (in thousands)

Cost of sales

   $ (132   $ 574    $ 1,120

Selling, general, and administrative expenses

     1,756        2,403      4,087
                     

Stock-based compensation

   $ 1,624      $ 2,977    $ 5,207
                     

Change in Estimated Forfeiture Rate

Based on historical experience, we modified the estimated annual forfeiture rate used in recognizing stock-based compensation expense, from a 10% forfeiture rate to a 15% forfeiture rate in the first quarter of fiscal 2009 and, for our executives, from a 5% forfeiture rate to a 10% forfeiture rate in the first quarter of fiscal 2008. During these same periods, we also realized benefits from actual forfeiture experience that was higher than previously estimated for unvested stock options and restricted common stock, resulting primarily from executive and other employee departures from our Company. See Note 2 of the notes to consolidated financial statements for further information.

Accounting for Income Taxes

Our income tax expense, deferred tax assets and reserves for unrecognized tax benefits reflect management’s best assessment of estimated future taxes to be paid. We are subject to income taxes in the United States federal jurisdiction as well as various state jurisdictions within the United States. Significant judgments and estimates are required in determining the consolidated income tax expense.

 

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Deferred income taxes arise from temporary differences between the tax and financial statement recognition of revenue and expense and net operating loss carryforwards (“NOLs”). In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, we consider whether it is more likely than not that some portion or all of the deferred tax assets will be realized using all available positive and negative evidence, projected future taxable income, tax planning strategies and recent financial operations. In projecting future taxable income, we begin with historical results adjusted for the results of changes in accounting policies and incorporate assumptions including the amount of future state and federal pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying business. In evaluating the objective evidence that historical results provide, we consider, among other things, three years of cumulative operating income. In 2004, as a result of disappointing sales results and historical operating losses, we fully reserved against our deferred tax assets. As of January 30, 2010, we performed a current analysis of all available evidence including, but not limited to, generating taxable income for the past four consecutive years, including 2009 in which we operated in an extremely challenging retail and economic environment, and concluded that the evidence supports that it is more likely than not that all of our deferred tax assets will be realized, and we reversed the valuation allowance against the net deferred tax assets in the amount of $71.3 million, which was recorded to (benefit) provision for income taxes on the consolidated statement of operations.

Section 382 of the Internal Revenue Code, or Section 382, contains provisions that may limit the availability of federal NOLs to be used to offset taxable income in any given year upon the occurrence of certain events, including significant changes in ownership interests of our common stock. Under Section 382, an ownership change that triggers potential limitations on NOLs occurs when there has been a greater than 50% change in ownership interest by shareholders owning 5% or more of a company over a period of three years or less. Based on our analyses, we had ownership changes in April 2005 and December 2006, which resulted in Section 382 limitations applying to federal NOLs generated prior to those dates, which were approximately $172.1 million.

As a result of those ownership changes, of our $116.6 million of remaining federal NOLs, we may utilize up to $62.4 million of our federal NOLs to offset taxable income in fiscal 2010. We may also experience additional ownership changes in the future, which could further limit the amount of federal NOLs annually available. As of January 30, 2010, there have been no ownership changes since 2006.

In addition, we may determine that varying state laws with respect to NOL utilization may result in lower limits, or an inability to utilize loss carryforwards in some states altogether, which could result in us incurring additional state income taxes. During fiscal 2008, the State of California passed legislation that suspended our ability to utilize NOLs to offset taxable income in fiscal 2008 and 2009. This resulted in our incurrence of additional state income taxes in California and an increase in our effective tax rate in fiscal 2009 and fiscal 2008. At this time, we expect to utilize our California NOLs in fiscal 2010 unless legislation is passed that would further suspend use of NOLs. The Company may also generate income in future periods on a federal alternative minimum tax basis, which would result in alternative minimum taxes payable on a portion of such income.

The calculation of our tax assets involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our operations. At January 30, 2010, we had no significant unrecognized tax benefits or expenses that, if recognized, would affect our effective income tax rate in future periods. We are currently unaware of any issues under review that could result in significant payments, accruals or material deviations from our recognized tax positions. However, if we later identify other income tax issues that result in significant additional payments or necessary accruals, this could have a material adverse effect on our reported results.

Insurance Reserves

We are partially self-insured for our workers’ compensation and group health plans. Under the workers’ compensation insurance program, we are liable for a deductible of $0.25 million for each individual claim and an

 

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aggregate annual liability of $1.4 million. Under our group health plan, we are liable for a deductible of $0.15 million for each claim and an aggregate monthly liability of $0.5 million. The monthly aggregate liability is subject to adjustment based on the number of participants in the plan each month. For both of the insurance plans, we record a liability for the costs associated with reported claims and a projected estimate for unreported claims considering historical experience and industry standards. We will continue to adjust the estimates as the actual experience dictates. A significant change in the number or dollar amount of claims could cause us to revise our estimate of potential losses and affect our reported results. Included in accrued liabilities within the consolidated balance sheets as of January 30, 2010, and January 31, 2009, are $1.8 million and $2.1 million, respectively, for reported claims and estimated unreported claims under our self-insured workers’ compensation and group health plans.

Current Trends and Outlook

We currently operate in a challenging retail environment driven by several factors, including disruptions in the U.S. housing and financial markets and high unemployment rates across all regions of the U.S. During the fourth calendar quarter of 2008 and the first and second calendar quarters of 2009, U.S. gross domestic product decreased 6.3%, 6.4% and 1.0%, respectively, on a year-over-year basis. Although U.S. gross domestic product showed improvement in the third and fourth calendar quarters of 2009, with increases of 3.5% and 5.7%, respectively, on a year-over-year basis, we continue to experience a volatile, and generally weak, retail environment. Our operating performance is susceptible to these general economic conditions, which have impacted consumer confidence and discretionary consumer spending in the U.S. These trends have led to a highly promotional retail environment, negatively impacting our margins. If the conditions remain uncertain or continue to be volatile, our operating performance may continue to be adversely affected.

Our comparable store sales decreased 7.1% for fiscal 2009, driven by an 8.5% comparable store sales decline in our Wet Seal division, slightly offset by a 0.2% comparable store sales increase in our Arden B division. The Wet Seal division comparable store sales decline was primarily driven by average unit retail price and transaction volume declines, partially offset by an increase in Wet Seal’s units purchased per customer. The Arden B division comparable store sales increase was primarily driven by a significant increase in transaction volumes, partially offset by a decline in comparable store average dollar sales per transaction, which were both due to our strategic decision to lower price points approximately 25% to 30% across all product categories in January 2009.

We made progress on several key initiatives at both divisions during 2009. We hired two new divisional merchandise managers at Wet Seal in July 2009 and appointed Sharon Hughes, formerly a consultant to the Arden B business since February 2008, as the president and chief merchandise officer at Arden B in November 2009. However, our president and chief merchandise officer of our Wet Seal division resigned in November 2009, and we have a search underway for her replacement. We continue to focus on improving inventory management, promotional planning and operating efficiencies at both divisions, increasing store level efficiencies and lowering operating costs. We will continue to take steps to revitalize sales productivity at Arden B, including sustaining higher inventory levels in an effort to facilitate consistent comparable store sales growth and balancing the right number of styles and mix of price points by store. We will also continue to focus on refining merchandise mix at Wet Seal, which we believe was weak in fiscal 2009 and contributed to a significant portion of the comparable store sales decline in that division. At the same time, we will remain focused on continuing productivity and cost savings initiatives, as well as on several initiatives to improve sales productivity at both divisions.

Our strategy is to return to positive comparable store sales growth, improve Wet Seal merchandise margins, sustain improvements in our Arden B business, expand our existing retail store base and expand our online businesses. To drive higher sales productivity in our retail stores, we have improved store layout and visual displays, and have embarked on several initiatives to improve gross margins, including efforts to optimize sourcing of merchandise, enhance our inventory planning and allocation functions, better align merchandise mix with target customer wants and improve supply chain efficiency through better coordination among and within our vendor, internal distribution and store operations organizations.

 

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Our operating performance since fiscal 2005 has resulted in increased liquidity and improved credit standing with suppliers. However, we may experience continued declines in comparable store sales or may be unsuccessful in executing some or all of our business strategy. If our comparable store sales drop significantly for an extended period of time, or we falter in execution of our business strategy, we may not achieve our financial performance goals, which could impact our results of operations and operating cash flow.

Store Openings and Closures

During fiscal 2009, we opened 17 and closed two Wet Seal stores and opened one and closed eight Arden B stores. We believe future closures for at least the next 12 months will primarily result from lease expirations where we decide not to extend, or are unable to extend, a store lease.

We expect to open 25 to 40 Wet Seal stores, net of closings, during fiscal 2010. We currently expect to have no net change in the number of Arden B stores during fiscal 2010. However, if we sustain recent improved performance in the Arden B business through the first quarter of fiscal 2010, we may begin to pursue growth of the Arden B store base later in the year.

Credit Extensions

Prior to our recapitalization and financing transactions in fiscal 2004 and 2005, we experienced a tight credit environment. Credit extended to us by vendors, factors, and others for merchandise and services was extremely limited. This credit tightening required us to issue letters of credit outside of the ordinary course of business, or, in many instances, shorten vendor credit terms. The lack of credit created a considerable need for working capital. Our improving sales trend that started in fiscal 2005, the completion of financing transactions in fiscal 2004 and 2005 and our improved operating results in fiscal 2005 through fiscal 2008 significantly improved our cash position and liquidity profile. As a result, during fiscal 2008 and fiscal 2009 we achieved improvements in credit terms with several vendors, and we believe, but cannot provide assurance, that we could now obtain longer credit terms with additional vendors.

Results of Operations

The following table sets forth selected statements of operations data as a percentage of net sales for the fiscal year indicated. The discussion that follows should be read in conjunction with the table below:

 

     As a Percentage of Sales  
Fiscal Year    2009     2008     2007  
Fiscal Year Ended    January 30,
2010
    January 31,
2009
    February 2,
2008
 

Net sales

   100.0   100.0   100.0

Cost of sales

   70.2      67.5      66.9   
                  

Gross margin

   29.8      32.5      33.1   

Selling, general, and administrative expenses

   25.3      26.2      29.0   

Asset impairment

   0.4      0.9      0.9   
                  

Operating income

   4.1      5.4      3.2   

Interest (expense) income, net

   (0.1   (0.1   0.7   
                  

Income before (benefit) provision for income taxes

   4.0      5.3      3.9   

(Benefit) provision for income taxes

   (12.7   0.2      0.1   
                  

Net income

   16.7   5.1   3.8
                  

 

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Fiscal 2009 compared to Fiscal 2008

The following summarizes the consolidated operating results of our company. This discussion is followed by an overview of operating results by reportable segment.

Net Sales

 

     2009    Change From
Prior Fiscal Year
     2008
     ($ in millions)

Net sales

   $ 560.9    $ (32.1    (5.4 )%     $ 593.0

Comparable store sales

         (7.1 )%    

Net sales in fiscal 2009 decreased as a result of the following:

 

   

A decrease of 7.1% in comparable store sales resulting from a 2.5% decline in comparable store average dollar sales and a 4.1% decrease in comparable store average transaction counts. Comparable store average dollar sales decreased mainly due to an 8.4% decline in our average unit retail prices, primarily driven by increased promotional activity and an increase in clearance sales at Wet Seal, our strategic decision to significantly lower price points at Arden B in January 2009, and a decline in Wet Seal frequent buyer program membership sales, partially offset by a 6.9% increase in the number of units purchased per customer, compared to the prior year, primarily at Wet Seal.

However, these factors were partially offset by:

 

   

An increase of $1.2 million in net sales resulting from a change in estimated breakage for unredeemed gift cards, gift certificates and store credits from greater than three years to greater than two years from their respective issuance dates;

 

   

An increase of $2.7 million in net sales for our internet business compared to the prior year, which is not a factor in calculating our comparable store sales; and

 

   

An increase in the number of stores open, from 496 stores as of January 31, 2009, to 504 stores as of January 30, 2010.

Cost of Sales

 

     2009     Change From
Prior Fiscal Year
     2008  
     ($ in millions)  

Cost of sales

   $ 394.1      $ (6.4       (1.6 )%     $ 400.5   

Percentage of net sales

     70.2     2.7      67.5

Cost of sales includes the cost of merchandise; markdowns; inventory shortages; inventory valuation adjustments; inbound freight; payroll expenses associated with design, buying, planning and allocation; processing, receiving and other warehouse costs; rent; and depreciation and amortization expense associated with our stores and distribution center.

Cost of sales decreased due primarily to the 5.4% decrease in net sales, a decrease in buying, planning and allocation costs primarily due to the full-year effect of eliminated positions as a result of the restructuring of the Arden B buying and design organization, favorable impact on stock-based compensation from forfeitures by previously employed executives and a change in stock compensation forfeiture rate from 10% to 15% based on historical analysis, a reduction in recruiting as the prior year period included a more significant recruiting retainer fee to search for a chief merchandise officer in the Wet Seal division, and a decrease in distribution costs due to operational efficiencies. Cost of sales was negatively impacted by an increase in occupancy costs primarily due to normal inflation of rents and common area maintenance charges for new stores and remodels/relocations.

 

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Cost of sales increased as a percentage of net sales due primarily to a deleveraging effect on occupancy cost from our comparable store sales decrease and a decrease in merchandise margin. Merchandise margin decreased as a result of an increase in markdown rates for our Wet Seal division, partially offset by a significantly lower markdown rate in our Arden B division, and a decrease in initial markup rates in both divisions, as compared to the prior year. Additionally, net sales includes a benefit of $1.2 million due to a change in estimated timing of when breakage of gift cards, gift certificates and store credits is recognized from greater than three years after their issuance dates to greater than two years after their issuance dates.

Selling, General, and Administrative Expenses (SG&A)

 

     2009     Change From
Prior Fiscal Year
     2008  
     ($ in millions)  

Selling, general, and administrative expenses

   $ 141.6      $ (13.1   (8.4 )%     $ 154.7   

Percentage of net sales

     25.3     (0.9 )%       26.2

Our SG&A expenses are comprised of two components. Selling expenses include store and field support costs, including personnel, advertising and merchandise delivery costs as well as Internet processing costs. General and administrative expenses include the cost of corporate functions such as executives, legal, finance and accounting, information systems, human resources, real estate and construction, loss prevention and other centralized services.

During fiscal 2009, we placed major emphasis on reducing costs across all SG&A categories, resulting in a significant decline in SG&A in absolute dollars as well as a percentage of sales.

Selling expenses decreased approximately $10.2 million from the prior year to $113.8 million. As a percentage of net sales, selling expense was 20.3% of net sales, or 60 basis points lower, as a percentage of net sales, than a year ago.

The following contributed to the current year decrease in selling expenses:

 

   

A $7.6 million decrease in payroll and benefits costs as a result of decreased payroll hours in response to lower sales volume, improved efficiency in controlling labor hours and a decrease in claim costs in our employee health care plan;

 

   

A $0.8 million decrease in advertising and marketing expenditures due to a decrease in in-store signage and the shift to more cost-effective advertising activities at our Arden B division;

 

   

A $0.4 million decrease in credit card fees due to funds received as a result of a Visa Check/Master Money antitrust litigation settlement and lower sales volume, partially offset by increases in interchange fee rates;

 

   

A $0.3 million decrease in store and field travel costs;

 

   

A $0.3 million decrease in bags and boxes usage as a result of lower sales volume;

 

   

A $0.2 million decrease in merchandise delivery costs as a result of a decrease in units processed and slightly lower cost per unit due to lower fuel surcharges compared to the prior year;

 

   

A $0.2 million decrease in store and field meetings and seminars expense; and

 

   

A $0.4 million net decrease in other selling costs.

General and administrative expenses decreased approximately $2.9 million from the prior year to $27.8 million. As a percentage of net sales, general and administrative expenses were 5.0%, or 30 basis points lower, than a year ago.

 

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The following contributed to the current year decrease in general and administrative expenses:

 

   

A $1.4 million decrease in corporate wages, primarily due to reduced staffing levels from the January 2009 organizational restructuring;

 

   

A $1.4 million decrease in corporate bonuses based on a shortfall in our financial performance relative to bonus targets;

 

   

A $0.6 million decrease in stock compensation, primarily due the favorable impact of forfeitures from previously employed executives and a change in stock compensation forfeiture rate from 10% to 15%;

 

   

A $0.3 million decrease in insurance due to favorably negotiated rates upon renewals;

 

   

A $0.2 million decrease in consultant fees; and

 

   

A $0.5 million net decrease in other general and administrative costs.

However, the decreases in general and administrative expenses were partially offset by the following increases:

 

   

A $1.0 million increase in legal fees associated with various litigation matters; and

 

   

A $0.5 million severance charge upon departure of the former chief merchandise officer for our Wet Seal division.

Asset Impairment

 

     2009     Change From
Prior Fiscal Year
     2008  
     ($ in millions)  

Asset impairment

   $ 2.3      $ (3.3    (58.3 )%     $ 5.6   

Percentage of net sales

     0.4      (0.5 )%       0.9

Based on our quarterly assessments of the carrying value of long-lived assets, in fiscal 2009, we identified certain stores with carrying values of their assets, including leasehold improvements, furniture, fixtures and equipment, in excess of such stores’ respective forecasted undiscounted cash flows. Accordingly, we reduced their respective carrying values to their estimated fair market values and wrote down the value of certain capital additions made to previously impaired stores. We incurred noncash charges of $2.3 million in writing down these stores to their respective fair values, primarily in the Wet Seal division.

During fiscal 2008, we recorded impairment charges of $5.6 million in writing down certain stores’ assets to their respective fair values, primarily within our Arden B division.

Interest Expense, Net

 

     2009     Change From
Prior Fiscal Year
     2008  
     ($ in millions)  

Interest expense, net

   $ (0.5   $ (0.2    (28.6 )%     $ (0.7

Percentage of net sales

     (0.1 )%       —        (0.1 )% 

We incurred interest expense, net, of $0.5 million in fiscal 2009 comprised of:

 

   

Non-cash interest expense of $0.9 million with respect to our secured convertible notes, comprised primarily of discount amortization and, to a lesser extent, annual interest at 3.76%, which we have elected to add to principal; partially offset by

 

   

Interest income of $0.4 million from investments in cash and cash equivalents and a nominal noncash benefit to recognize interest cost capitalized on fixed assets.

 

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We incurred interest expense, net, of $0.7 million in fiscal 2008 comprised of:

 

   

Noncash net accelerated interest charges of $1.9 million upon the conversion of $3.4 million of convertible notes into 2,274,804 shares of our common stock;

 

   

Noncash interest expense of $0.8 million with respect to our secured convertible notes comprised primarily of discount amortization and, to a lesser extent, annual interest at 3.76%, which we have elected to add to principal;

 

   

Amortization of deferred financing costs of $0.1 million associated with our revolving credit facility and secured convertible notes; partially offset by

 

   

Interest income of $2.1 million from investments in cash and cash equivalents and a nominal noncash benefit to recognize the decrease in market value of a derivative liability.

(Benefit) Provision for Income Taxes

 

     2009     Change From
Prior Fiscal Year
    2008
     ($ in millions)

(Benefit) provision for income taxes

   $ (71.1   $ (72.4   (5475.5 )%    $ 1.3

In 2004, as a result of disappointing sales results and historical operating losses, we fully reserved against our deferred tax assets. As of January 30, 2010, we performed a current analysis of all available evidence including, but not limited to, generating taxable income for the past four consecutive years, including 2009 in which we operated in an extremely challenging retail and economic environment, and concluded that the evidence supports that it is more likely than not that all of our deferred tax assets will be realized, and we reversed the valuation allowance against the net deferred tax assets in the amount of $71.3 million.

We have NOL carry forwards available, subject to certain limitation, to offset our regular taxable income in fiscal 2009 and 2008. Therefore, we incurred cash income taxes only for the limited portion of federal alternative minimum taxes and income taxes in the State of California which cannot be offset by NOL carry forwards in fiscal 2009 and 2008. Also, during fiscal 2009, we generated a nominal income tax benefit to reflect a prior period income tax overpayment to Puerto Rico.

Segment Information

The following is a discussion of the operating results of our business segments. We consider each of our operating divisions to be a segment. In the tables below, Wet Seal and Arden B reportable segments include data from their respective stores and Internet operations. Operating segment results include net sales, cost of sales, asset impairment and store closure costs, and other direct store and field management expenses, with no allocation of corporate overhead, interest income or expense.

Wet Seal:

 

(In thousands, except sales per square foot and store count data)

   Fiscal
2009
    Fiscal
2008
 

Net sales

   $ 465,630      $ 491,052   

% of consolidated net sales

     83     83

Comparable store sales % decrease compared to the prior fiscal year

     (8.5 )%      (4.5 )% 

Operating income

   $ 41,847      $ 71,113   

Sales per square foot

   $ 268      $ 292   

Number of stores as of year-end

     424        409   

Square footage as of year-end

     1,674        1,612   

 

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Wet Seal comparable stores sales decreased 8.5% during fiscal 2009, compared to a prior year decrease of 4.5%. The decrease during fiscal 2009 was due primarily to a 6.6% decrease in comparable store average transaction counts per store and a 1.2% decline in comparable store average dollar sales per transaction. The decrease in comparable store average dollar sales resulted from an 8.1% decrease in our average unit retail prices and a decline in frequent buyer program membership sales, partially offset by an 8.4% increase in units purchased per customer. We believe that the overall net sales decrease was attributable to the difficult retail and economic environment and our weak merchandise mix throughout most of fiscal 2009, partially offset by $0.8 million of additional net sales resulting from a change in estimated breakage for unredeemed gift cards, gift certificates and store credits remaining outstanding more than two years from their respective issuance dates, a $0.4 million increase in net sales in our internet business and a $12.0 million increase from stores not in the comparable store base.

Wet Seal’s operating income, before allocation of corporate general and administration expenses, decreased to 9.0% of net sales during fiscal 2009, from 14.5% during fiscal 2008. The decrease in operating income, as a percentage of sales, was due primarily to a decrease in merchandise margin as a result of higher markdown rates and a decrease in initial markup rates, as a result of the difficult retail and economic environment and our weak merchandise mix throughout most of fiscal 2009, an increase in occupancy costs primarily due to normal inflation of rents and common area maintenance charges for new stores and remodels/relocations and the resulting deleveraging effect of a decrease in comparable store sales on occupancy costs, compared to the prior year. Additionally, during fiscal 2009 and fiscal 2008, operating income included asset impairment charges of $2.0 million and $0.5 million, respectively, to write down the carrying value of long-lived assets that were identified during our quarterly impairment evaluations. Operating income for fiscal 2009 also included the $0.8 million breakage benefit noted above.

Arden B:

 

(In thousands, except sales per square foot and store count data )

   Fiscal
2009
     Fiscal
2008
 

Net sales

   $ 95,288       $ 101,908   

% of consolidated net sales

     17      17

Comparable store sales % increase (decrease) compared to the prior fiscal year

     0.2      (23.5 )% 

Operating income (loss)

   $ 9,107       $ (9,754

Sales per square foot

   $ 339       $ 326   

Number of stores as of year-end

     80         87   

Square footage as of year-end

     244         267   

Arden B comparable stores sales increased 0.2% during fiscal 2009, compared to a prior year decrease of 23.5%. The increase during fiscal 2009 was due primarily to a 32.7% increase in comparable store average transaction counts per store, largely offset by a 24.5% decrease in comparable store average dollar sales per transaction, which reflects our strategic decision to significantly lower price points across all categories in January 2009. The decrease in the average dollar sales per transaction resulted from a 25.9% decline in our average unit retail prices, slightly offset by a 1.7% increase in units purchased per customer. Throughout fiscal 2009, we were building inventories at Arden B to a level that supports its new fast fashion model. We began to see comparable store sales growth acceleration later in the year when the inventory levels began to peak. The net sales decrease was attributable to the decrease in the number of stores compared to prior year, partially offset by $0.4 million of additional net sales resulting from a change in estimated breakage for unredeemed gift cards, gift certificates and store credits remaining outstanding more than two years from their respective issuance dates and a $2.3 million increase in net sales in our internet business.

Arden B generated operating income of 9.6% of net sales during fiscal 2009, compared to an operating loss of 9.6% of net sales during fiscal 2008. The improvement in operating results was due primarily to a significant increase in merchandise margin resulting from a significant decrease in markdown rates, a decrease in buying

 

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costs upon restructuring the Arden B buying and design groups, partially offset by an increase in merchant incentive bonuses due to improvement in divisional performance, a decrease in occupancy costs due to a decrease in depreciation expense as a result of a number of underperforming Arden B stores being impaired during fiscal 2008, the decrease in store counts from 87 stores as of January 31, 2009, to 80 stores as of January 30, 2010, and a decrease in store payroll costs as a result of lower sales and improved efficiency in controlling labor hours compared to the prior year. Additionally, during fiscal 2009 and fiscal 2008, operating income (loss) included asset impairment charges of $0.3 million and $5.1 million, respectively, to write down the carrying value of long-lived assets that were identified during our quarterly impairment evaluations. Operating income for fiscal 2009 also included the $0.4 million breakage benefit noted above.

Fiscal 2008 compared to Fiscal 2007

The following summarizes the consolidated operating results of our company. This discussion is followed by an overview of operating results by reportable segment.

Net Sales

 

     2008    Change From
Prior Fiscal Year
     2007
     ($ in millions)

Net sales

   $ 593.0    $ (18.2    (3.0 )%     $ 611.2

Comparable store sales

         (8.5 )%    

Net sales in fiscal 2008 decreased as a result of the following:

 

   

A decrease of 8.5% in comparable store sales, which resulted from a 2.6% decrease in the number of transactions per store and a 6.7% decrease in the average dollar sale per transaction. The decline in average dollar sale per transaction resulted primarily from a 7.5% decrease in our average unit retail prices, partially offset by a 2.5% increase in units purchased per customer; and

 

   

A decrease of $2.8 million in net sales for the recording of breakage on unredeemed gift cards, gift certificates, and store credits, primarily as a result of the fourth quarter of fiscal 2007 including a $3.7 million benefit adjustment, versus no such similar adjustment in fiscal 2008.

However, these factors were partially offset by:

 

   

An increase of $4.3 million in net sales for our Internet business compared to the prior year, which is not a factor in calculating our comparable store sales; and

 

   

An increase in the number of stores open, from 494 stores as of February 2, 2008, to 496 stores as of January 31, 2009.

Cost of Sales

 

     2008     Change From
Prior Fiscal Year
     2007  
     ($ in millions)  

Cost of sales

   $ 400.5      $ (8.4    (2.0 )%     $ 408.9   

Percentage of net sales

     67.5      0.6      66.9

Cost of sales decreased due primarily to the 3.0% decrease in net sales and a decrease in buying, planning and allocation costs due to eliminated positions as a result of the restructuring of the Arden B buying and design organization, partially offset by an increase in occupancy costs due to normal inflation in common area maintenance and other costs, the full-year effect of occupancy cost for 78 stores opened in fiscal 2007 and the partial-year effect of occupancy cost for 13 stores opened in fiscal 2008.

 

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Cost of sales increased as a percentage of net sales due primarily to a deleveraging effect on occupancy cost from our comparable store sales decrease.

However, this increase was partially offset by the following decreases:

 

   

An increase in merchandise margin as a percentage of sales. The merchandise margin increased due to a decrease in markdown rates, as compared to the prior year; and

 

   

$0.2 million of preopening costs for our new stores incurred during fiscal 2008, associated with stores under construction and/or opened during the period, versus $1.4 million of such costs incurred in the prior year.

Selling, General, and Administrative Expenses (SG&A)

 

     2008     Change From
Prior Fiscal Year
     2007  
     ($ in millions)  

Selling, general, and administrative expenses

   $ 154.7      $ (22.8   (12.8 )%     $ 177.5   

Percentage of net sales

     26.2     (2.8 )%       29.0

During fiscal 2008, we placed major emphasis on reducing costs across all SG&A categories, resulting in a significant decline in SG&A in absolute dollars as well as a percentage of sales.

Selling expenses decreased approximately $17.2 million from the prior year. As a percentage of net sales, selling expense was 20.9% of net sales, or 210 basis points lower, as a percentage of net sales, than that of a year ago.

The following contributed to the current year decrease in selling expenses:

 

   

An $8.2 million decrease in payroll and benefits costs as a result of lower sales volume, improved alignment of store incentive programs with sales and labor productivity performance, reduced nonselling store activities, a decrease in claim costs in our employee health care plan, primarily due to an increase in claim costs in the prior year as a result of two unusual cases, and a reduction in store preopening costs;

 

   

A $3.5 million decrease in advertising and marketing expenditures due to elimination of print advertising programs in fiscal 2008 and the decision not to execute certain advertising activities at our Arden B division at least until merchandise content improves;

 

   

A $1.6 million decrease in store supply costs due to improved management oversight and favorable cost negotiations;

 

   

A $1.3 million decrease in store and field travel and meeting costs;

 

   

A $1.0 million decrease in merchandise delivery costs due to reduced shipping costs as a result of a change in freight carriers;

 

   

A $0.4 million decrease in bags and boxes due to lower sales volume;

 

   

A $0.3 million decrease in Internet production and ordering costs due to reduced shipping costs and improved efficiency in fulfillment;

 

   

A $0.3 million decrease in bad debt expenses primarily as a result of decreased credit card chargebacks in our Internet operations; and

 

   

A $0.6 million net decrease in other selling costs.

General and administrative expenses decreased approximately $5.6 million from the prior year to $30.8 million. As a percentage of net sales, general and administrative expenses were 5.3%, or 70 basis points lower, than a year ago.

 

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The following contributed to the current year decrease in general and administrative expenses:

 

   

A $2.2 million decrease in corporate wages and payroll taxes primarily due to reduced staffing levels from a January 2008 organizational restructuring;

 

   

A $0.8 million decrease in Board of Directors stock compensation expense;

 

   

A $0.9 million decrease in consultant fees as a result of a decrease in store lease review fees due to a decline in fiscal 2008 store openings, lower internal audit fees as a result of timing of services performed and the prior year including fees for a store efficiency project;

 

   

A $0.8 million decrease in recruiting fees, primarily due to fees incurred in the prior year associated with the search for a chief executive officer;

 

   

A $0.7 million decrease as a result of prior year charges associated with a separation agreement upon departure of our former chief executive officer;

 

   

A $0.7 million decrease in stock compensation primarily due higher than originally estimated forfeitures and a decrease in grants of stock options and other share-based awards;

 

   

A $0.4 million decrease in depreciation due to certain corporate assets becoming fully depreciated in the current year;

 

   

A $0.2 million decrease in loss on asset disposals as the prior year included disposals related to software programs;

 

   

A $0.2 million decrease in corporate travel; and

 

   

A $0.2 million net decrease in other general and administrative expenses.

However, the decreases in general and administrative expenses were partially offset by the following increases:

 

   

A $1.2 million increase in legal fees due to a $0.7 million prior year insurance reimbursement of previously incurred legal fees, and a general increase in the level of necessary legal services; and

 

   

A $0.3 million increase in computer maintenance expense primarily due to additional maintenance fees commencing upon the fiscal 2008 acquisition of Oracle systems to be implemented in fiscal 2009 and fiscal 2010.

Asset Impairment

 

     2008     Change From
Prior Fiscal Year
    2007  
     ($ in millions)  

Asset impairment

   $ 5.6      $ 0.1    1.2   $ 5.5   

Percentage of net sales

     0.9      —       0.9

Based on our quarterly assessments of the carrying value of long-lived assets, in fiscal 2008, we identified certain stores, primarily within our Arden B division, with carrying values of their assets, including leasehold improvements, furniture, fixtures and equipment, in excess of such stores’ respective forecasted undiscounted cash flows. Accordingly, we reduced their respective carrying values to their estimated fair market values and wrote down the value of certain capital additions made to previously impaired stores. We incurred noncash charges of $5.6 million in writing down these stores to their respective fair values.

During fiscal 2007, we recorded impairment charges of $2.0 million in writing down certain stores’ assets to their respective fair values. Additionally in fiscal 2007, based on our annual goodwill analysis, in which we considered the deteriorating operating performance of our Arden B division at that time and our resulting outlook for that business, we wrote off the entire $3.5 million carrying value of our goodwill, which was directly associated with the Arden B division.

 

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Interest (Expense) Income, Net

 

     2008     Change From
Prior Fiscal Year
     2007  
     ($ in millions)  

Interest (expense) income, net

   $ (0.7   $ (5.1   (115.6 )%     $ 4.4   

Percentage of net sales

     (0.1 )%      (0.8 )%       0.7

We generated interest expense, net, of $0.7 million in fiscal 2008 comprised of:

 

   

Noncash net accelerated interest charges of $1.9 million upon the conversion of $3.4 million of convertible notes into 2,274,804 shares of our common stock;

 

   

Noncash interest expense of $0.8 million with respect to our secured convertible notes comprised primarily of discount amortization and, to a lesser extent, annual interest at 3.76%, which we have elected to add to principal; and

 

   

Amortization of deferred financing costs of $0.1 million associated with our revolving credit facility and secured convertible notes; partially offset by

 

   

Interest income of $2.1 million from investments in cash and cash equivalents and a nominal noncash benefit to recognize the decrease in market value of a derivative liability.

We generated interest income, net, of $4.4 million in fiscal 2007, comprised of:

 

   

Interest income of $5.3 million from investments in cash, cash equivalents and marketable securities; and

 

   

Noncash credits of $0.1 million from capitalized interest during the construction period on new store openings; partially offset by

 

   

Noncash interest expense of $0.8 million with respect to our secured convertible notes comprised primarily of discount amortization and, to a lesser extent, annual interest at 3.76%, which we have elected to add to principal;

 

   

Amortization of deferred financing costs of $0.1 million associated with our revolving credit facility and secured convertible notes; and

 

   

Noncash interest expense of $0.1 million to recognize the increase in value of a derivative liability.

Provision for Income Taxes

 

     2008    Change From
Prior Fiscal Year
     2007
     ($ in millions)

Provision for income taxes

   $ 1.3    $ 0.9    249.7    $ 0.4

We had NOLs available, subject to certain limitations, that offset our regular taxable income in fiscal 2008. As a result of a California tax law change, we were disallowed in fiscal 2008 from utilizing NOLs to offset taxable income in that state. Accordingly, we recognized a provision for income taxes using estimated effective tax rates of 2.0% for federal income taxes and 2.2% for state income taxes. These effective rates are based on the portion of our taxable income for fiscal 2008 that cannot be offset by NOLs.

We ceased recognizing tax benefits related to our net operating losses and other deferred tax assets beginning with our second quarter of fiscal 2004, and through fiscal 2008, we recognized the tax benefits associated with our deferred tax assets only when they were realized.

In fiscal 2008 and fiscal 2007, we had sufficient NOLs available to fully offset taxable income generated in both fiscal years. However, under federal tax law, we are permitted to use NOLs to offset only 90% of our taxable income, as calculated on the alternative minimum tax basis. As such, our remaining 10% of income, as

 

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calculated on the alternative minimum tax basis, is subject to federal income taxes payable at a rate of 20%. Our fiscal 2008 and fiscal 2007 provisions for federal income taxes are primarily comprised of this alternative minimum tax and our fiscal 2008 provision for state income taxes is primarily comprised of California regular income taxes due to the NOL utilization disallowance noted above.

Segment Information

The following is a discussion of the operating results of our business segments. We consider each of our operating divisions to be a segment. In the tables below, Wet Seal and Arden B reportable segments include data from their respective stores and Internet operations. Operating segment results include net sales, cost of sales, asset impairment and store closure costs, and other direct store and field management expenses, with no allocation of corporate overhead, interest income or expense.

Wet Seal:

 

(In thousands, except sales per square foot and store count data)

   Fiscal
2008
    Fiscal
2007
 

Net sales

   $ 491,052      $ 478,405   

% of consolidated net sales

     83     78

Comparable store sales % (decrease) increase compared to the prior fiscal year

     (4.5 )%      1.2

Operating income

   $ 71,113      $ 69,188   

Sales per square foot

   $ 292      $ 314   

Number of stores as of year-end

     409        399   

Square footage as of year-end

     1,612        1,568   

Wet Seal comparable stores sales decreased 4.5% during fiscal 2008, compared to a prior year increase of 1.2%. Wet Seal comparable store sales decreased 6.1% during the second half of fiscal 2008, which coincided with a further decline in the U.S. economy. The decrease during fiscal 2008 was due primarily to a 4.2% decline in comparable store average dollar sale per transaction and a 1.2% decrease in comparable store average transaction counts per store. The decrease in comparable store average dollar sale per transaction resulted from a 4.2% decrease in our average unit retail prices, partially offset by a 2.0% increase in units purchased per customer. The net sales increase was attributable primarily to the increase in number of stores open, from 399 stores as of February 2, 2008, to 409 stores as of January 31, 2009, and a $5.7 million increase in net sales in our Internet business, partially offset by the comparable store sales decline.

Wet Seal’s operating income, before allocation of corporate general and administrative expenses, was 14.5% of its net sales for both fiscal 2008 and fiscal 2007. Wet Seal’s operating income rate, as a percentage of sales, remained stable in spite of the comparable store sales decline due primarily to a decrease in store payroll costs as a result of improved store labor management and reduced nonselling tasks, partially offset by a decrease in merchandise margin as a result of higher markdown rates due to the competitive retail environment compared to the prior year and an increase in occupancy costs resulting from the deleveraging effect of the decrease in comparable store sales. Additionally, during fiscal 2008 and fiscal 2007, operating income included $0.6 million and $2.9 million, respectively, of additional net sales resulting from the recognition of breakage on gift cards, gift certificates, and store credits and noncash asset impairment charges of $0.5 million and $0.2 million, respectively, to write down the carrying value of long-lived assets that were identified during our quarterly evaluations of the carrying value of long-lived assets in excess of forecasted undiscounted cash flows.

 

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Arden B:

 

(In thousands, except sales per square foot and store count data )

   Fiscal
2008
    Fiscal
2007
 

Net sales

   $ 101,908      $ 132,758   

% of consolidated net sales

     17     22

Comparable store sales % decrease compared to the prior fiscal year

     (23.5 )%      (8.2 )% 

Operating loss

   $ (9,754   $ (14,953

Sales per square foot

   $ 326      $ 420   

Number of stores as of year-end

     87        95   

Square footage as of year-end

     267        295   

Arden B comparable stores sales decreased 23.5% during fiscal 2008, compared to a prior year decrease of 8.2%. The decrease during fiscal 2008 was due primarily to a 17.4% decrease in comparable store average transaction counts per store and a 7.3% decrease in comparable store average dollar sale per transaction. The decrease in comparable store average dollar sale per transaction resulted from a 7.3% decline in our average unit retail prices and flat units purchased per customer. In addition, net sales during fiscal 2008 included a $1.4 million decrease in net sales in our Internet business.

Arden B incurred an operating loss, before allocation of corporate general and administrative expenses, of 9.6% of net sales during fiscal 2008, compared to an operating loss of 11.3% of net sales during fiscal 2007. The improvement in operating results was due primarily to an increase in merchandise margin resulting from a significant decrease in markdown rates and higher initial markup rates, a decrease in buying costs due to the restructuring of the Arden B buying and design group and a decrease in advertising and marketing expenditures due to elimination of Arden B print advertising programs in fiscal 2008 and the decision not to execute certain advertising activities at our Arden B division at least until merchandise content improves. These decreases were partially offset by the deleveraging effect on occupancy and other operating costs resulting from the decrease in comparable store sales. Additionally, during fiscal 2008 and fiscal 2007, operating loss included $0.3 million and $0.8 million, respectively, of additional net sales resulting from the recognition of breakage on gift cards, gift certificates, and store credits. Fiscal 2008 and fiscal 2007 operating loss also included noncash asset impairment charges of $5.1 million and $1.9 million, respectively, to write down the carrying value of long-lived assets that were identified during our quarterly evaluations of the carrying value of long-lived assets in excess of forecasted undiscounted cash flows, and fiscal 2007 included a $3.5 million write-off of the carrying value of the goodwill associated with the Arden B division.

Liquidity and Capital Resources

Net cash provided by operating activities was $40.5 million for fiscal 2009, compared to $58.3 million for the same period last year. For fiscal 2009, operating cash flows were due to our net income of $93.4 million and net non-cash charges, primarily depreciation and amortization, asset impairment, stock-based compensation and non-cash interest expense, of $20.4 million, and an increase in merchandise accounts payable, net of an increase in merchandise inventories, of $2.6 million, partially offset by $71.3 million reversal of a net deferred tax asset valuation allowance, and a net use of cash from changes in other operating assets and liabilities of $4.6 million, including gift card, gift certificate and store credit breakage of $1.2 million. For fiscal 2009, net cash used in investing activities of $21.3 million was comprised entirely of capital expenditures. Capital expenditures for the period were primarily for remodeling of existing Wet Seal stores upon lease renewals and/or store relocations, the construction of new Wet Seal stores, and investment in development of new markdown optimization and point-of-sale operating systems and a distribution sorting system. Capital expenditures that remain unpaid as of January 30, 2010, have decreased $0.3 million since the end of fiscal 2008. We expect to pay nearly all of the total balance of such amounts payable, in the amount of $2.6 million, during the first quarter of fiscal 2010.

We estimate that, in fiscal 2010, capital expenditures will be approximately $40 million, net of approximately $5 million in landlord tenant improvement allowances. Of the total net capital expenditures,

 

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approximately $30 million is expected to be for the remodeling of existing Wet Seal and Arden B stores upon lease renewals and/or store relocations and the construction of new Wet Seal and Arden B stores.

For fiscal 2009, net cash provided by financing activities was $0.5 million, comprised primarily of $7.8 million of proceeds from investor exercises of common stock warrants, which resulted in the issuance of 2,911,520 shares of our Class A common stock, and nominal proceeds from the exercise of stock options, partially offset by $7.3 million used to repurchase 2,025,720 shares of our Class A common stock pursuant to a $12.5 million repurchase authorization granted by our Board of Directors in November 2009. During February 2010, the Company completed its use of this authority and repurchased the balance of the authorized spending of approximately $5.2 million. As a result this authorized spending plan is now closed.

In March 2010, a holder of our convertible notes, preferred stock and Series E warrants converted $4.7 million in principal amount of the convertible notes into 3,111,111 shares of our Class A common stock and 1,611 shares of preferred stock into 537,000 of Class A common stock, and exercised Series E warrants into 625,000 shares of Class A common stock for an exercise price of $2.3 million. As an inducement for the holder to undertake these conversions and/or exercises of the convertible notes, preferred stock and Series E warrants, we provided the holder with a $0.7 million cash payment. The Company also repurchased an insignificant remaining convertible note balance from another holder. As a result of these transactions, there are no longer any remaining convertible notes and preferred stock outstanding.

For fiscal 2008, net cash provided by financing activities was $6.1 million, comprised of proceeds from investor exercises of common stock warrants, which resulted in the issuance of 1,793,139 shares of our Class A common stock, and nominal proceeds from the exercise of stock options.

During fiscal 2008, investors in the Company’s Secured Convertible Notes (the “Notes”) converted $3.4 million of Notes into 2,274,804 shares of Class A common stock and investors in our Convertible Preferred Stock (the “Preferred Stock”) converted $0.6 million of Preferred Stock into 185,333 shares of Class A common stock.

Total cash and cash equivalents at January 30, 2010, was $161.7 million, compared to $142.1 million at January 31, 2009.

We maintain a $35.0 million revolving credit facility, which can be increased up to $50.0 million in the absence of any default and upon the satisfaction of certain conditions precedent specified in the agreement. The revolving credit facility expires in May 2011. Under our revolving credit facility, we are subject to borrowing base limitations on the amount that can be borrowed and certain customary covenants, including covenants limiting our ability to incur additional indebtedness, make investments and acquisitions, grant liens, pay dividends, close stores and dispose of assets, subject to certain exceptions. Our ability to borrow and request the issuance of letters of credit is subject to the requirement that we maintain an excess of the borrowing base over the outstanding credit extensions of not less than $5.0 million. The interest rate on our line of credit under the revolving credit facility is the prime rate or, if we elect, the London Interbank Offered Rate (“LIBOR”) plus a margin ranging from 1.0% to 1.5%. The applicable LIBOR margin is based on the level of average excess availability, as defined under our revolving credit facility, at the time of election, as adjusted quarterly. The applicable LIBOR margin was 1.0% as of January 30, 2010. We also incur fees on outstanding letters of credit under the revolving credit facility in effect at a rate equal to the applicable LIBOR margin for standby letters of credit and 33.3% of the applicable LIBOR margin for commercial letters of credit.

The revolving credit facility ranks senior in right of payment to our Notes. Borrowings under the revolving credit facility are secured by all of our presently owned and hereafter acquired assets. Our obligations thereunder are guaranteed by one of our wholly owned subsidiaries, Wet Seal GC, LLC.

At January 30, 2010, the amount outstanding under the revolving credit facility consisted of $4.8 million in open commercial letters of credit related to merchandise purchases and $1.8 million in standby letters of credit.

 

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At January 30, 2010, we had $28.4 million available for cash advances and/or for the issuance of additional letters of credit. At January 30, 2010, we were in compliance with all covenant requirements in the revolving credit facility and the indenture governing our Notes.

We believe we will have sufficient cash and credit availability to meet our operating and capital requirements for at least the next 12 months. However, over the course of fiscal 2008 and fiscal 2009, consumer confidence and consumer spending deteriorated significantly, and could remain depressed for an extended period. As a result of this current economic crisis, we may experience continued declines in consolidated comparable store sales or experience other events that negatively affect our operating results. If our consolidated comparable store sales drop significantly for an extended period, or we falter in execution of our business strategy, including, among other things, the ability of one or more of our vendors to deliver their merchandise in a timely manner or otherwise meet their obligations, we may not achieve our financial performance goals, which could adversely impact our results of operations and operating cash flow. This could also cause a decrease in or elimination of excess availability under our revolving credit facility, which could force us to seek alternatives to address potential cash constraints, including seeking additional debt and/or equity financing.

The financial performance of our business is susceptible to the declines in discretionary consumer spending, availability of consumer credit and low consumer confidence in the United States. Volatile fuel prices and increasing commodity costs may also cause a shift in consumer demand away from the retail clothing products that we offer. There are no guarantees that government initiatives will limit the duration or severity of the current economic recession or stabilize factors that affect our sales and profitability. Recent adverse economic trends could affect us more significantly than companies in other industries.

Seasonality and Inflation

Our business is seasonal in nature, with the Christmas season, beginning the week of Thanksgiving and ending the first Saturday after Christmas, and the back-to-school season, beginning the last week of July and ending during September, historically accounting for a large percentage of our sales volume. For the past three fiscal years, the Christmas and back-to-school seasons together accounted for an average of slightly less than 30% of our annual sales. We do not believe that inflation has had a material effect on our results of operations during the past three years. However, we cannot be certain that our business will not be affected by inflation in the future.

Commitments and Contingencies

Our principal contractual obligations and commercial commitments at January 30, 2010 are summarized in the following charts. We have no other off-balance sheet commitments.

 

Contractual Obligations

(in thousands)

  Payments Due By Period
  Total   Less Than
1 Year
  1–3
Years
  3–5
Years
  Over 5
Years

Lease commitments:

         

Operating leases

  $ 336,900   $ 57,600   $ 98,800   $ 74,600   $ 105,900

Fixed common area maintenance

    88,100     11,300     22,800     19,900     34,100

Convertible notes, including accrued interest(1)

    5,622     —       5,622     —       —  

Supplemental Employee Retirement Plan

    1,985     220     440     440     885

Merchandise on order with suppliers

    64,096     64,096     —       —       —  

Projected interest on contractual obligations

    431     —       431     —       —  
                             

Total

  $ 497,134   $ 133,216   $ 128,093   $ 94,940   $ 140,885
                             

 

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(1) As of March 31, 2010, all of the outstanding secured convertible notes have been converted or repurchased and we have initiated a satisfaction and discharge of our obligations under the indenture governing such notes.

Lease commitments include operating leases for our retail stores, principal executive offices, warehouse facilities, vehicles, computers and office equipment under operating lease agreements expiring at various times through 2021. Certain leases for our retail stores include fixed common area maintenance obligations.

We have a defined benefit Supplemental Employee Retirement Plan (the “SERP”) for one former director. The SERP provides for retirement death benefits through life insurance. We funded a portion of the SERP obligation in prior years through contributions to a trust arrangement known as a “Rabbi” trust.

We place merchandise orders approximately 30 to 60 days in advance for domestic merchandise and 70 to 120 days in advance for imported merchandise. Occasionally, we have “promotional events” for which we purchase larger quantities at discounted prices. We do not maintain any long-term or exclusive commitments or arrangements to purchase merchandise from any single supplier. We have markdown risk to the extent we do not ultimately achieve adequate sell-through on such merchandise.

The projected interest component on our company’s contractual obligations was estimated based on the prevailing or contractual interest rates for the respective obligations over the period of the agreements (see Note 5 of notes to consolidated financial statements). This projected interest pertains to the 3.76% interest, compounded annually, on our secured convertible notes. Upon investor conversions of our secured convertible notes, we no longer become obligated to pay a ratable portion of such interest. As of March 31, 2010 all of our outstanding secured convertible notes have been converted.

Our other commercial commitments consist of letters of credit primarily for the procurement of domestic and imported merchandise and to secure obligations to certain insurance providers, and are secured through our senior revolving credit facility. At January 30, 2010, our contractual commercial commitments under these letter of credit arrangements were as follows:

 

Other Commercial Commitments

(in thousands)

   Total
Amounts
Committed
   Amount of Commitment Expiration Per Period
      Less Than
1 Year
   1–3
Years
   3–5
Years
   Over 5
Years

Letters of credit

   $ 6,550    $ 6,550    —      —      —  

Recently Adopted Accounting Pronouncements

Effective July 2009, the Financial Accounting Standards Board (FASB) codified accounting literature into a single source of authoritative accounting principles, except for certain authoritative rules and interpretive releases issued by the SEC. Since the codification did not alter existing accounting principles generally accepted in the United States of America (GAAP), it did not have an impact on our consolidated financial statements. All references to pre-codified GAAP have been removed from this Form 10-K.

In June 2008, the FASB issued guidance which requires entities to apply the two-class method of computing basic and diluted earnings per share to participating securities with nonforfeitable dividend rights, irrespective of whether the entity declares and/or pays a dividend. This guidance was effective for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2008, and all prior-period earnings per share data presented shall be adjusted retrospectively. Effective February 1, 2009, we adopted this guidance and it did not significantly impact our consolidated financial statements. Refer to Note 12 of the notes to consolidated financial statements for further information.

In December 2008, the FASB issued guidance which requires enhanced disclosures about plan assets in an employer’s defined benefit pension or other postretirement plan. Companies are required to disclose information

 

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about how investment allocation decisions are made, the fair value of each major category of plan assets, the basis used to determine the overall expected long-term rate of return on assets assumption, a description of the inputs and valuation techniques used to develop fair value measurements of plan assets, and significant concentrations of credit risk. This guidance was effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Effective February 1, 2009, we adopted this guidance and it did not significantly impact our consolidated financial statements. Refer to Note 11 of the notes to consolidated financial statements for further information.

New Accounting Pronouncements Not Yet Adopted

In October 2009, the FASB issued guidance related to revenue arrangements with multiple deliverables. Under the new guidance, when vendor specific objective evidence or third party evidence for deliverables in an arrangement cannot be determined, a best estimate of the selling price is required to separate deliverables and allocate arrangement consideration using the relative selling price method. Such guidance is to be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We do not believe adoption of this guidance will have any effect on our consolidated financial statements.

In January 2010, the FASB issued guidance and clarifications for improving disclosures about fair value measurements. This guidance requires enhanced disclosures regarding transfers in and out of the levels within the fair value hierarchy. Separate disclosures are required for transfers in and out of Level 1 and 2 fair value measurements, and the reasons for the transfers must be disclosed. In the reconciliation for Level 3 fair value measurements, separate disclosures are required for purchases, sales, issuances, and settlements on a gross basis. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements, which are effective for interim and annual reporting periods beginning after December 15, 2010. We do not believe adoption of this guidance will have any effect on our consolidated financial statements.

Additional information regarding new accounting pronouncements is contained in Note 1 of notes to consolidated financial statements herein.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

To the extent that we borrow under our revolving credit facility, we are exposed to market risk related to changes in interest rates. At January 30, 2010, no borrowings were outstanding under the revolving credit facility. As of January 30, 2010, we are not a party to any material derivative financial instruments.

Foreign Currency Exchange Rate Risk

We contract for and settle all purchases in U.S. dollars, and in fiscal 2009, we directly imported only approximately 18% of our merchandise inventories. Thus, we consider the effect of currency rate changes to be indirect and we believe the effect of a major shift in currency exchange rates on short-term results would be minimal. Over a longer period, the impact of such changes could be significant, albeit indirectly, through increased charges in U.S. dollars from our vendors that source their product internationally.

 

Item 8. Financial Statements and Supplementary Data

Information with respect to this item is set forth under Item 15.

 

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Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

None.

 

Item 9A. Controls and Procedures

Disclosure Controls and Procedures

We conducted an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report.

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Based on such evaluation, our chief executive officer and chief financial officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in recording, processing, summarizing, and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act and are effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

During the fiscal quarter ended January 30, 2010, no changes occurred with respect to our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting as of January 30, 2010, based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our management’s evaluation under the framework in Internal Control—Integrated Framework, our management concluded that our internal control over financial reporting was effective as of January 30, 2010.

Our internal control over financial reporting as of January 30, 2010, has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report which is included herein.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

The Wet Seal, Inc.:

We have audited the internal control over financial reporting of The Wet Seal, Inc. and subsidiaries (the “Company”) as of January 30, 2010, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 30, 2010, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended January 30, 2010, of the Company and our report dated March 31, 2010, expressed an unqualified opinion on those financial statements.

/s/ DELOITTE & TOUCHE LLP

Costa Mesa, CA

March 31, 2010

 

Item 9B. Other Information

None.

 

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PART III

 

Item 10. Directors, Executive Officers, and Corporate Governance of the Registrant

The following is a list, as of March 31, 2010, of the names and ages of the executive officers of The Wet Seal, Inc.

 

Name

  

Officers and Other Positions Held With Our Company

   Age

Edmond S. Thomas

   President and Chief Executive Officer    56

Steven H. Benrubi

   Executive Vice President, Chief Financial Officer, and Corporate Secretary    43

Sharon Hughes

   Chief Merchandise Officer, Arden B Division    50

Edmond S. Thomas. Mr. Edmond S. Thomas was appointed president and chief executive officer effective October 2007. Mr. Thomas previously served as president and chief operating officer of our company from 1992 through 2000. Immediately prior to joining us, Mr. Thomas served as president and co-chief executive officer of Tilly’s Inc., a privately owned company that sells action sports-related apparel, footwear, and accessories. Mr. Thomas had served in this position since 2005. Mr. Thomas is currently the managing partner of The Evans Thomas Company, LLC, which is the general partner of AXIS Capital Fund I, LP, which provides advisory services for retail, catalog, and consumer goods companies along with investment in emerging growth retail companies.

Steven H. Benrubi. Mr. Steven H. Benrubi was appointed our executive vice president and chief financial officer in September 2007. Since June 2005, Mr. Benrubi had previously served as our vice president and corporate controller. Immediately prior to that, from August 2003, he served as vice president and corporate controller of CKE Restaurants, Inc., the parent company of several fast food restaurant chains including Carl’s Jr. and Hardee’s. Prior to his employment with CKE Restaurants, Inc., Mr. Benrubi served as treasurer of Champion Enterprises, Inc., a manufacturer and retailer of manufactured homes.

Sharon Hughes. Ms. Sharon Hughes was appointed our president and chief merchandise officer for our Arden B division effective November 19, 2009. Ms. Hughes most recently served as a consultant to lead the Arden B merchant team from February 2008 to November 2009. Prior to that, from 2002 to 2008 Ms. Hughes provided merchandising and operational consulting services to various companies. From 1990 to 2002 Ms. Hughes was previously an employee of our Company, during which time she was involved in the formation of the Arden B concept, eventually serving as our senior vice president of merchandising for our Wet Seal division. From 1984 to 1990, Ms. Hughes served as a general merchandise manager at Saturday’s World, a women’s specialty retailer based in Seattle, Washington. Prior to her employment with Saturday’s World, Ms. Hughes served as a buyer for our Wet Seal division beginning in 1979.

Additional information with respect to this item is incorporated by reference from our definitive Proxy Statement to be filed with the Commission not later than 120 days after the end of the Registrant’s fiscal year covered by this Annual Report on Form 10-K.

 

Item 11. Executive Compensation

Information with respect to this item is incorporated by reference from our definitive Proxy Statement to be filed with the SEC not later than 120 days after the end of the Registrant’s fiscal year covered by this Annual Report.

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Information with respect to this item is incorporated by reference from our definitive Proxy Statement to be filed with the SEC not later than 120 days after the end of the Registrant’s fiscal year covered by this Annual Report.

 

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Item 13. Certain Relationships and Related Transactions, and Director Independence

Information with respect to this item is incorporated by reference from our definitive Proxy Statement to be filed with the SEC not later than 120 days after the end of the Registrant’s fiscal year covered by this Annual Report.

 

Item 14. Principal Accountant Fees and Services

Information with respect to this item is incorporated by reference from our definitive Proxy Statement to be filed with the SEC not later than 120 days after the end of the Registrant’s fiscal year covered by this Annual Report.

 

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PART IV

 

Item 15. Exhibits and Financial Statement Schedules

 

(a) The following documents are filed as part of this report:

 

  1. Financial Statements: The financial statements listed in the “Index to Consolidated Financial Statements and Financial Statement Schedules” at F-1 are filed as part of this report.

 

  2. Financial Statement Schedules: All schedules are omitted as they are not required, or the required information is shown in the consolidated financial statements or notes thereto.

 

  3. Exhibits: See “Exhibit Index.”

 

(b) See (a) 3 above.

 

(c) See (a) 1 and 2 above.

 

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EXHIBIT INDEX

 

Exhibit No.

  

Description

  3.1    Restated Certificate of Incorporation of our company (incorporated by reference to Exhibit 3.1 of our company’s Registration Statement on Form S-1 filed September 2, 1992)
  3.1.1    Amendment to Restated Certificate of Incorporation of our company (incorporated by reference to Exhibit 3.1.1 of our company’s Annual Report on Form 10-K for the fiscal year ended February 2, 2002)
  3.1.2    Amendment to Restated Certificate of Incorporation, as amended, of our company (incorporated by reference to Exhibit 3.1 of our company’s Current Report on Form 8-K filed on January 18, 2005)
  3.1.3    Amendment to Restated Certificate of Incorporation, as amended, of our company (incorporated by reference to Exhibit 3.1.3 of our company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2006)
  3.2    Amended and Restated Bylaws of our company (incorporated by reference to Exhibit 3.1 of our company’s Current Report on Form 8-K filed on May 29, 2009)
  4.1    Specimen Certificate of the Class A Stock, par value $.10 per share (incorporated by reference to Exhibit 4.1 of our company’s Registration Statement on Form S-1 filed September 2, 1992)
  4.2    Specimen Certificate of the Class B Stock, par value $.10 per share (incorporated by reference to Exhibit 4.2 of our company’s Registration Statement on Form S-1 filed September 2, 1992)
  4.3    Certificate of Designations, Preferences and Rights of Series C Convertible Preferred Stock of the Company (incorporated by reference to Exhibit 10.3 of our company’s Current Report on Form 8-K filed on May 3, 2005)
  4.4    Indenture entered into between our company and The Bank of New York, dated as of January 14, 2005 (incorporated by reference to Exhibit 10.7 of our company’s Current Report on Form 8-K filed on January 21, 2005)
  4.4.1    Supplemental Indenture entered into between our company and The Bank of New York, dated as of March 1, 2006 (incorporated by reference to Exhibit 4.5.1 of our company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2006)
  4.4.2    Second Supplemental Indenture entered into between our company and The Bank of New York, dated as of June 21, 2006 (incorporated by reference to Exhibit 4.1 of our company’s Quarterly Report on Form 10-Q for the fiscal quarter ended July 29, 2006)
  4.4.3    Third Supplemental Indenture entered into between our company and The Bank of New York, dated as of December 28, 2006 (incorporated by reference to Exhibit 4.5.3 of our company’s Annual Report on Form 10-K for the fiscal year ended February 3, 2007)
  4.5    Form of Registered Global 3.76% Secured Convertible Note due January 14, 2012 issued by our company (incorporated by reference to Exhibit 4.8 of our company’s Registration Statement on Form S-3 filed on May 17, 2005)
  4.6    Form of Series C Warrant issued by our company (incorporated by reference to Exhibit 10.6 of our company’s Current Report on Form 8-K filed on December 14, 2004)
  4.7    Form of Series D Warrant issued by our company (incorporated by reference to Exhibit 10.7 of our company’s Current Report on Form 8-K filed on December 14, 2004)
  4.8    Form of Series E Warrant issued by our company (incorporated by reference to Exhibit 10.4 of our company’s Current Report on Form 8-K filed on May 3, 2005)

 

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Exhibit No.

  

Description

10.1    Lease between our company and Foothill-Parkstone I, LLC, dated November 21, 1996 (incorporated by reference to Exhibit 10.1 of our company’s Annual Report on Form 10-K for the fiscal year ended January 31, 1998)
10.1.1    Lease Addendum between our company and FFP, LLC, dated October 28, 2006 (incorporated by reference to Exhibit 10.1.1 of our company’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 28, 2006)
10.2    1996 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.10 of our company’s Annual Report on Form 10-K for the fiscal year ended February 1, 1997)
10.2.1    Second Amendment to the 1996 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.10.1 of our company’s Annual Report on Form 10-K the fiscal year ended February 2, 2002)
10.3    Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.11 of our company’s Annual Report on Form 10-K for the fiscal year ended January 31, 1998)
10.4    2000 Stock Incentive Plan (incorporated by reference to Exhibit 10.12 of our company’s Annual Report on Form 10-K for the fiscal year ended February 3, 2001)
10.5    2005 Stock Incentive Plan (incorporated by reference to Exhibit B of our company’s Definitive Proxy Statement on Form DEF 14A, dated December 14, 2004)
10.5.1    Amendment to the 2005 Stock Incentive Plan (incorporated by reference to Exhibit B of our company’s Definitive Proxy Statement on Form DEF 14A, dated June 17, 2005)
10.6    Indemnification Agreement between our company and various executives and directors, dated January 3, 1995 (incorporated by reference to Exhibit 10.9 of our company’s Annual Report on Form 10-K for the fiscal year ended January 28, 1995)
10.7    Form of Indemnification Agreement between our company and members of our Board of Directors (incorporated by reference to Exhibit 10.33 of our company’s Annual Report on Form 10-K for the fiscal year ended February 29, 2005)
10.8    Employment Agreement between our company and Edmond S. Thomas, dated September 6, 2007 (incorporated by reference to Exhibit 10.1 of our company’s Current Report on Form 8-K filed on September 11, 2007)
10.9    Amended and Restated Employment Agreement between our company and Steven H. Benrubi, dated February 12, 2008 (incorporated by reference to Exhibit 10.2 of our company’s Current Report on Form 8-K filed on February 19, 2008)
10.10    Employment Agreement between our company and Sharon Hughes, dated November 19, 2009 (incorporated by reference to Exhibit 10.1 of our company’s Current Report on Form 8-K filed on November 20, 2009)
10.11    Form of Restricted Stock Agreement between our company and members of our Board of Directors (incorporated by reference to Exhibit 10.34 of our company’s Annual Report on Form 10-K for the fiscal year ended January 29, 2005)
10.12    Amended and Restated Credit Agreement entered into by and among our Company and Bank of America, N.A., dated August 14, 2006 (incorporated by reference to Exhibit 10.1 of our company’s Current Report on Form 8-K filed on August 18, 2006)
10.13    Security Agreement entered into among our company, Bank of America (f/k/a Fleet National Bank) and certain other parties thereto, dated May 26, 2004 (incorporated by reference to Exhibit 10.2 of our company’s Current Report on Form 8-K filed on January 5, 2005)

 

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Exhibit No.

  

Description

10.14    Amended and Restated Subordination Agreement entered into by and among our company, certain of the Senior Lenders, The Bank of New York and the Investors, dated January 14, 2005 (incorporated by reference to Exhibit 10.4 of our company’s Current Report on Form 8-K filed on January 21, 2005)
10.15    Amendment No. 1 to Amended and Restated Subordination Agreement entered into by and among our company, certain of the Senior Lenders, The Bank of New York and the Investors, dated April 29, 2005 (incorporated by reference to Exhibit 10.10 of our company’s Current Report on Form 8-K filed on May 3, 2005)
10.16    Subordination Agreement entered into by and among the Company, the Investors and Fleet Retail Group, Inc., as agent for the senior lenders, dated April 29, 2005 (incorporated by reference to Exhibit 10.8 of our company’s Current Report on Form 8-K filed on May 3, 2005)
10.17    Form of Stock Option Agreement between our company and employees of our company (incorporated by reference to Exhibit 10.27 of our company’s Annual Report on Form 10-K for the fiscal year ended February 3, 2007)
10.18    Stock Option Agreement between our company and Edmond S. Thomas, dated March 7, 2008 (incorporated by reference to Exhibit 10.1 of our company’s Current Report on Form 8-K filed on March 11, 2008)
12.1    Statement of Computation of Ratios
14.1    The Wet Seal, Inc. Code of Business Ethics and Conduct (incorporated by reference to Exhibit 14.1 of our company’s Current Report on Form 8-K filed on October 1, 2008)
21.1    Subsidiaries of the registrant
23.1    Consent of Independent Registered Public Accounting Firm
31.1    Certification of the Chief Executive Officer filed herewith pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2    Certification of the Chief Financial Officer filed herewith pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1    Certification of the Chief Executive Officer furnished herewith pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2    Certification of the Chief Financial Officer furnished herewith pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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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.

 

THE WET SEAL, INC.

(Registrant)

By:

 

/s/    EDMOND S. THOMAS        

 

Edmond S. Thomas

President and

Chief Executive Officer

By:

 

/s/    STEVEN H. BENRUBI        

 

Steven H. Benrubi

Executive Vice President and

Chief Financial Officer

Date Signed: March 31, 2010

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 indicated and on the dates indicated.

 

Signatures

  

Title

 

Date Signed

/s/    EDMOND S. THOMAS        

Edmond S. Thomas

   President and Chief Executive Officer (Principal Executive Officer) and Member of the Board of Directors   March 31, 2010

/s/    STEVEN H. BENRUBI        

Steven H. Benrubi

   Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)   March 31, 2010

/s/    HAROLD D. KAHN        

Harold D. Kahn

   Chairman of the Board of Directors   March 31, 2010

/s/    JONATHAN DUSKIN        

Jonathan Duskin

   Director   March 31, 2010

/s/    SIDNEY M. HORN        

Sidney M. Horn

   Director   March 31, 2010

/s/    KENNETH M. REISS        

Kenneth M. Reiss

   Director   March 31, 2010

/s/    HENRY D. WINTERSTERN        

Henry D. Winterstern

   Director   March 31, 2010

/s/    MICHAEL ZIMMERMAN        

Michael Zimmerman

   Director   March 31, 2010

 

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THE WET SEAL, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

AND FINANCIAL STATEMENT SCHEDULES

 

     Page

Report of Independent Registered Public Accounting Firm

   F-2

FINANCIAL STATEMENTS:

  

Consolidated balance sheets as of January 30, 2010 and January 31, 2009

   F-3

Consolidated statements of operations for the fiscal years ended January 30, 2010,  January 31, 2009, and February 2, 2008

   F-4

Consolidated statements of stockholders’ equity and comprehensive income for the fiscal years ended January 30, 2010, January 31, 2009, and February 2, 2008

   F-5

Consolidated statements of cash flows for the fiscal years ended January 30, 2010,  January 31, 2009, and February 2, 2008

   F-6

Notes to consolidated financial statements

   F-8

FINANCIAL STATEMENT SCHEDULES:

  

All schedules are omitted as they are not required, or the required information is shown in the consolidated financial statements or the notes thereto.

  

 

F-1


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

The Wet Seal, Inc.

We have audited the accompanying consolidated balance sheets of The Wet Seal, Inc. and subsidiaries (the “Company”) as of January 30, 2010 and January 31, 2009, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the three years in the period ended January 30, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The Wet Seal, Inc. and subsidiaries as of January 30, 2010 and January 31, 2009, and the results of their operations and their cash flows for each of the three years in the period ended January 30, 2010, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of January 30, 2010, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 31, 2010, expressed an unqualified opinion on the Company’s internal control over financial reporting.

/s/ DELOITTE & TOUCHE LLP

Costa Mesa, CA

March 31, 2010

 

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THE WET SEAL, INC.

CONSOLIDATED BALANCE SHEETS

 

     January 30,
2010
    January 31,
2009
 
    

(In thousands, except

share data)

 
ASSETS     

CURRENT ASSETS:

    

Cash and cash equivalents

   $ 161,693      $ 142,064   

Other receivables

     479        1,784   

Merchandise inventories

     29,159        25,529   

Prepaid expenses and other current assets

     10,939        10,600   

Deferred tax assets

     19,600        —     
                

Total current assets

     221,870        179,977   
                

EQUIPMENT AND LEASEHOLD IMPROVEMENTS:

    

Leasehold improvements

     108,958        102,062   

Furniture, fixtures, and equipment

     66,708        65,378   
                
     175,666        167,440   

Less accumulated depreciation and amortization

     (97,603     (92,571
                

Net equipment and leasehold improvements

     78,063        74,869   
                

OTHER ASSETS:

    

Deferred tax assets

     51,713        —     

Deferred financing costs, net of accumulated amortization of $5,684 and $5,586 at January 30, 2010 and January 31, 2009, respectively

     75        173   

Other assets

     2,509        1,640   
                

Total other assets

     54,297        1,813   
                

TOTAL ASSETS

   $ 354,230      $ 256,659   
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

CURRENT LIABILITIES:

    

Accounts payable—merchandise

   $ 14,588      $ 8,388   

Accounts payable—other

     9,480        9,188   

Income taxes payable

     47        228   

Accrued liabilities

     24,918        28,079   

Current portion of deferred rent

     2,735        3,378   
                

Total current liabilities

     51,768        49,261   
                

LONG-TERM LIABILITIES:

    

Secured convertible notes, including accrued interest of $956 and $752 at January 30, 2010 and January 31, 2009, respectively, and net of unamortized discount of $2,083 and $2,712 at January 30, 2010 and January 31, 2009, respectively

     3,540        2,707   

Deferred rent

     28,827        30,051   

Other long-term liabilities

     1,785        1,821   
                

Total long-term liabilities

     34,152        34,579   
                

Total liabilities

     85,920        83,840   
                

COMMITMENTS AND CONTINGENCIES (Note 6)

    

CONVERTIBLE PREFERRED STOCK, $0.01 par value, authorized 2,000,000 shares; 1,611 and 1,611 shares issued and outstanding at January 30, 2010 and January 31, 2009, respectively

     1,611        1,611   
                

STOCKHOLDERS’ EQUITY:

    

Common stock, Class A, $0.10 par value, authorized 300,000,000 shares; 106,889,150 shares issued and 98,046,279 shares outstanding at January 30, 2010, and 103,319,360 shares issued and 96,635,935 outstanding at January 31, 2009

     10,689        10,332   

Common stock, Class B convertible, $0.10 par value, authorized 10,000,000 shares; no shares issued and outstanding at January 30, 2010 and January 31, 2009, respectively

     —          —     

Paid-in capital

     309,745        300,607   

Accumulated deficit

     (24,398     (117,828

Treasury stock, 8,842,871 shares and 6,683,425 shares, at cost, at January 30, 2010 and January 31, 2009, respectively (Note 7)

     (29,758     (22,461

Accumulated other comprehensive income

     421        558   
                

Total stockholders’ equity

     266,699        171,208   
                

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 354,230      $ 256,659   
                

See notes to consolidated financial statements.

 

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THE WET SEAL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Fiscal Years Ended  
   January 30,
2010
    January 31,
2009
    February 2,
2008
 
     (In thousands, except share data)  

Net sales

   $ 560,918      $ 592,960      $ 611,163   

Cost of sales

     394,092        400,521        408,892   
                        

Gross margin

     166,826        192,439        202,271   

Selling, general, and administrative expenses

     141,633        154,671        177,468   

Asset impairment

     2,341        5,611        5,546   
                        

Operating income

     22,852        32,157        19,257   
                        

Interest income

     487        2,182        5,489   

Interest expense

     (973     (2,863     (1,136
                        

Interest (expense) income, net

     (486     (681     4,353   
                        

Income before (benefit) provision for income taxes

     22,366        31,476        23,610   

(Benefit) provision for income taxes

     (71,064     1,322        378   
                        

Net income

   $ 93,430      $ 30,154      $ 23,232   
                        

Net income per share, basic

   $ 0.92      $ 0.30      $ 0.23   
                        

Net income per share, diluted

   $ 0.92      $ 0.30      $ 0.22   
                        

Weighted-average shares outstanding, basic

     95,685,557        93,172,635        91,154,133   
                        

Weighted-average shares outstanding, diluted

     96,250,188        94,099,234        94,141,019   
                        

See notes to consolidated financial statements.

 

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THE WET SEAL, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

 

    Common Stock   Paid-In
Capital
    Accumulated
Deficit
    Treasury
Stock
    Comprehensive
Income (Loss)
    Accumulated
Other
Comprehensive
Income
    Total
Stockholders’
Equity
 
  Class A   Class B            
  Shares   Par
Value
  Shares   Par
Value
           

Balance at February 3, 2007

  96,218,013   $ 9,622   —     $ —     $ 280,163      $ (171,214   $ (2,400     $ 626      $ 116,797   

Net income

  —       —     —       —       —          23,232        —        $ 23,232        —          23,232   

Stock issued pursuant to long-term incentive plans

  1,201,460     120   —       —       (120     —          —          —          —          —     

Stock-based compensation

  —       —     —       —       5,207        —          —          —          —          5,207   

Amortization of stock payment in lieu of rent

  —       —     —       —       216        —          —          —          —          216   

Exercise of stock options

  48,334     5   —       —       172        —          —          —          —          177   

Exercise of common stock warrants

  909,752     91   —       —       2,210        —          —          —          —          2,301   

Amortization of actuarial gain under Supplemental Employee Retirement Plan

  —       —     —       —       —          —          —          (26     (26     (26

Actuarial net loss under Supplemental Employee Retirement Plan

  —       —     —       —       —          —          —          (4     (4     (4
                         

Comprehensive income

                $ 23,202       
                         

Repurchase of common stock

  —       —     —       —       —          —          (20,061         (20,061
                                                             

Balance at February 2, 2008

  98,377,559     9,838   —       —       287,848        (147,982     (22,461       596        127,839   

Net income

  —       —     —       —       —          30,154        —        $ 30,154        —          30,154   

Stock issued pursuant to long-term incentive plans

  682,525     68   —       —       (68     —          —          —          —          —     

Stock-based compensation

  —       —     —       —       2,977        —          —          —          —          2,977   

Amortization of stock payment in lieu of rent

  —       —     —       —       179        —          —          —          —          179   

Exercise of stock options

  6,000     1   —       —       10        —          —          —          —          11   

Exercise of common stock warrants

  1,793,139     179   —       —       5,939        —          —          —          —          6,118   

Conversions of secured convertible notes into common stock

  2,274,804     227   —       —       3,185        —          —          —          —          3,412   

Conversions of convertible preferred stock into common stock

  185,333     19   —       —       537        —          —          —          —          556   

Amortization of actuarial gain under Supplemental Employee Retirement Plan

  —       —     —       —       —          —          —          (26     (26     (26

Actuarial net loss under Supplemental Employee Retirement Plan

  —       —     —       —       —          —          —          (12     (12     (12
                         

Comprehensive income

                $ 30,116       
                                                                   

Balance at January 31, 2009

  103,319,360     10,332   —       —       300,607        (117,828     (22,461       558      $ 171,208   

Net income

  —       —     —       —       —          93,430        —        $ 93,430        —          93,430   

Stock issued pursuant to long-term incentive plans

  654,936     66   —       —       (66     —          —          —          —          —     

Stock-based compensation

  —       —     —       —       1,624        —          —          —          —          1,624   

Amortization of stock payment in lieu of rent

  —       —     —       —       97        —          —          —          —          97   

Exercise of stock options

  3,334     —     —       —       8        —          —          —          —          8   

Exercise of common stock warrants

  2,911,520     291   —       —       7,475        —          —          —          —          7,766   

Amortization of actuarial gain under Supplemental Employee Retirement Plan

  —       —     —       —       —          —          —          (25     (25     (25

Actuarial net loss under Supplemental Employee Retirement Plan

  —       —     —       —       —          —          —          (112     (112     (112
                         

Comprehensive income

                $ 93,293       
                         

Repurchase of common stock

  —       —     —       —       —          —          (7,297         (7,297
                                                             

Balance at January 30, 2010

  106,889,150   $ 10,689   —     $ —     $ 309,745      $ (24,398   $ (29,758     $ 421      $ 266,699   
                                                             

See notes to consolidated financial statements.

 

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THE WET SEAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Fiscal Years Ended  
   January 30,
2010
    January 31,
2009
    February 2,
2008
 
     (in thousands)  

CASH FLOWS FROM OPERATING ACTIVITIES:

      

Net income

   $ 93,430      $ 30,154      $ 23,232   

Adjustments to reconcile net income to net cash provided by operating activities:

      

Depreciation and amortization

     15,101        14,518        13,673   

Amortization of discount on secured convertible notes

     629        2,746        516   

Amortization of deferred financing costs

     98        284        143   

Amortization of stock payment in lieu of rent

     97        179        216   

Adjustment of derivatives to fair value

     (40     (40     70   

Interest added to (extinguished from) principal of secured convertible notes

     204        (210     328   

Asset impairment

     2,341        5,611        5,546   

Loss on disposal of equipment and leasehold improvements

     361        558        558   

Deferred income taxes

     (71,313     —          —     

Stock-based compensation (Note 2)

     1,624        2,977        5,207   

Changes in operating assets and liabilities:

      

Income taxes receivable

     —          167        (111

Other receivables

     1,305        3,931        (2,111

Merchandise inventories

     (3,630     6,061        2,641   

Prepaid expenses and other current assets

     (339     346        (2,196

Other non-current assets

     (869     62        (51

Accounts payable and accrued liabilities

     3,638        (8,113     (4,475

Income taxes payable

     (181     228        (128

Deferred rent

     (1,867     (986     8,533   

Other long-term liabilities

     (133     (133     (121
                        

Net cash provided by operating activities

     40,456        58,340        51,470   
                        

CASH FLOWS FROM INVESTING ACTIVITIES:

      

Purchase of equipment and leasehold improvements

     (21,304     (23,023     (38,523

Investments in marketable securities

     —          —          (72,659

Proceeds from sales of marketable securities

     —          —          72,659   
                        

Net cash used in investing activities

     (21,304     (23,023     (38,523
                        

 

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Table of Contents

THE WET SEAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

 

     Fiscal Years Ended  
   January 30,
2010
    January 31,
2009
   February 2,
2008
 
     (in thousands)  

CASH FLOWS FROM FINANCING ACTIVITIES:

       

Repurchase of common stock

     (7,297     —        (20,061

Proceeds from exercise of stock options

     8        11      177   

Proceeds from exercise of common stock warrants

     7,766        6,118      2,301   
                       

Net cash provided by (used in) financing activities

     477        6,129      (17,583
                       

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     19,629        41,446      (4,636

CASH AND CASH EQUIVALENTS, beginning of year

     142,064        100,618      105,254   
                       

CASH AND CASH EQUIVALENTS, end of year

   $ 161,693      $ 142,064    $ 100,618   
                       

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

       

Cash paid during the year for:

       

Interest

   $ 67      $ 69    $ 66   

Income taxes

   $ 505      $ 1,094    $ 586   

SUPPLEMENTAL DISCLOSURES OF NONCASH TRANSACTIONS:

       

Conversion of convertible preferred stock into 185,333 shares of Class A common stock

   $ —        $ 556    $ —     

Conversion of secured convertible notes into 2,274,804 shares of Class A common stock

   $ —        $ 3,412    $ —     

Amortization of actuarial gain under Supplemental Employee

Retirement Plan

   $ 25      $ 26    $ 26   

Actuarial net loss under Supplemental Employee Retirement Plan

   $ 112      $ 12    $ 4   

Purchase of equipment and leasehold improvements unpaid at end of year

   $ 2,627      $ 2,935    $ 3,283   

See notes to consolidated financial statements.

 

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THE WET SEAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the fiscal years ended January 30, 2010, January 31, 2009, and February 2, 2008

NOTE 1:    Summary of Significant Accounting Policies

Nature of the Business

The Wet Seal, Inc. (“Wet Seal”) is a national specialty retailer operating stores selling fashionable and basic apparel and accessory items designed for female customers aged 13 to 35 years old. The Company operates two nationwide, primarily mall-based, chains of retail stores under the names “Wet Seal” and “Arden B.” The Company’s success is largely dependent upon its ability to gauge the fashion tastes of its customers and to provide merchandise that satisfies customer demand.

The Company’s fiscal year ends on the Saturday closest to the end of January. The reporting periods include 52 weeks of operations in fiscal 2009, fiscal 2008 and fiscal 2007.

Principles of Consolidation

The consolidated financial statements include the accounts of The Wet Seal, Inc. and its subsidiaries (the “Company”), which are all wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

Basis of Presentation

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP).

Estimates and Assumptions

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses. Actual results could differ from those estimates.

The Company’s most significant areas of estimation and assumption are:

 

   

determination of the appropriate amount and timing of markdowns to clear unproductive or slow-moving inventory;

 

   

estimation of future cash flows used to assess the recoverability of long-lived assets, including goodwill;

 

   

estimation of ultimate redemptions of awards under the Company’s Arden B division customer loyalty program;

 

   

determination of the revenue recognition pattern for cash received under the Company’s Wet Seal frequent buyer program;

 

   

estimation of expected customer merchandise returns;

 

   

estimation of expected gift card, gift certificate, and store credit breakage;

 

   

determination of the appropriate assumptions to use to estimate the fair value of stock-based compensation for purposes of recording stock-based compensation;

 

   

estimation of the net deferred income tax asset valuation allowance; and

 

   

estimation, using actuarially determined methods, of self-insured claim losses under workers’ compensation and employee health care plans.

 

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THE WET SEAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

For the fiscal years ended January 30, 2010, January 31, 2009, and February 2, 2008

NOTE 1:    Summary of Significant Accounting Policies (Continued)

 

Cash and Cash Equivalents

The Company considers all highly liquid debt instruments purchased with an initial maturity of three months or less to be cash equivalents. Cash equivalents are carried at cost, which approximates their fair market value. As of January 30, 2010, cash equivalents principally consist of investments in money market funds invested in U.S. Treasury securities, U.S. government agency securities, or repurchase agreements fully collateralized by U.S. Treasury securities or U.S. government agency securities. The Company is potentially exposed to concentration of credit risk when cash deposits in banks are in excess of federally insured limits. Cash accounts at banks are currently insured by the Federal Deposit Insurance Corporation up to $250,000. At January 30, 2010, and at various other times throughout fiscal 2009, the Company had cash balances in excess of federally insured limits. At January 30, 2010, amounts in excess of federally insured limits were $22.5 million.

Fair Value Measurements

On February 1, 2009, the Company adopted guidance related to fair value measurements pertaining to nonfinancial assets and liabilities. This guidance establishes the authoritative definition of fair value, sets out a framework for measuring fair value and expands the required disclosures about fair value measurement. On February 3, 2008, the Company adopted this guidance as it pertains to the accounting for financial assets and liabilities as well as other assets and liabilities carried at fair value on a recurring basis. Refer to Note 8 for further information.

Merchandise Inventories

Merchandise inventories are stated at the lower of cost or market. Market is determined based on the estimated net realizable value, which generally is the merchandise selling price. Cost is calculated using the retail inventory method. Under the retail inventory method, inventory is stated at its current retail selling value and then is converted to a cost basis by applying a cost-to-retail ratio based on beginning inventory and the fiscal year purchase activity. The retail inventory method inherently requires management judgments and estimates, such as the amount and timing of permanent markdowns to clear unproductiv