UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

 

Commission File Number 1-12552

THE TALBOTS, INC.

(Exact name of registrant as specified in its charter)

 

 

One Talbots Drive, Hingham, Massachusetts 02043

(Address of principal executive offices)

Registrant’s telephone number, including area code

781-749-7600

 

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

 

 

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

None

(Title of class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     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 Exchange Act.  Yes o     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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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  o     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) 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 non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

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

 

The aggregate market value of the voting common stock held by non-affiliates as of the last business day of the registrant’s second fiscal quarter ended July 31, 2010 was $783.9 million.

 

As of March 23, 2011, 69,905,977 shares of the registrant’s common stock were outstanding.

 

Documents Incorporated by Reference

 

Portions of the registrant’s Proxy Statement to be filed in connection with the 2011 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K.

 

 

The Talbots, Inc.

 

Annual Report on Form 10-K for the Fiscal Year Ended January 29, 2011

 

 

 

General

 

The Talbots, Inc. is a specialty retailer and direct marketer of women’s apparel, accessories and shoes sold almost exclusively under the Talbots brand. As used in this report, unless the context indicates otherwise, all references herein to “the Company,” “we,” “us” and “our,” refer to The Talbots, Inc. and its wholly-owned subsidiaries.

 

The Talbots brand vision is “tradition transformed” and focuses on honoring the classic heritage of our brand while emphasizing a relevant and innovative approach to style that is both modern and timeless. We strive to be the leading resource for timeless classics infused with modern luxury while delivering exceptional business results, driving shareholder value and operating as a best-in-class retailer. We are dedicated to our core values of being creatively led, customer-centric and socially conscious while building a winning organization and demonstrating strong brand pride.

 

We are committed to designing and providing our customers with high quality, timeless fashion pieces that have been sourced from socially conscious and cost effective manufacturers and strategically distributed to our store locations based on customer lifestyle, behavior and local climate. We have two primary sales channels, stores and direct marketing, through which we seek to offer a cross-functional means of providing our customers access to our merchandise. Our stores channel consists of retail stores, upscale outlets and surplus outlets. Our direct marketing channel consists of our Internet business, at www.talbots.com, and our catalog business. As of January 29, 2011, we operated 551 stores in the United States and 17 stores in Canada.

 

Description of Operations

 

Stores

 

Our stores are located in 46 states and Canada. In 2010, our stores accounted for 81.7% of our consolidated net sales.

 

As of January 29, 2011, we operated a total of 568 stores under the Talbots name, including retail stores, upscale outlets and surplus outlets. Retail stores represent our principal store concept and offer our most recent, core Talbots brand merchandise. Upscale outlets, introduced in 2009 to reach an upscale outlet customer in her preferred shopping venue, offer a unique assortment of merchandise that is exclusively available at upscale outlet locations. Surplus outlets primarily sell end-of-season excess inventory from our retail stores at value prices. The effective use of surplus outlets allows us to keep a fresh flow of product in our core retail stores.

 

We operate stores in various location types, including specialty centers, malls, village and urban centers, each representing 42.8%, 28.5%, 26.9% and 1.8% of U.S. retail store location type, respectively. The unique range of our store portfolio, both in location type and square footage, allows us to both offer product across a broad size range and better allocate merchandise to best serve our customers’ individual needs.

 

Our store portfolio as of January 29, 2011 is as follows:

 

The majority of the floor area of our stores is devoted to selling space (including fitting rooms) with the balance allocated to stockroom and other non-selling space.

 

We continuously seek to enhance store productivity by management of our real estate portfolio, expense management and identification of operational efficiencies. We view the management of our real estate portfolio as an ongoing strategic process, wherein we seek to rationalize our existing store portfolio, improve the portfolio of the existing square footage, close, consolidate and downsize stores where appropriate and selectively add square footage primarily through our growth in upscale outlets. We evaluate store lease expirations, renewals and other opportunities with these goals in mind, by assessing, on a market-by-market basis, factors such as overall size and potential sales in each market, current performance and growth potential of each store, and available lease expirations, lease renewals and other lease termination opportunities. We expect to seek to reduce our total store square footage over the coming years by carefully evaluating lease and market opportunities.

 

Our stores segment accounted for $991.4 million, $1,027.9 million and $1,261.5 million of our net sales in fiscal years 2010, 2009 and 2008, respectively. Direct profit for the stores segment was $120.9 million, $81.2 million and $65.9 million in fiscal years 2010, 2009 and 2008, respectively. Certain of our most significant assets, including customer accounts receivable, are not allocated or tracked by segment. Therefore, no measure of segment assets is available.

 

Direct Marketing

 

Our direct marketing segment includes our catalog, Internet and red-line phone channels which have been designed to offer customers convenience in ordering Talbots merchandise. In 2010, direct marketing accounted for 18.3% of our consolidated net sales, with the Internet channel comprising 73.0% of our net direct marketing sales.

 

Our catalogs are designed to promote our brand image and drive customers to their preferred shopping channel, including stores, a call center and the Internet. In 2010, we issued 15 separate Talbots catalogs across all business concepts with a circulation of approximately 38.7 million, an increase of 5.7% in circulation from 2009.

 

We utilize computer applications which employ mathematical models to improve the efficiency of our catalog mailings through refinement of our customer list. A principal factor in improving customer response has been the development of our own proprietary list of active customers. We routinely monitor customer interest and update and refine this list. Our customer list also provides important demographic information and serves as an integral part of both our store portfolio management strategy, by helping to identify markets with the potential to support a new store or to identify where a store is no longer warranted, as well as our merchandise allocation strategy, by helping us to determine what type of merchandise will be most sought after in which markets.

 

We strive to make catalog shopping as convenient as possible. We maintain toll-free numbers, accessible seven days a week (except Christmas Day), to accept requests for catalogs and to take customer orders. We maintain a call center in Knoxville, Tennessee designed to provide service to customers. Telephone calls are answered by knowledgeable call center sales associates who enter customer orders and retrieve information about merchandise and its availability. These sales associates also suggest and help to select merchandise and can provide detailed information regarding size, color, fit and other merchandise features. We have achieved efficiencies in order entry and fulfillment, which permit the shipment of most orders the next business day. Our red-line phone channel complements our catalog channel by providing customers direct access from our stores to our call center.

 

Our Internet channel is a natural extension of our existing store and catalog channels, offering a similar broad assortment of our merchandise. We also utilize our Internet channel as an inventory clearance tool via our on-line surplus outlet. In the fall of 2009, we made major enhancements to our Talbots website by providing enhanced visuals and greater ease of functionality to better meet customer needs and to better communicate our “tradition transformed” brand image. We have continued and will continue to refine our website’s functionality and visual content going forward.

 

Sales orders from our website are merged into the existing catalog fulfillment system, allowing efficient shipping of merchandise. Customers can check the availability of merchandise at the time of purchase and the website will provide examples of alternative merchandise if items are unavailable. Additionally, the website’s “online chat” feature allows customers to communicate with customer service representatives. Customers shopping online at

www.talbots.com can also enjoy the benefit of our “find in a store” feature which allows a customer to select merchandise online and then reserve it at a store of her choice. As with the catalog, customer online purchases can be returned by mail or at our retail stores.

 

Our direct marketing segment accounted for $221.7 million, $207.7 million and $233.6 million of our net sales in fiscal years 2010, 2009 and 2008, respectively. Direct profit for the direct marketing segment was $54.2 million, $40.6 million and $24.7 million in fiscal years 2010, 2009 and 2008, respectively. Certain of our most significant assets, including customer accounts receivable, are not allocated or tracked by segment. Therefore, no measure of segment assets is available.

 

In total, our net sales for fiscal years 2010, 2009 and 2008 were earned in the United States, $1.2 billion, $1.2 billion and $1.4 billion, respectively, and Canada, $36.2 million, $34.7 million and $45.8 million, respectively. Similarly, our long-lived assets at January 29, 2011, January 30, 2010 and January 31, 2009 were located in the United States, $184.8 million, $218.2 million and $275.0 million, respectively, and Canada, $1.8 million, $2.2 million and $2.4 million, respectively.

 

Merchandising, Sourcing and Inventory Control & Distribution

 

Merchandising

 

Our evolved merchandising strategy focuses on honoring the classics, while infusing relevant and updated merchandise across all product classifications for our brand. We continue to work to infuse our “tradition transformed” brand vision into our product assortment and merchandise branding in a way that will connect with our target customer while continuing to appeal to our traditional core customer.

 

Our merchandise assortment is designed almost exclusively by our in-house creative team and then edited based on our assessed inventory needs and our brand vision for the upcoming season. By conceptualizing and designing in-house, we have been able to realize higher average initial gross profit margins for our clothing and accessories, while at the same time providing value to our customers. Styles for our merchandise are developed based upon analysis of historical, current and anticipated future fashion trends that will appeal to our target customers. Our merchandising strategy focuses on establishing superior customer satisfaction and a matchless customer experience through a commitment to quality, style and price.

 

We offer selections of our merchandise assortment across a broad size range under the following business concepts: Misses, Petites, and Woman and Woman Petites, our plus size concepts. We believe our ability to service “every woman, every size” sets us apart.

 

Our apparel selection is complemented by our accessories offerings, which primarily includes fashion jewelry, scarves, handbags and footwear. Our merchandising team works to deliver apparel and accessory offerings that communicate a cohesive look which enables customers to assemble complete outfits. Sales associates are trained to assist customers in merchandise selection and wardrobe coordination, helping them achieve the Talbots look from “head-to-toe.”

 

Sourcing

 

We procure our merchandise globally from a balanced and diversified manufacturing network, not relying solely on any one region. Our merchandise is produced by independent manufacturers to our specifications and standards which, for fiscal year 2010 purchases, were located in Asia (84.6%), the Mediterranean (7.8%) and the Americas (7.6%). We seek to manufacture our merchandise with vendors that share our same values and demonstrate a commitment to fair labor standards and the welfare of their workforce and community.

 

In August 2009, we entered into a buying agency agreement with an affiliate of Li & Fung Limited (“Li & Fung”) which, effective September 2009, is acting as our exclusive global apparel sourcing agent for substantially all Talbots apparel. The exclusive agency does not cover certain other products (including swimwear, intimate apparel, sleepwear, footwear, fashion accessories, jewelry and handbags) for which Li & Fung may act as our non-exclusive buying agent at our discretion. As a result of this agreement, we downsized our internal sourcing organization as well as closed our sourcing offices in Hong Kong and India in 2009.

We frequently analyze our overall distribution of manufacturing to ensure that no particular vendor or country is responsible for what we believe would be a disproportionate amount of our merchandise. With the appointment of Li & Fung as our exclusive buying agent for substantially all of our apparel product, we have been able to more readily gain access to additional sourcing countries and regions under its substantial global sourcing network. In 2010, we sourced our merchandise from 153 factories, representing 108 vendors in 23 countries, including purchasing 10.3% of our product from countries with trade preference agreements with the United States. Our top ten vendors, determined based on first-cost dollars, represented 49.1% of our total purchases in fiscal 2010. We expect to continue to manage the geographic dispersion of our sourcing within the Li & Fung network in the coming year, adding further diversity to the regions in which our manufacturers operate while seeking to select vendors that operate in countries that have trade preference agreements with the United States.

 

The following is our sourcing activity, based on first-cost dollars, by top-five countries for 2010:

 

 

In 2010, we upgraded our social responsibility standards to align with leading specialty apparel retailers, and we enhanced our social compliance program to better address global supply chain issues, including child labor, excessive working hours, freedom of association and safe working conditions. We have partnered with Li & Fung to test compliance with these standards at the factories from which we source our product and, further, employed a third party independent monitoring agency to correlate and verify compliance findings. Additionally, in 2010, we launched a community reinvestment program, in partnership with a global non-governmental organization and Li & Fung, to deliver a factory-based women’s education program in certain developing countries from which we source our product. As we learn more about the benefits and impacts of this educational program, we expect to expand to other factories from which we source.

 

While we make efforts to develop strategic partnerships with our top vendors, we do not maintain any long-term or exclusive commitments or arrangements to purchase merchandise from any vendor. No single supplier is critical to our sourcing needs, and we believe that we have sufficient alternative suppliers from which we could source our product in the event that we need to secure additional or replacement production capacity. Further, we take measures to monitor our vendors for compliance with the Fair Labor Standards Act, security procedures and rules mandated by the U.S. Customs and Border Patrol.

 

Inventory Control & Distribution

 

Inventory distribution for our stores and merchandise fulfillment for our direct marketing business is managed through a central distribution facility in Lakeville, Massachusetts. Merchandise is allocated to our stores based on a localization strategy which contemplates customer lifestyle, behavior and local climate. We deliver new and what we believe will be compelling merchandise assortments with fresh floor sets to our stores on at least a monthly basis.

 

While merchandise offerings may vary between stores and sales channels, we seek to provide our customers with cross-functional access to available merchandise by providing red-line phones in stores, which are direct lines in our stores to our call center; offering a “find in a store” feature on our website; and seeking to reach our customers across multiple channels through coordinated direct marketing campaigns and in-store events, promotions and visual presentation.

 

We monitor inventory levels on an on-going basis and use markdowns to clear merchandise as needed. While most inventory is cleared in-store or through our own surplus outlets, certain residual inventory may be liquidated through unaffiliated third parties.

Customer Credit

 

We extend credit to our Talbots customers through the use of our proprietary Talbots credit card. The Talbots credit card is managed through Talbots Classics National Bank, a national banking association organized under the laws of the United States with a main office and principal place of business in Rhode Island, and Talbots Classics Finance Company, both wholly-owned subsidiaries. While our primary objective in offering the Talbots credit card is to enhance customer loyalty and drive merchandise sales, the Company also benefits from finance charge income earned and decreased third party bank card fees.

 

U.S. Talbots credit card holders are automatically enrolled in our customer loyalty program, referred to as our classic awards program, which rewards U.S. Talbots customers with a twenty-five dollar appreciation award for every five hundred points earned. Prior to January 2009, one point was earned for every dollar of merchandise purchased on a Talbots credit card. Commencing in January 2009, we launched an expanded program with three tiers: red, platinum, and black. The red tier is open to all customers, regardless of whether they hold a Talbots credit card, and accrues 0.5 points for every net dollar of merchandise purchased with a non-Talbots credit card payment. The platinum tier is the same as the prior program with one point being earned for every net dollar of merchandise purchased on a Talbots credit card. The black tier is for Talbots credit card holders who spend more than $1,000, net per calendar year on their Talbots credit card, and accrues 1.25 points for every net dollar of merchandise purchased on their Talbots credit card. Points not converted into appreciation awards expire at the end of the calendar year at the red and platinum tiers; points do not expire at the black tier. Appreciation awards can be redeemed against future purchases and expire one year from the date of issuance.

 

Management Information Systems

 

Our systems consist of a full range of retail, catalog, e-commerce, financial and merchandising systems, including credit, inventory distribution and control, sales reporting, accounts payable, procurement, payroll, product design, budgeting and forecasting, financial reporting, merchandise reporting and distribution. We seek to protect company-sensitive information on our servers from unauthorized access using industry standard network security systems in addition to anti-virus and firewall protection. Our e-commerce website makes use of encryption technology to help protect sensitive customer information. Our management information systems and electronic data processing systems are located at our systems center in Tampa, Florida, and at our corporate facilities in Hingham, Massachusetts. We also have a collections system at Talbots Classics Finance Company located in Lincoln, Rhode Island.

 

All of our stores have point-of-sale terminals that transmit information daily on sales by item, color and size. Our stores are equipped with bar code scanning programs for the recording of store sales, returns, inventories, price changes, receipts and transfers. We evaluate this information, together with weekly reports on trend analyses and merchandise statistics, prior to making merchandising decisions regarding allocation of merchandise and promotional activity.

 

During fiscal 2010, we began the reinvestment phase of our three-year IT systems strategic plan which focuses on making systems enhancements designed to aid management in understanding and meeting customer needs, driving growth across the business and promoting operational excellence. Most significantly, during fiscal 2010, we commenced the process of upgrading our Oracle financial system and implementing our Oracle and JDA merchandise financial planning, assortment planning and allocation systems. These systems will provide cross-functional support and analysis tools to better serve our business as well as a foundation for developing a leaner systems operation which will allow us to eliminate redundant systems and reduce customizations. We expect these phases of our systems upgrade to be completed by the close of fiscal 2011 and expect to continue to reinvest in our information systems in the coming year as we continue to execute on this plan.

 

Marketing

 

Our marketing initiatives focus on building and communicating our brand and increasing customer acquisition and retention. Our primary marketing programs consist of catalog circulation, customer mailings, e-commerce advertising, in-store visual presentation, digital and social media outreach, national and regional print advertising as well as other marketing campaigns such as direct promotional customer incentives and events.

In 2010, we reinvested in national print advertising, which had been eliminated from our marketing program in 2008 and 2009 as part of cost-cutting measures; increased our presence in e-commerce advertising; and launched our store refresh and renovation initiative, which represents a significant reinvestment in our in-store visual presentation. These programs are part of a coordinated campaign designed to communicate our updated “tradition transformed” brand image and connect with prospective customers.

 

Seasonality

 

Our business has two distinct selling seasons, spring and fall. The spring selling season is generally reflected in the results of the first and second quarters of the fiscal year, and the fall selling season is generally reflected in the results of the third and fourth quarters of the fiscal year. Direct marketing sales typically peak during the first half of each selling season, in the first and third quarters of the fiscal year, while store sales are generally consistent across quarters and selling seasons. Our total net sales have not shown significant seasonal variation which we believe is attributable to several factors including, but not limited to, our promotional strategies and our merchandising and marketing strategies.

 

Our operating results may fluctuate quarter to quarter as a result of market acceptance of our products, product mix, pricing and presentation of the products offered and sold, the cost of goods sold, the incurrence of other operating costs, the timing of holidays, weather and factors beyond our control, such as general economic conditions and actions of competitors.

 

Competition

 

The women’s specialty retail apparel industry is highly competitive. We compete with many other specialty retailers, department stores and catalog and Internet businesses that offer similar categories of merchandise. We believe that the breadth of our product offering, which provides for complete wardrobe coordination and the ability to achieve the Talbots look from “head-to-toe,” as well as the availability of our merchandise in multiple concepts and through multiple channels, including several store concepts, catalog and Internet, distinguishes us from other women’s apparel retailers.

 

Employees

 

As of January 29, 2011, we had approximately 9,096 employees of whom approximately 2,141 were full-time salaried employees, approximately 1,343 were full-time hourly employees, and approximately 5,612 were part-time hourly employees. None of our employees are represented by a labor union. We believe that our relationship with our employees is good.

 

Executive Officers of the Company

 

The following table sets forth certain information regarding our executive officers as of March 23, 2011:

 

 

Ms. Sullivan joined The Talbots, Inc. as President and Chief Executive Officer and as a Director in August 2007. Prior to joining the Company, Ms. Sullivan served as President of Liz Claiborne, Inc. from January 2006 until July 2007. Ms. Sullivan joined Liz Claiborne, Inc. in 2001 as Group President of the company’s Casual, Collections, and

Elisabeth businesses. She was named Executive Vice President in March 2002 with added responsibilities for all non-apparel business, all direct-to-consumer business (retail and outlet) and the International Alliances business at Liz Claiborne, Inc. She served in this position until she was named President of Liz Claiborne, Inc. in 2006. Prior to joining Liz Claiborne, Inc., Ms. Sullivan served as President of J. Crew Group, Inc. from 1997 until 2001. Additionally, in September 2010, Ms. Sullivan joined the Board of The Yankee Candle Company, Inc.

 

Mr. Scarpa joined The Talbots, Inc. as Chief Operating Officer in December 2008 and was also named Chief Financial Officer and Treasurer in January 2009. Prior to joining the Company, Mr. Scarpa served as Chief Operating Officer of Liz Claiborne, Inc. from January 2007 until November 2008. Mr. Scarpa joined Liz Claiborne in 1983 and served in many senior leadership roles, including Senior Vice President, Chief Financial Officer from July 2002 until May 2005, and Senior Vice President, Finance and Distribution and Chief Financial Officer from May 2005 until January 2007.

 

Mr. Smaldone joined The Talbots, Inc. as Chief Creative Officer in December 2007. Prior to joining the Company, Mr. Smaldone served as Senior Vice President of Design for Ann Taylor Stores Corporation from September 2003 until December 2007. Mr. Smaldone also held senior leadership roles in design at Anne Klein, where he served as Chief Design Officer from July 2001 to September 2003, and Elie Tahari, from May 2000 to May 2001.

 

Ms. Casamento joined The Talbots, Inc. as Executive Vice President, Finance in April 2009. Prior to joining the Company, she spent nine years at Liz Claiborne, Inc., most recently as President of Liz Claiborne, Claiborne and Monet brands from July 2007 until October 2008. Prior to that position, Ms. Casamento served in various other leadership roles within Liz Claiborne, including President of Ellen Tracy and Dana Buchman brands from January 2007 until July 2007, Vice President, Group Operating Director, Better & Moderate Apparel from January 2004 until January 2007, Vice President, Financial Planning and Analysis from November 2000 until January 2004, and Vice President, Group Financial Director, Retail & International Group. Ms. Casamento started her career at Saks Fifth Avenue where she held roles of increasing responsibility in accounting and finance, including Controller of OFF 5th, Saks Fifth Avenue Outlet and the Folio catalog division.

 

Mr. O’Connell was appointed Executive Vice President, Real Estate, Legal, Store Planning & Construction, and Secretary in June 2008. From November 2006 until this appointment, he served as Executive Vice President, Legal and Real Estate, and Secretary. Mr. O’Connell joined The Talbots, Inc. in 1988 as Vice President, Legal and Real Estate, and Secretary, and became Senior Vice President, Legal and Real Estate, and Secretary in 1989. Prior to joining the Company, he served as Vice President, Group Counsel of the Specialty Retailing Group at General Mills, Inc.

 

Mr. Poole joined The Talbots, Inc. as Executive Vice President, Chief Supply Chain Officer in June 2008. From June 2007 until joining the Company, he was Senior Vice President, Chief Procurement Officer for Ann Taylor Stores Corporation. Mr. Poole held various leadership positions at The Gap, Inc. from 1993 through 2006, including Senior Vice President of Sourcing and Vendor Development from August 2004 to February 2006, Senior Vice President of Corporate Administration, Architecture & Construction from August 2001 to August 2004, and Senior Vice President of Corporate Architecture and Construction from July 2000 to August 2001. Mr. Poole has also held leadership positions in supply chain management at Esprit de Corp. and The North Face, Inc.

 

Ms. Wagner joined The Talbots, Inc. as Executive Vice President, Chief Marketing Officer in March 2008. From 2006 until joining the Company, Ms. Wagner held the position of Senior Vice President, Chief Marketing Officer at Cole Haan, a division of Nike. Prior to joining Cole Haan, she served as Senior Vice President of Marketing for Kenneth Cole Productions from 2001 to 2006 and, previously, as Senior Vice President of Brand Marketing and Creative for J. Crew from 1991 until joining Kenneth Cole.

 

Available Information

 

Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are available free of charge on our website located at www.thetalbotsinc.com as soon as reasonably practicable after they are filed with or furnished to the Securities and Exchange Commission (the “SEC”). These reports are also available at the Securities and Exchange Commission’s Internet website at www.sec.gov.

A copy of our Corporate Governance Guidelines, Code of Business Conduct and Ethics, and the charters of the Audit Committee, the Compensation Committee and the Corporate Governance and Nominating Committee are posted on our website, www.thetalbotsinc.com, under “Investor Relations,” and are available in print to any person who requests copies by contacting Talbots Investor Relations by calling (781) 741-4500, by writing to Investor Relations Department, The Talbots, Inc., One Talbots Drive, Hingham, Massachusetts 02043, or by e-mail at investor.relations@talbots.com. Information contained on the website is not incorporated by reference or otherwise considered part of this document.

 

 

Careful consideration should be given to the following risk factors, in addition to the other information included in this Form 10-K and in other documents that we file with the SEC, in evaluating the Company and our business. If any of the risks and uncertainties described below actually occurs, our business, financial condition and results of operations could be materially and adversely affected. The risks described below are not intended to be exhaustive and are not the only risks facing the Company. New risk factors can emerge from time to time and it is not possible to predict the impact that any factor or combination of factors may have on our business, financial condition and results of operations.

 

The success of our business depends on our ability to develop merchandise offerings that resonate with our existing customers and help to attract new customers as well as our ability to continue to develop, evolve, promote and protect the value of our brand.

 

Our future success depends on our ability to consistently anticipate, gauge and respond to our customers’ demands and tastes in the design, pricing, style and production of our merchandise. Our merchandise offerings also require long lead times, making it difficult to respond quickly to changes in customer preferences. Our failure to anticipate, identify or react appropriately and in a timely manner to changes in customer preferences and economic conditions could lead to lower sales, missed opportunities, excessive inventories and more frequent markdowns, each of which could have a material adverse impact on our business and our sales levels. At the same time, as part of our “tradition transformed” brand vision, we are striving to have our product offerings and our brand image and marketing approach increase and expand our customer base while continuing to appeal to our traditional core customer. There is no assurance that we will be successful in increasing our number of customers and customer base or that our product offerings will resonate with our traditional core and expanded customer base. Merchandise misjudgments could also negatively impact our margins, markdown exposure and operating profitability, as well as our image with our customers, and could likely result in diminished brand loyalty.

 

Our future success also depends upon our ability to effectively define, evolve, promote and protect the value of our brand. The Talbots brand name and “tradition transformed” niche is integral to the success of our business. Maintaining, promoting and positioning our brand will depend largely on the success of the brand’s design, merchandising and marketing efforts and the ability to provide a consistent, high quality customer experience. We need to continue to translate market trends into appropriate product offerings while minimizing excess inventory positions and correctly balance the level of our merchandise commitments with actual customer orders.

 

We face substantial competitive pressures from other retailers.

 

The specialty apparel retail industry in which we operate is highly competitive. We compete with many other specialty retailers, department stores and catalog and Internet businesses. The competition among apparel retailers for the reduced discretionary consumer spending we have seen over the past two years has been intense, particularly beginning at the end of 2008 with the significant deterioration in the U.S. and global economies. Many of our competitors are companies with substantially greater financial, marketing and other resources. There is no assurance that we can compete successfully with them in the future.

 

We have experienced, and anticipate that we will continue to experience, significant pricing pressure and significantly increased promotional activity from our competitors. Customers are very selective in their purchasing and may be less connected to any particular brand. Such competition and promotional activity could reduce our

sales, increase our level of excess inventory, result in increased markdowns and reduced margins and adversely affect our results of operations.

 

In addition to competing for sales, we compete for favorable store locations. Increased competition could reduce our ability to find suitable sites for new stores or negotiate acceptable lease terms.

 

Increased store productivity will be largely dependent upon our success in continuing to rationalize our existing store portfolio as well as in increasing customer traffic in our stores.

 

Our ability to increase the productivity of our stores will be largely dependent upon our ability to continue to rationalize our existing store portfolio as well as our ability to generate increased customer traffic in our stores.

 

In March 2011, we announced the acceleration of our store rationalization plan, with an expectation to close approximately 90 to 100 stores and consolidate or downsize approximately 15 to 20 stores over the next two years, with a majority of these actions expected to be completed in fiscal 2011. These actions are expected to reduce gross square footage by approximately 0.5 million square feet. We expect that this reduction in store locations and square footage will help to increase productivity by eliminating overlap in certain markets and allowing management to focus its resources, such as store merchandise inventories and capital expenditures, on a more refined store base. If we are unable to successfully execute on this program to the extent or within the time that we expect or if the improvements in productivity are not at the level that we expect, our margins, liquidity and results of operations could be adversely affected.

 

Customer traffic depends upon our ability to successfully promote our brand with our existing customers and potential new customers through our strategic initiatives, providing merchandise that satisfies customer demand in terms of price, quality, fit and in-stock position, predicting fashion trends for our customers and providing an appealing shopping environment and experience. Our comparable store customer traffic decreased 8.0% in fiscal 2010 compared to the prior year. There can be no assurance that our efforts to increase customer traffic in our stores will be successful or at the levels we would expect, which would negatively impact our sales and store productivity and may leave us with excess inventory. We may need to respond to declines in customer traffic by increasing markdowns or initiating or continuing additional promotions to attract customers to our stores, which would adversely impact our margins and operating results.

 

There are significant risks associated with our strategic initiatives.

 

We are in the early stages of executing a number of major strategic initiatives as part of our transformation strategy designed to drive long-term shareholder value and improve our store productivity, sales and results of operations. These strategic initiatives include:

 

 

There can be no assurance that we will be able to successfully implement each of these strategic initiatives or that our transformation strategy will result in improved results of operations. In addition, depending upon our customers’ reaction and acceptance of these initiatives and, as we obtain more information, we may also need to adjust any one or more of these initiatives. These changes could be substantial and could result in significant costs. If we do not successfully execute on these strategic initiatives or if our transformation strategy does not achieve its intended results, we may experience a material adverse impact on our business and financial results.

Our 2011 operating plan and strategic plan are based on a number of material assumptions that may not occur.

 

Our fiscal 2011 operating plan and strategic plan are based on a number of significant assumptions which we developed based on our historical information, current and expected economic conditions, expectations of our ability to adequately manage rising raw material and freight costs, and expectations and perceptions of our near-term and longer-term sales, margins, other financial results and cost savings as well as many other assumptions. The current economic environment makes it difficult to project or forecast the results expected to be achieved from all of our strategic initiatives. There can be no assurance that our assumptions or expectations will prove to be accurate and it is possible that actual events, actions taken and results actually achieved will be materially different, and could take longer or be more costly than what we have assumed or forecasted, which could have a material adverse impact on our results of operations, liquidity and financial position.

 

Our ability to attract and retain a talented and experienced management team is critical to the continued execution of our turnaround strategy.

 

Our ability to continue to execute our turnaround strategy and generate long-term sustainable growth and profitability depends, to a significant extent, on our ability to attract, motivate and retain key members of our executive and senior management team. In recent years, we have added a significant number of key senior executives in the areas of brand leadership, creative, merchandising, marketing, finance and sourcing. We are also in the process of filling certain open senior management positions including our Chief Stores Officer and Executive Vice President of Merchandising. There can be no assurance that we will be able at all times to attract and retain individuals with the talent, skill and experience necessary for our senior leadership positions. Our operations and the execution of our strategic plan could be adversely affected if we cannot attract and retain a skilled management team.

 

Unfavorable economic conditions or the slowing, stalling or reversal of an economic recovery could materially and adversely impact our financial condition and results of operations.

 

As a retailer that is dependent upon consumer discretionary spending, our results of operations are particularly sensitive to changes in macro-economic conditions. Over the past several years, the U.S. economy weakened significantly as a result of the global economic crisis and may remain depressed for the foreseeable future. Continued weak or uncertain economic conditions may materially and adversely impact consumer confidence and consumer spending and, as a result, our ability to forecast our continuing operations and to achieve our expected operating results would be adversely affected. Further, our ability to meet debt service requirements, invest in capital expenditures and fulfill the obligations arising in the operation of our business may be impacted. Any further decline in economic conditions may negatively impact our business, continuing operations, financial results, liquidity and financial position. A sustained economic downturn would also likely cause a number of the risks that we currently face to increase in likelihood and scope.

 

If we are unable to manage our inventory effectively, we may incur lower margins or losses.

 

Our success depends upon our ability to manage proper inventory levels and respond quickly to shifts in consumer demand patterns. If we overestimate customer demand for our merchandise, we will likely need to record inventory markdowns and move the excess inventory to our surplus outlets to be sold at discount or closeout prices which would negatively impact operating results and could impair our brand image. If we underestimate customer demand for our merchandise, we may experience inventory shortages which may result in missed sales opportunities, negative impact on customer loyalty and loss of revenues. The inability to fill customer orders efficiently could lower customer satisfaction and could cause customers to go to an alternate source for the desired products. This lowered level of customer satisfaction and improper inventory levels could adversely affect our operations.

 

The sufficiency and availability of our sources of liquidity may be affected by a variety of factors.

 

The sufficiency and availability of our sources of liquidity may be affected by a variety of factors, including, without limitation: (i) the level of our operating cash flows, which are impacted by consumer acceptance of our

merchandise, general economic conditions and the level of consumer discretionary spending; and (ii) our ability to maintain required levels of borrowing availability and to comply with applicable covenants included in our senior secured revolving credit facility.

 

As a specialty retailer dependent upon consumer discretionary spending, we have been adversely affected by the global economic crisis, which has impacted our sales, margins, cash flows, liquidity, results of operations and financial condition. Our ability to operate profitably and to generate positive cash flows is dependent upon many factors, including improvement in economic conditions and consumer spending and our ability to successfully execute our long-term financial plan and strategic initiatives. There can be no assurance that our cash flows from operations will be sufficient at all times to support our Company without additional financing or credit availability.

 

On April 7, 2010, we completed our merger with BPW Acquisition Corp., a special purpose acquisition company (“BPW”), which resulted in net cash proceeds of $333.0 million, before our acquisition costs. We simultaneously executed a senior secured revolving credit facility with a third party lender (the “Credit Facility”), which provides borrowing capacity up to $200.0 million, subject to satisfaction of all borrowing conditions. Our Credit Facility contains a borrowing base that is determined primarily by the level of our eligible accounts receivable and inventory. If we do not have a sufficient borrowing base at any given time, borrowing availability under our Credit Facility may not be sufficient to support our liquidity needs. Insufficient borrowing availability under our Credit Facility would likely have a material adverse effect on our business, financial condition, liquidity and results of operations.

 

Moreover, under the Credit Facility, we are subject to various covenants and requirements. Should we be unable to comply with any of the covenants and requirements in the Credit Facility, we would be unable to borrow under such Credit Facility, and any amounts outstanding would become immediately due and payable unless we were able to secure a waiver or an amendment under the Credit Agreement. Should we be unable to borrow under the Credit Facility we may not have the cash resources for our operations and if outstanding borrowings under the facility become immediately due and payable we may not have the cash resources to repay any such accelerated obligations, and in each case, our liquidity would be significantly impaired, which would have a material adverse effect on our business, financial condition and results of operations.

 

There are risks associated with our reliance on an exclusive global merchandise buying agent.

 

In August 2009, we reorganized our global sourcing activities and entered into a long-term buying agency agreement with an affiliate of Li & Fung Limited (“Li & Fung”) pursuant to which Li & Fung was appointed as exclusive global apparel sourcing agent for substantially all of our apparel effective September 2009. There can be no assurance that the anticipated benefits from this arrangement will be realized or realized within the time periods expected. Moreover, we cannot provide assurance that upon cessation of this relationship, for any reason, we would be able to successfully transition to an internal or other external sourcing function.

 

Our overseas merchandise purchasing strategy makes us vulnerable to certain risks, and any disruption in our supply of merchandise would materially impact us.

 

All of our merchandise is manufactured to our specifications by third party suppliers and intermediary vendors, most of which are located outside the United States. Our arrangements with foreign suppliers and with our foreign buying agents are subject, generally, to the risks of doing business abroad, including:

 

 

 

We do not own or operate any manufacturing facilities and rely solely on third party manufacturers. We cannot be certain that we will not experience operational difficulties with our manufacturers, such as reductions in the availability of production capacity, errors in complying with merchandise specifications, insufficient quality control and failures to meet production deadlines or increases in manufacturing costs. A manufacturer’s failure to ship merchandise to us on a timely basis or to meet the required product safety and quality standards could cause supply shortages, failure to meet customer expectations and damage to our brand, which could adversely impact our sales and operating results. Further, any significant negative impacts to our suppliers could have an adverse impact on our business, financial position, liquidity and results of operations. Moreover, there is a risk that our suppliers and vendors could respond to any decrease in or any concern with our liquidity or financial results by requiring or conditioning their sale of merchandise to us on more stringent payment terms, such as requiring standby letters of credit, earlier or advance payment of invoices or payment upon delivery, or other assurances or credit support. There can be no assurance that one or more of our suppliers may not slow or cease shipments or require or condition their sale or shipment of merchandise on more stringent payment terms. If these events were to occur and we did not or were not able to adequately respond, it could materially disrupt our supply of merchandise.

 

We cannot predict whether the foreign countries in which our apparel and accessories are currently manufactured, or any of the foreign countries in which our apparel and accessories may be manufactured in the future, will be subject to import restrictions by the U.S. government, including the likelihood, type or effect of any trade retaliation. Trade restrictions, including increased tariffs or more restrictive quotas, applicable to apparel items could affect the importation of apparel and, in that event, could increase the cost or reduce the supply of apparel available to us and adversely affect our operations.

 

Our third party manufacturers may fail to comply with our social compliance program requirements.

 

We require our third party manufacturers to comply with our social compliance program standards that cover many areas including child labor, excessive working hours, freedom of association and safe working conditions. We monitor their compliance with these standards using our third party global apparel sourcing agent in conjunction with third party monitoring firms. Although we have an active program to provide training for our independent manufacturers and monitor their compliance with these standards, we do not control the manufacturers or their practices. Any failure of our independent manufacturers to comply with our standards or local laws in the country of manufacture could disrupt the shipment of merchandise to us, force us to locate alternative manufacturing sources, reduce demand for our merchandise or damage our reputation.

 

Fluctuations in the price, availability and quality of raw materials could have an adverse impact on our business and financial results.

 

Fluctuations in the price, availability and quality of the fabrics or other raw materials used by us in our manufactured apparel and in the price of materials used to manufacture our footwear and accessories could have a material adverse effect on our cost of sales or our ability to meet our customers’ demands. The prices for such fabrics depend largely on the market prices for the raw materials used to produce them, particularly cotton, leather and synthetics. The price and availability of such raw materials may fluctuate significantly.

 

Commodity prices for cotton, other fabrics and other raw materials which comprise our products have recently increased significantly. If commodity prices continue to rise and if we are not able to recover these cost increases through price increases to our customers, who may be resistant, then such increases will have an adverse effect on our margins and our results of operations.

 

While we have endeavored to manage the impact of changing commodity prices through commercial terms with our vendors, our ability to mitigate the impact of price changes is impacted by many factors, many of which are outside of our control, and our cost mitigation strategies may not be successful or sufficiently responsive to such commodity price increases, either in the short-term or the long-term.

The loss of or infringement upon our trademarks and other proprietary rights could have a material adverse effect on our business.

 

We believe that our “Talbots” trademarks are important to our success and competitive position. Even though we register and take necessary steps to protect our trademark and other intellectual property rights, there is no assurance that our actions will protect us from the prior registration of others or prevent others from infringing on our trademarks and proprietary rights or seeking to block sales of our products as infringements of their trademarks and proprietary rights. Any litigation regarding our trademarks and other proprietary rights could be time-consuming and costly. Further, the laws of foreign countries may not protect proprietary rights to the same extent as do the laws of the United States. Because we have not registered our trademarks in all foreign countries in which we currently manufacture merchandise or may manufacture merchandise in the future, our sourcing of merchandise could be limited.

 

If our intangible or long-lived assets become impaired, we may need to record significant non-cash impairment charges.

 

We review the carrying value of our intangible assets for potential impairment using a combination of an income approach and a market value approach. If an impairment charge is identified, the carrying value is compared to the estimated fair value and an impairment charge is recorded as appropriate. Impairment losses are significantly impacted by estimates of future operating cash flows and estimates of fair value. Our estimates of future operating cash flows are based upon our experience, knowledge and expectations; however, these estimates can be affected by such factors as our future operating results, future store profitability and future economic conditions, all of which can be difficult to predict. The carrying value of our assets may also be impacted by such factors as declines in stock price and in market capitalization. Significant declines in our performance, for any reason, could impact the fair value of our goodwill and other intangible assets and could result in future material impairment charges, which would adversely impact our results of operations.

 

Additionally, we monitor the performance and productivity of our store portfolio. When we determine that a store is underperforming or is to be closed, we reassess the recoverability of the store’s long-lived assets, which in some cases can result in an impairment charge. When a store is identified for impairment analysis, we estimate the fair value of the store assets using an income approach, which is based on estimates of future operating cash flows at the store level. These estimates, which include estimates of future net store sales, direct store expenses, and non-cash store adjustments, are based on the experience of management, including historical store operating results, its knowledge and expectations. These estimates can be affected by factors that can be difficult to predict, such as future operating results, customer activity and future economic conditions, and require management to apply judgment. We have announced our intention to rationalize our store portfolio under a program aimed at increasing the productivity of our store square footage. In addition to any other potential or actual future store closings or any negative trends in store performance, any decision to close, consolidate or downsize a store in connection with this program may result in additional future impairments of store assets.

 

The costs to close underperforming stores may be significant and may negatively impact our cash flows and our results of operations.

 

We regularly assess our portfolio of stores for profitability, and we close certain underperforming stores when appropriate under the circumstances. Our strategic plans include closing underperforming stores in order to reduce operating losses and to achieve improved long-term profitability of our store base. Substantially all of our stores are leased, with original lease terms continuing for up to ten years or more, and we have significant annual rent and other amounts due under each lease. While in closing underperforming stores we endeavor to negotiate with landlords the amount of remaining lease obligations, there is no assurance we will reach acceptable negotiated lease settlements. As a result, costs to close underperforming stores may be significant and may negatively impact our cash flows and our results of operations. The estimated costs and charges associated with store closings are also based on management’s assumptions and projections and actual amounts may vary materially from our forecasts and expectations. Additionally, while our goal in closing certain stores is to increase the productivity of our store portfolio, reductions in selling square footage could directly impact our net sales.

We may not be able to successfully execute or manage our plan to grow our upscale outlet portfolio.

 

Our plan for our store portfolio includes opening additional upscale outlets, a store concept we introduced in 2009. Our ability to successfully expand our upscale outlet concept depends, to a significant degree, on our ability to identify suitable store locations and to negotiate acceptable lease terms. We face substantial competition from other retailers for such sites. In fiscal 2011, we expect to open approximately 20 new upscale outlets. There can be no assurance that our upscale outlets will open timely, operate successfully or result in greater profitability for the Company.

 

In connection with the sale in 2009 of the J. Jill business we remain contingently responsible for certain material risks and obligations.

 

In July 2009, we completed the sale of the J. Jill business. There can be no assurance that the anticipated benefits from the sale of the J. Jill business will be realized in the time or amounts anticipated. There also can be no assurance that the estimated or anticipated costs, charges and liabilities to settle and complete the transition and exit from the J. Jill business, including both retained obligations and contingent risk for assigned obligations, will not materially differ from or be materially greater than anticipated. In connection with the sale of the J. Jill business to J. Jill Acquisition LLC (“Purchaser”), the Purchaser agreed to acquire and assume from us certain assets and liabilities relating to the J. Jill business. Under the terms of the Purchase Agreement, the Purchaser is obligated for liabilities that arise after the closing under assumed contracts, which include leases for 205 J. Jill stores assigned to the Purchaser, of which 203 assigned leases remained outstanding at January 29, 2011, and a sublease through December 2014 of approximately 65,749 square feet of space at the Company’s leased office facility in Quincy, Massachusetts. Certain of our subsidiaries remain contingently liable for obligations and liabilities transferred to the Purchaser, including those related to leases and other obligations transferred to and assumed by the Purchaser, as to which obligations and liabilities we now rely on the Purchaser’s creditworthiness as counterparty. If any material defaults were to occur which the Purchaser does not satisfy or fully indemnify us against and we are required to respond, it would likely have a material negative impact on our financial condition and results of operations. We have accrued a liability for the estimated exposure related to these guarantees, which is subject to future adjustment and any actual exposure could vary materially from estimated amounts.

 

We are subject to credit risk and to potential increased defaults and delinquencies on our customer credit card account portfolio.

 

We extend credit to our customers for merchandise purchases through our proprietary credit card. While we monitor our credit card account portfolio and we believe that our credit card account portfolio continues to be sound, the deteriorated economic environment and current high levels of unemployment may lead to higher customer delinquencies and defaults. There can be no assurance that our credit risk monitoring or our monitoring of our credit card account portfolio will guard against or enable us to adequately and timely respond to any increased risk of or actual increased customer delinquencies or defaults, which could materially and negatively impact the value of our credit card portfolio, our results of operations and liquidity, including our borrowing base under our Credit Facility.

 

Recently enacted financial system reforms could have a negative impact on our profitability.

 

Recent economic conditions, particularly in the financial market, have resulted in increased legislative and regulatory actions. In May 2009, the Credit Card Accountability Responsibility and Disclosure Act of 2009 (the “Credit CARD Act”) was signed into law, which resulted in new restrictions on credit card pricing, finance charges and fees, customer billing practices and payment allocation as well as imposed additional disclosure requirements. Certain provisions of this legislation became effective in August 2010 and, as a result, we implemented new procedures to our credit card business practices and systems to ensure compliance with these rules. Finance charge income from our credit operations could be adversely affected as we adjust our practices to current and future regulations related to the Credit CARD Act.

There are risks associated with Internet sales.

 

We sell merchandise over the Internet through our website, www.talbots.com. Our Internet operations are subject to numerous risks, including: rapid technological change and the implementation of new systems and platforms; diversion of sales from our stores; liability for online content; violations of state or federal laws, including those relating to online privacy; credit card fraud; the failure of the computer systems that operate our website and their related support systems, including computer viruses; and telecommunications failures and electronic break-ins and similar disruptions. Any failure of our systems, policies or procedures to protect against such risks could materially damage our brand and reputation as well as result in significant damage claims, any of which could have a material adverse impact on our business and results of operations.

 

We must protect against security breaches or other disclosures of private data of our customers as well as of our employees and other third parties.

 

As part of our normal operations, we receive and maintain personal information about our customers, our employees and other third parties. The confidentiality of all of our internal private data must at all times be protected against security breaches or other disclosure. We have systems and processes in place that are designed to protect information and protect against security and data breaches as well as fraudulent transactions and other activities. Despite our safeguards and security processes and protections, we cannot be assured that all of our systems and processes are free from vulnerability to security breaches by third parties or inadvertent data disclosure by us. Any failure to protect the confidential data of our customer or of our employees or other third parties could materially damage our brand and reputation as well as result in significant damage claims, any of which could have a material adverse impact on our business and results of operations.

 

Our Credit Facility contains provisions which may restrict our operations and proposed financing and strategic transactions.

 

Under the terms of our Credit Facility, we cannot create, assume or suffer to exist any lien securing indebtedness incurred after the closing date of the Facility subject to certain limited exceptions set forth in the Credit Facility. The Credit Facility contains negative covenants prohibiting the Company and its subsidiaries, with certain exceptions, from, among other things, incurring indebtedness and contingent obligations, making investments, intercompany loans and capital contributions, and disposing of property or assets. The Credit Facility also contains customary representations, warranties and covenants relating to the Company and its subsidiaries. The agreement provides for events of default, including failure to repay principal and interest when due and failure to perform or violation of the provisions or covenants of the agreement.

 

Any of the above requirements or other restrictions and limitations under the Credit Facility could reduce our flexibility by limiting, without lender consent, our ability to borrow additional funds or enter into dispositions or collateralization transactions involving any of our assets or other significant transactions. Further, if we default under our Credit Facility, any amounts outstanding could become immediately due and payable prior to the maturity date, in which case, absent replacement financing, we may not have sufficient liquidity to satisfy this debt.

 

Failure to meet market expectations of our financial performance will likely affect the market price and volatility of our stock.

 

Our annual and quarterly operating results have fluctuated and may continue to fluctuate in the future. Among the factors that may cause our operating results to fluctuate are market acceptance of our products, customer traffic, product mix, pricing and presentation of the products offered and sold, the timing of merchandise receipts, our cost of merchandise, unanticipated operating costs and other factors, many of which are beyond our control, including the general economic conditions as well as the actions of competitors. As a result, period-to-period comparisons of historical and future results will not necessarily be meaningful and should not be relied on as an indication of future performance. Failure to meet market expectations going forward, particularly with respect to sales, margins and earnings, will likely result in a decline and/or increased volatility in the market price of our stock.

 

We depend on a single distribution facility and a principal third party transportation company.

 

We handle merchandise distribution for all of our stores and fulfillment of customer orders through our direct channel from a single facility in Lakeville, Massachusetts. A principal third party transportation company delivers our merchandise to our stores and our customers. Any significant interruption in the operation of the distribution facility or the domestic transportation infrastructure due to natural disasters, accidents, inclement weather, epidemics, system failures, work stoppages, slowdowns or strikes, or other unforeseen causes could delay or impair our ability to distribute merchandise to our stores or our customers, which could result in lower sales, a loss of loyalty to our brand and excess inventory.

 

We depend on information systems to manage our operations and any failure in or our inability to upgrade or maintain these systems could materially and adversely affect our operations.

 

We depend on information systems to manage our operations. Our information systems consist of a full range of retail, catalog, e-commerce, financial and merchandising systems, including credit, inventory distribution and control, sales reporting, accounts payable, procurement, payroll, product design, budgeting and forecasting, financial reporting, merchandise reporting and distribution. We regularly make investments to upgrade, enhance or replace such systems and believe they meet industry standards. Any delays or difficulties in transitioning to these systems, or in integrating these systems with our current systems or any disruptions affecting our information systems could have a material adverse impact on our operations.

 

We are required to comply with certain legal and regulatory requirements, including in the area of health care reform.

 

Our policies, procedures and internal controls are designed to comply with all applicable laws and regulations, including those imposed by the U.S. Securities and Exchange Commission and the New York Stock Exchange, as well as applicable employment laws. Any changes in regulations, the imposition of additional regulations, such as the new and emerging consumer credit rules, or the enactment of any new legislation may increase the complexity of the regulatory environment in which we operate and the related cost of compliance. Failure to comply with such laws and regulations may result in damage to our reputation, financial condition and the market price of our stock.

 

We are continuing to review the health care reform law enacted by Congress in March 2010. As part of our review, we are evaluating the potential impacts of this new law on our business and will accommodate various parts of the law as they take effect. There are no assurances that our cost management efforts can accommodate all of the costs associated with compliance.

 

The outcome of litigation and other claims is unpredictable and any rulings not in our favor could have a material adverse effect on our business and results of operations.

 

We are and may become subject to litigation, claims and administrative proceedings for which we cannot or may not be able to predict or determine the ultimate outcome or quantify the potential financial impact. Because of the inherent difficulty of predicting the outcome of any legal claims and administrative proceedings, we cannot provide assurance as to the outcome of any pending or future matters, or if ultimately determined adversely to us, the loss, expense or other amounts attributable to any such matter. The resolution of such matter or matters, if unfavorable, could have a material adverse effect on our business, liquidity and results of operations. Refer to Item 3. Legal Proceedings, for a more detailed discussion of certain current litigation and other proceedings.

 

External economic factors could materially impact our Pension Plan.

 

Our future funding obligations with respect to our defined benefit Pension Plan, which was frozen in 2009, will depend upon the future performance of assets set aside for this Pension Plan, interest rates used to determine funding levels, actuarial data and experience and any changes in government laws and regulations. Our Pension Plan primarily holds investments in equity and debt securities. If the market values of these securities decline, our pension expense would increase and, as a result, could materially adversely affect our business. Decreases in interest rates or asset returns could also increase our obligations under the Pension Plan. Although no additional benefits have been earned under the Pension Plan since it was frozen, depending on the Pension Plan’s funded status, there will likely be ongoing contribution obligations which could be material.

 

None.

 

 

The following presents certain information relating to our properties at January 29, 2011:

 

 

 

 

These leases typically provide for an initial term between 10 and 15 years, with renewal options permitting us to extend the term between five and ten years thereafter. Under most store leases, provisions include a fixed annual base rent plus a contingent rent (“percentage rent”) based on the store’s annual sales in excess of specified levels. In a majority of these leases, we have the right to terminate earlier than the specified expiration date if certain sales levels are not achieved; such right is usually exercisable after five years of operation. Most of these leases also require us to pay real estate taxes, insurance and utilities and, in shopping center locations, to make contributions toward the shopping center’s common area operating costs and marketing programs. Most of these lease arrangements also provide for an increase in annual fixed rental payments during the lease term. We generally have been successful in renewing the store leases that we would like to extend as they expire. We believe that our facilities are adequate and suitable for our current needs.

 

As of January 29, 2011, the terms of our store leases (assuming solely for the purpose of this disclosure that we will exercise all lease renewal options) were as follows:

 

 

 

 

 

On February 3, 2011, a purported Talbots shareholder filed a putative class action captioned Washtenaw County Employees’ Retirement System v. The Talbots, Inc. et al., Case No. 1:11-cv-10186-NMG, in the United States District Court for the District of Massachusetts against Talbots and certain of its officers. The complaint, purportedly brought on behalf of all purchasers of Talbots common stock from December 8, 2009 through and including January 11, 2011, asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and seeks, among other things, damages and costs and expenses.

Specifically, the complaint alleges that Talbots, under the authority and control of the individual defendants, made certain false and misleading statements and allegedly omitted certain material information. The complaint alleges that these actions artificially inflated the market price of Talbots common stock during the class period, thus purportedly harming investors. We cannot predict the outcome of such proceedings or an estimate of damages, if any. We believe that these claims are without merit and intend to defend against them vigorously.

 

On February 24, 2011, a putative Talbots shareholder filed a derivative action in Massachusetts Superior Court, captioned Greco v. Sullivan, et al., Case No. 11-0728 BLS, against certain of Talbots’ officers and directors. The complaint, which purports to be brought on behalf of Talbots, asserts claims for breach of fiduciary duties, insider trading, abuse of control, waste of corporate assets and unjust enrichment, and seeks, among other things, damages, equitable relief, and costs and expenses. The complaint alleges that the defendants either caused or neglected to prevent, due to mismanagement or failure to provide effective oversight, the issuance of false and misleading statements and omissions regarding the Company’s financial condition. The complaint alleges that the defendants’ actions injured the Company insofar as they (a) caused Talbots to waste corporate assets through incentive-based bonuses for senior management, (b) subjected the Company to significant potential civil liability and legal costs and (c) damaged the Company through a loss of market capitalization as well as goodwill and other intangible benefits. We believe that these claims are without merit and intend to defend against them vigorously.

 

On January 12, 2010, a Talbots common shareholder had filed a putative class and derivative action captioned Campbell v. The Talbots, Inc., et al., C.A. No. 5199-VCS, in the Court of Chancery of the State of Delaware (the “Chancery Court”) against Talbots; Talbots’ Board of Directors; AEON (U.S.A.), Inc.; BPW Acquisition Corp. (“BPW”); Perella Weinberg Partners LP, a financial advisor to the audit committee of the Board of Directors of the Company and an affiliate of Perella Weinberg Partners Acquisition LP, one of the sponsors of BPW; and the Vice Chairman, Chief Executive Officer, and Senior Vice President of BPW. Among other things, the complaint asserted claims for breaches of fiduciary duties, aiding and abetting breaches of fiduciary duties, and violations of certain sections of the Delaware General Corporation Law (“DGCL”) and Talbots’ by-laws in connection with the negotiation and approval of the merger agreement between Talbots and BPW. The complaint sought injunctive, declaratory and monetary relief, including an order to enjoin the consummation of the merger and related transactions.

 

On March 6, 2010, a Stipulation (the “Stipulation”) entered into by the Company; the Company’s Board of Directors; AEON (U.S.A.), Inc.; BPW, Perella Weinberg Partners LP, the Vice Chairman, Chief Executive Officer, and Senior Vice President of BPW (collectively, the “Defendants”) and John C. Campbell (the “Plaintiff”) was filed in the Chancery Court with respect to this action. Pursuant to the Stipulation, the Plaintiff withdrew its motion for a preliminary injunction to enjoin consummation of the merger and related transactions between Talbots and BPW. In exchange, the Company agreed to implement and maintain certain corporate governance measures, subject to the terms and conditions specified in the Stipulation. The Stipulation did not constitute dismissal, settlement or withdrawal of Plaintiff’s claims in the litigation.

 

On December 20, 2010, the Chancery Court issued an Order and Final Judgment (the “Order”) granting final approval of a stipulation of settlement entered into by the Defendants and the Plaintiff. Pursuant to the terms of the Order, the lawsuit was dismissed with prejudice. On January 28, 2011 the Defendants (other than the Company and AEON (U.S.A.), Inc.) delivered $3.75 million to Talbots, and Perella Weinberg Partners LP delivered 175,000 shares of Talbots common stock to Talbots. The Plaintiff’s counsel was awarded a total of $2.1 million in fees and expenses which were paid by us in February 2011. We recorded the net gain on this settlement, of $2.7 million, to merger-related costs in the consolidated statement of operations in fiscal 2010.

 

We are periodically named as a defendant in various lawsuits, claims and pending actions and are exposed to tax risks. If a potential loss arising from these lawsuits, claims and pending actions is probable and reasonably estimable, we record the estimated liability based on circumstances and assumptions existing at the time. While we believe any recorded liabilities are adequate, there are inherent limitations in projecting the outcome of these matters and in the estimation process whereby future actual liabilities may exceed projected liabilities, which could have a material adverse effect on our financial condition and results of operations.

 

We are subject to tax in various domestic and international jurisdictions and, as a matter of course, are regularly audited by federal, state and foreign tax authorities. During the third quarter of 2009, the Massachusetts Appellate

Tax Board (the “ATB”) rendered an adverse decision on certain tax matters of Talbots, which was recently affirmed by the Massachusetts Appeals Court. We are considering an application to the Supreme Judicial Court of Massachusetts for further appellate review of the case. In order to pursue the original appeal, we were required to make payments to the Massachusetts Department of Revenue on the assessment rendered on those tax matters, of which approximately $3.5 million remains to be paid. An additional assessment, relating to a subsequent period, has also been appealed by the Company to the ATB covering similar issues. Refer to Contractual Obligations, Commercial Commitments and Contingent Liabilities for additional information on this matter. These assessments have been adequately reserved and did not have a material impact on our results of operations.

 

It can be difficult to predict or determine the final outcome of any legal or administrative proceedings or to quantify the amount or range of any potential financial impact. Because of the inherent difficulty of predicting the outcome of any legal claims and administrative proceeding or other matters, we cannot provide assurance as to the outcome of these or other pending or future matters, or if ultimately determined adversely to us, the loss, expense or other amounts attributable to any such matter. The resolution of such matter or matters, if unfavorable, could have a material adverse effect on our operating results.

 

 

 

Our common stock is listed and traded on the New York Stock Exchange under the trading symbol “TLB.” The following table sets forth the high and low sale prices per share of our common stock on the New York Stock Exchange for the periods indicated:

 

 

As of March 18, 2011, the number of holders of record of our common stock was 16,477.

 

Any determination to pay dividends and the amount thereof is at the discretion of our Board of Directors, subject to the restrictions imposed by our Credit Facility, which prohibits the payment of dividends except for those issued in the form of stock or stock equivalents. In February 2009, our Board of Directors approved the indefinite suspension of our cash dividends; therefore, no dividends were paid in fiscal 2010 or fiscal 2009.

 

A summary of our repurchase activity under certain equity programs for the thirteen weeks ended January 29, 2011 is set forth below:

 

 

 

 

 

 

We did not have any shares available to be repurchased under any announced or approved repurchase programs or authorizations as of January 29, 2011.

Stock Performance Graph

 

The following graph compares the percentage changes in the cumulative total shareholders’ return on our common stock on a year end basis, using the last day of trading prior to our fiscal year end, with the cumulative total return on the Standard & Poor’s 500 Stock Index (“S&P 500 Index”) and the Dow Jones U.S. General Retailers Index for the same period. Returns are indexed to a value of $100 and assume that all dividends were reinvested.

 

Comparison of Cumulative Five-Year Total Return of The Talbots, Inc.,
S&P 500 Index, and Dow Jones General Retailers Index

 

 

 

The Performance Graph in this Item 5 is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934 or to the liabilities of Section 18 of the Securities Exchange Act of 1934 and will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent we specifically incorporate it by reference into such a filing.

 

The following selected financial data has been derived from our consolidated financial statements. The information set forth below should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and with our consolidated financial statements and notes thereto included elsewhere in this document.

 

 

 

 

 

 

Our management’s discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements included in this Annual Report on Form 10-K, which have been prepared by us in accordance with accounting principles generally accepted in the United States of America. This discussion and analysis should be read in conjunction with these consolidated financial statements and the notes thereto included elsewhere in this Annual Report.

 

We conform to the National Retail Federation’s fiscal calendar. Where reference is made to a particular year or years, it is a reference to our 52-week or 53-week fiscal year. References in this Annual Report to “2010,” “2009” and “2008” refer to the 52-week fiscal years ended January 29, 2011, January 30, 2010 and January 31, 2009, respectively.

 

Management Overview

 

In 2010, we executed a comprehensive financing solution and commenced the implementation of several broad strategic initiatives. These activities are components of our comprehensive strategy to build our updated brand and strengthen our organization with a focus on top-line sales, profitability and productivity improvements over the long-term.

 

On April 7, 2010, we completed a series of transactions (collectively, the “BPW Transactions”) which, in the aggregate, substantially reduced our indebtedness and significantly deleveraged our balance sheet, consisting of three related transactions: (i) an Agreement and Plan of Merger between Talbots and BPW Acquisition Corp. (“BPW”) pursuant to which a wholly-owned subsidiary of the Company merged with and into BPW in exchange for the Company’s issuance of Talbots common stock and warrants to BPW stockholders; (ii) the repurchase and retirement of all shares of Talbots common stock held by AEON (U.S.A.), Inc. (“AEON (U.S.A.)”), our then majority shareholder, totaling 29.9 million shares; the issuance of warrants to purchase one million shares of Talbots common stock to AEON (U.S.A.) and the repayment of all of our outstanding debt with AEON Co., Ltd. (“AEON”) and AEON (U.S.A.) at its principal value plus accrued interest and other costs for total cash consideration of $488.2 million; and (iii) the execution of a third party senior secured revolving credit facility which provides borrowing capacity up to $200.0 million, subject to availability and satisfaction of all borrowing conditions.

 

As of April 7, 2010, as a result of these transactions, we reduced our outstanding debt by approximately $361.5 million and increased stockholders’ equity by approximately $327.3 million. Since the close of these transactions, we have sought to translate our operating results into a further improved financial position, reducing debt by an additional $99.5 million through January 29, 2011 and ending the year with a positive equity balance and positive net working capital.

 

With the liquidity provided by the BPW Transactions, management has been able to expand the scope of its strategic initiatives to include programs designed to provide planned reinvestment in key aspects of the business, including an enhanced marketing campaign, the launch of a store re-image initiative and an information technology enhancement and upgrade, while continuing to focus on programs designed and intended to improve upon our leaner operating structure, including the launch of our segmentation strategy and a plan to rationalize and reduce our store real estate portfolio and square footage.

 

In March 2011, we announced the acceleration of our store rationalization plan, with an expectation to close approximately 90 to 100 stores and consolidate or downsize approximately 15 to 20 stores over the next two years, with a majority of these actions expected to be completed in fiscal 2011. These actions are expected to reduce gross square footage by approximately 0.5 million square feet over the two year period. We anticipate that a substantial part of these expected closings and square footage reductions will be implemented at stores which have lease expirations or other lease termination events occurring in this two year period. In connection with this plan, we expect to incur approximately $18.0 million in estimated lease exit, severance and related costs over the next two years. The number, identity and timing of these actions are not final, continue to be subject to further ongoing evaluation and may be adjusted as we continue to finalize our plan. We will continue to evaluate our store portfolio and may determine to close additional stores over the coming years.

Going forward, we remain committed to our long-range plan and strategic initiatives which focus on top-line sales, profitability and productivity improvements, and include ongoing strategic reinvestments in our marketing campaign and capital expenditures related to our store re-image initiative and information technology.

 

Results of Operations

 

Results of fiscal year 2010 include:

 

 

 

 

The following table sets forth the percentage relationship to net sales of certain items in our consolidated statements of operations for the periods shown below:

 

 

Cost of sales, buying and occupancy is comprised primarily of the cost of merchandise including duties, inbound freight charges, shipping, handling and distribution costs associated with our direct operations, salaries and expenses incurred by our merchandising and sourcing operations and occupancy costs associated with our stores. Occupancy costs consist primarily of rent and associated depreciation, maintenance, property taxes and utilities.

 

Selling, general and administrative is comprised primarily of the costs of employee compensation and benefits in the selling and administrative support functions, catalog operation costs relating to catalog production and call center, advertising and marketing costs, the cost of our customer loyalty program, costs related to management information systems and support and the costs and income associated with our credit card operations. Additionally, costs associated with our warehouse operations are included in selling, general and administrative and include costs of receiving, inspecting and warehousing merchandise as well as the costs related to store distribution of merchandise. Warehouse operations costs for 2010, 2009 and 2008 are approximately $17.9 million, $20.2 million and $27.6 million, respectively.

Our gross margins may not be comparable to certain other companies, as there is diversity in practice as to which costs companies include in selling, general and administrative and cost of sales, buying and occupancy. Specifically, we include the majority of the costs associated with our warehousing operations in selling, general and administrative, while other companies may include these costs in cost of sales, buying and occupancy.

 

2010 Compared to 2009

 

Net Sales

 

The following is a comparison of net sales for fiscal years 2010 and 2009:

 

 

Store Sales

 

Reflected in net store sales for fiscal year 2010 is a $31.8 million, or 3.4%, decrease in comparable store sales compared to fiscal year 2009. This decrease is significantly attributable to reduced customer traffic due to, among other factors, weaker than anticipated customer response to our merchandise assortment, increased levels of competitive promotional activity and weather-related issues in the fourth quarter, which led to a decline in the number of comparable store transactions. We began fiscal year 2010 building on momentum from the second half of fiscal year 2009 and saw positive comparable store sales in the first half of the year. This momentum did not continue in the second half of the year, despite our increased promotional activity and efforts in the fourth quarter in order to be more competitive in what proved to be a more promotional environment than anticipated.

 

In the second half of the year, our enhanced marketing campaign entered a significant phase with the roll-out of our national advertising campaign. We believe our enhanced marketing strategy and related initiatives are significant to achieving our “tradition transformed” brand vision and believe that these brand building efforts will take time to gain traction and translate into increased customer traffic and net sales.

 

Sales metrics for comparable stores for fiscal year 2010 were as follows: customer traffic decreased 8.0% year-over-year, yet the rate of converting traffic to transactions increased 0.9%, contributing to a 7.2% decrease in the number of transactions per store. Additionally, units per transaction were up 3.2% which, combined with a 0.7% increase in average unit retail, contributed to a 3.9% increase in dollars per transaction over fiscal year 2009.

 

Comparable stores are those stores, excluding surplus outlets, that are open for at least 13 full months. When the square footage of a store is increased or decreased by at least 15%, the store is excluded from the computation of comparable store sales for a period of 13 full months. As of January 29, 2011, we operated a total of 568 stores with gross and selling square footage of approximately 4.1 million square feet and 3.1 million square feet, respectively, a decrease of approximately 2.8% in gross square footage and 3.0% in selling square footage from January 30, 2010, when we operated 580 retail stores.

 

Direct Marketing Sales

 

Direct marketing sales in fiscal 2010 increased 6.7% compared to fiscal year 2009 while the percentage of our net sales derived from direct marketing increased to 18.3% from 16.8% in fiscal 2009. These increases can be primarily attributed to an $8.2 million comparative increase in red-line phone sales, which are sales resulting from direct lines in our stores to our call center, as well as increased Internet sales. Internet sales were $161.8 million in fiscal 2010 compared to $144.5 million in fiscal 2009. This increase is primarily due to changing trends in consumer purchasing behavior, with declines in catalog sales partially offsetting the increase in Internet sales.

Cost of Sales, Buying and Occupancy

 

The following is a comparison of cost of sales, buying and occupancy for fiscal years 2010 and 2009:

 

 

In fiscal year 2010, net sales declines of $22.5 million were offset by cost of sales, buying and occupancy declines of $66.1 million, resulting in a 420 basis point improvement in gross profit margin to 37.7% from 33.5% in fiscal year 2009. This improvement in gross profit margin was primarily driven by gains in merchandise margin, which was up 310 basis points as a result of changes to our sourcing practices and correlated to improvements in our initial mark-up rate (“IMU”) compared to fiscal year 2009. Occupancy expenses as a percent of net sales also improved 90 basis points, primarily due to comparatively lower depreciation expense, while buying expenses as a percent of net sales improved 20 basis points.

 

Although we recorded a 420 basis point improvement in gross profit margin year-over-year in fiscal 2010, we do not expect our gross profit margin improvements to be as strong year-over-year in fiscal 2011, largely due to expectations of incrementally higher merchandise costs, correlated to rising commodity prices, and continued promotional pressure in the market.

 

Selling, General and Administrative

 

The following is a comparison of selling, general and administrative for fiscal years 2010 and 2009:

 

 

In fiscal year 2010, we reinstated and enhanced operational performance-based and certain other employee compensation programs that were suspended in the prior year, recording related incremental compensation expense of $9.9 million in fiscal 2010. Further, in 2010, we increased our investment in marketing, including expanded national and regional advertising, e-commerce advertising and increased in-store visual, recording incremental marketing expense of $9.4 million in fiscal 2010. These planned reinvestments in our business were offset by expense savings that continue to be realized from actions taken under our fiscal year 2009 expense reduction program, allowing us to reduce selling, general and administrative year-over-year while making these strategic reinvestments.

 

Selling, general and administrative in fiscal 2010 also reflect a change in our estimate of gift card breakage, whereby in fiscal 2010, we refined our estimate of gift card redemptions and began to recognize income from the breakage of gift cards when the likelihood of redemption of the gift card is considered remote. Gift card breakage income of $6.9 million, including a cumulative, one-time adjustment of $6.3 million, was recorded in fiscal year 2010 as an offset to selling, general and administrative.

 

Merger-Related Costs

 

During fiscal years 2010 and 2009, we incurred $25.9 million and $8.2 million of merger-related costs, respectively, in connection with our acquisition of BPW. These costs primarily consist of investment banking, professional services fees, an incentive award given to certain executives and members of senior management as a result of the closing of this transaction and, in 2010, are partially offset by a net gain on the settlement of shareholder litigation. Refer to Part I Item 3., Legal Proceedings, for further information regarding this settlement.

Restructuring Charges

 

The following is a comparison of restructuring charges for fiscal years 2010 and 2009:

 

 

The restructuring charges incurred in fiscal 2010 primarily relate to the consolidation of our Madison Avenue flagship location wherein we reduced active leased floor space and wrote down certain assets and leasehold improvements no longer used in the redesigned lay-out. Restructuring charges incurred in fiscal 2009 primarily include severance costs recorded in February 2009 and June 2009 due to corporate headcount reductions, estimated lease termination costs associated with the portion of our Tampa, Florida data center which we ceased to use in July 2009 and severance and lease termination costs incurred related to the closing of our Hong Kong and India sourcing offices and the reduction of corporate sourcing headcount.

 

Impairment of Store Assets

 

We regularly monitor the performance and productivity of our store portfolio. When we determine that a store is underperforming or is to be closed, we reassess the recoverability of the store’s long-lived assets, which in some cases can result in an impairment charge. When a store is identified for impairment analysis, we estimate the fair value of the store assets using an income approach, which is based on estimates of future operating cash flows at the store level. These estimates, which include estimates of future net store sales, direct store expenses and non-cash store adjustments, are based on the experience of management, including historical store operating results, its knowledge and expectations. These estimates can be affected by factors that can be difficult to predict, such as future operating results, customer activity and future economic conditions. In both fiscal years 2010 and 2009, we recorded impairments of store assets of $1.4 million. In fiscal year 2010, store impairment analyses were triggered both by management reviews of the stores’ operating results as well as our anticipated closures of store locations. In fiscal year 2009, store impairment analyses were primarily triggered by management reviews of the stores’ operating results.

 

Our analysis of the store locations approved for closure, consolidation or downsizing under our accelerated store rationalization plan as well as any additional store closures or negative trends in store performance may result in additional impairments of store assets in the coming year.

 

Interest Expense, net

 

The following is a comparison of net interest expense for fiscal years 2010 and 2009:

 

 

Net interest expense in fiscal 2010 decreased compared to fiscal 2009 primarily due to reductions in the weighted average debt outstanding in the respective periods, from $498.7 million in fiscal 2009 to $152.9 million in fiscal 2010, partially offset by an increase in the comparable effective interest rates, from 4.9% in fiscal 2009 to 5.5% in fiscal 2010. While the year-over-year effective interest rate increased in fiscal 2010, it has sequentially declined over each quarterly period to a low of 3.8% in the fourth quarter of 2010. Reductions in debt-related interest expense were partially offset by increased tax-related interest expense year-over-year. We expect interest expense to be comparatively lower in the coming year.

Income Tax Expense (Benefit)

 

The following is a comparison of income tax expense (benefit) for fiscal years 2010 and 2009:

 

 

In fiscal years 2010 and 2009, our effective income tax rate, including discrete items, was 40.0% and 31.3%, respectively. The effective income tax rate is based upon the income or loss for the year, the composition of the income or loss in different jurisdictions and discrete adjustments for settlements of tax audits or assessments, the resolution or identification of tax position uncertainties and non-deductible costs associated with the merger. Income tax expense in fiscal 2010 is comprised primarily of discrete items, specifically changes in estimates related to previously existing uncertain tax positions based on new information recorded in the second quarter of 2010. The income tax benefit in fiscal 2009 was primarily impacted by the intra-period tax allocation arising from other comprehensive income recognized from the remeasurement of our Pension Plan and Supplemental Executive Retirement Plan obligations due to our decision to discontinue future benefits being earned under the plans effective as of May 1, 2009, which resulted in an allocated tax benefit of $10.5 million to continuing operations and an offsetting tax expense included in other comprehensive income.

 

We continue to provide a full valuation allowance against our net deferred tax assets, excluding deferred tax liabilities for non-amortizing intangibles.

 

2009 Compared to 2008

 

Net Sales

 

The following is a comparison of net sales for fiscal years 2009 and 2008:

 

 

Store Sales

 

Reflected in Talbots store sales is a $218.3 million, or 19.3%, decline in comparable store sales for 2009, due to the lackluster customer shopping behaviors we experienced throughout the first half of the year. We believe this was a carryover from the latter part of 2008 as the difficult economic environment significantly influenced consumers’ discretionary spending. When our customer was shopping, key fashion items at entry level price points were the main driver of sales. We remained steadfast in managing on lean inventory while improving our flow of merchandise, optimizing our markdowns and presenting our customer with a stronger mix of regular-price to markdown merchandise.

 

Sales metrics for 2009 were as follows: customer traffic declined 14.6% and the rate of converting traffic to transactions declined 3.2%, resulting in a 17.8% decline in the number of transactions. Additionally, units per transaction were down 3.8%, with a 1.6% increase in average unit retail, resulting in a 2.2% decline in dollars per transaction. We began to see improvement in our sales metrics beginning in the third quarter which continued through the end of the year. Although we experienced a decline in fourth quarter traffic and transactions, dollars per transaction increased 13% reflecting an improvement in regular-price selling.

 

Despite a year over year decline in sales and certain other related metrics, we had reason to believe that customer perception of our merchandise continued to improve. Market research we conducted during the third quarter of 2009 indicated that our best customers, those who spend the most money shopping with us, gave our merchandise its

highest rating in recent years. Our lower spenders also rated our merchandise at its highest levels in recent years, although not as high as our best customers.

 

Comparable stores are those stores, excluding surplus outlets, that are open for at least 13 full months. When the square footage of a store is increased or decreased by at least 15%, the store is excluded from the computation of comparable store sales for a period of 13 full months. As of January 30, 2010, we operated a total of 580 stores with gross and selling square footage of approximately 4.1 million square feet and 3.2 million square feet. This represents a decrease of approximately 1.4% in gross and selling square footage, respectively, from January 31, 2009, when we operated 587 retail stores with gross and selling square footage of approximately 4.2 million square feet and 3.2 million square feet, respectively. The decrease in square footage is due to the opening of 11 upscale outlets and one retail store offset by the closing of 19 retail stores.

 

Direct Marketing Sales

 

We experienced an 11.1% decline in direct marketing sales in 2009 compared to 2008 while the percentage of our net sales derived from direct marketing increased to 16.8% in 2009 from 15.6% in 2008. The increase in direct marketing as a percent of total sales is partially due to more aggressive selling and promoting of our direct marketing sales that originate in our stores via red-line phones, which are direct lines to our call center. Also contributing to the improvement, beginning in the fall season, we presented our customer with a stronger mix of regular-price merchandise, achieved better fulfillment and experienced lower returns. Direct marketing sales in the third quarter were essentially flat compared to the prior year and we experienced an 11.0% increase in the fourth quarter on a year-over-year basis. Internet sales in 2009 represented 70.0% of our direct marketing sales compared to 68.0% in 2008. We believe our investment in our new Internet platform coupled with changing trends in consumer purchasing behavior, contributed to the increase in Internet sales as a percentage of direct marketing.

 

Cost of Sales, Buying and Occupancy

 

The following is a comparison of cost of sales, buying and occupancy for fiscal years 2009 and 2008:

 

 

The decrease in cost of sales, buying and occupancy represents a 370 basis point improvement from the prior year. The improvement includes a 620 basis point improvement in merchandise margin as a percent of sales. The improvement in merchandise margin was driven by changes to our sourcing practices, improved inventory management and stronger regular-price selling specifically in the second half of the year. The improvement in cost of sales is offset by a 200 basis point increase in occupancy costs and a 50 basis point increase in buying costs, both of which rose as a percent of sales despite reductions in actual costs. These increases as a percent of sales are attributable to negative leverage from the decline in sales for the year, as actual costs for occupancy and buying were reduced from the prior year.

 

Selling, General and Administrative

 

The following is a comparison of selling, general and administrative for fiscal years 2009 and 2008:

 

 

In early 2009, we established a goal of reducing annual expense by $150.0 million by the end of fiscal 2010. Approximately 80% of this reduction was expected to be within selling, general and administrative. By the end of fiscal 2009, we reduced selling, general and administrative by $119.9 million, substantially achieving our two-year

goal in one year. Our expense reductions were primarily realized in payroll and employee benefits and the balance in other corporate overhead expenses as we reduced our workforce by 32% during 2009.

 

Merger-Related Costs

 

In 2009, we incurred $8.2 million of merger-related costs in connection with our acquisition of BPW. These costs primarily consist of investment banking and professional services fees.

 

Restructuring Charges

 

The following is a comparison of restructuring charges for fiscal years 2009 and 2008:

 

 

The 2009 restructuring charges primarily relate to severance costs due to the corporate headcount reductions in February 2009 and June 2009 and costs to settle lease liabilities for a portion of our Tampa, Florida data center that is no longer being used. Additionally, we reorganized our global sourcing activities and entered into a buying agency agreement with Li & Fung effective September 2009. Li & Fung is now our exclusive global apparel sourcing agent for substantially all Talbots apparel.

 

Impairment of Store Assets

 

The following is a comparison of impairment of store assets in fiscal years 2009 and 2008:

 

 

We regularly monitor our store portfolio to identify stores that are underperforming and close stores when appropriate. When we determine that a store is underperforming or is to be closed, we reassess the expected future cash flows of the store, which in some cases results in an impairment charge. During the third quarter of 2009, we identified and recorded an impairment charge of $1.4 million related to underperforming stores.

 

Interest Expense, net

 

The following is a comparison of net interest expense for fiscal years 2009 and 2008:

 

 

The increase in net interest expense was primarily due to higher average outstanding debt levels combined with a higher average interest rate on those borrowings. Interest expense in 2009 also includes $0.5 million of amortization of the $1.7 million loan fees paid to AEON in 2009 and $1.1 million of breakage fees resulting from our early repayment of the bank debt on December 29, 2009.

Income Tax (Benefit) Expense

 

The following is a comparison of income tax (benefit) expense for fiscal years 2009 and 2008:

 

 

The income tax benefit in 2009 resulted primarily from the intra-period tax allocation arising from other comprehensive income recognized from the remeasurement of our Pension Plan and SERP obligations due to our decision to discontinue future benefits being earned under the plans effective as of May 1, 2009. This resulted in a tax expense of approximately $10.5 million in other comprehensive income and an offsetting benefit in continuing operations. The income tax expense in 2008 is due to the establishment of a valuation allowance of $61.0 million for substantially all of our net deferred tax assets. During the fourth quarter of 2008, we concluded there was insufficient evidence that all of our deferred tax assets would be realized in the future.

 

Discontinued Operations

 

Our discontinued operations include the Talbots Kids, Mens and U.K. businesses, all of which ceased operations in 2008, and the J. Jill business, which was sold on July 2, 2009. The operating results of these businesses have been classified as discontinued operations on the consolidated statements of operations for all periods presented, and the cash flows from discontinued operations, including proceeds from the sale of J. Jill, have been separately presented in the consolidated statements of cash flows.

 

On July 2, 2009, we completed the sale of the J. Jill business for net proceeds of $64.3 million, pursuant to which Jill Acquisition LLC (the “Purchaser”) agreed to acquire and assume from us certain assets and liabilities relating to the J. Jill business, including acquiring 205 of the 280 J. Jill stores held at the time of purchase and executing a sublease with us for a portion of the Quincy, Massachusetts office space previously used for the J. Jill business. The 75 J. Jill stores that were not sold were closed. As of January 29, 2011, we had settled the lease liabilities of 73 of the 75 stores not acquired by the Purchaser as well as a portion of the vacant Quincy, Massachusetts office space.

 

At the time of closing or vacating leased spaces associated with our discontinued operations, we record estimated lease termination costs. As of January 29, 2011, we had recorded lease liabilities for the two remaining leases for former J. Jill stores, the remaining portion of the Quincy office space and six remaining leases for former Talbots Kids and Mens stores that have not been assigned or settled. We remain contingently liable for obligations and liabilities transferred to certain third parties, including the remaining 203 J. Jill leases of the 205 J. Jill leases originally assigned to the Purchaser as well as certain assigned leases related to our closed U.K. and Mens businesses. We record adjustments to our estimated lease liabilities when new information suggests that actual costs may vary from initial or previous estimates, resulting in changes to the income (loss) from discontinued operations. Total cash expenditures related to any of these lease liabilities will depend on either the outcome of negotiations with third parties or performance under the assigned leases by third parties. As a result, actual costs related to these leases may vary from current estimates and management’s assumptions and projections may continue to change. Refer to Contractual Commitments for further discussion of discontinued operations’ lease liabilities.

 

The $3.2 million income from discontinued operations recorded in fiscal 2010 includes adjustments to the estimated lease liabilities of the J. Jill, Talbots Kids and Mens businesses, primarily relating to negotiated settlements on four of the retained and closed J. Jill retail locations and a portion of the vacant Quincy office space. The $4.1 million loss from discontinued operations recorded in fiscal 2009 includes a loss on the sale and disposal of the J. Jill business, adjustments to the estimated lease liabilities of the J. Jill, Talbots Kids and Mens businesses and losses incurred by the J. Jill business prior to ceasing operations in July 2009. The $416.1 million loss from discontinued operations recorded in fiscal 2008 includes an impairment charge to the assets of the J. Jill business, the recording of estimated lease liabilities of the Talbots Kids, Mens and U.K. businesses upon ceasing operations and the income (losses) incurred by the J. Jill business as well as the Talbots Kids, Mens and U.K. businesses prior to ceasing operations.

Liquidity and Capital Resources

 

Over the past several years, management’s strategies have focused on actions and initiatives designed to streamline our organization, reduce our cost structure and improve our gross margin performance and liquidity, culminating in the completion of the BPW Transactions on April 7, 2010. With the completion of these transactions, we gained additional capital to strengthen our balance sheet, significantly reduced our outstanding indebtedness and corresponding interest expense and restored positive shareholders’ equity.

 

With the liquidity provided by the BPW Transactions, management has been able to expand the scope of its strategic initiatives to include programs designed and intended to provide planned reinvestment in key aspects of the business, including enhanced marketing campaigns, the launch of a store re-image initiative and an information technology enhancement and upgrade, while continuing to focus on programs designed and intended to continue to improve upon our leaner operating structure and enhance operating efficiencies, including a plan to rationalize and reduce our store portfolio. The enhanced marketing campaign and store re-image initiative represented incremental expense and capital expenditure spend in fiscal 2010 and will continue to require the use of the Company’s capital resources in fiscal 2011. Our evaluation of our store portfolio includes consideration, on a market-by-market basis, of factors such as overall size and potential sales in each market, current performance and growth potential of each store, and available lease expirations, lease renewals and other lease termination opportunities. In March 2011, we announced the acceleration of our store rationalization plan, with an expectation to close approximately 90 to 100 stores and consolidate or downsize approximately 15 to 20 stores over the next two years, with a majority of these actions expected to be completed in fiscal 2011. These actions are expected to reduce gross square footage by approximately 0.5 million square feet over the two year period. We anticipate that a substantial part of these expected closings and square footage reductions will be implemented at stores which have lease expirations or other lease termination events occurring in this two year period. Any action to close stores under this program, particularly prior to the end of their lease terms, may require the Company to provide up-front payment in the form of lease exit or termination fees. In connection with this plan, we expect to incur approximately $18.0 million in estimated lease exit, severance and related costs over the next two years, some of which will require the use of Company resources. We continue to monitor our expenditures and expect to make our most significant reinvestments in planned programs intended to improve top-line sales, profitability or productivity.

 

We finance our working capital needs, operating costs, capital expenditures, strategic initiatives and restructurings and debt and interest payment requirements through cash generated by operations and existing credit facilities. At January 29, 2011 we held $10.2 million of cash and cash equivalents, with cash equivalents defined as highly liquid instruments with a purchased maturity of three months or less, including payments due from credit card processors and banks for third party credit card and debit card transactions which are generally processed within one to five business days.

 

Any determination to pay dividends and the amount thereof is at the discretion of our Board of Directors, subject to the restrictions imposed by our Credit Facility, which prohibits the payment of dividends except for those issued in the form of stock or stock equivalents. In February 2009, our Board of Directors approved the indefinite suspension of our cash dividends; therefore, no dividends were paid in fiscal 2010 or fiscal 2009 or are expected to be paid in the near-term. We currently intend to retain our future earnings, if any, for use in the operation of our business.

 

Merger with BPW and Related Financing Transactions

 

On April 7, 2010, we completed a series of transactions (collectively, the “BPW Transactions”) which, in the aggregate, substantially reduced our indebtedness and significantly deleveraged our balance sheet, consisting of three related transactions: (i) an Agreement and Plan of Merger between Talbots and BPW Acquisition Corp. (“BPW”) pursuant to which a wholly-owned subsidiary of the Company merged with and into BPW in exchange for the Company’s issuance of Talbots common stock and warrants to BPW stockholders; (ii) the repurchase and retirement of all shares of Talbots common stock held by AEON (U.S.A.), Inc. (“AEON (U.S.A.)”), our then majority shareholder; the issuance of warrants to purchase one million shares of Talbots common stock to AEON (U.S.A.) and the repayment of all of our outstanding debt with AEON Co., Ltd. (“AEON”) and AEON (U.S.A.) at its principal value plus accrued interest and other costs for total cash consideration of $488.2 million; and (iii) the

execution of a third party senior secured revolving credit facility which provides borrowing capacity up to $200.0 million, subject to availability and satisfaction of all borrowing conditions.

 

In connection with the merger, we issued 41.5 million shares of Talbots common stock and warrants to purchase 17.2 million shares of Talbots common stock (the “Talbots Warrants”) for 100% ownership of BPW. Approximately 3.5 million BPW warrants that did not participate in the exchange offer (the “Non-Tendered Warrants”) remained outstanding at the closing of the merger. Additionally, in connection with the merger, we repurchased and retired the 29.9 million shares of Talbots common stock held by AEON (U.S.A.), our former majority shareholder, in exchange for warrants to purchase one million shares of Talbots common stock (the “AEON Warrants”).

 

The Talbots Warrants are immediately exercisable at $14.85 per warrant for one share of Talbots common stock, have a stated term of five years from the date of issuance, April 9, 2010, and beginning after April 9, 2011, are subject to accelerated expiration under certain conditions including, at our discretion, if the trading value of Talbots common stock exceeds $19.98 per share for 20 of 30 consecutive trading days in a period ending not more than 15 days prior to notice of such acceleration. The warrants may be exercised on a cashless basis. These warrants began trading on the NYSE Amex in April 2010. Approximately 17.2 million Talbots Warrants were outstanding at January 29, 2011.

 

The Non-Tendered Warrants have an exercise price of $7.50 per warrant for 0.9853 share of Talbots common stock. Approximately 2.5 million Non-Tendered Warrants were exercised for total cash proceeds of $19.0 million immediately following the transaction. The 0.9 million Non-Tendered Warrants that remained outstanding at January 29, 2011 become exercisable one year from April 7, 2010, the effective date of the merger, do not have anti-dilution rights, were de-listed from the NYSE Amex concurrent with the merger and expire on February 26, 2015.

 

The AEON Warrants are immediately exercisable at $13.21 per share for one share of Talbots common stock, have a stated term of five years from the date of issuance, April 7, 2010, and beginning after April 7, 2011, are subject to accelerated expiration under certain conditions including, at our discretion, if the trading value of Talbots common stock exceeds $23.12 per share for 20 of 30 consecutive trading days in a period ending not more than 15 days prior to notice of such acceleration. The warrants may be exercised on a cashless basis. One million AEON Warrants were outstanding at January 29, 2011.

 

Further in connection with the consummation and closing of the BPW merger, we executed a new senior secured revolving credit agreement with third party lenders (the “Credit Facility”). The Credit Facility is an asset-based revolving credit facility (including a $25.0 million letter of credit sub-facility) that permits us to borrow up to the lesser of (a) $200.0 million and (b) the borrowing base, calculated as a percentage of the value of eligible credit card receivables and the net orderly liquidation value of eligible private label credit card receivables, the net orderly liquidation value of eligible inventory in the United States and the net orderly liquidation value of eligible in-transit inventory from international vendors (subject to certain caps and limitations), net of reserves as set forth in the agreement, minus the lesser of (x) $20.0 million and (y) 10% of the borrowing base. Loans made pursuant to the immediately preceding sentence carried interest, at our election, at either (a) the three-month LIBOR plus 4.0% to 4.5% depending on availability thresholds or (b) the base rate plus 3.0% to 3.5% depending on certain availability thresholds, with the base rate established at a prime rate pursuant to the terms of the agreement. On August 31, 2010, we entered into a First Amendment to the Credit Agreement with the lenders (the “First Amendment”), which modified the following terms under the Credit Facility: (i) reduced the interest rates by one hundred basis points on loan amounts under the Credit Facility for loans provided by the lenders to either (a) three-month LIBOR plus 3.0% to 3.5%, or (b) the base rate plus 2.0% to 2.5%, in each case depending on certain availability thresholds; (ii) adjusted the fee structure on the unused portion of the commitment and reduced by one-half the rates applicable to documentary letters of credit; and (iii) extended the time period during which a prepayment premium will be assessed upon the reduction or termination of the revolving loan commitments from April 7, 2011 to April 7, 2012. Interest on borrowings is payable monthly in arrears. We pay a fee on the unused portion of the commitment and outstanding letters of credit, if any, monthly in arrears in accordance with formulas set forth in the First Amendment. As of January 29, 2011, our effective interest rate was 3.9%, and we had additional borrowing availability of up to $116.7 million.

 

Amounts are borrowed and repaid on a daily basis through a control account arrangement. Cash received from customers is swept on a daily basis into a control account in the name of the agent for the lenders. We are permitted

to maintain a certain amount of cash in disbursement accounts, including such amounts necessary to satisfy our current liabilities incurred in the ordinary course of our business. Amounts may be borrowed and re-borrowed from time to time, subject to the satisfaction or waiver of all borrowing conditions, including without limitation perfected liens on collateral, accuracy of all representations and warranties, the absence of a default or an event of default, and other borrowing conditions, all subject to certain exclusions as set forth in the agreement.

 

The agreement matures on October 7, 2013, subject to earlier termination as set forth in the agreement. The entire principal amount of loans under the facility and any outstanding letters of credit will be due on the maturity date. Loans may be voluntarily prepaid at any time at our option, in whole or in part, at par plus accrued and unpaid interest and any break funding loss incurred. We are required to make mandatory repayments in the event of receipt of net proceeds from asset dispositions, receipt of net proceeds from the issuance of securities and to the extent that our outstanding indebtedness under the Credit Facility exceeds our maximum borrowing availability at any time. Upon any voluntary or mandatory prepayment of borrowings outstanding at the LIBOR rate on a day that is not the last day of the respective interest period, we will reimburse the lenders for any resulting loss or expense that the lenders may incur. Amounts voluntarily repaid prior to the maturity date may be re-borrowed.

 

The Company and certain of our subsidiaries have executed a guaranty and security agreement pursuant to which all obligations under the Credit Facility are fully and unconditionally guaranteed on a joint and several basis. Additionally, pursuant to the security agreement, all obligations are secured by (i) a first priority perfected lien and security interest in substantially all assets of the Company and any guarantor from time to time and (ii) a first lien mortgage on our Hingham, Massachusetts headquarters facility and Lakeville, Massachusetts distribution facility. In connection with the lenders’ security interest in our proprietary Talbots credit card program, Talbots and certain of our subsidiaries have also executed an access and monitoring agreement that requires us to comply with certain monitoring and reporting obligations to the agent with respect to such program, subject to applicable law.

 

We may not create, assume or suffer to exist any lien securing indebtedness incurred after the closing date of the Credit Facility subject to certain limited exceptions set forth in the agreement. The Credit Facility contains negative covenants prohibiting us, with certain exceptions, from among other things, incurring indebtedness and contingent obligations, making investments, intercompany loans and capital contributions, declaring or making any dividend payment except for dividend payments or distributions payable solely in stock or stock equivalents, and disposing of property or assets. We have agreed to keep the mortgaged properties in good repair, reasonable wear and tear excepted. The agreement also provides for events of default, including failure to repay principal and interest when due and failure to perform or violation of the provisions or covenants of the agreement. The Credit Facility does not contain any financial covenant tests.

 

Concurrent with the execution of the First Amendment, we and the lenders entered into (a) a Master Agreement for Documentary Letters of Credit and (b) a Master Agreement for Standby Letters of Credit (each a “Master Agreement”), pursuant to which the lenders will provide either documentary or standby letters of credit at our request to various beneficiaries on the terms set forth in the applicable Master Agreement, subject to any applicable limitations set forth in the Credit Facility.

 

The Credit Facility is our only outstanding debt agreement at January 29, 2011. Of the $125.0 million borrowed under the Credit Facility at its inception, approximately $25.5 million was outstanding at January 29, 2011. Further at January 29, 2011, we had $9.1 million in outstanding letters of credit and letter of credit availability of up to $15.9 million under the Master Agreement, included as part of our total additional borrowing availability under the Credit Facility, subject to borrowing capacity restrictions described therein.

 

Outlook

 

Our ability to obtain additional financing as needed depends upon many factors, including our financial projections and our prospects and creditworthiness, as well as external economic conditions and general liquidity in the credit markets.

 

We expect that our primary uses of cash in the next twelve months will be concentrated in (i) funding operations, strategic initiatives and working capital needs; (ii) investing in capital expenditures with approximately $60.0 million in capital expenditures expected for fiscal 2011, primarily related to the store re-image initiative

and investments in our operations, finance and information technology systems; and (iii) seeking to continue to further deleverage our consolidated balance sheet by further reducing our outstanding obligation under the Credit Facility. Additionally, we may be required to make significant payments over the next twelve months to a state tax authority regarding certain tax matters which have been subject to appeal, pending final resolution and the outcome of potential negotiations with this authority.

 

Our cash and cash equivalents were $10.2 million as of January 29, 2011. Based on our current assumptions, our forecast and operating cash flow plan for fiscal year 2011, our anticipated borrowing availability under the Credit Facility and the improvements to the Company’s capital composition, we anticipate that the Company will have sufficient liquidity to finance anticipated working capital and other expected cash needs for at least the next twelve months. Our ability to meet our cash needs, obtain additional financing as needed and satisfy our operating and other non-operating costs will depend upon, among other factors, our future operating performance and creditworthiness as well as external economic conditions and the general liquidity of the credit markets.

 

Cash Flows

 

The following is a summary of cash flows from continuing operations for fiscal years 2010, 2009 and 2008:

 

 

Cash provided by operating activities

 

Cash provided by operating activities was $54.1 million in fiscal 2010 compared to $81.2 million in fiscal 2009 and $16.3 million in fiscal 2008. Cash provided by operating activities in fiscal 2010 is the result of earnings excluding non-cash items of $66.7 million, partially offset by a $12.6 million increase in cash used in working capital changes; whereas cash provided by operating activities in fiscal 2009 and fiscal 2008 is the result of lower investment in working capital of $45.5 million and $15.0 million, respectively, supplemented by earnings excluding non-cash items of $35.7 million and $1.3 million, respectively. This shift in the composition of cash provided by operating activities, from being primarily the result of working capital changes to being primarily the result of earnings excluding non-cash items in fiscal 2010, is primarily owed to the Company’s leaner operating structure in fiscal 2010 and improvements in the Company’s capital composition as a result of the BPW Transactions. Cash provided by operating activities in fiscal 2010 and 2009 also includes the payment of $27.1 million and $3.5 million in merger-related costs, respectively.

 

Cash provided by (used in) investing activities

 

Cash provided by investing activities was $304.2 million during fiscal 2010 compared to cash used in investing activities of $20.9 million in fiscal 2009 and $42.1 million in fiscal 2008. The cash flows provided by investing activities in fiscal 2010 primarily reflect the $333.0 million of cash and cash equivalents acquired in the merger with BPW on April 7, 2010. Refer to Merger with BPW and Related Financing Transactions for further information regarding this transaction.

 

Cash flows used in investing activities relate solely to purchases of property and equipment in all periods presented. Cash used for purchases of property and equipment during fiscal 2010 was $28.8 million compared to $21.0 million during fiscal 2009 and $44.7 million in fiscal 2008. In fiscal 2009, we planned a reduction in capital expenditures, generally limiting our capital investments to more essential replacement property, additions for new stores and a strategic platform refresh of our e-commerce site as part of an overall spend reduction program. In fiscal 2010, we planned an increase in capital expenditures for strategic reinvestments through our store re-image initiative, investments in our information technology systems and the expansion of our upscale outlets, with eleven new locations opening in fiscal 2010.

In fiscal 2010, we completed store renovations of fourteen retail locations in three key markets under our store re-image initiative and began storefront refreshes of eleven additional locations. These refreshes were completed in early fiscal 2011. Further, in fiscal 2010, we completed the full rebuild of an additional location in a key market, designed to reflect the Company’s comprehensive vision of its updated brand image, with the transformed store re-opening at the start of fiscal 2011, and began rebuilds of similar scope on two additional locations, expected to be completed around the start of the second quarter of fiscal 2011. These phases of the store re-image initiative represented incremental capital expenditures and related expenses, including accelerated depreciation of existing property and equipment disposed of under these phases in fiscal 2010, with primarily all of the expenses classified as cost of sales, buying and occupancy in the consolidated statements of operations.

 

These renovations marked the introduction of a multi-faceted store re-image initiative, a program designed to translate our updated brand vision of “tradition transformed” into a renovated storefront and store lay-out. Implementation of this initiative was primarily comprised of two programs — first, a store renovation with new lay-out, fixtures, and exterior updates and signage and second, a storefront refresh with new signage and exterior updates. We have evaluated the renovations and refreshes completed to-date and developed a modified program which combines key components of the store renovation and storefront refresh programs. We believe this value engineering will enable us to improve and update an increased number of stores more quickly, incorporating the critical elements of a store renovation at a reduced cost. We plan to initiate the next phase of our re-image initiative, under this modified program, in fiscal 2011, including renovations of up to approximately 70 stores. We believe the store re-image initiative is a key component in our plan to improve customer traffic and drive store productivity and could be a significant portion of our future capital investment. Going forward, we will continue to evaluate the results achieved as well as the scope and execution of any future phases of the initiative.

 

We expect to spend approximately $60.0 million in gross capital expenditures during the fiscal 2011, primarily related to the store re-image initiative and information technology improvements.

 

Cash (used in) provided by financing activities

 

Cash used in financing activities was $453.0 million in fiscal 2010 compared to cash provided by financing activities of $4.3 million in fiscal 2009 and $57.8 million in fiscal 2008. This change is primarily correlated to an outstanding debt reduction in fiscal 2010 compared to an outstanding debt increase in fiscal years 2009 and 2008, with outstanding debt totaling $25.5 million at January 29, 2011 and $486.5 million at January 30, 2010. The fiscal 2010 reduction of debt reflects the full repayment of all related party debt as part of the BPW Transactions, totaling $486.5 million. Refer to Merger with BPW and Related Financing Transactions for further information regarding this transaction. In addition to this repayment, cash used in financing activities in fiscal 2010 includes the payment of $9.8 million in debt and equity issuance costs related to the BPW Transactions and the repurchase of shares from employee stock award holders, partially offset by net borrowings on our revolving credit facility of $25.5 million, proceeds from the exercise of Non-Tendered Warrants of $19.0 million and proceeds from stock options exercised. In addition to net debt increases, financing activities in fiscal 2009 include the payment of debt issuance costs and the repurchase of shares from employee stock award holders. In fiscal 2008, financing activities include the payment of cash dividends, payment of debt issuance costs, the repurchase of shares from employee stock award holders and proceeds from stock options exercised, in addition to net debt increases.

Contractual Obligations, Commercial Commitments and Contingent Liabilities

 

The following summarizes our significant contractual obligations and commercial commitments as of January 29, 2011:

 

 

 

As described in Discontinued Operations, under the terms of the sale of the J. Jill business, the Purchaser is obligated for liabilities that arise after the closing under assumed contracts, which includes leases for 205 J. Jill stores assigned to the Purchaser as part of the sale, of which 203 assigned leases remained outstanding at January 29, 2011. Further, in connection with closing our U.K. stores in 2008, three store leases were assigned to a local retailer who assumed the primary lease obligations; and, in connection with the closing of our Mens stores, one store lease was assigned to a third party who assumed the primary lease obligations. We remain secondarily liable in the event that the Purchaser, the local retailer or other third party does not fulfill its lease obligations. We have accrued a liability for the estimated exposure related to these contingent obligations. At January 29, 2011, the future aggregate lease payments for which we remain contingently obligated, as transferor or sublessor, total $110.9 million extending to various dates through fiscal 2020. Any actual exposure may materially vary from estimated amounts. The table above excludes these contingent liabilities.

 

 

 

Critical Accounting Policies

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations  is based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the balance sheets and the reported amounts of net sales and expenses during the reporting periods. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances at the time such estimates are made. Actual results and outcomes may differ materially from our estimates, judgments and assumptions. Estimates are periodically reviewed in light of changes in circumstances, facts and experience. The effects of material revisions in estimates are reflected in the consolidated financial statements prospectively from the date of the change in estimate.

 

We define our “critical accounting policies” as those accounting principles generally accepted in the United States of America that require us to make subjective estimates and judgments about matters that are uncertain and are likely to have a material impact on our financial condition and results of operations as well as the specific manner in which we apply those principles. The principles that we believe to be our critical accounting policies are outlined below.

 

Inventory Markdown Reserve — Merchandise inventories is a significant asset on our balance sheet, representing approximately 23.6% of our total assets at January 29, 2011. We manage our inventory levels by using markdowns to clear merchandise as needed. Consistent with the retail inventory method, at the end of each reporting period, reductions in gross margin and inventory are recorded for estimated future markdowns necessary to liquidate remaining past-season inventory.

 

The key factors influencing the reserve calculation are the overall level of past season inventory at the end of the reporting period and the expectation of future markdowns on this same merchandise. The future markdown rate is

reviewed regularly by comparing actual markdowns taken against previous estimates. These results are then factored into future estimates. Historically, the difference between management’s estimates and actual markdowns has not been significant.

 

If market conditions were to decline, customer acceptance of product was not favorable or our sales were otherwise less than anticipated, we may have excess inventory on hand and may be required to mark down inventory at a greater rate than estimated, resulting in an incremental charge to earnings. We believe that at January 29, 2011 and January 30, 2010, the markdown reserve was appropriate based on the respective past season inventory levels, historical markdown trends and forecasts of future sales of past season inventory. The markdown reserve rate of past season inventory was 60.0% and 62.0% at January 29, 2011 and January 30, 2010, respectively. A 100 basis point increase or decrease in this rate would impact income (loss) before taxes by approximately $0.2 million in both fiscal years 2010 and 2009.

 

Gift Card Breakage — Proceeds from the sale of gift cards are recorded as a liability and are recognized as net sales when the cards are redeemed for merchandise. Our gift cards do not have an expiration date. Prior to the fourth quarter of 2010, all unredeemed gift card proceeds were reflected as a liability until escheated in accordance with applicable laws. We only recognized income from the non-escheated portion of unredeemed gift cards after a period of time had passed subsequent to the filing of the corresponding escheatment, approximately equal to the statute of limitations for state audit of the escheated funds. During the fourth quarter of 2010, we identified a history of redemption and breakage patterns associated with our gift cards which supports a change in our estimate of the term over which we should recognize income on gift card breakage. Accordingly, beginning with the fourth quarter of 2010, we recognize income from the breakage of gift cards when the likelihood of redemption of the gift card is remote. We determine our gift card breakage rate based upon historical redemption patterns. Based on this historical information, the likelihood of a gift card remaining unredeemed can be reasonably estimated at the time of gift card issuance. Breakage income is then recognized over the estimated average redemption period of redeemed gift cards, for those gift cards for which the likelihood of redemption is deemed to be remote and for the amount for which there is no legal obligation for us to remit the value of such unredeemed gift cards to any relevant jurisdictions. Gift card breakage income is recorded as other operating income and is classified as a reduction of selling, general and administrative in our consolidated statement of operations. Breakage income of $6.9 million, including a cumulative change in estimate of $6.3 million, was recognized during fiscal 2010.

 

Sales Return Reserve — As part of the normal sales cycle, we receive customer merchandise returns through both our store and direct marketing channels. To account for the financial impact of this process, management estimates future returns on previously sold merchandise. Reductions in sales and gross margin are recorded for estimated merchandise returns based on return history, current sales levels, projected future return levels and any changes in our return policy. Our estimated sales returns are periodically compared to actual sales returns. Historically, the difference between the estimated sales returns and actual sales returns has not been significant. If customer acceptance of our product is not favorable or if the product quality were to deteriorate, future actual returns may increase, resulting in a higher return rate and increased charges to earnings.

 

Customer Loyalty Program — We sponsor a customer loyalty program referred to as our classic awards program which rewards U.S. Talbots customers with a twenty-five dollar appreciation award for every five hundred points earned. Prior to January 2009, one point was earned for every dollar of merchandise purchased on a Talbots credit card. Commencing in January 2009, we launched an expanded program with three tiers: red, platinum, and black. The red tier is open to all customers, regardless of whether they hold a Talbots credit card, and accrues 0.5 points for every net dollar of merchandise purchased with a non-Talbots credit card payment. The platinum tier is the same as the prior program with one point being earned for every net dollar of merchandise purchased on a Talbots credit card. The black tier is for Talbots credit card holders who spend more than $1,000, net per calendar year on their Talbots credit card, and accrues 1.25 points for every net dollar of merchandise purchased on their Talbots credit card. Appreciation awards may be applied to future merchandise purchases and expire one year after issuance.

 

Appreciation award expense is calculated and recognized at the time of the initial customer purchase and is included in selling, general and administrative in the consolidated statement of operations. Our estimate of appreciation award expense at the time of recording is based on several factors which are subject to estimate and judgment, including actual and estimated purchase levels, actual awards issued and historical redemption rates. Actual awards

issued and redemptions of awards may vary from the estimates used in our analysis based on actual customer responsiveness to the program, which could result in additional expense.

 

Retirement Plans — We sponsor a noncontributory defined benefit pension plan (the “Pension Plan”) covering substantially all full-time Talbots and shared service employees in the U.S. hired on or before December 31, 2007; two unfunded non-qualified supplemental executive retirement plans (collectively, the “SERP”) for certain Talbots current and former key executives impacted by Internal Revenue Code limits; and we provide certain medical benefits for most Talbots retirees under postretirement medical plans. In February 2009, we announced our decision to discontinue future benefits being earned under the Pension Plan and SERP effective May 1, 2009, and as a result, a remeasurement of the plan obligations occurred as of February 28, 2009. The remeasurement resulted in a decrease to other liabilities of $25.4 million and $2.0 million for the Pension Plan and SERP, respectively, and an increase to other comprehensive income of $15.2 million and $1.2 million, net of tax, for the Pension Plan and SERP, respectively. Additionally, effective January 2011, the Company’s general postretirement medical plan became completely self-funded. Three current and former executive officers continue to be covered under the Company’s executive postretirement medical plan which is not self-funded; however, due to the limited number of participants, the Company’s expense under this plan has not historically been significant to any individual year.

 

In calculating our retirement plan obligations and related expense, we make various assumptions and estimates. The annual determination of expense, which occurs at the end of our fiscal year, involves calculating the estimated total benefit ultimately payable to our plan participants and allocating this cost to the periods in which services are expected to be rendered. Significant assumptions related to the calculation of our obligations include the discount rate used to calculate the actuarial present value of benefit obligations to be paid in the future and the expected long-term rate of return on assets held by the Pension Plan. These assumptions are reviewed annually based upon currently available information.

 

The discount rates that we apply are based, in part, upon a discount rate modeling process which matches the future benefit payment stream to a discount curve yield for the plan. The discount rate is used, principally, to calculate the actuarial present value of our obligation and periodic expense attributable to our employee benefits plans. The discount rate applied for the Pension Plan was 6.0% and 6.5% at January 29, 2011 and January 30, 2010, respectively. The discount rate applied for the SERP was 5.5% and 6.5% at January 29, 2011 and January 30, 2010, respectively. To the extent that the discount rate increases or decreases, our obligations are decreased or increased accordingly. A 25 basis point change in the discount rates would have impacted our income (loss) before taxes by approximately $0.2 million in both fiscal years 2010 and 2009.

 

The expected long-term rate of return on assets is the weighted average rate of earnings expected on the funds invested or to be invested to provide for the pension obligation and is based on an analysis which considers actual net returns for the Pension Plan since inception, Ibbotson Associates historical investment returns data for the three major classes of investments in which we invest (equity, debt and foreign securities) for the period since the Pension Plan’s inception and for the longer period commencing when the return data was first tracked and expectations of future market returns from outside sources for the three major classes of investments in which we invest. This rate is used primarily in estimating the expected return on plan assets component of the annual pension expense. To the extent that the actual rate of return on assets is less than or more than the assumed rate, that year’s annual pension expense is not affected. Rather, this loss or gain adjusts future pension expense over a period of approximately five years. We used an expected long-term rate of return on assets of 8.25% and 8.5% at January 29, 2011 and January 30, 2010, respectively. A 25 basis point change in the expected long-term rate of return on plan assets would have impacted our pre-tax income by $0.3 million and $0.2 million in fiscal years 2010 and 2009, respectively.

 

Long-lived Assets — We regularly monitor the performance and productivity of our store portfolio. When we determine that a store is underperforming or is to be closed, we reassess the recoverability of the store’s long-lived assets, which in some cases can result in an impairment charge. When a store is identified for impairment analysis, we estimate the fair value of the store assets using an income approach, which is based on estimates of future operating cash flows at the store level. These estimates, which include estimates of future net store sales, direct store expenses, and non-cash store adjustments, are based on the experience of management, including historical store operating results, its knowledge and expectations. These estimates can be affected by factors that can be difficult to

predict, such as future operating results, customer activity and future economic conditions, and require management to apply judgment.

 

Goodwill and Other Intangible Assets — We test our goodwill and trademarks for impairment on an annual basis, on the first day of each fiscal year, or more frequently if events or changes in circumstances indicate that these assets might not be recoverable. We concluded that we have two reporting units, stores and direct marketing, and that the balance of goodwill recorded relates entirely to the stores reporting unit. Our trademarks are allocated between both reporting units.

 

We determine the fair value of our goodwill using a combination of an income approach and market value approach which collectively contemplate our operating results and financial position, forecasted operating results, industry trends, market uncertainty and comparable industry multiples. The income approach requires significant judgments and estimates to project future revenues and expenses, changes in gross margins, cash flows and estimates of future capital expenditures for the reporting unit over a multi-year period, as well as to determine the weighted-average cost of capital to be used as a discount rate. We believe the discount rate that we apply is consistent with the risks inherent in our business and with the retail industry. The market approach requires the application of industry multiples of operating performance which are derived from comparable publicly traded companies with operating characteristics similar to our stores reporting unit. Our evaluation of goodwill inherently involves judgments as to assumptions used to project these amounts and the impact of market conditions on those assumptions. Our estimates may differ from actual results due to, among other matters, economic conditions, changes to our business model or changes in our operating performance. Significant differences between these estimates and actual results could result in future impairment charges and could materially affect our future financial results. We performed an impairment test of goodwill as of January 30, 2011, January 31, 2010 and February 1, 2009. These tests did not indicate an impairment of our goodwill.

 

We performed a sensitivity analysis on our significant assumptions and determined that a negative change in our assumptions, namely a 1% increase in the discount rate, a 10% decrease in the market approach multiple or a 10% decrease in forecasted earnings, would not have resulted in a change in our conclusions in 2010 or 2009 as to the recoverability of our goodwill as the computed fair value of the stores reporting unit was in excess of its carrying value by a significant margin.

 

We determine the fair value of our trademarks using an income approach, specifically the relief-of-royalty method. This methodology assumes that, in lieu of ownership, a third party would be willing to pay a royalty in order to exploit the related benefits of the asset. This approach is dependent on a number of factors, including estimates of future sales, royalty rates of intellectual property, discount rates and other variables. Significant differences between these estimates and actual results could result in future impairment charges and could materially affect our future financial results. We performed an impairment test of our trademarks as of January 30, 2011, January 31, 2010 and February 1, 2009. These tests did not indicate an impairment of our trademarks.

 

We performed a sensitivity analysis on our significant assumptions and determined that a negative change in our assumptions, namely a 1% increase in the discount rate, a 10% decrease in the market approach multiple or a 10% decrease in forecasted earnings, would not have resulted in a change in our conclusions in 2010 or 2009 as to the recoverability of our trademarks.

 

Income Taxes — We record deferred income taxes to recognize the effect of temporary differences between tax and financial statement reporting. We calculate the deferred taxes using enacted tax rates expected to be in place when the temporary differences are realized and record a valuation allowance to reduce deferred tax assets if it is determined that it is more likely than not that all or a portion of the deferred tax asset will not be realized. We consider many factors when assessing the likelihood of future realization of deferred tax assets, including recent earnings results, expectations of future taxable income, carry forward periods available and other relevant factors. Changes in the required valuation allowance are recorded in the period that the determination is made. In fiscal year 2008, we determined that it was more likely than not that we would not realize the benefits from our deferred tax assets and recorded a valuation allowance for substantially all of our net deferred tax assets, after considering sources of taxable income from reversing deferred tax liabilities. We have maintained a full valuation allowance against our net deferred tax assets, excluding deferred tax liabilities for non-amortizing intangibles, through fiscal years 2009 and 2010.

There is inherent uncertainty in quantifying our income tax positions. We assess our income tax positions and record tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances and information available at the reporting date. For those tax positions where it is more likely than not that a tax benefit will be sustained, we record the largest amount of tax benefit with a greater than 50 percent likelihood of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevant information. For those income tax positions where it is not more likely than not that a tax benefit will be sustained, no tax benefit is recognized in the financial statements. We classify our recorded uncertain tax positions as other liabilities on the consolidated balance sheets, unless expected to be resolved within one year. We classify interest on uncertain tax positions in interest expense, income tax refunds in interest income and estimated penalties in selling, general and administrative in the consolidated statements of operations.

 

We are routinely under audit by various domestic and foreign tax jurisdictions. There is significant judgment that is required in determining our provision for income taxes such as the composition of the taxable income or loss in different jurisdictions, changes in tax laws or rates, changes in the expected outcome of audits, the expiration of the statute of limitations on some tax positions and the effect of any new information about particular tax positions that may cause us to change our estimates. Changes in estimates may create volatility in our effective tax rate in future periods and may materially affect our results of operations. We believe that our income tax related accruals are appropriate at January 29, 2011 and January 30, 2010.

 

Stock-Based Compensation — We issue stock-based compensation awards including stock options, nonvested stock and restricted stock units. Related to such awards, we measure stock-based compensation at the grant date based on the fair value of the award, and we recognize such fair value as expense, on a straight-line basis, over the corresponding vesting period. We have selected the Black-Scholes option pricing model to determine the fair value of stock option awards which requires the input of various assumptions which require management to apply judgment and make assumptions and estimates, including the expected life of the stock option award and the volatility of the underlying common stock. Our assumptions may differ from those used in prior periods, and changes to the assumptions may have a significant impact on the fair value of future stock option awards, which could have a material impact on our consolidated financial statements. Nonvested stock and restricted stock units are valued at the closing market price of our common stock on the date of grant.

 

In addition, we are required to estimate the expected forfeiture rate of our stock-based compensation awards and only recognize expense for those awards expected to vest. If the actual forfeitures are materially different from our estimate, stock-based compensation could be different from what we have recorded in the current period.

 

Inflation and Changing Prices

 

We believe that changes in revenues and net earnings that have resulted from inflation or deflation have not been material during the periods presented. There is no assurance, however, that inflation or deflation will not materially affect us in the future.

 

Exchange Rates

 

We enter into certain purchase obligations outside the United States which are predominately settled in U.S. dollars. In addition, as of January 29, 2011, we operated 17 stores in Canada which generate sales and incur expenses in local currency. However, the local currency is generally stable and these operations represent only a small portion of our total operations. Accordingly, we have not experienced any significant impact from changes in exchange rates.

 

Recent Accounting Pronouncements

 

In January 2010, the FASB issued ASU 2010-6, Fair Value Measurements and Disclosures. ASU 2010-6 amends ASC 820-10, Fair Value Measurements and Disclosures, and requires new disclosures surrounding certain fair value measurements. ASU 2010-06 is effective for the first interim or annual reporting period beginning on or after December 15, 2009, except for certain disclosures about purchases, sales, issuances and settlements in the rollforward of activity in Level 3 fair value measurements, which are effective for the first interim or annual reporting period beginning on or after December 15, 2010. During fiscal 2010, we adopted the disclosure requirements effective for the first interim or annual reporting period beginning on or after December 15,

2009. We intend to adopt the remaining disclosure requirements of ASU 2010-6 when they become effective in the first quarter of fiscal 2011. The adoption of this ASU has expanded our disclosures regarding fair value measurements in the notes to the consolidated financial statements included elsewhere in this document. We do not expect the additional disclosure requirements of ASU 2010-06 will have any impact on our consolidated financial statements.

 

In July 2010, the FASB issued ASU 2010-20, Disclosures About the Credit Quality of Financing Receivables and the Allowance for Credit Losses. ASU 2010-20 amends ASC 310-10, Receivables, and requires additional disclosures about the credit quality of financing receivables, including credit card receivables, and the associated allowance for credit losses. ASU 2010-20 is effective for the first interim or annual reporting period ending on or after December 15, 2010, except for certain disclosures of information regarding activity that occurs during the reporting period, which are effective for the first interim or annual reporting period beginning on or after December 15, 2010. We have adopted the disclosure requirements effective for the first interim or annual reporting period ending on or after December 15, 2010 as of January 29, 2011. We intend to adopt the remaining disclosure requirements of ASU 2010-20 when they become effective in the first quarter of 2011. The adoption of this ASU has expanded our disclosures regarding customer accounts receivable and the associated allowance for doubtful accounts in the notes to the consolidated financial statements included elsewhere in this document. We are still evaluating the impact of the additional provisions of this ASU not yet adopted on our consolidated financial statements; however they are disclosure-only in nature.

 

In December 2010, the FASB issued ASU 2010-28, When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units With Zero or Negative Carrying Amounts. ASU 2010-28 amends ASC 350-20, Goodwill, by modifying the process of performing Step 1 of a goodwill impairment test for reporting units with zero or negative carrying values to add an additional layer of qualitative evaluation. Under this amended guidance, a company would be required to perform Step 2 of a goodwill impairment test for a reporting unit with zero or negative carrying value if adverse qualitative factors indicate that it is more likely than not that a goodwill impairment exists. ASU 2010-28 is effective for impairment tests performed during entities’ fiscal years that begin after December 15, 2010. The adoption of this ASU is not expected to materially affect our goodwill impairment analyses in fiscal 2011, as the fiscal year 2011 annual goodwill impairment test, performed as of January 30, 2011, reflected a positive carrying value of our stores reporting unit.

 

Recent Regulatory Changes

 

In May 2009, the Credit Card Accountability Responsibility and Disclosure Act of 2009 (the “Credit CARD Act”) was signed into law which resulted in new restrictions on credit card pricing, finance charges and fees, customer billing practices, payment allocation and also imposed additional disclosure requirements. Certain provisions of this legislation became effective in August 2010 and, as a result, we implemented new procedures to our credit card business practices and systems to ensure compliance with these rules. Revenue from our credit operations could be adversely affected as we adjust our practices to current and future regulations related to the Credit CARD Act.

 

In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Reform Act”) was enacted, which is intended to govern the practices and increase oversight of financial institutions and other participants in the financial markets. The Reform Act also creates a new federal agency, the Consumer Financial Protection Bureau, to supervise and enforce consumer lending laws and expands state authority over consumer lending. We expect numerous rules to be adopted in order to implement the provisions of the Reform Act. The potential impacts to our business and results of operations are uncertain at this time.

 

Forward-looking Information

 

This Annual Report on Form 10-K contains forward-looking information within the meaning of The Private Securities Litigation Reform Act of 1995. These statements may be identified by such forward-looking terminology as “expect,” “achieve,” “plan,” “look,” “projected,” “believe,” “anticipate,” “outlook,” “will,” “would,” “should,” “potential” or similar statements or variations of such terms. All of the information concerning our future liquidity, future financial performance and results, future credit facilities and availability, future cash flows and cash needs, strategic initiatives and other future financial performance or financial position, as well as our assumptions

underlying such information, constitute forward-looking information. Our forward-looking statements are based on a series of expectations, assumptions, estimates and projections about the Company, are not guarantees of future results or performance, and involve substantial risks and uncertainty, including assumptions and projections concerning our internal plan, regular-price and markdown selling, operating cash flows, liquidity and credit availability for all forward periods. Our business and our forward-looking statements involve substantial known and unknown risks and uncertainties, including the following risks and uncertainties:

 

 

 

All of our forward-looking statements are as of the date of this Annual Report only. In each case, actual results may differ materially from such forward-looking information. We can give no assurance that such expectations or forward-looking statements will prove to be correct. An occurrence of or any material adverse change in one or more of the risk factors or risks and uncertainties referred to in this Annual Report or included in our other public disclosures or our other periodic reports or other documents or filings filed with or furnished to the SEC could materially and adversely affect our continuing operations and our future financial results, cash flows, prospects and liquidity. Except as required by law, we do not undertake or plan to update or revise any such forward-looking statements to reflect actual results, changes in plans, assumptions, estimates or projections or other circumstances affecting such forward-looking statements occurring after the date of this Annual Report, even if such results, changes or circumstances make it clear that any forward-looking information will not be realized. Any public statements or disclosures by us following this Annual Report which modify or impact any of the forward-looking statements contained in this Annual Report will be deemed to modify or supersede such statements in this Annual Report.

 

 

The market risk inherent in our financial instruments and in our financial position represents the potential loss arising from adverse changes in interest rates. We do not enter into financial instruments for trading purposes.

 

As of January 29, 2011, we had outstanding variable-rate borrowings of $25.5 million under our Credit Facility. The impact of a hypothetical 10% adverse change in interest rates for this variable rate debt would have resulted in additional expense of approximately $0.1 million for the year ended January 29, 2011. Our Pension Plan assets are generally invested in readily-liquid investments, primarily equity and debt securities. Generally, any deterioration in the financial markets or changes in discount rates may require us to make a contribution to our Pension Plan.

 

We enter into certain purchase obligations outside the United States which are predominately settled in U.S. dollars and, therefore, we have only minimal exposure to foreign currency exchange risks. We do not hedge against foreign currency risks and believe that the foreign currency exchange risk is not material. In addition, we operated 17 stores in Canada as of January 29, 2011. We believe that our foreign currency translation risk is immaterial, as a hypothetical 10% strengthening or weakening of the U.S. dollar relative to the applicable foreign currency would not materially affect our results of operations or cash flow.

 

The information required by this item may be found on pages F-2 through F-47 as listed below, including the quarterly information required by this item.

 

INDEX

 

 

 

None.

 

 

Disclosure Controls and Procedures

 

The Company has established disclosure controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and is accumulated and communicated to management, including the principal executive officer (our Chief Executive Officer) and principal financial officer (our Chief Financial Officer), to allow timely decisions regarding required disclosure.

 

Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Annual Report on Form 10-K. Management recognizes that any disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of January 29, 2011.

 

Management’s Annual Report on Internal Control Over Financial Reporting

 

The Company’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act as a process designed by, or under the supervision of, a company’s principal executive and principal financial officers, 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 and includes those policies and procedures that: pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; 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 provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of the effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Management assessed the effectiveness of the Company’s internal control over financial reporting as of January 29, 2011. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Based on this assessment, management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, concluded that the Company maintained effective internal control over financial reporting as of January 29, 2011.

 

The effectiveness of the Company’s internal control over financial reporting as of January 29, 2011 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in its report included on page 50 of this Annual Report on Form 10-K.

 

Changes in Internal Controls over Financial Reporting

 

No changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended January 29, 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders of

The Talbots, Inc.

Hingham, Massachusetts

 

We have audited the internal control over financial reporting of The Talbots, Inc. and subsidiaries (the “Company”) as of January 29, 2011, 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 Annual 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 29, 2011, 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 29, 2011 of the Company and our report dated March 30, 2011 expressed an unqualified opinion on those financial statements.

 

/s/ Deloitte & Touche LLP

 

Boston, Massachusetts

March 30, 2011

 

None.

 

 

 

The information set forth under the captions “Election of Directors,” “Corporate Governance - Board Committees” and “Corporate Governance — Audit Committee” in our Proxy Statement for the 2011 Annual Meeting of Shareholders; information set forth in Part I, Item 1 in this Annual Report under the caption “Executive Officers of the Company” and the information under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in our Proxy Statement for the 2011 Annual Meeting of Shareholders, are each incorporated herein by reference.

 

We have adopted a Code of Business Conduct and Ethics (the “Code of Conduct”) that applies to our Chief Executive Officer, senior financial officers and all other employees, officers and Board members. The Code of Conduct is available on our website, www.thetalbotsinc.com, under “Investor Relations,” and is available in print to any person who requests a copy by contacting Talbots Investor Relations by calling (781) 741-4500, by writing to Investor Relations Department, The Talbots, Inc., One Talbots Drive, Hingham, MA 02043, or by e-mail at investor.relations@talbots.com. Any substantive amendment to the Code of Conduct and any waiver in favor of a Board member or an executive officer may only be granted by the Board of Directors and will be publicly disclosed on our website, www.thetalbotsinc.com, under “Investor Relations.”

 

 

The information set forth under the captions “Executive Compensation,” “Director Compensation,” “Corporate Governance — Compensation Risk Assessment” and “Corporate Governance-Compensation Committee Interlocks and Insider Participation” in our Proxy Statement for the 2011 Annual Meeting of Shareholders, are each incorporated herein by reference. The information included under “Compensation Committee Report” is incorporated herein by reference but shall be deemed “furnished” with this report and shall not be deemed “filed” with this report.

 

 

The information set forth under the caption “Beneficial Ownership of Common Stock” in our Proxy Statement for the 2011 Annual Meeting of Shareholders is incorporated herein by reference.

 

The following table sets forth certain information about our 2003 Executive Stock Based Incentive Plan, as amended, and the Restated Directors Stock Plan, as amended, as of January 29, 2011. These plans are our only active equity compensation plans and were both previously approved by our shareholders.

 

Equity Compensation Plan Information

 

 

 

 

The information set forth under the caption “Transactions with Related Persons” and “Corporate Governance — Board Independence and Composition” in our Proxy Statement for the 2011 Annual Meeting of Shareholders are each incorporated herein by reference.

 

 

The information set forth under the caption “Ratification of Appointment of Independent Registered Public Accounting Firm” in the Proxy Statement for the 2011 Annual Meeting of Shareholders is incorporated herein by reference.

 

 

The following exhibits are filed herewith or incorporated by reference:

 

(a)(1) Financial Statements:  The following Report of Independent Registered Public Accounting Firm and Consolidated Financial Statements of Talbots are included in this report:

 

Report of Independent Registered Public Accounting Firm

 

Consolidated Statements of Operations for the Years Ended January 29, 2011, January 30, 2010 and January 31, 2009

 

Consolidated Balance Sheets as of January 29, 2011 and January 30, 2010

 

Consolidated Statements of Cash Flows for the Years Ended January 29, 2011, January 30, 2010 and January 31, 2009

 

Consolidated Statements of Stockholders’ Equity (Deficit) for the Years Ended January 29, 2011, January 30, 2010 and January 31, 2009

 

Notes to Consolidated Financial Statements

 

(a)(2) Financial Statement Schedules:

 

All financial statement schedules have been omitted because the required information is either presented in the consolidated financial statements or the notes thereto or is not applicable or required.

 

(a)(3) Exhibits:

 

The following exhibits are filed herewith or incorporated by reference: