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WTSLA > SEC Filings for WTSLA > Form 10-Q on 21-Nov-2012All Recent SEC Filings

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Form 10-Q for WET SEAL INC


21-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our unaudited condensed consolidated financial statements and the notes thereto. The following discussion and analysis contains forward-looking statements. Forward-looking statements include statements that are predictive in nature, which depend upon or refer to future events or conditions, and/or which include words such as "believes," "plans," "intends," "anticipates," "estimates," "expects," "may," "will," or similar expressions. In addition, any statements concerning future financial performance, ongoing strategies or prospects, and possible future actions, which may be provided by our management, are also forward-looking statements. Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties, and assumptions about the Company, economic and market factors and the industry in which we do business, among other things. These statements are not guarantees of future performance and we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

Actual events and results may differ materially from those expressed or forecasted in forward-looking statements due to a number of factors. Factors that could cause our actual performance, future results and actions to differ materially from any forward-looking statements include, but are not limited to, those discussed in "Risk Factors" included in our Annual Report on Form 10-K for the fiscal year ended January 28, 2012, and elsewhere in this Quarterly Report on Form 10-Q.

All references to "we," "our," "us," and "the Company" in this Quarterly Report on Form 10-Q mean The Wet Seal, Inc. and its wholly owned subsidiaries.

Executive Overview

We are a national specialty retailer operating stores selling fashionable and contemporary apparel and accessory items designed for female customers from their early teens to 39 years old. We operate two nationwide, primarily mall-based, chains of retail stores under the names "Wet Seal" and "Arden B." At October 27, 2012, we had 553 retail stores in 47 states and Puerto Rico. Of the 553 stores, there were 472 Wet Seal stores and 81 Arden B stores. Our merchandise can also be purchased online through the respective websites of each of our chains.

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

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

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

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

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

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


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Business Segments

We report our results as two reportable segments representing our two retail divisions. Although the two operating segments have many similarities in their products, production processes, distribution methods, and regulatory environment, there are differences in most of these areas and distinct differences in their economic characteristics. As a result, we consider these segments to be two distinct reportable segments.

Wet Seal. Wet Seal is a junior apparel brand for girls and young women who seek fashionable clothing at a value, with a target customer age range of teens to early twenties. Wet Seal seeks to provide its customer base with a balance of trend right and fashion basic apparel and accessories that are affordably priced.

Arden B. Arden B is a fashion brand at value price points for the contemporary woman. Arden B targets customers aged 25 to 39 years old and seeks to deliver differentiated contemporary fashion, dresses, sportswear separates and accessories for any occasion of the customers' lifestyles.

We maintain a Web-based store located at www.wetseal.com, offering Wet Seal merchandise comparable to that carried in our stores, to customers over the Internet. We also maintain a Web-based store located at www.ardenb.com, offering Arden B merchandise comparable to that carried in our stores, to customers over the Internet. Our e-commerce stores are designed to serve as an extension of the in-store experience and offer an expanded selection of merchandise, with the goal of growing both e-commerce and in-store sales. We continue to develop our Wet Seal and Arden B websites to increase their effectiveness in marketing our brands. We do not consider our Web-based business to be a distinct reportable segment. The Wet Seal and Arden B reportable segments include, in addition to data from their respective stores, data from their respective e-commerce operations.

See Note 7, "Segment Reporting," to the unaudited condensed consolidated financial statements for financial information regarding segment reporting, which information is incorporated herein by reference.

Current Trends and Outlook

The retail environment in the U.S. has shown slight improvement in the first three quarters of 2012. However, only modest growth in the retail industry is expected for 2012 due to continued uncertainty regarding the global economy and the lack of significant improvement in the U.S. housing market and unemployment rates. In addition, U.S. gross domestic product growth remains slow, further contributing to a volatile, and generally weak, retail environment. Year-to-date fiscal 2012, we ran aggressive promotions and incurred high levels of clearance markdowns at both Wet Seal and Arden B to address product that was performing below expectations, primarily in the tops category, and more recently during the fiscal 2012 third quarter, in an effort to clear merchandise from the previous strategy and re-merchandise our Wet Seal stores with product that appeals to a broader demographic. As a result, we experienced significant declines in our merchandise margin and comparable store sales. Although we expect improvement in our merchandise margins once our stores are fully re-merchandised, we expect a very competitive environment throughout the holiday season will require aggressive promotional levels that will continue to challenge our margins.

Our performance is subject to general economic conditions and their impact on levels of consumer confidence and consumer spending. Consumer purchases of discretionary items, including our merchandise, generally decline during periods when disposable income is adversely affected or there is economic uncertainty. As a result of the continued difficult economic conditions, we may face risks that will impact many facets of our operations, including, among other things, the ability of one or more of our vendors to deliver their merchandise in a timely manner or otherwise meet their obligations to us. Although we believe we are sufficiently prepared and financially strong enough to endure poor economic conditions in the U.S. and world economic markets, if such conditions continue, or if they deteriorate further, our business, financial condition, and results of operations may be further materially adversely affected.

Our comparable store sales decreased 13.5% during the 13 weeks ended October 27, 2012, driven by a 13.5% comparable store sales decrease in our Wet Seal division and a 13.8% comparable store sales decrease in our Arden B division. The Wet Seal division's comparable store sales decrease was primarily driven by a decrease in transaction volume and average dollar sales per transaction, which was driven by a decrease in average unit selling price, partially offset by an increase in units purchased per customer. At Wet Seal, our underperformance reflected our planned strategy to transition away from an assortment geared toward more elevated product and a more mature customer, versus our historical product mix and customer target, with aggressive promotions. Our tops, excluding woven tops, dressy bottoms, active, and jewelry businesses declined significantly, while woven tops, denim bottoms, shoes, outerwear and accessory sales increased. The Arden B division comparable store sales decrease was primarily driven by a decline in transaction volume and a decrease in average dollar sales per transaction, which was driven by a decrease in average unit selling price, partially offset by an increase in units purchased per customer. At Arden B, our performance reflects declines in all categories except outerwear and bottoms. Although the Arden B dress business did not increase over the prior year, it did perform well on lower inventory levels. We are focused on continuing to build our inventory levels in dresses and the other key categories to drive near term sales increases during the holiday season. Our combined e-commerce sales increased 8.7% during the 13 weeks ended October 27, 2012, as compared to the prior year quarter.


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The third quarter marked an important transition period for us as we executed upon our decision to return to our core expertise of fast fashion merchandising. We took aggressive actions towards refocusing our Wet Seal division strategy, including returning to merchandising to a broader demographic, including the young teen customer, sourcing a broader variety of product more directly from fast fashion vendors, committing to merchandise purchases closer to time of need, and focusing our price points on our core customer, which long supported our success. These actions allowed us to achieve progressive improvement in comparable store sales trend from month to month in the fiscal 2012 third quarter, as we had planned. We seek continued improvement in the fiscal 2012 fourth quarter that we expect will ultimately return us to a level of sales and earnings that our fast fashion strategy has driven for many years.

Store Openings and Closures

For all of fiscal 2012, we expect to have four net store closings at Wet Seal and 20 net store closings at Arden B. As a result, we estimate we will end fiscal 2012 with 468 Wet Seal stores and 66 Arden B stores.

At Wet Seal, we opened five new stores and closed one store during the 13 weeks ended October 27, 2012. At Arden B, we closed one store during the 13 weeks ended October 27, 2012.

Critical Accounting Policies and Estimates

Our condensed consolidated financial statements were prepared in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

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

We believe the application of our accounting policies, and the estimates inherently required therein, are reasonable. Our accounting policies and estimates are reevaluated on an ongoing basis, and adjustments are made when facts and circumstances dictate a change. Our accounting policies are more fully described in Note 1 of Notes to Consolidated Financial Statements and in Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended January 28, 2012.

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

We have certain accounting policies that require more significant management judgment and estimates than others. These include our accounting policies with respect to revenue recognition, merchandise inventories, long-lived assets, stock-based compensation, accounting for income taxes and insurance reserves. There have been no significant additions to or modifications of the application of the critical accounting policies described in our Annual Report on Form 10-K for the fiscal year ended January 28, 2012, except for the following updates for our critical accounting policies for long-lived assets and accounting for income taxes.

Long-Lived Assets

We evaluate the carrying value of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Factors that are considered important that could result in the necessity to perform an impairment review include a current-period operating or cash flow loss combined with a history of operating or cash flow losses and a projection or forecast that indicates continuing losses or insufficient income associated with the realization of a long-lived asset or asset group. Other factors include a significant change in the manner of the use of the asset or a significant negative industry or economic trend. This evaluation is performed based on estimated undiscounted future cash flows from operating activities compared with the carrying value of the related assets. If the estimated undiscounted future cash flows are less than the carrying value, an impairment loss will be recognized, measured as the difference between the carrying value and the estimated fair value of the assets, based on discounted estimated future cash flows using our weighted average cost of capital. We have considered all relevant valuation techniques that could be applied without undue cost and effort and have determined that the discounted estimated future cash flow approach continues to provide the most relevant and reliable means by which to determine fair value in this circumstance.


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Our quarterly evaluation of store assets includes consideration of current and historical performance and projections of future profitability. The profitability projections rely upon estimates made by us, including store-level sales, gross margins, and direct expenses, and, by their nature, include judgments about how current strategic initiatives will impact future performance.

Our financial performance in the first three quarters of fiscal 2012 declined more than projected by us in past impairment analyses, which resulted in asset impairment charges each quarter since the beginning of fiscal 2012. Each period reflected our best estimate at the time. If we are not able to achieve our projected key financial metrics, and strategic initiatives being implemented do not result in significant improvements in our current financial performance trend, we would incur additional impairment of assets in the future.

During the 13 and 39 weeks ended October 27, 2012, and October 29, 2011, we determined such events or changes in circumstances had occurred with respect to certain of our retail stores, and that operating losses or insufficient operating income would likely continue. As such, we recorded noncash charges of $6.5 million, $19.0 million, $0.7 million and $2.0 million, in our condensed consolidated statements of operations for the 13 and 39 weeks ended October 27, 2012, and October 29, 2011, respectively, to write down the carrying value of these stores' long-lived assets to their estimated fair values.

Accounting for Income Taxes

We have approximately $75.9 million of federal net operating loss ("NOL") carry forwards available to offset taxable income in fiscal 2012 and thereafter, subject to certain annual limitations based on the provisions of Section 382 of the Internal Revenue Code.

Our effective income tax rates for the 13 and 39 weeks ended October 27, 2012, were 40.5% and 38.8%, respectively. We expect a 38.8% effective income tax rate for fiscal 2012. Our effective income tax rates reflect a $0.3 million write-off of certain deferred tax assets in the fiscal 2012 second quarter as a result of IRS adjustments from our closed IRS audit of our fiscal 2008 and 2009 tax years and $0.3 million for tax credits taken on our fiscal year 2011 tax return and recorded in the fiscal 2012 third quarter, which are discrete items. We anticipate cash payment for income taxes for the fiscal year will be approximately $0.1 million, representing certain state income taxes. The difference between the effective income tax rate and the anticipated cash income taxes is recorded as a non-cash benefit for deferred income taxes.

Recently Adopted Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (the "FASB") issued guidance on the application of fair value accounting where its use is already required or permitted by other standards within U.S. GAAP. This guidance changed the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. Amendments include those that clarify the FASB's intent about the application of existing fair value measurement and disclosure requirements, and change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. For many of the requirements, the FASB does not intend for the amendments to result in a change in the application of the requirements. This guidance became effective for interim and annual periods beginning after December 15, 2011. We adopted this guidance and it did not significantly impact our condensed consolidated financial statements.

In June 2011, the FASB issued amended guidance on the presentation of comprehensive income. This guidance provided an entity with an option to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both options, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. The guidance became effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011, and is to be applied on a retrospective basis. We have adopted this guidance and have presented total comprehensive (loss) income, the components of net (loss) income and the components of other comprehensive (loss) income in two separate but consecutive statements within our condensed consolidated financial statements.


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Results of Operations

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



                                       As a Percentage of Net Sales                 As a Percentage of Net Sales
                                              13 Weeks Ended                               39 Weeks Ended
                                   October 27,              October 29,          October 27,            October 29,
                                       2012                     2011                 2012                   2011
Net sales                                 100.0 %                  100.0 %              100.0 %                100.0 %
Cost of sales                              80.8                     69.5                 76.0                   68.1

Gross margin                               19.2                     30.5                 24.0                   31.9
Selling, general, and
administrative expenses                    32.8                     26.0                 30.1                   26.5
Asset impairment                            4.7                      0.5                  4.6                    0.4

Operating (loss) income                   (18.3 )                    4.0                (10.7 )                  5.0
Interest (expense) income,
net                                        (0.0 )                    0.0                 (0.0 )                  0.0

(Loss) income before (benefit
from) provision for income
taxes                                     (18.3 )                    4.0                (10.7 )                  5.0
(Benefit from) provision for
income taxes                               (7.4 )                    1.5                 (4.2 )                  1.9

Net (loss) income                         (10.9 )%                   2.5 %               (6.5 )%                 3.1 %

Thirteen Weeks Ended October 27, 2012, Compared to Thirteen Weeks Ended
October 29, 2011

Net sales



                                         13 Weeks                                                  13 Weeks
                                          Ended                     Change From                     Ended
                                     October 27, 2012           Prior Fiscal Period            October 29, 2011
                                                                  ($ in millions)

Net sales $ 135.5 $ (16.6 ) (10.9 )% $ 152.1 Comparable store sales decrease (13.5 )%

Net sales for the 13 weeks ended October 27, 2012, decreased primarily as a result of a decrease of 13.5% in comparable store sales, resulting from a 13.0% decrease in comparable store average transactions and a 0.8% decrease in comparable store average dollar sales per transaction. Comparable store average dollar sales per transaction decreased mainly due to a 4.2% decrease in average unit retail prices, partially offset by a 3.4% increase in the number of units purchased per customer.

The decrease in net sales was partially offset by an increase in number of stores, from 550 stores as of October 29, 2011, to 553 stores as of October 27, 2012, and an increase of $0.7 million in net sales for our e-commerce business as compared to the prior year, which is not a factor in calculating our comparable store sales.

Cost of sales

                                        13 Weeks                                                        13 Weeks
                                         Ended                        Change From                        Ended
                                    October 27, 2012              Prior Fiscal Period               October 29, 2011
                                                                    ($ in millions)
Cost of sales                      $            109.5         $     3.7                3.5 %       $            105.8
Percentage of net sales                          80.8 %                               11.3 %                     69.5 %

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

Cost of sales as a percentage of net sales increased due primarily to a decrease in merchandise margin as a result of significantly higher markdown rates in both the Wet Seal and Arden B divisions, as compared to the prior year, and the deleveraging effect on occupancy, buying and planning and allocation costs from the decline in comparable store sales.

Cost of sales dollars increased primarily due to higher markdowns, partially offset by the decline in sales.


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Selling, general, and administrative expenses (SG&A)

                                         13 Weeks                                                      13 Weeks
                                          Ended                        Change From                      Ended
                                     October 27, 2012              Prior Fiscal Period             October 29, 2011
                                                                     ($ in millions)
Selling, general, and
administrative expenses             $             44.4         $     4.9               12.4 %     $             39.5
Percentage of net sales                           32.8 %                                6.8 %                   26.0 %

Our SG&A expenses are comprised of two components. Selling expenses include store and field support costs, including personnel, advertising, merchandise delivery, and transaction processing costs, as well as e-commerce processing and advertising costs. General and administrative expenses include the cost of corporate functions such as executives, legal, finance and accounting, . . .

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