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BEBE > SEC Filings for BEBE > Form 10-K on 19-Sep-2013All Recent SEC Filings

Show all filings for BEBE STORES, INC.

Form 10-K for BEBE STORES, INC.


19-Sep-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements and related Notes included elsewhere in this report. The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward looking statements, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under "Risks Factors" under Item 1A of this report.

Overview

We design, develop and produce a distinctive line of contemporary women's apparel and accessories under the bebe, BEBE SPORT, bbsp and 2b bebe brand names. We operate stores in the United States, Puerto Rico, Virgin Islands and Canada. In addition we have on-line stores at www.bebe.com and www.2bstores.com that ship to customers in the United States, Canada, Puerto Rico, the U.S. Protectorates and, for www.bebe.com, internationally via our third-party provider, International Checkout. We also have international stores operated by licensees in South East Asia, United Arab Emirates, Israel, Russia, South America, South Africa and Turkey. Our distinctive product offering includes a full range of separates, tops, dresses, active wear and accessories to satisfy her every day wardrobe needs across all occasions. We design and develop the majority of our merchandise in-house, which is manufactured to our specifications. The remainder is sourced directly from third-party manufacturers.

Fiscal 2013 financial highlights include the following:

Net sales from continuing operations for fiscal 2013 were $484.7 million, down 8.7% from $530.8 million for fiscal 2012. Comparable store sales for fiscal 2013 decreased 8.8% compared to an increase of 5.3% in the previous fiscal year. The inclusion of the on-line stores increased the comparable store percentage by 1.5% for the fiscal year ended July 6, 2013.

Gross margin from continuing operations for fiscal 2013 was 32.7% compared to 39.8% for fiscal 2012.



Selling, general and administrative expenses from continuing operations for the 2013 fiscal year were $209.5 million, up 9.3% from $191.7 million for fiscal 2012.

Net loss from continuing operations for the fiscal year ended July 6, 2013 was $77.4 million, or $0.95 per share on a diluted basis, compared to net income of $11.7 million, or $0.14 per share on a diluted basis, in the prior year.

In fiscal 2013, cash decreased by $18.0 million, down from an increase of $9.8 million for fiscal 2012, primarily as a result of share repurchases made during the year.

Our strategic focus for fiscal 2014 is to achieve sequential improvement, detailed as follows:

Increase product distinction with a contemporary accessible fashionable merchandise offering designed for the confident, sexy woman.

Refine merchandising process and offerings to improve top-line sales and margin expansion.

Further develop our omni-channel strategy by elevating retail experience with new prototype and redesign of website through enhanced sophisticated user experience to engage our customer wherever she shops.

Align our marketing campaign across traditional and new media focused on messaging that speaks to the bebe woman.

Identify store closure opportunities based on profitability for bebe and 2b bebe retail stores as well as continue international expansion.

Invest for sustainable future growth in marketing, technology, new store proto-type and talent.

Critical Accounting Policies

Management's Discussion and Analysis of Financial Condition and Results of Operations are based upon our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America.

The preparation of these financial statements requires the appropriate application of certain accounting policies, many of which require us to make estimates and assumptions about future events and their impact on amounts reported in our financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates. Such differences could be material to the financial statements. We believe our application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are constantly reevaluated, and adjustments are made when facts and circumstances dictate a change. Our accounting policies are more fully described in Note 1 to our consolidated financial statements included in this report.

We have identified certain critical accounting policies, which are described below.

Revenue recognition. We recognize revenue at the time the products are received by the customers. We recognize revenue for store sales at the point at which the customer receives and pays for the merchandise at the register. For on-line sales, we recognize revenue at the time we estimate the customer receives the product. We estimate and defer revenue and the related product costs for shipments that are in transit to the customer. Customers typically receive goods within one week of shipment. We reflect amounts related to shipping billed to customers in net sales and the related costs in cost of goods sold. We record retail sales net of sales tax collected from customers at the time of the transaction.

We record a reserve for estimated product returns based on historical return trends. If actual returns are greater than those projected, we may record additional sales returns in the future. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our sales return reserve. However, if the actual rate of sales returns increases significantly, our operating results could be adversely affected.


Discounts offered to customers consist primarily of point of sale markdowns and are recorded at the time of the related sale as a reduction of revenue.

We include the value of points and rewards earned by our loyalty program members as a liability and a reduction of revenue at the time the points and rewards are earned based on historical conversion and redemption rates. We recognize the associated revenue when the rewards are redeemed or expire.

Gift certificates sold are recorded as a liability and we recognize sales revenue when the gift certificate is redeemed. Similarly, customers may receive a store credit in exchange for returned goods.

We carry store credits as a liability until redeemed. We recognize unredeemed store credits and gift certificates as other income three and four years, respectively, after issuance, which is when management deems redemptions to be remote. In addition, we sell gift cards with no expiration dates to customers in our retail store locations, through our on-line stores, and through third parties. We recognize sales revenue from gift cards when they are redeemed by the customer. In addition, we recognize income on unredeemed gift cards when we can determine that the likelihood of the gift card being redeemed is remote and there is no legal obligation to remit the unredeemed gift cards to relevant jurisdictions (gift card breakage), which we estimate is four years. Gift card breakage is included as other income within selling, general and administrative expenses. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our breakage income. However, if the actual rate of redemption for gift certificates, store credits, and gift cards increases significantly, our operating results could be adversely affected.

We record royalty revenue from product licensees as the greater of the minimum amount guaranteed in the contract or amount sold.

We recognize wholesale licensee revenue from sale of product to international licensee operated bebe stores at the time we estimate the licensee receives shipment. We exclude these stores from comparable store sales.

Stock Based Compensation. We recognize stock-based awards to employees as compensation expense, based on the calculated fair value on the date of grant. We determine the fair value using the Black-Scholes option pricing model. This model requires subjective assumptions, which are affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee exercise behaviors, risk-free interest rate and expected dividends. As the stock-based compensation expense recognized in the consolidated statements of operations and comprehensive income for fiscal 2013, 2012 and 2011 is based on awards ultimately expected to vest, such amount has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We estimate forfeitures based on our historical experience.

Inventories. We state inventories at the lower of weighted average cost or market. We determine market based on the estimated net realizable value, which is generally the merchandise selling price. To ensure that our raw material is properly valued, we age the fabric inventory and record a reserve in accordance with our established policy, which is based on historical experience. To ensure our finished goods inventory is properly valued, we review the age and turnover of our inventory and record an adjustment if the selling price is estimated to be marked down below cost. These assumptions can have an impact on current and future operating results and financial position. We estimate and record shrinkage for the period between the last physical count and balance sheet date based on historic shrinkage trends.

Investments. We hold a variety of interest bearing auction rate securities ("ARS") consisting of federally insured student loan backed securities and insured municipal authority bonds. As of July 6, 2013, our ARS portfolio totaled approximately $34.2 million, net of a temporary impairment charge of $6.2 million, classified as available for sale securities. These ARS investments are intended to provide liquidity via an auction process that resets the applicable interest rate at predetermined calendar intervals, allowing investors to either roll over their holdings or gain immediate liquidity by selling such interests at par. The uncertainties in the credit markets that


began in February 2008 have affected our holdings in ARS investments and auctions for our investments in these securities have failed to settle on their respective settlement dates. Historically the fair value of ARS investments had approximated par value due to the frequent resets through the auction process. While we continue to earn interest on our ARS investments at the maximum contractual rate, the majority of these investments are not currently trading and therefore do not currently have a readily determinable market value. Accordingly, the estimated fair value of ARS no longer approximates par value. Consequently, the investments are not currently liquid, and we will not be able to access these funds until a future auction of these investments is successful, the issuer redeems the securities or at maturity. Maturity dates for these ARS range from 2018 to 2042 with principal distributions occurring on certain securities prior to maturity.

We also hold short-term available for sale securities totaling $38.9 million at July 6, 2013 that consist of treasury bills and certificates of deposit as well as long-term available for sale securities totaling $54.2 million that consist of ARS and treasury bills.

We review our investments for impairment in accordance with guidance issued by the FASB and SEC in order to determine the classification of the impairment as "temporary" or "other-than-temporary". A temporary impairment charge results in an unrealized loss being recorded in the other comprehensive income component of shareholders' equity. Such an unrealized loss does not affect net income for the applicable accounting period. An other-than-temporary impairment charge is recorded as a loss in the consolidated statements of operations and reduces net income for the applicable accounting period. When evaluating the investments for other-than-temporary impairment, we estimate the expected cash flows of the underlying collateral by reviewing factors such as the length of time and extent to which the fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and our intent to sell, or whether it is more likely than not it will be required to sell, the investment before recovery of the investment's unamortized cost basis.

The valuation of our investment portfolio is subject to uncertainties that are difficult to predict. Factors that may impact our valuation include changes to credit ratings of the issuers of the securities as well as to the underlying assets supporting those securities, rates of default of the underlying assets, underlying collateral value, discount rates and ongoing strength and quality of market credit and liquidity.

Impairment of long-lived assets. We review long-lived assets for impairment whenever events or changes in circumstances, such as planned store closures or poor performing stores, indicate that the carrying value of an asset may not be recoverable. Assets are grouped and evaluated for impairment at the lowest level of which there are identifiable cash flows, which is generally at a store level. Store assets are reviewed using factors including, but not limited to, the Company's future operating plans and projected cash flows. The determination of whether impairment has occurred is based on an estimate of undiscounted future cash flows directly related to that store, compared to the carrying value of the assets. If the sum of the undiscounted future cash flows of a store does not exceed the carrying value of the assets, full or partial impairment may exist. For impaired assets, we recognize a loss equal to the difference between the net book value of the asset and its estimated fair value. Fair value is based upon discounted future cash flows of the asset using a discount rate commensurate with the risk. In addition, at the time a decision is made to close a store, we record an impairment charge, if appropriate, or accelerate depreciation over the revised useful life of the asset. During the fourth quarter of fiscal 2013, management was able to obtain sufficient historical data which resulted in a change in its assumptions of the retail market for a certain, newer, group of stores. As such, during fiscal 2013 we recorded a $7.0 million charge for the impairment of store assets. We believe at this time that the long-lived assets' carrying values and useful lives continue to be appropriate; however significant changes from our current future forecasts could result in additional impairment charges.

Income Taxes. We account for income taxes using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. We are subject to periodic audits by the Internal Revenue Service and other foreign, state and local taxing authorities. These audits may challenge certain of our tax positions such as the timing and amount of income and deductions and the allocation of taxable income to various tax jurisdictions. We evaluate our tax positions and establish liabilities in accordance with applicable


accounting guidance on uncertainty in income taxes. To the extent that our estimates change or the final tax outcome of these matters is different than the amounts recorded, such differences will impact the income tax provision in the period in which such determinations are made. We regularly asses the need for a valuation allowance against our deferred tax assets. In evaluating whether it is more likely than not that some or all of our deferred tax assets will not be realized, we consider all available positive and negative evidence, including recent year's operational results which is objectively verifiable evidence. As a result of this evaluation, as of July 6, 2013, we concluded that it is more likely than not that the majority of our deferred tax assets will not be realized and therefore we increased our valuation allowance by approximately $44.8 million in the current fiscal year. Our effective tax rate in a given financial statement period may be materially impacted by changes in the mix and level of earnings, changes in the expected outcome of audits or changes in the deferred tax valuation allowance.

Recent Accounting Pronouncements

Fair Value

In May 2011, the FASB issued guidance to amend the accounting and disclosure requirements on fair value measurements. The new guidance limits the highest-and-best-use measure to nonfinancial assets, permits certain financial assets and liabilities with offsetting positions in market or counterparty credit risks to be measured on a net basis and provides guidance on the applicability of premiums and discounts. Additionally, the new guidance expands the disclosures on Level 3 inputs by requiring quantitative disclosure of the unobservable inputs and assumptions, as well as description of the valuation processes and the sensitivity of the fair value to changes in unobservable inputs. The new guidance was effective for us beginning in fiscal 2013, which is July 1, 2012. The disclosure guidance adopted July 1, 2012 did not have a material impact our consolidated financial statements.

Other Comprehensive Income

In June 2011, the FASB issued ASU 2011-05, which requires that all non-owner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income and the total of comprehensive income. The new guidance eliminates the current option to report other comprehensive income and its components in the consolidated statements of shareholders' equity. For public entities, the amendments in ASU 2011-05 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, and are to be applied retrospectively, with early adoption permitted. The adoption did not have a material effect on our consolidated financial statements.

In February 2013, the FASB issued an ASU that requires enhanced disclosures around the amounts reclassified out of accumulated other comprehensive income. The amendments do not change the requirements for reporting net income or other comprehensive income. The ASU requires an entity to present information about significant reclassifications out of accumulated other comprehensive income and their corresponding effects on the respective line items in net income. The ASU is effective for annual and interim reporting periods beginning after December 15, 2012 and as such, we will adopt the disclosure provisions in the first quarter of fiscal 2014.

Income Tax

In July 2013, the FASB issued ASU 2013-11 to clarify the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The ASU is effective prospectively for fiscal years and interim periods within those years beginning after December 15, 2013. We early adopted this ASU, which did not have a material impact on our consolidated financial statements.

Results of Operations

Our fiscal year ends on the first Saturday on or after June 30. Fiscal 2013 included 53 weeks, while fiscal 2012 and 2011 each included 52 weeks.


The following table sets forth certain financial data as a percentage of net sales for the periods indicated:

                                                                Fiscal Year Ended
                                                    July 6,          June 30,         July 2,
                                                      2013             2012             2011
Statement of Operating Data:
Net sales                                              100.0 %           100.0 %         100.0 %
Cost of sales, including production and
occupancy(1)                                            67.3              60.2            61.1

Gross margin                                            32.7              39.8            38.9
Selling, general and administrative expenses(2)         43.2              36.1            37.7

Operating income (loss)                                (10.6 )             3.7             1.2
Interest and other income, net                           0.2               0.2             0.2

Income (loss) from continuing operations before
income taxes                                           (10.4 )             3.9             1.4
Income tax provision                                     5.6               1.6             0.6

Income (loss) from continuing operations, net
of tax                                                 (16.0 )             2.3             0.8
Loss from discontinued operations, net of tax             -                 -             (1.2 )

Net income (loss)                                      (16.0 )%            2.3 %          (0.4 )%

(1) Cost of sales includes the cost of merchandise, occupancy costs and production costs.

(2) Selling, general and administrative expenses primarily consist of non-occupancy store costs, corporate overhead and advertising costs.

Fiscal Years Ended July 6, 2013 and June 30, 2012

Net Sales. Net sales from continuing operations decreased to $484.7 million during the fiscal year ended July 6, 2013 from $530.8 million in fiscal 2012, a decrease of $46.1 million, or 8.7%. The decrease in net sales was primarily attributable to an 8.8% decrease in comparable store sales due to a decrease in comparable store traffic as well as a decrease in wholesale sales of $3.9 million, or 9.3%. On-line store sales increased 4.2% during the year. The increase in e-commerce sales was driven by increased sales of both bebe and 2b bebe brand merchandise. A significant contributor to our increase in e-commerce sales in 2013 was the continued movement towards more seamless multi-channel capabilities, including increasing our on-line assortment and improving on-line ordering capabilities in stores. We believe that bringing website administration in house in the first quarter of 2013 has enabled us and will continue to enable us to continue to grow on-line sales, although not necessarily at the same rate as in the past given the progress we have already made in this area.

Gross Margin. Gross margin from continuing operations decreased to $158.3 million for the fiscal year ended July 6, 2013 from $211.1 million in fiscal 2012, a decrease of $52.8 million, or 25.0%. As a percentage of net sales, gross margin of 32.7% was lower than the prior year at 39.8% primarily due to an increase in markdowns coupled with unfavorable occupancy leverage. Gross margin in fiscal 2013 also included $2.9 million in reserves for inventory and fabric under the legacy strategy.

Selling, General and Administrative Expenses. Selling, general and administrative expenses from continuing operations, which primarily consist of non-occupancy store costs, corporate overhead and advertising costs, increased to $209.5 million during fiscal 2013 from $191.7 million in fiscal 2012, an increase of $17.8 million, or 9.3%. This increase was primarily attributable to store impairment and closure costs of $9.3 million, costs related to executive transitions of $4.9 million, settlement related expenses of $3.3 million, and rebranding agency costs of $1.4 million. The comparable period of the prior year included $4.7 million in incentive compensation costs as well as $0.2 million in store impairment and closure costs.

Interest and Other Income, Net. We generated $0.8 million of interest and other income, net of other expenses, during fiscal 2013 as compared to $0.9 million in fiscal 2012. The year over year consistency reflected our continued investment in lower-yielding tax-exempt investments and money market funds.


Provision for Income Taxes. Our effective tax rate was 53.5% for fiscal 2013 as compared to 42.4% for fiscal 2012. During the third quarter of fiscal 2013 we recorded a valuation allowance for the majority of our deferred tax assets. As a result, our effective tax rate for fiscal 2013 is not comparable to the comparable period of the prior year. In future years, the continuing impact of maintaining a valuation allowance against deferred tax assets is expected to result in a near 0% effective tax rate.

Fiscal Years Ended June 30, 2012 and July 2, 2011

Net Sales. Net sales from continuing operations increased to $530.8 million during the fiscal year ended June 30, 2012 from $493.3 million in fiscal 2011, an increase of $37.5 million, or 7.6%. The increase in net sales was primarily attributable to a 5.3% increase in comparable store sales as well as an increase in wholesale sales of $9.3 million, or 30.5%.

Gross Margin. Gross margin from continuing operations increased to $211.1 million for the fiscal year ended June 30, 2012 from $191.8 million in fiscal 2011, an increase of $19.3 million, or 10.1%. As a percentage of net sales, gross margin of 39.8% was higher than the prior year at 38.9% primarily due to positive occupancy leverage.

Selling, General and Administrative Expenses. Selling, general and administrative expenses from continuing operations, which primarily consist of non-occupancy store costs, corporate overhead and advertising costs, increased to $191.7 million during fiscal 2012 from $185.9 million in fiscal 2011, an increase of $5.8 million, or 3.1%. This increase in dollars was primarily a result of increases in compensation expenses including incentive compensation.

Interest and Other Income, Net. We generated $0.9 million of interest and other income, net of other expenses, during fiscal 2012 as compared to $0.9 million in fiscal 2011. The year over year consistency reflected our continued investment in lower-yielding tax-exempt investments and money market funds.

Provision for Income Taxes. Our effective tax rate from continuing operations was 42.4% for fiscal 2012 as compared to 39.8% for fiscal 2011. The higher tax rate in the current year was due to various discrete items, including elective changes to state apportionment factors and the cumulative impact of those changes on the related deferred balances.

Discontinued Operations. In the fourth quarter of fiscal 2010, we decided to discontinue operations of the PH8 division, allowing us to focus our efforts on improving bebe sales and profitability, expanding internationally and continuing to develop our 2b bebe business. We closed 24 PH8 stores in the first fiscal quarter of 2011 and during the second fiscal quarter of 2011, closed the remaining 25 PH8 stores, converting one store to a 2b bebe. The results of the PH8 stores closed to date, net of income tax benefit, which consists of 49 stores for the fiscal year ended July 2, 2011, have been presented as a discontinued operation in the accompanying consolidated statements of operations . . .

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