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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

Form 10-Q

(Mark One)
 
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended November 1, 2014
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-31314

Aéropostale, Inc.
(Exact name of registrant as specified in its charter)

Delaware
31-1443880
(State of incorporation)
(I.R.S. Employer Identification No.)
 
 
112 W. 34th Street, New York, NY
10120
(Address of Principal Executive Offices)
(Zip Code)

(646) 485-5410
(Registrant’s Telephone Number, Including Area Code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate 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 þ No ¨

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.

Large accelerated filer þ
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting
 
 
(Do not check if a smaller reporting company)
company ¨

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

The Registrant had 79,122,539 shares of common stock outstanding as of December 4, 2014.

 



AÉROPOSTALE, INC. AND SUBSIDIARIES

TABLE OF CONTENTS
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2



PART I — FINANCIAL INFORMATION

Item 1.  Financial Statements

AÉROPOSTALE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
(Unaudited)
 
November 1,
2014
 
February 1,
2014
 
November 2,
2013
ASSETS
 
 
 
 
 
Current Assets:
 
 
 
 
 
Cash and cash equivalents
$
109,198

 
$
106,517

 
$
68,018

Merchandise inventory
211,136

 
172,311

 
262,587

Income taxes receivable
9,198

 
50,388

 
42,021

Prepaid expenses and other current assets
47,958

 
47,405

 
60,552

Total current assets
377,490

 
376,621

 
433,178

Fixtures, equipment and improvements, net
151,196

 
235,401

 
274,402

Goodwill
13,919

 
13,919

 
13,919

Intangible assets, net
14,097

 
14,661

 
14,849

Other assets
21,622

 
7,039

 
5,965

TOTAL ASSETS
$
578,324

 
$
647,641

 
$
742,313

 
 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

 
 

Current Liabilities:
 

 
 

 
 

Accounts payable
$
143,354

 
$
138,245

 
$
179,821

Accrued expenses and other current liabilities
99,319

 
102,116

 
86,644

Total current liabilities
242,673

 
240,361

 
266,465

 
 
 
 
 
 
Indebtedness to related party - non-current (See Note 3)
136,042

 

 

 
 
 
 
 
 
Other non-current liabilities
95,766

 
126,588

 
128,981

 
 
 
 
 
 
Commitments and contingent liabilities (See Notes 3, 5, 10, 11, 12 and 13)


 


 


 
 
 
 
 
 
Stockholders’ Equity:
 

 
 

 
 

Preferred stock, $0.01 par value; 5,000 shares authorized; 1; 0 and 0 shares issued or outstanding

 

 

Common stock, $0.01 par value; 200,000 shares authorized; 79,568; 78,616 and 78,608 shares issued
796

 
786

 
786

Additional paid-in capital
244,910

 
231,202

 
225,843

Accumulated other comprehensive loss
2,640

 
(1,183
)
 
20

Accumulated (deficit) earnings
(141,431
)
 
51,493

 
121,799

Treasury stock 472; 118 and 114 shares, at cost
(3,072
)
 
(1,606
)
 
(1,581
)
Total stockholders’ equity
103,843

 
280,692

 
346,867

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
578,324

 
$
647,641

 
$
742,313


See Notes to Unaudited Condensed Consolidated Financial Statements

3



AÉROPOSTALE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)


 
13 weeks ended
 
39 weeks ended
 
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Net sales
$
452,889

 
$
514,588

 
$
1,244,902

 
$
1,420,895

Cost of sales (includes certain buying, occupancy and warehousing expenses)
384,011

 
426,699

 
1,042,977

 
1,150,400

Gross profit
68,878

 
87,889

 
201,925

 
270,495

Selling, general and administrative expenses
121,250

 
128,923

 
361,877

 
375,827

Restructuring charges
1,713

 

 
39,221

 

Loss from operations
(54,085
)
 
(41,034
)
 
(199,173
)
 
(105,332
)
Interest expense 1
3,035

 
314

 
5,808

 
705

Loss before income taxes
(57,120
)
 
(41,348
)
 
(204,981
)
 
(106,037
)
Income tax benefit
(4,797
)
 
(15,725
)
 
(12,057
)
 
(34,512
)
Net loss
$
(52,323
)
 
$
(25,623
)
 
$
(192,924
)
 
$
(71,525
)
Basic loss per share
$
(0.66
)
 
$
(0.33
)
 
$
(2.45
)
 
$
(0.91
)
Diluted loss per share
$
(0.66
)
 
$
(0.33
)
 
$
(2.45
)
 
$
(0.91
)
Weighted average basic shares
79,015

 
78,488

 
78,775

 
78,442

Weighted average diluted shares
79,015

 
78,488

 
78,775

 
78,442


1 Includes interest expense to related party of $2.7 million during the third quarter of 2014 and $4.8 million for the first thirty-nine weeks of 2014.


CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
(Unaudited)

 
13 weeks ended
 
39 weeks ended
 
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Net loss
$
(52,323
)
 
$
(25,623
)
 
$
(192,924
)
 
$
(71,525
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Pension liability, net of income taxes of $0, $561, $0 and $645, respectively
3,658

 
840

 
3,758

 
968

Foreign currency translation adjustment (See Note 6)
(31
)
 
(64
)
 
65

 
(1,138
)
Other comprehensive income (loss)
$
3,627

 
$
776

 
$
3,823

 
$
(170
)
Comprehensive loss
$
(48,696
)
 
$
(24,847
)
 
$
(189,101
)
 
$
(71,695
)





See Notes to Unaudited Condensed Consolidated Financial Statements

4


AÉROPOSTALE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
39 weeks ended
 
November 1,
2014
 
November 2,
2013
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net loss
$
(192,924
)
 
$
(71,525
)
Adjustments to reconcile net loss to net cash used in operating activities:
 

 
 

Depreciation and amortization
39,388

 
47,281

Asset impairment charges
64,612

 
13,624

Amortization of intangible assets
564

 
564

Stock-based compensation
11,495

 
11,857

Other
(1,325
)
 
(4,733
)
Changes in operating assets and liabilities:
 

 
 

Merchandise inventory
(39,013
)
 
(107,564
)
Income taxes receivable and other assets
29,604

 
(48,302
)
Accounts payable
5,136

 
90,030

Accrued expenses and other liabilities
(19,090
)
 
(24,723
)
Net cash used in operating activities
$
(101,553
)
 
$
(93,491
)
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 

 
 

Capital expenditures
(21,127
)
 
(68,013
)
Change in restricted cash
(2,210
)
 

Final working capital adjustment related to the acquisition of GoJane.com, Inc.

 
(381
)
Net cash used in investing activities
$
(23,337
)
 
$
(68,394
)
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 

 
 

Proceeds from exercise of stock options

 
219

Net proceeds from financing transaction with related party
137,648

 

Borrowings under revolving credit facility
75,500

 

Repayments under revolving credit facility
(75,500
)
 

Fees related to financing transaction with related party
(6,165
)
 

GoJane contingent consideration payment
(1,531
)
 

Financing fees related to revolving credit facility
(687
)
 

Purchase of treasury stock
(1,466
)
 
(1,581
)
Net cash provided by (used in) financing activities
$
127,799

 
$
(1,362
)
 
 
 
 
Effect of exchange rate changes
$
(228
)
 
$
(236
)
 
 
 
 
Net increase (decrease) in cash and cash equivalents
2,681

 
(163,483
)
Cash and cash equivalents, beginning of year
106,517

 
231,501

Cash and cash equivalents, end of period
$
109,198

 
$
68,018



See Notes to Unaudited Condensed Consolidated Financial Statements

5


AÉROPOSTALE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.  Description of Business

Aéropostale, Inc. and its subsidiaries (“we”, “us”, “our”, the “Company” or “Aéropostale”) is a primarily mall-based, specialty retailer of casual apparel and accessories, principally targeting 14 to 17 year-old young women and men through its Aéropostale stores and 4 to 12 year-olds through its P.S. from Aéropostale stores.  We provide customers with a focused selection of high quality fashion and fashion basic merchandise at compelling values in an exciting and customer friendly store environment.  Aéropostale maintains control over its proprietary brands by designing, sourcing, marketing and selling all of its own merchandise.  Aéropostale products can be purchased in Aéropostale stores and online at www.aeropostale.com (this and any other references in this Quarterly Report on Form 10-Q to www.aeropostale.com or www.ps4u.com are solely references to a uniform resource locator, or URL, and are inactive textual references only, not intended to incorporate the websites into this Quarterly Report on Form 10-Q).  P.S. from Aéropostale products can be purchased in P.S. from Aéropostale stores, certain Aéropostale stores and online at www.ps4u.com.  As of November 1, 2014, we operated 911 Aéropostale stores, consisting of 842 stores in all 50 states and Puerto Rico, 69 stores in Canada, as well as 141 P.S. from Aéropostale stores in 32 states and Puerto Rico. Since November 2012, our Company acquired and now operates GoJane.com, Inc. (“GoJane”), an online women's fashion footwear and apparel retailer. In addition, pursuant to various licensing agreements, our licensees operated 220 Aéropostale locations and one Aéropostale and P.S. from Aéropostale combination location in the Middle East, Asia, Europe and Latin America as of November 1, 2014. We recently signed licensing agreements in Chile for both Aéropostale and P.S. from Aéropostale locations. Additionally, we recently signed a licensing agreement in Mexico that will allow our licensee to operate P.S. from Aéropostale locations.
  
2.  Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with Rule 10-01 of Regulation S-X and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America. However, in the opinion of our management, all adjustments necessary for a fair presentation of the results of the interim periods have been made. These adjustments consist primarily of normal recurring accruals and estimates that impact the carrying value of assets and liabilities. Actual results may materially differ from these estimates.

Our business is highly seasonal, and historically, we have realized a significant portion of our sales and cash flows in the second half of the year, attributable to the impact of the back-to-school selling season in the third quarter and the holiday selling season in the fourth quarter.  As a result, our working capital requirements fluctuate during the year, increasing in mid-summer in anticipation of the third and fourth quarters. Our business is also subject, at certain times, to calendar shifts which may occur during key selling times such as school holidays, Easter and regional fluctuations in the calendar during the back-to-school selling season. Therefore, our interim period unaudited condensed consolidated financial statements may not be indicative of our full-year results of operations, financial condition or cash flows.  These unaudited condensed consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for our fiscal year ended February 1, 2014 (“Fiscal 2013 10-K”).

References to “2014” or “fiscal 2014” mean the 52-week period ending January 31, 2015 and references to “2013” or “fiscal 2013” mean the 52-week period ended February 1, 2014.  References to “the third quarter of 2014” mean the thirteen-week period ended November 1, 2014 and references to “the third quarter of 2013” mean the thirteen-week period ended November 2, 2013.

3.  Closing of $150.0 Million Financing Transaction

On May 23, 2014, we entered into (i) a Loan and Security Agreement (the "Loan Agreement") with affiliates of Sycamore Partners, (ii) a Stock Purchase Agreement (the "Stock Purchase Agreement") with Aero Investors LLC, an affiliate of Sycamore Partners for the purchase of 1,000 shares of Series B Convertible Preferred Stock of the Company, $0.01 par value (the "Series B Preferred Stock"), and (iii) an Investor Rights Agreement with Sycamore Partners.

The Loan Agreement made available to us term loans in the principal amount of $150.0 million, consisting of two tranches: a five-year $100.0 million term loan facility (the "Tranche A Loan") and a 10-year $50.0 million term loan facility (the "Tranche B Loan" and, together with the Tranche A Loan, the "Term Loans").

Simultaneously with entering into the Loan Agreement, we amended our existing revolving credit facility with Bank of America, N.A. to allow for the incurrence of the additional debt under the Loan Agreement.


6


Sycamore Partners is considered a related party due to its ownership interest in us. As of May 23, 2014, Sycamore Partners owned approximately 8% of our outstanding common stock. Stefan Kaluzny, a managing director at Sycamore Partners, had joined our Board of Directors upon the closing of this transaction. In addition to Mr. Kaluzny, Sycamore Partners had received the right to appoint one additional member to our Board, and appointed Julian R. Geiger, who subsequently agreed to become our CEO on August 18, 2014. Additionally a third independent appointee was mutually agreed upon by Sycamore Partners and us.

The accounting guidance related to multiple deliverables in an arrangement provides direction on determining if separate contracts should be evaluated as a single arrangement and if an arrangement involves a single unit of accounting or separate units of accounting. We determined that there were four units of accounting or elements of the arrangement which included Tranche A Loan, Tranche B Loan, Series B convertible preferred stock and the Sourcing Agreement (as hereinafter defined). We allocated the initial value based on the relative fair values of each element in the transaction. We estimated the fair values of Tranche A Loan and Tranche B Loan using the discounted cash flow method. Under this method, the projected interest and principal payments are projected through the life of each loan. These cash flows are then discounted to the present value at an appropriate market-derived discount rate, taking into account market yields at the date of issuance and an assessment of the credit rating applicable to us based on the consideration of various credit metrics along with the terms of each loan (such as duration, coupon rate, etc.) to derive an indication of fair value. These instruments are classified as a Level 3 measurement, as they are not publicly traded and we are therefore unable to obtain quoted market prices. The Series B Preferred Stock represents a convertible security that can be exchanged for shares of Company common stock upon the payment of a cash conversion price of $7.25 per common share equivalent.  Effectively, the Series B Preferred Stock has the characteristic of a warrant as each share represents an option to purchase 3,932.018 shares of common stock at an exercise price of $7.25 per common share, and there is no dividend or liquidation preference associated with the Series B Preferred Stock. Accordingly, the Black-Scholes model was used to determine the fair value of the Convertible Shares with an expected life of 10 years, a risk free interest rate of 2.54%, and expected volatility of 50%. The Sourcing Agreement was determined to be at fair value and therefore no proceeds were allocated to the agreement.
  
On May 23, 2014, the Term Loans were disbursed in full and we received net proceeds of $137.6 million from an affiliate of Sycamore Partners, after deducting the first year interest payment and certain issuance fees.

Loan Agreement

The Tranche A Loan bears interest at an interest rate equal to 10% per annum and, at our election, up to 50% of the interest can be payable-in-kind during the first three years and up to 20% of the interest can be payable-in-kind during the final two years. The first year of interest under the Tranche A Facility in the amount of $10.0 million was prepaid in cash in full on May 23, 2014, and no other interest payments are required to be paid during the first year of the Tranche A Loan. The Tranche A Loan has no annual scheduled repayment requirements. The Tranche A Loan is scheduled to mature on May 23, 2019. The Tranche B Loan will not accrue any interest. The Tranche B Loan has no stated interest rate and will be repaid in equal annual installments of 10% per annum. The Tranche B Loan is scheduled to mature on the earlier of (a) tenth anniversary of the end of the Start-Up Period (as such term is defined in the Sourcing Agreement) and (b) the expiration or termination of the Sourcing Agreement described below.

The Term Loans are guaranteed by certain of our domestic subsidiaries and secured by a second priority security interest in all assets of the Company and certain of our subsidiaries that were already pledged for the benefit of Bank of America, N.A., as agent, under its existing revolving credit facility, and a first priority security interest in our, and certain of our subsidiaries', remaining assets.

The Loan Agreement contains representations, covenants and events of default that are substantially consistent with our existing revolving credit facility with Bank of America, N.A. The Loan Agreement also contains a $70.0 million minimum liquidity covenant. The Company was in compliance with the minimum liquidity covenant and other covenants under the Loan Agreements at November 1, 2014.

The proceeds of the Term Loans are to be used for working capital and other general corporate purposes. Prepayment of the Tranche A Loan will require payment of a premium of 10% of the principal amount prepaid on or before the one year anniversary of the closing, and 5% of the principal amount prepaid on or before the second anniversary of the closing. There is no prepayment penalty after the second anniversary of the closing. The Tranche B Loan may be prepaid at any time without premium or penalty.

We recorded liabilities for the Term Loans using imputed interest based on our best estimate of its incremental borrowing rates. The effective interest rate used for Tranche A Loan was 7.19%, resulting in an initial present value of $101.7 million and a resulting debt premium of $1.7 million. The premium is being amortized to interest expense over the expected term of the debt using the effective interest method. The effective interest rate for Tranche B Loan used was 7.86%, resulting in an initial present value of $30.0 million and a debt discount of $20.0 million, which is also being amortized to interest expense over the expected term of the

7


debt. Additionally, we recorded deferred financing fees of $5.9 million related to the Term Loans which are being amortized to interest expense over the expected terms of the debt.

We had fair values of $136.0 million in borrowings outstanding under the Loan Agreement, with face value of $150.0 million, as of November 1, 2014. Fair value outstanding for Tranche A Loan was $105.0 million, with a face value of $100.0 million. Fair value outstanding for Tranche B Loan was $31.0 million, with a face value of $50.0 million. Fair values approximate carrying values. Total interest and fees expense associated with this transaction was $2.7 million for the third quarter of 2014 and $4.8 million for the first thirty-nine weeks of 2014.
 
Series B Convertible Preferred Stock

Concurrent with, and as a condition to, entering into the Loan Agreement, we issued 1,000 shares of the Series B Preferred Stock to Investor at an aggregate offer price of $100,000. Each share of Series B Preferred Stock is convertible at any time at the option of the holder on or prior to May 23, 2024 into shares of common stock at an initial conversion rate of 3,932.018 for each share of Series B Preferred Stock. The common stock underlying the Series B Preferred Stock represents 5% of our issued and outstanding common stock as of May 23, 2014. The Series B Preferred Stock is convertible into shares of the common stock at an initial cash conversion price of $7.25 per share of the underlying common stock. The number of shares of Series B Preferred Stock or common stock to be issued upon exercise and the respective exercise prices are subject to adjustment for changes in the Series B Preferred Stock or common stock, such as stock dividends, stock splits, and similar changes. In the event of a change of control transaction, the Series B Preferred Stock will automatically convert into common stock subject to payment by the holder of such Series B Preferred of the aggregate cash conversion price then in effect, if such conversion price is lower than the per share consideration to be received in the change of control transaction. If the per share consideration to be received in the change of control transaction is less than or equal to the per share cash conversion price then in effect, the Series B Preferred will be automatically converted into a right to receive an amount per share equal to the par value of such share of Series B Preferred Stock.

We analyzed the embedded conversion option for derivative accounting consideration under Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Subtopic 815-15, “Derivatives and Hedging” and determined that the conversion option should be classified as equity. We also analyzed the conversion option for beneficial conversion features consideration under ASC Subtopic 470-20 “Convertible Securities with Beneficial Conversion Features” and noted none. The Series B Preferred Stock was recorded in equity at a fair value of $5.9 million upon issuance, and was not recorded as a liability on the consolidated balance sheet.

Non-Exclusive Sourcing Agreement

As a condition to funding the Tranche B Loan, we and one of our subsidiaries also entered into a non-exclusive Sourcing Agreement (the "Sourcing Agreement") with TSAM (Delaware) LLC (d/b/a MGF Sourcing US LLC), an affiliate of Sycamore Partners ("MGF"). The price of merchandise sold to us by MGF pursuant to the Sourcing Agreement is required to be competitive to market. We expect to commence sourcing goods with MGF pursuant to the Sourcing Agreement during the fourth quarter of 2014.

We guarantee the obligations of our subsidiary under the Sourcing Agreement. The Sourcing Agreement requires us to purchase a minimum volume of product for a period of 10 years commencing on our first fiscal quarter of 2016 (such period, the "Minimum Volume Commitment Period"), of between $240.0 million and $280.0 million per annum depending on the year (the "Minimum Volume Commitment"). If we fail to purchase the applicable Minimum Volume Commitment in any given year, we will pay a shortfall commission to MGF, based on a scaled percentage of the applicable Minimum Volume Commitment shortfall during the applicable period.

Under the Sourcing Agreement, MGF is required to pay to us an annual rebate equal to a fixed amount multiplied by the percentage of annual purchases made by us (including purchases deemed to be made by virtue of payment of the shortfall commission) relative to the Minimum Volume Commitment to be applied towards the payment of the required amortization on the Tranche B Loan. The Sourcing Agreement also provides for certain carryover credits if we purchase a volume of product above the Minimum Volume Commitment during the applicable Minimum Volume Commitment Period.

We may terminate the Sourcing Agreement upon nine (9) months' notice at any time after the first three years of the Minimum Volume Commitment Period have elapsed, subject to payment of a termination fee scaled to the term remaining under the Sourcing Agreement.


8


4.  Restructuring Program

On April 30, 2014, following an assessment of changing consumer patterns, management and the Board of Directors approved a comprehensive plan to restructure the P.S. from Aéropostale business and to reduce costs. We plan to close approximately 125 mall-based P.S. from Aéropostale stores and streamline and improve the Company's expense structure. We plan to focus on sales channels with higher expectations for growth, including off-mall locations (including outlets), e-commerce and international licensing of P.S. from Aéropostale. We anticipate that substantially all of the planned store closures will be completed on or around the end of fiscal 2014. As of November 1, 2014, 11 mall-based P.S. from Aéropostale stores have been closed. The cost reduction program will also target direct and indirect spending across the organization. This has included the reduction of corporate headcount by eliminating approximately 100 open or occupied positions to align with our current business strategies.

We estimate that we will incur pre-tax restructuring and impairment charges related to these actions totaling approximately $40.0 million to $65.0 million throughout fiscal 2014, of which approximately $25.0 million to $40.0 million are estimated to be cash expenses. Included in the estimate of total pre-tax charges are approximately:

$5.5 million of consulting and severance expenses resulting from the announced corporate cost reduction initiatives, of which $0.4 million were recorded during the third quarter of 2014 and $5.1 million during the first thirty-nine weeks of 2014.
$30.5 million of store asset impairments resulting primarily from the expected closures of the P.S. from Aéropostale stores, all of which were recorded during the first quarter of 2014.
$4.0 million of additional severance resulting from the store closures, of which $1.2 million was recorded during the third quarter of 2014 and $2.5 million for the first thirty-nine weeks of 2014. These costs are expected to be recorded through the remainder of fiscal 2014 until the stores are closed.
The remainder of the charges relate to estimated lease costs in connection with the store closures, which are expected to be recorded during the remainder of fiscal 2014. We expect to pay significantly all lease costs during the fourth quarter of 2014 and first quarter of 2015.

The charges are recognized in restructuring charges in the statement of operations.

The following is a summary of expenses incurred during the third quarter of 2014 and the first thirty-nine weeks of 2014 associated with the above ongoing actions:

 
13 weeks ended
 
39 weeks ended
 
November 1, 2014
 
(In thousands)
Severance
$
1,236

 
$
3,749

Lease costs
146

 
1,198

Impairment

 
30,497

Other exit costs
331

 
3,777

Total
$
1,713

 
$
39,221


The Company accrued liabilities for the above mentioned restructuring charges as of November 1, 2014, which are expected to be paid during fiscal 2014 as follows:
 
Impairments
 
Severance
 
Lease Costs
 
Other Exit Costs
 
Total
 
(In thousands)
Liability/Charge at Program Inception
$
30,497

 
$
1,060

 
$
1,046

 
$
1,886

 
$
34,489

Additions

 
2,689

 
152

 
1,891

 
4,732

Paid or Utilized
(30,497
)
 
(1,435
)
 
(315
)
 
(3,754
)
 
(36,001
)
Adjustments

 

 

 

 

Liability as of November 1, 2014
$

 
$
2,314

 
$
883

 
$
23

 
$
3,220


Of the above liabilities, $2.7 million is recorded in accrued expenses and other current liabilities and the balance is included in non-current liabilities.

9


5.  Fair Value Measurements

We follow the guidance in ASC Topic 820, “Fair Value Measurement” (“ASC 820”) as it relates to financial and nonfinancial assets and liabilities. ASC 820 prioritizes inputs used in measuring fair value into a hierarchy of three levels:

Level 1 – Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

Level 2 – Observable inputs other than quoted prices included in Level 1, including quoted prices for similar assets or liabilities in active markets, quoted prices for identical assets or liabilities in inactive markets, inputs other than quoted prices that are observable for the asset or liability and inputs derived principally from or corroborated by observable market data.
 
Level 3 – Unobservable inputs reflecting the Company’s own assumptions about the inputs that market participants would use in pricing the asset or liability based on the best information available.

In accordance with the fair value hierarchy described above, the following table shows the fair value of our financial assets and liabilities that are required to be remeasured at fair value on a recurring basis:
 
Level 1
 
Level 2
 
Level 3
 
November 1,
2014
 
February 1,
2014
 
November 2,
2013
 
November 1,
2014
 
February 1,
2014
 
November 2,
2013
 
November 1,
2014
 
February 1,
2014
 
November 2,
2013
 
(In thousands)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents 1
$
80,005

 
$
82,378

 
$
36,265

 
$

 
$

 
$

 
$

 
$

 
$

Total
$
80,005

 
$
82,378

 
$
36,265

 
$

 
$

 
$

 
$

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
GoJane performance plan liability 2
$

 
$

 
$

 
$

 
$

 
$

 
$
5,915

 
$
7,416

 
$
7,350

Exit costs obligation 3

 

 

 

 

 

 
2,889

 

 

Total
$

 
$

 
$

 
$

 
$

 
$

 
$
8,804

 
$
7,416

 
$
7,350


1 Cash and cash equivalents include money market investments valued as Level 1 inputs in the fair value hierarchy. The fair value of cash and cash equivalents approximates their carrying value due to their short-term maturities.

2 Under the terms of the fiscal 2012 GoJane acquisition agreement, the purchase price also includes contingent cash payments of up to an aggregate of $8.0 million if certain financial metrics are achieved by the GoJane business during the five year period beginning on the acquisition date (the "GJ Performance Plan"). These performance payments are not contingent upon continuous employment by the two individual stockholders. The GJ Performance Plan liability is measured at fair value using Level 3 inputs as defined in the fair value hierarchy. The fair value of the contingent payments as of the acquisition date was estimated to be $7.0 million. This was based on a weighted average expected achievement probability and a discount rate over the expected payment stream. Each quarter, we remeasure the GJ Performance Plan liability at fair value.

3 In accordance with the lease assignment for the 34th Street store, we placed $2.4 million in escrow for payment of real estate taxes. We recorded an exit cost obligation related to the real estate taxes at fair value of $2.0 million on the cease-use date. Additionally, the above exit costs obligation includes $1.0 million of lease costs related to four P.S. from Aéropostale stores with previously executed leases that will not open in connection with our restructuring program. These exit cost liabilities are measured at fair value using Level 3 inputs as defined in the fair value hierarchy. This was based on a discount rate over the expected payment streams. Each quarter we remeasure these liabilities at fair value.



10


The following table provides a reconciliation of the beginning and ending balances of the GJ Performance Plan measured at fair value using significant unobservable inputs (Level 3):
 
 
39 weeks ended
 
 
November 1, 2014

 
November 2, 2013

 
 
(In thousands)
Balance at beginning of period
 
$
7,416

 
$
7,019

Accretion of interest expense
 
99

 
331

GoJane consideration payment
 
(1,600
)
 

Balance at end of period
 
$
5,915

 
$
7,350


The $5.9 million liability as of November 1, 2014 was included in non-current liabilities. Of the $7.4 million liability as of November 2, 2013, $1.6 million was included in accrued expenses and other current liabilities and the balance was included in non-current liabilities.

The following table provides a reconciliation of the beginning and ending balances of the Exit Cost Obligations measured at fair value using significant unobservable inputs (Level 3):

 
 
39 weeks ended
 
 
November 1, 2014

 
November 2, 2013

 
 
(In thousands)
Balance at beginning of period
 
$

 
$

Fair value of exit costs obligations at cease-use date
 
3,009

 

Accretion of rent expense
 
245

 

Payments
 
(365
)
 

Balance at end of period

$
2,889

 
$


Of the $2.9 million liability as of November 1, 2014, $0.8 million was included in accrued expenses and other current liabilities and the balance was included in non-current liabilities.

Non-Financial Assets

Our non-financial assets, which include fixtures, equipment and improvements and intangible assets, are not required to be measured at fair value on a recurring basis.  However, if certain triggering events occur, or if an impairment test is required and we are required to evaluate the non-financial asset for impairment, a resulting asset impairment would require that the non-financial asset be recorded at a new cost based on its measured fair value.  

We recorded asset impairment charges, all of which was included in the cost of sales, of approximately $12.5 million during the third quarter of 2014 primarily for 59 stores. We recorded asset impairment charges of approximately $64.6 million during the first thirty-nine weeks of 2014 for primarily 277 stores. Of these charges, $34.1 million was included in cost of sales. The remaining $30.5 million was included in restructuring charges, as it related to the P.S. from Aéropostale stores to be exited. We recorded store asset impairment charges of approximately $5.1 million during the third quarter of 2013 for primarily 25 stores and $13.6 million during the first thirty-nine weeks of 2013 for primarily 72 stores. These charges were included in cost of sales.  These amounts included the write-down of long-lived assets at stores that were assessed for impairment because of (a) changes in circumstances that indicated the carrying value of assets may not be recoverable, or (b) management’s intention to relocate or close stores.  Impairment charges were primarily related to revenues and/or gross margins not meeting targeted levels at the respective stores as a result of macroeconomic conditions, location related conditions and other factors that are negatively impacting the sales and cash flows of these locations.

Long-lived assets are measured at fair value on a nonrecurring basis for purposes of calculating impairment using Level 3 inputs as defined in the fair value hierarchy.  The fair value of long-lived assets is determined by estimating the amount and timing of net future discounted cash flows.  We estimate future cash flows based on our experience, current trends and local market conditions. Based upon future results of operations at the store level, additional impairment charges may be recorded in future periods if loss trends continue and/or the current cash flow projections are not achieved.

11


The table below sets forth by level within the fair value hierarchy the fair value of long-lived assets for which impairment was recognized for the first thirty-nine weeks of 2014 and the first thirty-nine weeks of 2013:

 
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
 
 
 
Total Fair Value
 
Total Losses
 
 
(In thousands)
November 1, 2014:
 
 
 
 
 
 
 
 
 
 
Long-lived assets held and used
 
$

 
$

 
$
6,488

 
$
6,488

 
$
64,611

 
 
 
 
 
 
 
 
 
 
 
November 2, 2013:
 
 
 
 
 
 
 
 
 
 
Long-lived assets held and used
 
$

 
$

 
$
5,431

 
$
5,431

 
$
13,624


6.  Stockholders’ Equity

Stockholders Rights Plan

On November 26, 2013, we entered into a Rights Agreement with American Stock Transfer & Trust Company, LLC (the “Rights Agreement”), pursuant to which the Company, among other things, issued one right (a “Right”) for each outstanding share of common stock, par value $0.01 per share, of the Company (the “Rights Plan”). By its terms, the Rights Plan provided that, among other things, the Rights would expire upon the close of business on the earliest to occur of: (i) November 26, 2014, (ii) the date on which the rights are redeemed or exchanged by the Company in accordance with the Rights Agreement and (iii) the date of the Company’s 2014 annual meeting of stockholders if requisite stockholder approval of the Rights Agreement is not obtained at such meeting. The Board determined not to seek stockholder approval of the Rights Plan at the 2014 Annual Meeting which occurred on June 30, 2014. Consequently, pursuant to the terms of the Rights Plan, and without any further action, as of the date of the Annual Meeting, the right to exercise the Rights terminated, each Right is null and void and the Rights Plan expired.

Stock Repurchase Program

We have the ability to repurchase our common stock under a stock repurchase program, which was announced on December 9, 2003. The repurchase program may be modified or terminated by the Board of Directors at any time and there is no expiration date for the program. The extent and timing of repurchases will depend upon general business and market conditions, stock prices, opening and closing of the stock trading window, and liquidity and capital resource requirements going forward.

We did not repurchase shares of our common stock during the first thirty-nine weeks of 2014 or 2013 under the stock repurchase program.  We have repurchased 60.1 million shares of our common stock for $1.0 billion under the program to date.  As of November 1, 2014, we have approximately $104.4 million of repurchase authorization remaining under our $1.15 billion share repurchase program.

In addition to the above program, we withheld 354,000 shares for minimum statutory withholding taxes of $1.5 million related to the vesting of stock awards during the first thirty-nine weeks of 2014.

Accumulated Other Comprehensive Loss

The following table sets forth the components of accumulated other comprehensive loss:

 
November 1,
2014
 
February 1,
2014
 
November 2,
2013
 
(In thousands)
Pension liability, net of tax
$
1,751

 
$
(2,007
)
 
$
(1,573
)
Cumulative foreign currency translation adjustment 1 
889

 
824

 
1,593

Total accumulated other comprehensive loss
$
2,640

 
$
(1,183
)
 
$
20


1 Foreign currency translation adjustments are not adjusted for income taxes as they relate to a permanent investment in our subsidiary in Canada.

12


The changes in components in accumulated other comprehensive (loss) income are as follows:
 
39 weeks ended
 
November 1, 2014
 
Pension Liability
 
Foreign Currency Translation
 
Total
 
(In thousands)
Beginning balance at February 2, 2014
$
(2,007
)
 
$
824

 
$
(1,183
)
Other comprehensive income before reclassifications

 
65

 
65

Reclassified from accumulated other comprehensive income
3,758

 

 
3,758

Tax effect on pension liability

 

 

Net current-period other comprehensive income
$
3,758

 
$
65

 
$
3,823

Ending balance at November 1, 2014
$
1,751

 
$
889

 
$
2,640


 
39 weeks ended
 
November 2, 2013
 
Pension Liability
 
Foreign Currency Translation
 
Total
 
(In thousands)
Beginning balance at February 3, 2013
$
(2,541
)
 
$
2,731

 
$
190

Other comprehensive loss before reclassifications

 
(1,138
)
 
(1,138
)
Reclassified from accumulated other comprehensive income
1,613

 

 
1,613

Tax effect on pension liability
(645
)
 

 
(645
)
Net current-period other comprehensive income (loss)
$
968

 
$
(1,138
)
 
$
(170
)
Ending balance at November 2, 2013
$
(1,573
)
 
$
1,593

 
$
20


The details related to the reclassifications out of accumulated comprehensive loss are as follows:

 
13 weeks ended
 
 
November 1, 2014
 
November 2, 2013
 
 
(In thousands)
 
Amortization of defined benefit plan items:
 
 
 
 
Net gain
$
3,633

1 
$
739

1 
Amortization of loss
$
6

1 
68

1 
Amortization of prior service cost
18

1 
18

1 
Settlement loss

1 
577

1 
Total before tax
$
3,657

 
$
1,402

 
Tax expense

 
(561
)
 
Net of tax
$
3,657

 
$
841

 


13


 
39 weeks ended
 
 
November 1, 2014
 
November 2, 2013
 
 
(In thousands)
 
Amortization of defined benefit plan items:
 
 
 
 
Net gain
$
3,633

1 
$
739

1 
Amortization of loss
69

1 
241

1 
Amortization of prior service cost
56

1 
56

1 
Settlement loss

1 
577

1 
Total before tax
$
3,758

 
$
1,613

 
Tax expense

 
(645
)
 
Net of tax
$
3,758

 
$
968

 

1 These accumulated other comprehensive (loss) income components are included in the computation of net periodic benefit cost (see Note 11).

7.  Loss Per Share

The following table sets forth the computations of basic and diluted loss per share:

 
13 weeks ended
 
39 weeks ended
 
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
 
(In thousands, except per share data)
Net loss
$
(52,323
)
 
$
(25,623
)
 
$
(192,924
)
 
$
(71,525
)
Weighted average basic shares
79,015

 
78,488

 
78,775

 
78,442

Impact of dilutive securities

 

 

 

Weighted average diluted shares
79,015

 
78,488

 
78,775

 
78,442

Basic loss per share
$
(0.66
)
 
$
(0.33
)
 
$
(2.45
)
 
$
(0.91
)
Diluted loss per share
$
(0.66
)
 
$
(0.33
)
 
$
(2.45
)
 
$
(0.91
)

All options to purchase shares, in addition to restricted, performance shares and convertible preferred shares, were excluded from the computation of diluted loss per share because the effect would be anti-dilutive during fiscal 2014 and fiscal 2013.

8.  Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consist of the following:

 
November 1, 2014
 
February 1, 2014
 
November 2, 2013
 
(In thousands)
Accrued gift cards
$
17,030

 
$
27,783

 
$
21,076

Accrued compensation and retirement benefit plan liabilities
22,014

 
16,939

 
10,928

Current portion of tenant allowances
14,057

 

 

Other
46,218

 
57,394

 
54,640

Total accrued expenses and other current liabilities
$
99,319

 
$
102,116

 
$
86,644

 

14


9.  Other Non-current Liabilities

Other non-current liabilities consist of the following:

 
November 1, 2014
 
February 1, 2014
 
November 2, 2013
 
(In thousands)
Deferred rent
$
43,685

 
$
46,831

 
$
47,153

Deferred tenant allowance
29,515

 
51,189

 
54,613

Retirement benefit plan liabilities
5,841

 
14,339

 
14,172

Uncertain tax contingency liabilities
2,075

 
3,702

 
3,343

Other
14,650

 
10,527

 
9,700

Total other non-current liabilities
$
95,766

 
$
126,588

 
$
128,981


10.  Revolving Credit Facility

In September 2011, we entered into an amended and restated revolving credit facility with Bank of America, N.A. (the “Credit Facility”). The Credit Facility originally provided for a revolving credit line up to $175.0 million. The Credit Facility is available for working capital and general corporate purposes. The Credit Facility is scheduled to expire on September 22, 2016, and is guaranteed by all of our domestic subsidiaries (the “Guarantors”). No amounts were outstanding during fiscal 2013 or as of November 1, 2014 under the Credit Facility. During the first twenty-six weeks of 2014, we borrowed and repaid $75.5 million. During the third quarter of 2014, we had no borrowings. Management has no reason at this time to believe that the participating institutions will be unable to fulfill their obligations to provide financing in accordance with the terms of the Credit Agreement in the event of our election to draw funds in the foreseeable future.

On February 21, 2014, the Company, certain of its direct and indirect subsidiaries, including GoJane LLC, the Lenders party thereto, and Bank of America, N.A., as agent for the ratable benefit of the Credit Parties (in such capacity, the “Agent”), entered into a Joinder and First Amendment to Third Amended and Restated Loan and Security Agreement and Amendment to Certain Other Loan Documents (the “First Amendment”). The First Amendment amended the Credit Facility, among other things, to increase from $175.0 million to $230.0 million the aggregate amount of loans and other extensions of credit available to the Borrower under the Credit Facility by (i) the addition of a $30.0 million first-in, last-out revolving loan facility based on the appraised value of certain intellectual property of the Company, and (ii) an increase in the Company’s existing revolving credit facility by $25.0 million, from $175.0 million to $200.0 million (which continues to include a $40.0 million sublimit for the issuance of letters of credit). In addition, the accordion feature of the Credit Facility, under which the Company may request an increase in the commitments of the Lenders thereunder from time to time, was reduced from $75.0 million to $50.0 million. GoJane LLC, an indirect wholly-owned subsidiary of the Company, also joined the Credit Facility as a new guarantor.

On May 23, 2014, we entered into $150.0 million senior secured credit facilities with Sycamore Partners. In connection with this agreement, we amended the revolving credit facility with Bank of America N.A. to allow for the incurrence of this additional debt under the Loan Agreement (see Note 3).

Loans under the Credit Facility are secured by substantially all of our assets and are guaranteed by the Guarantors. Upon the occurrence of a Suspension Event (which is defined in the Credit Facility as an event of default or any occurrence, circumstance or state of facts which would become an event of default after notice, or lapse of time, or both) or, in certain circumstances, a Cash Dominion Event (which is defined in the Credit Facility as either any event of default or failure to maintain availability in an amount greater than 12.5% of the lesser of the borrowing base and facility commitment), our ability to borrow funds, make investments, pay dividends and repurchase shares of our common stock may be limited, among other limitations. Direct borrowings under the Credit Facility bear interest at a margin over either LIBOR or at the Prime Rate (as each such term is defined in the Credit Facility).

The Credit Facility also contains covenants that, subject to specified exceptions, restrict our ability to, among other things:

incur additional debt or encumber assets of the Company;
merge with or acquire other companies, liquidate or dissolve;
sell, transfer, lease or dispose of assets; and
make loans or guarantees.


15


Events of default under the Credit Facility include, but not limited to, and subject to grace periods and notice provisions in certain circumstances, failure to pay principal amounts when due, breaches of covenants, misrepresentation, default on leases or other indebtedness, excess uninsured casualty loss, excess uninsured judgment or restraint of business, failure to maintain specified availability levels, business failure or application for bankruptcy, legal challenges to loan documents and a change in control. Upon the occurrence of an event of default under the Credit Facility, the Lenders may take action, including but not limited to, cease making loans, termination of the Credit Facility and declaration that all amounts outstanding are immediately due and payable, and taking possession of and selling all assets that have been used as collateral. 

The Company is subject to a restriction requiring the maintenance of minimum availability levels based upon the lesser of 10% of the borrowing base or commitments, as defined in the Credit Facility.  

Availability under the Credit Facility is based on a borrowing base consisting of merchandise inventory, certain intellectual property and receivables. As of November 1, 2014, we had no borrowings and our remaining availability was $173.6 million. During fiscal 2013 and as of February 1, 2014, we had no outstanding balances under the Credit Facility. In June 2012, Bank of America, N.A. issued a stand-by letter of credit. As of November 1, 2014, the outstanding letter of credit was $0.2 million and expires on June 30, 2015. We do not have any other stand-by or commercial letters of credit outstanding as of November 1, 2014 under the Credit Facility.  
 
As of November 1, 2014, we are not aware of any instances of noncompliance with any financial covenants.  

11.  Retirement Benefit Plans

Retirement benefit plan liabilities consisted of the following:

 
November 1,
2014
 
February 1,
2014
 
November 2,
2013
 
(In thousands)
Supplemental Executive Retirement Plan (“SERP”)
$
7,511

 
$
10,551

 
$
10,434

Other retirement plan liabilities
4,140

 
4,050

 
3,738

Total
$
11,651

 
$
14,601

 
$
14,172

Less amount classified in accrued expenses related to SERP
5,810

 

 

Less amount classified in accrued expenses related to other retirement plan liabilities

 
262

 

Long-term retirement benefit plan liabilities
$
5,841

 
$
14,339

 
$
14,172


401(k) Plan

We maintain a qualified, defined contribution retirement plan with a 401(k) salary deferral feature that covers substantially all of our employees who meet certain requirements.  Under the terms of the plan, employees may contribute, subject to statutory limitations, up to 100% of gross earnings and historically, including fiscal 2013, we have provided a matching contribution of 50% of the first 5% of gross earnings contributed by the participants.  We also have the option to make additional contributions or to suspend the employer contribution at any time. The employer's matching contributions vest over a five-year service period with 20% vesting after two years and 50% vesting after year three.  Vesting increases thereafter at a rate of 25% per year so that participants will be fully vested after five years of service. We also have separate defined contribution plans for eligible employees in both Canada and Puerto Rico who meet certain requirements. We have suspended the Company's matching contribution under the plan in the U.S. and Canada for fiscal 2014. Contribution expense for all plans was not material to the unaudited condensed consolidated financial statements for any period presented.

Supplemental Executive Retirement Plan

We maintain a Supplemental Executive Retirement Plan, or SERP, which is a non-qualified defined benefit plan for certain executives.  The plan is non-contributory and not funded and provides benefits based on years of service and compensation during employment.  Participants are fully vested upon entrance in the plan. Pension expense is determined using the projected unit credit cost method to estimate the total benefits ultimately payable to officers and this cost is allocated to service periods.  The actuarial assumptions used to calculate pension costs are reviewed annually.


16


The components of net periodic pension benefit cost are as follows:

 
13 weeks ended
 
39 weeks ended
 
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
 
(In thousands)
Service cost
$
55

 
$
131

 
$
314

 
$
397

Interest cost
76

 
108

 
279

 
328

Amortization of prior experience cost
18

 
18

 
55

 
56

Amortization of net loss
6

 
69

 
68

 
241

Net periodic pension benefit cost
$
155

 
$
326

 
$
716

 
$
1,022


We expect to make a payment to Thomas P. Johnson, our former Chief Executive Officer, from our Supplemental Executive Retirement Plan (“SERP”) of approximately $5.8 million, subject to interest rate fluctuations, during the first quarter of 2015. Accordingly, the SERP liability related to Mr. Johnson has been classified as a current liability in our unaudited condensed consolidated balance sheet as of November 1, 2014. Such amount will be paid from our cash flows from operations. At the date of payment to Mr. Johnson, we will record a benefit estimated to be approximately $0.9 million in selling, general and administrative expenses, with a corresponding amount recorded to relieve accumulated other comprehensive loss included in our stockholders' equity. This accounting treatment is in accordance with settlement accounting procedures under the provisions of ASC Topic 715, "Compensation - Retirement Benefits".

During September 2013, we made a payment of approximately $2.2 million to our former President from our SERP. Such amount was paid from our cash flows from operations. In connection with this payment, during the third quarter of 2013, we recorded a charge of $0.6 million of the net actuarial loss (the "settlement loss") as a charge in SG&A, with a corresponding amount recorded to relieve accumulated other comprehensive loss included in our stockholders' equity ($0.4 million, net of tax).

Other Retirement Plan Liabilities

We have a long-term incentive deferred compensation plan established for the purpose of providing long-term incentives to a select group of management. The plan is a non-qualified, non-contributory defined contribution plan and is not funded. Participants in this plan include all employees designated by us as Vice President, or other higher-ranking positions that are not participants in the SERP. We record annual monetary credits to each participant's account based on compensation levels and years as a participant in the plan. Annual interest credits are applied to the balance of each participant's account based upon established benchmarks. Each annual credit is subject to a three-year cliff-vesting schedule, and participants' accounts will be fully vested upon retirement after completing five years of service and attaining age 55. The liability related to this plan was $4.0 million as of November 1, 2014, $3.9 million as of February 1, 2014 and $3.6 million as of November 2, 2013. Compensation expense related to this plan was not material to our unaudited condensed consolidated financial statements for any period presented.

We maintain a postretirement benefit plan for certain executives that provides retiree medical and dental benefits. The plan is an other post-employment benefit plan, or OPEB, and is not funded. Pension expense and the liability related to this plan were not material to our unaudited condensed consolidated financial statements for any period presented.


17


12.  Stock-Based Compensation

Under the provisions of ASC Topic 718, “Compensation – Stock Compensation” (“ASC 718”), all forms of share-based payment to employees and directors, including stock options, must be treated as compensation and recognized in the statement of operations.

On May 8, 2014, the Board unanimously approved the 2014 Omnibus Incentive Plan (the “Omnibus Plan”), which is an amendment and restatement of our Second Amended and Restated 2002 Long-Term Incentive Plan, as amended (the “2002 Plan”). The Omnibus Plan became effective upon stockholder approval at the Annual Meeting of Shareholders on June 30, 2014 (the “Omnibus Plan Effective Date”). The Omnibus Plan includes the following key modifications, effective upon the 2014 Omnibus Plan Effective Date:

Increase of the Aggregate Share Reserve. The aggregate share reserve increased by an additional 5,900,000 shares of common stock for a total share reserve of 6,113,891 shares of common stock under the Omnibus Plan. As of November 1, 2014, there were 4,863,305 shares outstanding under the Omnibus Plan.
Cash Performance Awards. The Omnibus Plan includes Cash Performance Awards that may be granted with the intent to comply with the “performance-based compensation” exception under Section 162(m) of the Code. Because Cash Performance Awards may be made in addition to stock-based awards, the 2002 Plan has been renamed the “2014 Omnibus Incentive Plan.”
Term Extension. We extended the term of the Omnibus Plan until May 8, 2024 (the 2002 Plan was scheduled to expire on June 16, 2021).

Restricted Stock Units

Beginning in fiscal 2013, certain of our employees have been awarded restricted stock units, pursuant to restricted stock unit agreements. The restricted stock units awarded to employees cliff vest at varying times, most typically following between one and three years of continuous service from the award date. Certain shares awarded may also vest upon a qualified retirement at or following age 65, or upon a qualified early retirement under the provisions adopted in 2012 whereby the awardee completes 10 years of service, attains age 55 and retires. All restricted stock units immediately vest upon a change in control of the Company. 

The following table summarizes share-settled restricted stock units outstanding as of November 1, 2014:

 
 
 
Shares
 
Weighted Average
Grant-Date Fair Value
 
(In thousands)
 
 
Outstanding as of February 2, 2014
230

 
$
9.05

Granted
322

 
4.81

Vested
(419
)
 
6.02

Canceled

 

Outstanding as of November 1, 2014
133

 
$
8.34


Total compensation expense is being amortized over the shorter of the achievement of retirement or early retirement status, or the vesting period.  Compensation expense related to restricted units activity was $0.2 million for the third quarter of 2014 and $1.9 million for the first thirty-nine weeks of 2014. There was no compensation expense related to restricted units for the third quarter of 2013 or the first thirty-nine weeks of 2013. As of November 1, 2014, there was $0.4 million of unrecognized compensation cost related to restricted stock units that is expected to be recognized over the weighted average period of one year.  The total fair value of units vested was $2.4 million during the third quarter of 2014 and $2.5 million during the first thirty-nine weeks of 2014. No units vested during the third quarter 2013 or the first thirty-nine weeks of 2013.

Additionally, beginning in the first quarter of fiscal 2014, certain of our employees have been awarded cash-settled restricted stock units, pursuant to cash-settled restricted stock unit agreements. The cash-settled restricted stock units awarded to employees cliff vest at varying times up to approximately three years of continuous service. Certain shares awarded may also vest upon a qualified retirement at or following age 65, or upon a qualified early retirement under the provisions adopted in 2013 whereby the awardee completes 10 years of service, attains age 55 and retires. All cash-settled restricted stock units immediately vest upon a change in control of the Company.  We may, in our sole discretion, at any time during the term, convert the cash-settled restricted

18


stock units for stock-settled restricted stock units. Currently, we do not have the intent to convert the cash-settled restricted stock units for stock-settled restricted stock units and as a result it is classified as a liability. The cash-settled restricted stock units are treated as liability awards in accordance with ASC 718.

The following table summarizes cash-settled restricted stock units outstanding as of November 1, 2014:

 
 
 
Shares
 
Weighted Average
Grant-Date Fair Value
 
(In thousands)
 
 
Outstanding as of February 2, 2014

 
$

Granted
1,219

 
3.01

Vested

 

Canceled
(103
)
 
3.01

Outstanding as of November 1, 2014
1,116

 
$
3.01


Total compensation expense is being amortized over the shorter of the achievement of retirement or early retirement status, or the vesting period.  Compensation expense related to restricted shares activity was $0.4 million for the third quarter of 2014 and $1.1 million for the first thirty-nine weeks of 2014. As of November 1, 2014, there was $2.2 million of unrecognized compensation cost related to cash-settled restricted stock units that is expected to be recognized over the weighted average period of two years.  

Restricted Shares

Certain of our employees and all of our directors have been awarded non-vested stock (restricted shares), pursuant to restricted stock award agreements. The restricted shares awarded to employees generally cliff vest after up to three years of continuous service.  Beginning in November 2012, certain shares awarded after such date may also vest upon a qualified retirement at age 65, or upon a qualified early retirement under the provisions adopted in 2012 whereby an awardee completes 10 years of service, attains age 55 and retires. All restricted shares immediately vest upon a change in control of the Company.  Grants of restricted shares awarded to directors vest in full after one year.

The following table summarizes non-vested shares of stock outstanding as of November 1, 2014:

 
 
 
Shares
 
Weighted Average
Grant-Date Fair Value
 
(In thousands)
 
 
Outstanding as of February 2, 2014
1,856

 
$
14.82

Granted
299

 
4.50

Vested
(533
)
 
18.44

Canceled
(109
)
 
12.07

Outstanding as of November 1, 2014
1,513

 
$
11.70


Total compensation expense is being amortized over the shorter of the achievement of retirement or early retirement status, or the vesting period.  Compensation expense related to restricted shares activity was $2.0 million for the third quarter of 2014 and $2.4 million for the third quarter of 2013.  Compensation expense related to restricted shares activity was $5.7 million for the first thirty-nine weeks of 2014 and $10.0 million for the first thirty-nine weeks of 2013. As of November 1, 2014, there was $6.9 million of unrecognized compensation cost related to restricted shares awards that is expected to be recognized over the weighted average period of one year.  The total fair value of shares vested was $1.5 million during the third quarter of fiscal 2014 and $0.1 million during the third quarter of fiscal 2013. The total fair value of shares vested was $9.8 million for the first thirty-nine weeks of 2014 and $7.7 million for the first thirty-nine weeks of 2013.

In connection with the GoJane acquisition, we granted restricted shares to the two individual stockholders of GoJane, with compensation expense recognized over the three year cliff vesting period. If the aggregate dollar value of the restricted shares on the vesting date is less than $8.0 million, then we shall pay to the two individual stockholders an amount in cash equal to the

19


difference between $8.0 million and the fair market value of the restricted shares on the vesting date. As of the third quarter of 2014, we recorded additional compensation expense of $0.6 million and a corresponding liability of $4.0 million based on the Company's stock price as of November 1, 2014. As of the first thirty-nine weeks of 2014, we recorded additional compensation expense of $2.6 million. As of the third quarter of 2013 and the first thirty-nine weeks of 2013, we recorded additional compensation expense and a corresponding liability of $0.7 million as of November 2, 2013.
 
On October 31, 2013, we entered into Restricted Stock Award Rescission Agreements with certain executives to rescind 229,760 aggregate shares of restricted stock granted on March 29, 2013 under the Aéropostale, Inc. 2002 Long-Term Incentive Plan. The rescission did not have a material impact on the unaudited condensed consolidated financial statements for any period presented and we recorded $1.0 million of compensation cost during the third quarter of 2013 as a result of rescinding such restricted stock awards.

Performance Shares

Certain of our executives have been awarded performance shares, pursuant to performance share agreements. The performance shares cliff vest at the end of three years of continuous service with us. The shares awarded during fiscal 2013 are contingent upon meeting various separate performance conditions based upon consolidated earnings targets or market conditions based upon total shareholder return targets. All performance shares immediately vest upon a change in control of the Company (as communicated to the executives awarded performance shares). Compensation cost for the performance shares with performance conditions related to consolidated earnings targets is periodically reviewed and adjusted based upon the probability of achieving certain performance targets. If the probability of achieving targets changes, compensation cost will be adjusted in the period that the probability of achievement changes. The fair value of performance based awards is based upon the fair value of the Company's common stock on the date of grant. For market based awards that vest based upon total shareholder return targets, the effect of the market conditions is reflected in the fair value of the awards on the date of grant using a Monte-Carlo simulation model. A Monte-Carlo simulation model estimates the fair value of the market based award based upon the expected term, risk-free interest rate, expected dividend yield and expected volatility measure for the Company and its peer group. Compensation expense for market based awards is recognized over the vesting period regardless of whether the market conditions are expected to be achieved.

The following table summarizes performance shares of stock outstanding as of November 1, 2014:

 
Performance-based
 
Market-based
 
Performance Shares
 
Performance Shares
 
 
 
Shares
 
Weighted Average
Grant-Date Fair Value
 
Shares
 
Weighted Average
Grant-Date Fair Value
 
(In thousands)
 
 
 
(In thousands)
 
 
Outstanding as of February 2, 2014

 
$

 
391

 
$
20.01

Granted

 

 
676

 
5.34

Vested

 

 

 

Canceled

 

 
(528
)
 
11.06

Outstanding as of November 1, 2014

 
$

 
539

 
$
10.37


Total compensation expense is being amortized over the vesting period. Compensation expense related to the market-based performance shares was a benefit of $1.5 million for the third quarter of 2014 and expense of $0.6 million for the third quarter of 2013. Compensation expense related to the market-based performance shares was expense of $0.2 million for the first thirty-nine weeks of 2014 and expense of $1.4 million for the first thirty-nine weeks of 2013. Certain of our performance-based performance shares did not achieve a grant date and therefore are not reflected in the table. As a result of the departure of Mr. Johnson after the end of the second quarter of 2014, we recognized a benefit of $2.0 million during the third quarter of 2014 resulting from the reversal of the related stock-based compensation expense.
  





20


The following table summarizes unrecognized compensation cost and the weighted-average years expected to be recognized related to performance share awards outstanding as of November 1, 2014:
 
Performance-based
 
Market-based
 
Performance Shares
 
Performance Shares
Total unrecognized compensation (in millions)
$

 
$
3.2

Weighted-average years expected to be recognized over (years)
0

 
2


Cash-Settled Stock Appreciation Rights ("CSARs")

In conjunction with the execution of the employment agreement with Mr. Johnson on May 3, 2013, we granted him an award of CSARs, with an award date value of $5.6 million. The number of CSARs granted was determined in accordance with the agreement by dividing $5.6 million by the Black Scholes value of the closing price of a share of the Company's common stock on the award date. The CSARs are currently being treated as a liability based award. For the third quarter of 2014, our expected volatility was 64%, expected term was 0.8 years, risk-free interest rate was 0.09% and expected forfeiture rate was 0%. The CSARs have a term of seven years and will vest in equal 1/3 increments over three years. Additionally, we may, in our sole discretion, at any time during the term, exchange a CSAR for another form of equity which is of equal value to the CSAR at the time of the exchange. For the third quarter of 2014, we recorded less than $0.1 million of benefit related to this incentive award and $0.3 million of benefit during the first thirty-nine weeks of 2014. For the third quarter of 2013, we recorded less than $0.1 million of benefit related to this award and $0.4 million of expense during the first thirty-nine weeks of 2013. As of November 1, 2014, there was no unrecognized compensation cost related to CSARs.  As a result of the departure of Mr. Johnson after the end of the second quarter of 2014, 2/3 of these CSARs were forfeited. The remaining vested shares will expire within a year from Mr. Johnson's departure date.
 
Performance Based Bonus

The Employment Agreement with Julian R. Geiger, our Chief Executive Officer, provides for a special performance based bonus. If, during any consecutive 90 calendar day period during the 3rd year of the term of the Employment Agreement the average closing price per share of the Company’s common stock is $15.93 or higher, Mr. Geiger will be entitled to a performance-based cash bonus equal to 2% of the amount, if any, by which the Company’s average market capitalization during the period with the highest 90 day average stock price during the 3rd year of the term of the Employment Agreement exceeds $255,360,600 (the “Effective Date Market Cap”). If prior to the achievement of such performance metric (but not during the first 90 days of the term of the agreement), Mr. Geiger’s employment is terminated by the Company without Cause, by Mr. Geiger for Good Reason, upon Mr. Geiger’s death or by the Company due to his Disability, or there is a Change of Control (each a “Qualifying Event”), and as of the date of such Qualifying Event the common stock price exceeds $3.24, then, the amount of the performance-based cash bonus will instead be 2% of the amount, if any, by which the Company’s average market capitalization over the 30 calendar day period immediately preceding the Qualifying Event exceeds the Effective Date Market Cap.

This bonus is a market and service based liability award that is required to be marked-to-market under ASC 718. The fair value of this award is estimated using a Monte-Carlo simulation model. A Monte-Carlo simulation model estimates the fair value of a market based award based upon the expected term, risk-free interest rate, expected dividend yield and expected volatility measure for the Company. Compensation expense for this award is recognized over the vesting period regardless of whether the market condition is expected to be achieved. We have recorded a liability for this award that was immaterial to the unaudited condensed financial statements as of November 1, 2014.
 
Stock Options

We have an Omnibus Incentive Plan under which we may grant qualified and non-qualified stock options to purchase shares of our common stock to executives, consultants, directors, or other key employees.  Stock options may not be granted at less than the fair market value at the date of grant. Stock options generally vest over four years on a pro-rata basis and expire after eight years. All outstanding stock options immediately vest upon (i) a change in control of the Company (as defined in the plan) and (ii) termination of the employee within one year of such change of control.

The fair value of options granted is estimated on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes model requires certain assumptions, including estimating the length of time employees will retain their vested stock options before exercising them (“expected term”), the estimated volatility of our common stock price over the expected term and the number of options that will ultimately not complete their vesting requirements (“forfeitures”). For the first thirty-nine weeks of 2014, our expected volatility was 52.8% to 56.1%, expected term was 3.96 to 5.00 years, risk-free interest rate was 1.17% to 1.58%

21


and expected forfeiture rate was 0%. Changes in the subjective assumptions can materially affect the estimate of fair value of stock-based compensation and consequently, the related amount recognized in the unaudited condensed consolidated statements of operations.

The effects of applying the provisions of ASC 718 and the results obtained through the use of the Black-Scholes option-pricing model are not necessarily indicative of future values.
 
The following table summarizes stock option transactions for common stock during the first thirty-nine weeks of 2014:

 
 
 
Number of Shares
 
Weighted Average Exercise Price
 
Weighted-Average Remaining Contractual Term
 
Aggregate Intrinsic Value
 
(In thousands)
 
 
 
(In years)
 
(In millions)
Outstanding as of February 2, 2014
377

 
$
16.61

 
 
 
 
Granted
2,030

 
3.24

 
 
 
 
Exercised

 

 
 
 
 
Canceled1 
(110
)
 
13.84

 
 
 
 
Outstanding as of November 1, 2014
2,297

 
$
4.93

 
2.63
 
$

Options vested as of November 1, 2014 and expected to vest2
2,297

 
$
4.93

 
2.63
 
$

Exercisable as of November 1, 2014
262

 
$
17.78

 
0.75
 
$


1 The number of options canceled includes approximately 105,000 expired shares.
2 The number of options expected to vest takes into consideration estimated expected forfeitures.

Included in the table above and in connection with his employment agreement, Mr. Geiger was granted an award of options to purchase 2.0 million shares of our common stock. These stock options have a strike price of $3.24 per share, vest over three years on a pro-rata basis, and have a seven year life.

We recognized $0.2 million in compensation expense related to stock options during the third quarter of 2014 and less than $0.1 million during the third quarter of 2013.   We recognized $0.2 million in compensation expense related to stock options during the first thirty-nine weeks of 2014 and less than $0.1 million during the first thirty-nine weeks of 2013. For the first thirty-nine weeks of 2014 and thirty-nine weeks of 2013, the intrinsic value of options exercised was zero.

The following table summarizes information regarding non-vested outstanding stock options as of November 1, 2014:

 
 
 
 
Shares
 
Weighted Average
Grant-Date Fair Value
 
(In thousands)
 
 
Non-vested as of February 2, 2014
10

 
$
6.41

Granted
2,030

 
3.24

Vested

 

Canceled
(5
)
 
6.43

Non-vested as of November 1, 2014
2,035

 
$
3.25


As of November 1, 2014, there was $2.8 million of unrecognized compensation cost related to non-vested options that we expect to be recognized over the remaining weighted-average vesting period of three years.


22


13.  Commitments and Contingent Liabilities

Legal Proceedings - In October 2011, Aéropostale, Inc. and senior executive officers Thomas P. Johnson and Marc D. Miller were named as defendants in an action amended in February 2012, City of Providence v. Aéropostale, Inc., et al., No. 11-7132, a class action lawsuit alleging violations of the federal securities laws.  The lawsuit was filed in New York federal court on behalf of purchasers of Aéropostale securities between March 11, 2011 and August 18, 2011.  The lawsuit alleges that the defendants made materially false and misleading statements regarding the Company's business and prospects and failed to disclose that Aéropostale was experiencing declining demand for its women's fashion division and increasing inventory.  A motion to dismiss was denied on March 25, 2013.  Aéropostale and the plaintiffs have entered into a settlement agreement resolving the claims made in this action, without any admission of liability, for the amount of $15 million, all of which was funded with insurance proceeds. The settlement received final court approval on May 9, 2014.

Also in October 2011, current and former Aéropostale directors and/or senior executive officers Julian R. Geiger, Ronald R. Beegle, Robert B. Chavez, Michael J. Cunningham, Evelyn Dilsaver, John Haugh, Karin Hirtler-Garvey, John D. Howard, Thomas P. Johnson, and David B. Vermylen were named as defendants in Bell v. Geiger, et al., No. 652931/2011, a shareholder derivative lawsuit filed in New York state court seeking relief derivatively on behalf of Aéropostale.  The action alleged that the defendants breached their fiduciary duties to Aéropostale between February 3, 2011 and August 3, 2011 by failing to establish and maintain internal controls that would have prevented the Company from disseminating allegedly false and misleading and inaccurate statements and other information to shareholders, and to manage and oversee the Company.  As a result, plaintiff alleged that the defendants exposed the Company to potential liability in the federal securities class action lawsuit described above.

In February 2012, current and former Aéropostale directors and/or senior executive officers Mindy Meads, Bodil Arlander, Julian Geiger, Karin Hirtler-Garvey, Ronald Beegle, Robert Chavez, Michael Cunningham, Evelyn Dilsaver, John Haugh, John Howard, Thomas Johnson, Arthur Rubinfeld, and David Vermylen were named as defendants in The Booth Family Trust v. Meads, et al., No. 650594/2012, a shareholder derivative lawsuit filed in New York state court, seeking relief derivatively on behalf of Aéropostale.  As in Bell, this action alleges that the defendants breached their fiduciary duties to Aéropostale by failing to establish and maintain internal controls that would have prevented the Company from disseminating allegedly false and misleading and inaccurate statements and other information to shareholders, and to manage and oversee the Company.  As a result, and as in Bell, plaintiff alleges that the defendants have exposed the Company to losses and damages, including civil liability from the securities class action suit described above.

On April 24, 2012, the New York Supreme Court, New York County, issued an Order consolidating and staying the Bell and Booth actions pending a ruling on the motion to dismiss filed in the City of Providence federal securities class action. Following denial of the motion to dismiss in the federal securities class action, plaintiff filed an amended complaint in the consolidated Bell/Booth action. Defendants have moved to dismiss that complaint. A hearing on the motion to dismiss the Bell/Booth action occurred on January 7, 2014 and at that hearing the court granted the Defendants motion to dismiss the complaint. The plaintiffs have not appealed and the court's decision is final.

During February 2014, we settled litigations related to California wage and hour matters. During the first thirty-nine weeks of 2014, we made settlement payments of $3.6 million. In addition, we have remaining liabilities previously recorded of $0.8 million as of November 1, 2014 related to these settlements.
 
We are also party to various litigation matters and proceedings in the ordinary course of business.  In the opinion of our management, dispositions of these matters are not expected to have a material adverse effect on our financial position, results of operations or cash flows.

Contingencies - On May 23, 2014, we entered into $150.0 million senior secured credit facilities with affiliates of Sycamore Partners. In connection with this agreement, we entered into an exclusive sourcing agreement with an affiliate of Sycamore Partners that requires us to purchase a minimum volume of product for 10 years. This purchase commitment will commence during the first quarter of fiscal 2016, and is between $240.0 million and $280.0 million per annum depending on the year (see Note 3).

In June 2012, Bank of America, N.A. issued a stand-by letter of credit. As of November 1, 2014, the outstanding letter of credit was $0.2 million and expires on June 30, 2015. We do not have any other stand-by or commercial letters of credit as of November 1, 2014.

We have various product license agreements that obligate us to pay the licensee at least the guaranteed minimum royalty amount based on sales of their products.


23


We have not issued any third party guarantees or commercial commitments as of November 1, 2014.

Executive Severance Plan - On November 12, 2013, we adopted a Change of Control Severance Plan ("the Plan"), which entitles certain executive level employees to receive certain payments upon a termination of employment after a change of control (as defined in the Plan) of the Company. The adoption of the Plan did not have any impact on the unaudited condensed consolidated financial statements for any periods presented.

Employment Agreement - On August 18, 2014, we entered into an Employment Agreement with Mr. Geiger pursuant to which he will serve as our Chief Executive Officer. The Employment Agreement, which has a three-year term, provides for an annual salary of $1.5 million in addition to a performance based bonus (see Note 12).

14.  Income Taxes

We review the annual effective tax rate on a quarterly basis and make necessary changes if information or events merit.  The estimated annual effective tax rate is forecasted quarterly using actual historical information and forward-looking estimates.  The estimated annual effective tax rate may fluctuate due to changes in forecasted annual operating income; changes to the valuation allowance for deferred tax assets; changes to actual or forecasted permanent book to tax differences (non-deductible expenses); impacts from future tax settlements with state, federal or foreign tax authorities (such changes would be recorded discretely in the quarter in which they occur), or impacts from tax law changes.  To the extent such changes impact our deferred tax assets/liabilities, these changes would generally be recorded discretely in the quarter in which they occur. During the third quarter of 2014, we recorded a tax benefit of approximately $7.1 million related to the carryback of certain NOL’s due to tax accounting method changes filed in the third quarter and the release of reserves for uncertain tax benefits due to a favorable audit resolution. During the first thirty-nine weeks of 2014, we recorded a net discrete benefit of approximately $2.7 million. This net tax benefit was the result of tax expense of approximately $4.4 million to reduce certain state deferred tax assets, primarily resulting from the planned closures of the mall-based P.S. from Aéropostale stores offset by the above mentioned $7.1 million in discrete tax benefit recorded in the third quarter which is discussed above.

We follow the provisions of ASC Topic 740, “Income Taxes”, which includes the accounting and disclosure for uncertainty in income taxes.  We recognize interest and penalties related to unrecognized tax benefits as a component of income tax expense. Uncertain tax positions, inclusive of interest and penalties were $8.2 million as of November 1, 2014, $9.9 million at February 1, 2014, and $3.3 million at November 2, 2013.  Of these amounts, $6.2 million was recorded as a direct reduction of the related deferred tax assets as of November 1, 2014 and February 1, 2014. During the third quarter of 2014 we released $0.8 million of reserves due to a favorable audit resolution within the quarter. This reversal of uncertain tax positions, along with reversal of related deferred tax assets, favorably impacts our effective tax rate. These uncertain tax positions are subject to change based on future events, the timing of which is uncertain, however the Company does not anticipate that the balance of such uncertain tax positions will significantly decrease during the next twelve months.

We file income tax returns in the U.S. and in various states, Canada and Puerto Rico. All tax returns remain open for examination generally for our 2010 through 2013 tax years by various taxing authorities. However, certain states may keep their statute open for six to ten years.

15.  Segment Information

ASC Topic 280, “Segment Reporting” establishes standards for reporting information about a company’s operating segments. In the fourth quarter of 2013, management concluded that we have two reportable segments: a) retail stores and e-commerce; and b) international licensing. As a result, prior year segment information has been recasted to conform to the current year presentation. These reportable segments were identified based on how our business is managed and evaluated. The reportable segments represent the Company’s activities for which separate financial information is available and which is utilized on a regular basis by the Company’s chief operating decision maker (“CODM”) to evaluate performance and allocate resources. The retail stores and e-commerce segment includes Aéropostale U.S., Aéropostale Canada, P.S. from Aéropostale and GoJane. In identifying our reportable segments, the Company considers economic characteristics, as well as products, customers, sales growth potential and long-term profitability. The accounting policies of the Company’s reportable segments are consistent with those described in Note 1 of our Annual Report on Form 10-K for the fiscal year ended February 1, 2014. All intercompany transactions are eliminated in consolidation. We do not rely on any major customers as a source of revenue.  





24


The following tables provide summary financial data for each of our segments (in thousands):

 
 
13 weeks ended
 
39 weeks ended
 
 
November 1, 2014
 
November 2, 2013
 
November 1, 2014
 
November 2, 2013
Net sales:
 
 
 
 
 
 
 
 
Retail stores and e-commerce                                                                                               
 
$
442,906

 
$
508,813

 
$
1,219,668

 
$
1,407,700

International licensing                                                                                                     
 
9,983

 
5,775

 
25,234

 
13,195

Total net sales                                                                                                             
 
$
452,889

 
$
514,588

 
$
1,244,902

 
$
1,420,895


 
 
13 weeks ended
 
39 weeks ended
 
 
November 1, 2014
 
November 2, 2013
 
November 1, 2014
 
November 2, 2013
Loss from operations:
 
 
 
 
 
 
 
 
Retail stores and e-commerce 1                                                                                                    
 
$
(43,839
)
 
$
(41,369
)
 
$
(140,191
)
 
$
(101,118
)
International licensing                                                                                                      
 
9,253

 
5,388

 
23,048

 
12,070

Other 2
 
(19,499
)
 
(5,053
)
 
(82,030
)
 
(16,284
)
Total loss from operations                                                                                             
 
$
(54,085
)
 
$
(41,034
)
 
$
(199,173
)
 
$
(105,332
)

1 Such amounts include all corporate overhead and shared service function costs. We have not allocated a portion of these costs to international licensing in this presentation to be consistent with how the CODM reviews the results.

2 Other items for the third quarter and first thirty-nine weeks of 2014, which are all related to the retail stores and e-commerce segment, included restructuring charges (See Note 3), store asset impairment charges (See Note 4) and other income (charges) that are not included in the segment income (loss) from operations reviewed by the CODM. Other items for the third quarter of 2013 and first thirty-nine weeks of 2013 included store asset impairment and other charges.

Depreciation expense and capital expenditures have not been separately disclosed as the amounts primarily relate to the retail stores and e-commerce segment. Such amounts are not material for the international licensing segment.

 
 
November 1, 2014
 
February 1, 2014
 
November 2, 2013
Total assets:
 
 
 
 
 
 
Retail stores and e-commerce                                                                                               
 
$
567,032

 
$
637,927

 
$
734,083

International licensing                                                                                                     
 
11,292

 
9,714

 
8,230

Total assets                                                                                                          
 
$
578,324

 
$
647,641

 
$
742,313


16.  Recent Accounting Developments

In August, 2014, the FASB issued Accounting Standards Update No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern ("ASU 2014-15"). It addresses financial reporting considerations about an entity’s ability to continue as a going concern. Under ASU 2014-15, management is required to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. An entity must provide certain disclosures if “conditions or events raise substantial doubt about [the] entity’s ability to continue as a going concern.” The new standard applies to all entities and is effective for annual periods ending after December 15, 2016, and interim periods thereafter, with early adoption permitted. Management is still assessing the impact of the adoption to the unaudited condensed consolidated financial statements.

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers ("ASU 2014-09"). It outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” ASU

25


2014-09 is effective for annual periods beginning after December 15, 2016 and interim periods within those annual periods. Management is still assessing the impact of the adoption to the unaudited condensed consolidated financial statements.

In April 2014, the FASB issued Accounting Standards Update No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity ("ASU 2014-08"). Under ASU 2014-08, only disposals that represent a strategic shift that has (or will have) a major effect on the entity’s results and operations would qualify as discontinued operations. In addition, the ASU expands the disclosure requirements for disposals that meet the definition of a discontinued operation, requires entities to disclose information about disposals of individually significant components and defines “discontinued operations” similarly to how it is defined under International Financial Reporting Standards 5, Non-current Assets Held for Sale and Discontinued Operations. The ASU is effective prospectively for all disposals (except disposals classified as held for sale before the adoption date) or components initially classified as held for sale in periods beginning on or after December 15, 2014, with early adoption permitted. Management is still assessing the impact of the adoption to the unaudited condensed consolidated financial statements.

26


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

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  Such forward-looking statements involve certain risks and uncertainties, including statements regarding our strategic direction, prospects and future results.  Forward-looking statements are generally written in the future tense and/or are preceded by words such as “will”, “may”, “could”, “expect”, “believe”, “anticipate”, “intend”, “estimate”, “seek” or other similar words. Certain factors, including factors outside of our control, may cause actual results to differ materially from those contained in the forward-looking statements.  Among the factors that could cause actual results to materially differ from those projected in the forward-looking statements, include changes in the competitive marketplace, including the introduction of new products or pricing changes by our competitors; changes in the economy and other events leading to a reduction in discretionary consumer spending; seasonality; risks associated with changes in social, political, economic and other conditions and the possible adverse impact of changes in import restrictions; risks associated with uncertainty relating to the Company's ability to implement its strategies and risks associated with the Company’s ability to implement and realize the anticipated benefits of the Company’s strategic initiatives and cost reduction program. The following discussion as well as any evaluation of our business and future prospects should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended February 1, 2014 and the Risk Factors in Part 1, Item 1A thereof, as well as other reports filed with the SEC. All forward-looking statements included in this report are based on information available to us as of the date hereof, and we assume no obligation to update or revise such forward-looking statements to reflect events or circumstances that occur after such statements are made.

Introduction

Management’s Discussion and Analysis of Financial Condition and Results of Operations, or “MD&A,” is intended to provide information to help you better understand our financial condition and results of operations.  Our business is highly seasonal, and historically we realize a significant portion of our sales and cash flow in the second half of the year, driven by the impact of the back-to-school selling season in our third quarter and the holiday selling season in our fourth quarter.  Therefore, our interim period unaudited condensed consolidated financial statements may not be indicative of our full-year results of operations, financial condition or cash flows. We recommend that you read this section along with the unaudited condensed consolidated financial statements and notes included in this report and along with our Annual Report on Form 10-K for the year ended February 1, 2014.

The discussion in the following section is on a consolidated basis, unless indicated otherwise.

Overview

While the United States macro-economic environment and mall traffic continue to remain challenging, we are focused on executing our key merchandising, operational and financial initiatives to improve our performance. As part of our on-going initiative to change perception of the brand and accelerate customer adoption, we created a new brand platform that we have identified as AERO NOW. This new brand platform aims to convey our brand’s authenticity, emotion and relevance to today’s teen. We also continue to make progress on our key initiative of increasing the fashion in our overall assortment, including our exclusive sub-brand businesses, Live Love Dream and the Bethany Mota Collection. We continue to increase our focus on the use of social media influencers in order to be more relevant to today’s teenagers. We recently implemented a new vertical organizational structure to focus on more specific and narrowly defined merchandise classifications. Additionally, significant additional initiatives have recently begun including brand positioning and assortment planning and allocation strategies. Lastly, we are focused on the continued growth of our international licensing business.
  
We also continue to make progress on our key financial strategies of maintaining appropriate levels of liquidity, optimizing our real estate portfolio and managing our capital spending prudently. With regard to liquidity, on February 21, 2014, we increased the aggregate borrowing capacity on our revolver from $175.0 million to $230.0 million (see Note 10 to the Notes to Unaudited Condensed Consolidated Financial Statements). Additionally, on May 23, 2014, to enhance our liquidity, we entered into $150.0 million in senior secured credit facilities with Sycamore Partners (see Note 3 to the Notes to Unaudited Condensed Consolidated Financial Statements). During the second quarter of 2014, we received an income tax refund of approximately $45.0 million.

Operationally, on April 30, 2014, following a strategic review and assessment of changing consumer patterns, management and the Board of Directors approved a comprehensive plan to restructure the P.S. from Aéropostale business and to reduce costs. We have identified key initiatives we estimate will generate approximately $30.0 million to $35.0 million in annualized pre-tax savings, of which approximately $5.0 million to $10.0 million is expected to be achieved during fiscal 2014. Based on changing consumer

27


patterns, we plan to close approximately 125 mall-based P.S. from Aéropostale stores on or around the end of fiscal 2014. We plan to focus on faster growing sales channels, including off-mall locations (including outlets), e-commerce and international licensing of P.S. from Aéropostale. We are also exploring other potential third party distribution channels. By taking these steps, we expect to eliminate pre-tax losses of approximately $15.0 million that were generated in the mall-based business in fiscal 2013, excluding any impairment charges. We anticipate that substantially all of the planned store closures will be completed by the end of fiscal 2014. As of November 1, 2014, 11 mall-based P.S. from Aéropostale stores have been closed. The cost reduction program will also target direct and indirect spending across the organization. This has included the reduction of approximately 100 open or occupied corporate positions to align with our current business strategies.

We estimate that we will incur pre-tax restructuring and impairment charges related to these actions totaling approximately $40.0 million to $65.0 million throughout fiscal 2014, of which approximately $25.0 million to $40.0 million are estimated to be cash expenses. Included in the estimate of total pre-tax charges are approximately:

$5.5 million of consulting and severance expenses resulting from the announced corporate cost reduction initiatives, of which $0.4 million were recorded during the third quarter of 2014 and $5.1 million during the first thirty-nine weeks of 2014.
$30.5 million of the charges relate to fixed asset impairments resulting primarily from the expected closures of the P.S. from Aéropostale stores, all of which were recorded during the first quarter of 2014.
$4.0 million of additional severance resulting from the store closures, of which $1.2 million was recorded during the third quarter of 2014 and $2.5 million for the first thirty-nine weeks of 2014. These costs are expected to be recorded through the remainder of fiscal 2014 until the stores are closed.
The remainder of the charges relate to estimated lease costs in connection with the store closures, which are expected to be recorded during the remainder of fiscal 2014. We expect to pay significantly all lease costs during the fourth quarter of 2014 and first quarter of 2015.

The charges are recognized in restructuring charges in the condensed consolidated statements of operations. The amounts of these estimated costs and charges are preliminary and remain subject to change, pending, among other factors, the outcome of negotiations with third parties. Total charges, actual savings and timing may vary positively or negatively from these estimates due to changes in the scope, underlying assumptions or execution risk of the program throughout its duration.

We also expect to close approximately 75 under-performing Aéropostale stores in the fourth quarter of 2014, bringing the total 2014 closures to approximately 120 U.S. and Canada Aéropostale stores. During 2015, we are considering potentially closing approximately 50 to 75 additional Aéropostale stores, which would bring total closures to a range of approximately 220 to 240 Aéropostale stores since 2013.
 
On August 18, 2014, we entered into an Employment Agreement (the "Agreement") with Julian R. Geiger pursuant to which he will serve as our Chief Executive Officer. Also, on August 18, 2014, Thomas P. Johnson stepped down as Chief Executive Officer of the Company and no longer serves as a member of the Board. The Agreement provides that Mr. Geiger will be nominated to serve on our Board of Directors at each annual meeting of the Company’s stockholders during the term of the Agreement. Mr. Geiger, 69, previously served as the Company’s Chairman and Chief Executive Officer from August 1998 to February 2010, and thereafter continued to serve as Chairman of the Board and as a part-time advisor to the Company until February 2012. On May 23, 2014, in connection with our strategic transaction with Sycamore Partners, Mr. Geiger was appointed to serve on the Board as a Series B holders designee (see Note 3 to the Notes to Unaudited Condensed Consolidated Financial Statements).


28


Results of Operations

The following table sets forth our results of operations as a percentage of net sales. We also use this information to evaluate the performance of our business:

 
13 weeks ended
 
39 weeks ended
 
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Net sales
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Gross profit
15.2
 %
 
17.1
 %
 
16.2
 %
 
19.0
 %
Selling, general and administrative expenses
26.8
 %
 
25.1
 %
 
29.1
 %
 
26.5
 %
Restructuring charges
0.3
 %
 
 %
 
3.1
 %
 
 %
Loss from operations
(11.9
)%
 
(8.0
)%
 
(16.0
)%
 
(7.4
)%
Interest expense
0.7
 %
 
 %
 
0.5
 %
 
 %
Loss before income taxes
(12.6
)%
 
(8.0
)%
 
(16.5
)%
 
(7.4
)%
Income tax benefit
(1.0
)%
 
(3.0
)%
 
(1.0
)%
 
(2.4
)%
Net loss
(11.6
)%
 
(5.0
)%
 
(15.5
)%
 
(5.0
)%

Key Performance Indicators

We use a number of key indicators of financial condition and operating performance to evaluate the performance of our business, some of which are set forth in the following table. Comparable changes for the 13-weeks ended November 1, 2014 are compared to the 13-weeks ended November 2, 2013.

 
13 weeks ended
 
39 weeks ended
 
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Net sales (in millions)
$
452.9

 
$
514.6

 
$
1,244.9

 
$
1,420.9

Total store count at end of period
1,052

 
1,124

 
1,052

 
1,124

Comparable store count at end of period
1,010

 
1,038

 
1,010

 
1,038

Net sales change
(12
)%
 
(15
)%
 
(12
)%
 
(11
)%
Comparable sales change (including the e-commerce channel)
(11
)%
 
(15
)%
 
(12
)%
 
(15
)%
Comparable average unit retail change (including the e-commerce channel)
3
 %
 
(7
)%
 
4
 %
 
(7
)%
Comparable units per sales transaction change (including the e-commerce channel)
(4
)%
 
2
 %
 
(5
)%
 
2
 %
Comparable sales transaction change (including the e-commerce channel)
(11
)%
 
(10
)%
 
(11
)%
 
(10
)%
Net sales per average square foot
$
100

 
$
110

 
$
274

 
$
308

Gross profit (in millions)
$
68.9

 
$
87.9

 
$
201.9

 
$
270.5

Loss from operations (in millions)
$
(54.1
)
 
$
(41.0
)
 
$
(199.2
)
 
$
(105.3
)
Diluted loss per share
$
(0.66
)
 
$
(0.33
)
 
$
(2.45
)
 
$
(0.91
)
Average square footage growth over comparable period
(4
)%
 
3
 %
 
(2
)%
 
3
 %
Change in total inventory over comparable period
(20
)%
 
(5
)%
 
(20
)%
 
(5
)%
Change in store inventory per retail square foot over comparable period
(16
)%
 
(11
)%
 
(16
)%
 
(11
)%
Percentages of net sales by category:
 

 
 

 
 

 
 

Young Women’s
65
 %
 
65
 %
 
65
 %
 
65
 %
Young Men’s
35
 %
 
35
 %
 
35
 %
 
35
 %


29


Comparison of the 13 weeks ended November 1, 2014 to the 13 weeks ended November 2, 2013

Net Sales

Net sales consist of our sales from comparable stores, our non-comparable stores, our e-commerce business and international licensing revenue. Our wholly-owned stores are included in comparable store sales after 14 months of operation. Additionally, we have included GoJane sales in our comparable sales beginning in February of fiscal 2014. We consider a remodeled or relocated store with more than a 25% change in square feet to be a new store. Prior period sales from stores that have closed are not included in comparable store sales.

Net sales decreased by $61.7 million, or 12% for the third quarter of 2014. Comparable store sales declined by 11%, compared to the same period last year. The net sales decrease reflects:

a decrease of $46.5 million in comparable store sales (excluding the e-commerce channel)
a decrease of $11.9 million in non-comparable store sales
a decrease of $7.5 million in our e-commerce business
an increase of $4.2 million in international licensing revenue primarily due to the increase in licensee operated locations to 221 as of November 1, 2014 from 89 as of November 2, 2013.

Consolidated comparable sales, including the e-commerce channel, decreased by 12% in our young men's category and 11% in our young women's category. The overall comparable sales, including the e-commerce channel, reflected decreases of 11% in the number of sales transactions and 4% in units per sales transaction, partially offset by an increase of 3% in average unit retail.

Cost of Sales and Gross Profit

Cost of sales includes costs related to merchandise sold, including inventory valuation adjustments, distribution and warehousing, freight from the distribution center to the stores, shipping and handling costs, payroll for our design, buying and merchandising departments and occupancy costs. Occupancy costs include rent, contingent rents, common area maintenance, real estate taxes, utilities, repairs and maintenance, depreciation and amortization and store impairment charges.

Gross profit decreased by $19.0 million for the third quarter of 2014 compared to the same period last year. Gross profit included asset impairment charges of $12.5 million during the third quarter of 2014 and $5.1 million for the third quarter of 2013. Gross profit decreased by 1.9 percentage points, as a percentage of net sales. Gross profit for the third quarter of 2014 included higher asset impairment charges of 1.8 percentage points and lease termination costs of 0.8 percentage points compared to the same period last year. Merchandise margin increased by 1.5 percentage points and depreciation was lower by 0.5 percentage points. These increases were offset by 1.3 percentage points of deleverage impact in occupancy and buying expense resulting from the above mentioned decrease in store sales.

SG&A

SG&A includes costs related to selling expenses, store management and corporate expenses such as payroll and employee benefits, marketing expenses, employment taxes, information technology maintenance costs and expenses, insurance and legal expenses, e-commerce transaction expenses, store pre-opening costs and other corporate level expenses. Store pre-opening costs include store level payroll, grand opening event marketing, travel, supplies and other store pre-opening expenses.

SG&A decreased by $7.7 million for the third quarter of 2014 compared to the third quarter of 2013. SG&A for the third quarter of 2014 included consulting fees of $1.4 million for strategic initiatives. The decrease in SG&A was due to lower store-line expenses of $7.3 million, which primarily consisted of payroll resulting from cost savings initiatives, transaction expenses of $2.1 million primarily due to lower sales and lower corporate expenses of $2.7 million. These decreases were partially offset by higher marketing costs of $2.8 million to support our brand awareness initiatives.

SG&A was 26.8% for the third quarter of 2014 compared to 25.1% for the same period last year, as a percentage of net sales. The increase in SG&A, as a percentage of sales, was due primarily to the deleverage in marketing expenses of 0.9 percentage points, corporate expenses of 0.3 percentage points, the above mentioned consulting fees of 0.3 percentage points, and store-line expenses of 0.2 percentage points, which primarily consisted of payroll.




30


Restructuring Charges

Restructuring charges related to the cost reduction program discussed above were $1.7 million, or 0.3% as a percentage of net sales, for the third quarter of 2014. These charges included severance charges of $1.2 million and other exit costs of $0.5 million.

Loss from Operations

As a result of the above, consolidated loss from operations was $54.1 million for the third quarter of 2014, compared to $41.0 million for the third quarter of 2013. The consolidated loss from operations included income from our international licensing segment of $9.3 million for the third quarter of 2014 compared to $5.4 million for the prior period. The increase from international licensing was due to the increase in licensee locations as discussed above.

Income taxes

The effective tax rate was 8.4% for the third quarter of 2014 and 38.0% for the third quarter of 2013. During the first quarter of 2014, we accounted for the utilization of most remaining available NOL carrybacks.  While the balance of 2014 anticipated losses can be carried forward and utilized against future taxable income, the related deferred tax assets have a full valuation allowance.  The lower tax rate for the third quarter of 2014 was primarily due to the valuation allowance provided for these assets. This was partially offset by the recording of tax benefits related to the carryback of certain NOL’s due to tax accounting method changes filed in the third quarter and the release of reserves due to a favorable audit resolution. We expect that our effective tax rate for fiscal 2014 will continue to be unfavorably impacted by the establishment of valuation allowances against deferred tax assets.
Net loss

Net loss was $52.3 million, or $0.66 per diluted share, for the third quarter of 2014, compared to net loss of $25.6 million, or $0.33 per diluted share, for the third quarter of 2013.

Comparison of the 39 weeks ended November 1, 2014 to the 39 weeks ended November 2, 2013

Net Sales

Net sales decreased by $176.0 million for the first thirty-nine weeks of 2014. Both net sales and comparable store sales declined by 12% compared to the same period last year. The net sales decrease reflects:

a decrease of $141.1 million in comparable store sales (excluding the e-commerce channel)
a decrease of $26.9 million in non-comparable store sales
a decrease of $20.0 million in our e-commerce business
an increase of $12.0 million in international licensing revenue primarily due to the increase in licensee operated locations to 221 as of November 1, 2014 from 89 as of November 2, 2013.

Consolidated comparable sales, including the e-commerce channel, decreased by 13% in our young men's category and 12% in our young women's category. The overall comparable sales, including the e-commerce channel, reflected decreases of 11% in the number of sales transactions and 5% in units per sales transaction, partially offset by an increase of 4% in average unit retail.

Cost of Sales and Gross Profit

Cost of sales includes costs related to merchandise sold, including inventory valuation adjustments, distribution and warehousing, freight from the distribution center to the stores, shipping and handling costs, payroll for our design, buying and merchandising departments and occupancy costs. Occupancy costs include rent, contingent rents, common area maintenance, real estate taxes, utilities, repairs and maintenance, depreciation and amortization and store impairment charges.

Gross profit decreased by $68.6 million for the first thirty-nine weeks of 2014 compared to the same period last year. Gross profit included asset impairment charges of $34.1 million during the first thirty-nine weeks of 2014 and $13.6 million for the first thirty-nine weeks of 2013. Gross profit decreased by 2.8 percentage points, as a percentage of net sales. Gross profit included higher asset impairment charges of 1.7 percentage points and lease termination charges of 0.3 percentage points compared to the same period last year. Additionally, the deleverage impact in occupancy expense and distribution and transportation expense of 1.7 percentage points was partially offset by an increase in merchandise margin of 0.9 percentage points.



31


SG&A

SG&A includes costs related to selling expenses, store management and corporate expenses such as payroll and employee benefits, marketing expenses, employment taxes, information technology maintenance costs and expenses, insurance and legal expenses, e-commerce transaction expenses, store pre-opening costs and other corporate level expenses. Store pre-opening costs include store level payroll, grand opening event marketing, travel, supplies and other store pre-opening expenses.

SG&A decreased by $14.0 million for the first thirty-nine weeks of 2014 compared to the first thirty-nine weeks of 2013. SG&A for the first thirty-nine weeks of 2014 included consulting fees of $4.4 million for strategic initiatives. The decrease was due to lower store-line expenses of $16.4 million, which primarily consisted of payroll resulting from cost savings initiatives, transaction expenses of $6.9 million primarily due to lower sales and lower corporate expenses of $2.8 million. These decreases were partially offset by higher marketing costs of $7.5 million, primarily to support our brand awareness initiatives.

SG&A was 29.1% for the first thirty-nine weeks of 2014 compared to 26.5% for the same period last year, as a percentage of net sales. The increase in SG&A, as a percentage of sales, was due primarily to the deleverage impact in corporate expenses of 0.8 percentage points, marketing expenses of 0.9 percentage points, store-line expenses of 0.6 percentage points, which primarily consisted of payroll and the above mentioned consulting fees of 0.4 percentage points. These increases were partially offset by 0.1 percentage points of leverage from transaction costs.

Restructuring Charges

Restructuring charges related to the cost reduction program discussed above were $39.2 million, or 3.1% as a percentage of net sales, for the first thirty-nine weeks of 2014. These charges included P.S. from Aéropostale store impairment charges of $30.5 million, other exit costs of $3.8 million, severance charges of $3.7 million and lease costs of $1.2 million.

Loss from Operations

As a result of the above, consolidated loss from operations was $199.2 million for the first thirty-nine weeks of 2014, compared to $105.3 million for the first thirty-nine weeks of 2013. The consolidated loss from operations included income from our international licensing segment of $23.0 million for the first thirty-nine weeks of 2014 compared to $12.1 million for the prior period. The increase from international licensing was due to the increase in licensee locations as discussed above.

Income taxes

The effective tax rate was 5.9% for the first thirty-nine weeks of 2014 and 32.5% for the first thirty-nine weeks of 2013. Please see the comparison of the 13 weeks ended November 1, 2014 to the 13 weeks ended November 2, 2013 for a further discussion about the effective tax rates.
  
Net loss

Net loss was $192.9 million, or $2.45 per diluted share, for the first thirty-nine weeks of 2014, compared to net loss of $71.5 million, or $0.91 per diluted share, for the first thirty-nine weeks of 2013.

Liquidity and Capital Resources

Our cash requirements are primarily for working capital, construction of new stores, remodeling or updating of existing stores, and the improvement or enhancement of our information technology systems. Due to the seasonality of our business, we have historically realized a significant portion of our cash flows from operations during the second half of the year. Generally, our cash requirements have been met primarily through cash and cash equivalents on hand during the first half of the year, and through cash flows from operations during the second half of the year. We expect to meet our operating and investing net cash requirements for the next twelve months through existing cash and cash equivalents and by utilizing our revolving credit facility, if necessary.

As of November 1, 2014, we had working capital of $134.8 million, cash and cash equivalents of $109.2 million and $136.0 million of long-term debt as a result of the closing of the financing transaction with Sycamore Partners, an owner of a portion of our outstanding common stock and a related party, on May 23, 2014. We plan to use the proceeds of this financing transaction for working capital and other general corporate purposes (see Note 3 to the Notes to Unaudited Condensed Consolidated Financial Statements for a further discussion). As of November 1, 2014, we had no borrowings outstanding under our revolving credit facility. On February 21, 2014, we increased the aggregate borrowing capacity under our revolving credit facility from $175.0

32


million to $230.0 million (see Note 10 to the Notes to Unaudited Condensed Consolidated Financial Statements). During the second quarter of 2014, we received an income tax refund of approximately $45.0 million.

Additionally, while we have in the past repurchased our common stock under a stock repurchase program (see Note 6 to the Notes to Unaudited Condensed Consolidated Financial Statements), we do not currently expect to do so during fiscal 2014.

The following table sets forth our cash flows for the period indicated:
 
39 weeks ended
 
November 1,
2014
 
November 2,
2013
 
(In thousands)
Net cash used in operating activities
$
(101,553
)
 
$
(93,491
)
Net cash used in investing activities
(23,337
)
 
(68,394
)
Net cash provided by (used in) financing activities
127,799

 
(1,362
)
Effect of exchange rate changes
(228
)
 
(236
)
Net increase (decrease) in cash and cash equivalents
$
2,681

 
$
(163,483
)

Operating activities - Net cash used in operating activities increased by $8.1 million for the first thirty-nine weeks of 2014 compared to the same period in 2013. The increase in period to period net loss was partially offset by lower cash used for prepaid expenses, other assets and cash from income taxes receivable. During the second quarter of 2014, we received an income tax refund of approximately $45.0 million. Merchandise inventory decreased by 20% in total, or 16% on a per retail square foot basis as of November 1, 2014 compared with November 2, 2013, primarily as a result of lower planned merchandise purchases and the result of sales promotions to liquidate certain aged inventory. Cash flow from accounts payable decreased by $84.9 million, primarily as a result of the lower merchandise inventory.
 
Investing activities - Investments in capital expenditures are principally for the construction of new stores, remodeling of existing stores and investments in information technology. Net cash used in investing activities decreased by $45.1 million for the first thirty-nine weeks of 2014 compared to the same period in 2013 primarily due to lower capital expenditures. Our future capital requirements will depend primarily on the number of new stores we open, the number of existing stores we remodel and the timing of these expenditures. During fiscal 2014, we plan to invest a total of approximately $22.0 million in capital expenditures. During the first thirty-nine weeks of 2014, we invested $21.1 million, which excludes accruals related to purchases of property and equipment. During the first thirty-nine weeks of 2014, we opened seven Aéropostale stores and one combination store and remodeled 13 Aéropostale stores.

During the first thirty-nine weeks of 2013, we invested $68.0 million in capital expenditures, primarily to construct eight Aéropostale stores, 49 P.S. from Aéropostale stores, to remodel 23 Aéropostale stores and for a number of information technology investments.

Financing activities - Net cash provided by financing activities increased by $129.2 million for the first thirty-nine weeks of 2014 compared to the same period in 2013. Net cash provided by financing activities during the first thirty-nine weeks of 2014, included $137.6 million of net proceeds related to the Sycamore transaction offset by $6.2 million of related deferred financing fees paid in connection with the transaction (see Note 3 to the Notes to Unaudited Condensed Consolidated Financial Statements for a further discussion).

Revolving Credit Facility and Financing Transaction with Related Party

In September 2011, we together with certain of our direct and indirect subsidiaries entered into a Third Amended and Restated Loan and Security Agreement with the Lenders party thereto, and Bank of America, N.A., as agent for the ratable benefit of the Credit Parties (the “Credit Facility”). The Credit Facility originally provided for a revolving credit line up to $175.0 million. On February 21, 2014, the Credit Facility was amended, among other things, to increase from $175.0 million to $230.0 million the aggregate amount of loans and other extensions of credit available to the Borrower under the Credit Facility. The Credit Facility is available for working capital and general corporate purposes (see Note 10 to the Notes to Unaudited Condensed Consolidated Financial Statements for a further discussion).

On May 23, 2014, we entered into (i) a Loan and Security Agreement (the "Loan Agreement") with affiliates of Sycamore Partners, (ii) a Stock Purchase Agreement (the "Stock Purchase Agreement") with Aero Investors LLC, an affiliate of Sycamore

33


Partners ("Investor"), for the purchase of 1,000 shares of Series B Convertible Preferred Stock of the Company, $0.01 par value (the "Series B Preferred Stock"), and (iii) an Investor Rights Agreement with Sycamore Partners. The Loan Agreement makes available to us term loans in the principal amount of $150.0 million, consisting of two tranches: a five-year $100.0 million term loan facility (the "Tranche A Loan") and a 10-year $50.0 million term loan facility (the "Tranche B Loan" and, together with the Tranche A Loan, the "Term Loans"). The net proceeds of the Term Loans are to be used for working capital and other general corporate purposes (see Note 3 to the Notes to Unaudited Condensed Consolidated Financial Statements for a further discussion).

Contractual Obligations

The following table summarizes our contractual obligations as of November 1, 2014:

 
 
 
Payments Due
 
Total
 
Balance of
2014
 
In 2015
and 2016
 
In 2017
and 2018
 
After
2018
 
(In thousands)
Contractual Obligations
 
 
 
 
 
 
 
 
 
Real estate operating leases
$
804,807

 
$
37,683

 
$
247,623

 
$
200,959

 
$
318,542

Short-term borrowings 1

 

 

 

 

Sycamore Tranche A Loan principal
100,000

 

 

 

 
100,000

Sycamore Tranche B Loan principal 2
50,000

 

 
5,000

 
10,000

 
35,000

Sycamore Tranche A Loan interest
40,000

 

 
15,000

 
20,000

 
5,000

Employment agreement 3
4,125

 
375

 
3,000

 
750

 

Equipment operating leases
8,319

 
989

 
5,112

 
2,218

 

Total contractual obligations
$
1,007,251

 
$
39,047

 
$
275,735

 
$
233,927

 
$
458,542


1 The short-term borrowings were repaid on May 23, 2014.

2 Although interest is imputed on the Tranche B Loan and recorded as interest expense, the Tranche B Loan does not require any contractual interest payments. The Tranche B Loan will be paid off in equal annual installments of 10% per annum. The Tranche B Loan is scheduled to mature on the earlier of (a) tenth anniversary of the end of the Start-Up Period (as such term is defined in the Sourcing Agreement) and (b) the expiration or termination of the Sourcing Agreement. Under the Sourcing Agreement, MGF is required to pay to us an annual rebate equal to a fixed amount multiplied by the percentage of annual purchases made by us (including purchases deemed to be made by virtue of payment of the shortfall commission) relative to the Minimum Volume Commitment to be applied towards the payment of the required amortization on the Tranche B Loan. The Sourcing Agreement also provides for certain carryover credits if we purchase a volume of product above the Minimum Volume Commitment during the applicable Minimum Volume Commitment Period. See Note 3 to the Notes to Unaudited Condensed Consolidated Financial Statements for a further discussion.

3 On August 18, 2014 we entered into an Employment Agreement with Mr. Geiger pursuant to which he will serve as our Chief Executive Officer. The Employment Agreement has a three-year term at a base salary of $1.5 million per annum and is included in the above table.

Mr. Johnson stepped down as Chief Executive Officer of the Company and will no longer serve as a member of the Board, effective as of August 18, 2014. In connection with his employment agreement, Mr. Johnson will be entitled to receive a bonus of approximately $0.4 million during the first quarter of 2015. Mr. Johnson will also be entitled to a retirement plan payment currently estimated at $5.8 million, subject to interest rate fluctuations, paid six months from retirement date (see Note 11 to the Notes to Unaudited Condensed Consolidated Financial Statements). Such amounts are not reflected in the table above.

The real estate operating leases included in the above table do not include contingent rent based upon sales volume, which amounted to approximately 6% of minimum lease obligations in fiscal 2013. In addition, the above table does not include variable costs paid to landlords such as maintenance, insurance and taxes, which represented approximately 53% of minimum lease obligations in fiscal 2013.

As discussed in Note 11 to the Notes to Unaudited Condensed Consolidated Financial Statements, we have a SERP liability of $7.5 million and other retirement plan liabilities of $4.1 million at November 1, 2014.  Such liability amounts are not reflected in the

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table above. We expect to make a payment in the next 12 months of approximately $5.8 million from our SERP which is included in the total SERP liability of $7.5 million.

Our total liabilities for unrecognized tax benefits were $8.2 million at November 1, 2014. Of this amount, $6.2 million was recorded as a direct reduction of the related deferred tax assets.  We cannot make a reasonable estimate of the amount and timing of related future payments. Therefore this amount was not included in the above table.

In June 2012, Bank of America, N.A. issued a stand-by letter of credit under the Credit Facility. As of November 1, 2014, the outstanding letter of credit was $0.2 million and expires on June 30, 2015. We have not issued any other stand-by or commercial letters of credit as of November 1, 2014.

The above table also does not include contingent bonus compensation agreements with certain of our employees. The bonuses become payable if the individual is employed by us on the future payment date. The amount of contingent bonuses that may be paid is $0.2 million during the remainder of fiscal 2014, $0.7 million during fiscal 2015 and $0.2 million during fiscal 2016.

The above table does not reflect contingent purchase consideration related to the fiscal 2012 acquisition of GoJane that is discussed in Note 5 to the Notes to Unaudited Condensed Consolidated Financial Statements. The purchase price includes contingent cash payments of up to an aggregate of $8.0 million if certain financial metrics are achieved by the GoJane business during the five year period beginning on the acquisition date. The fair value of the contingent payments as of November 1, 2014 was estimated to be $5.9 million based on expected probability of payment and we have recorded such liability on a discounted basis.

We have not issued any third party guarantees or commercial commitments as of November 1, 2014.

Off-Balance Sheet Arrangements

Other than operating lease commitments set forth in the table above, and an outstanding letter of credit of $0.2 million, we are not party to any material off-balance sheet financing arrangements.  We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating our business.  We do not have any arrangements or relationships with entities that are not consolidated into the financial statements that are reasonably likely to materially affect our liquidity or the availability of capital resources.  As of November 1, 2014, we have not issued any letters of credit for the purchase of merchandise inventory or any capital expenditures.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements. These estimates and assumptions also affect the reported amounts of revenues and expenses. Estimates by their nature are based on judgments and available information. Therefore, actual results could materially differ from those estimates under different assumptions and conditions.

Critical accounting policies are those that are most important to the portrayal of our financial condition and the results of operations and require management's most difficult, subjective and complex judgments as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our most critical accounting policies have been discussed in our Annual Report on Form 10-K for the fiscal year ended February 1, 2014.  In applying such policies, management must use significant estimates that are based on its informed judgment. Because of the uncertainty inherent in these estimates, actual results could differ from estimates used in applying the critical accounting policies. Changes in such estimates, based on more accurate future information, may affect amounts reported in future periods.

Asset Impairment Charges

We have recently recorded significant asset impairment charges, and we may be required to record additional charges in the future. Our determination of whether asset impairment has occurred is based on a comparison of the assets’ fair market values with the assets’ carrying values. While we believe that current estimates of the impairment are appropriate, significant and unanticipated changes in future results could require a provision for impairment in a future period that could substantially affect our statement of operations in a period of such change. To the extent that actual cash flows differ materially from our projections, certain stores that are either not impaired or partially impaired may be further impaired in future periods. A 100 basis points decrease in each of our

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future comparable sales assumptions as of November 1, 2014, would have resulted in an additional impairment charge of $1.4 million. Alternatively, a 100 basis points decrease in each of our future gross margin assumptions as of November 1, 2014, would have resulted in an additional impairment charge of $1.7 million.

As of November 1, 2014, there have been no material changes to any of the critical accounting policies as disclosed in our Annual Report on Form 10-K for the fiscal year ended February 1, 2014.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We maintain our cash equivalents in financial instruments, primarily money market funds, with original maturities of three months or less.

As of November 1, 2014, we had no outstanding borrowings under our Credit Facility. The average interest rate for the Credit Facility was 5.75% for the first thirty-nine weeks of 2014. In June 2012, Bank of America, N.A. issued a stand-by letter of credit under the Credit Facility. As of November 1, 2014, the outstanding letter of credit was $0.2 million and expires on June 30, 2015. We have not issued any other stand-by or commercial letters of credit as of November 1, 2014 under the Credit Facility. To the extent that we may borrow pursuant to the Credit Facility in the future, we may be exposed to market risk from interest rate fluctuations.

Unrealized foreign currency gains and losses, resulting from the translation of our Canadian subsidiary financial statements into our U.S. dollar reporting currency, are reflected in the equity section of our unaudited condensed consolidated balance sheet in accumulated other comprehensive income (loss). The unrealized gain of approximately $0.9 million is included in accumulated other comprehensive loss as of November 1, 2014. A 10% movement in quoted foreign currency exchange rates could result in a fair value translation fluctuation of approximately less than $0.5 million, which would be recorded in other comprehensive income (loss) as an unrealized gain or loss.

We also face transactional currency exposures relating to merchandise that our Canadian subsidiary purchases using U.S. dollars.  These foreign currency transaction gains and losses are charged or credited to earnings as incurred. We do not hedge our exposure to this currency exchange fluctuation and transaction gains and losses to date have not been significant.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures: Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), our management carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer along with our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act). Based upon that evaluation, our Chief Executive Officer along with our Chief Financial Officer concluded that as of the end of our third quarter ended November 1, 2014, our disclosure controls and procedures are effective.

Changes in Internal Controls Over Financial Reporting: During our third fiscal quarter, there have been no changes in our internal controls over our financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over our financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

For a description of our legal proceedings, please see the description set forth in the “Legal Proceedings” section in Note 13 to the Notes to Unaudited Condensed Consolidated Financial Statements.


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Item 1A. Risk Factors

Other than as set forth below, there are no material changes from the Risk Factors as previously disclosed in our Form 10-K for the fiscal year ended February 1, 2014.

Our ability to make payments on and to repay or refinance our debt and to fund planned capital expenditures depends upon cash balances, availability under our Credit Facility, and our ability to generate cash.

Our ability to make payments on and to repay or refinance our debt and to fund planned capital expenditures will depend on cash balances, availability under our Credit Facility and our ability to generate cash, which is to some extent, subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. If we are unable to service our debt and meet our other commitments, we may be required to adopt one or more alternatives, such as refinancing all or a portion of our debt, selling material assets or operations or raising additional debt or equity capital. We may not be able to successfully carry out any of these actions on a timely basis, on commercially reasonable terms or at all, or be assured that these actions would be sufficient to meet our capital requirements. In addition, the terms of our existing or future debt agreements may restrict us from affecting any of these alternatives. To the extent we are not able to comply with required covenants in our Credit Facility and/or Loan Agreement with affiliates of Sycamore Partners or fail to make scheduled payments on our debt and are unable to obtain a waiver or amendment, our access to the Credit Facility may be limited and we could be in default under the Credit Facility and/or the Loan Agreement.

Failure to effectively execute on or to realize the anticipated benefits of our announced strategic initiatives and cost reduction program could have an adverse effect on our financial condition, results of operations, cash flows and liquidity.

We have previously announced strategic initiatives and a comprehensive cost reduction program as a part of our on-going turnaround plans and strategic business review (the “Program”). As a part of the Program, we have announced that we expect to close approximately 125 mall-based P.S. from Aéropostale stores and pursue other cost reduction efforts. Risks associated with the Program include delays in implementation, changes in plans that impact associated costs, impact on employee morale and failure to meet operational and strategic targets. These efforts could result in our recording additional charges. The inability to successfully implement these initiatives or failure to do so as timely as we anticipate, could impact our ability to achieve anticipated cost reductions or may otherwise harm our business and could have an adverse effect on our financial condition, results of operations, cash flow and liquidity.
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.


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Item 6. Exhibits

Exhibit No.       
 
 
Description
10.1
 
Separation Agreement and Release dated August 18, 2014 between Aéropostale, Inc. and Thomas P. Johnson.*
31.1
 
Certification by Julian R. Geiger, Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31.2
 
Certification by Marc D. Miller, Executive Vice President and Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
32.1
 
Certification by Julian R. Geiger pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**
32.2
 
Certification by Marc D. Miller pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**
101.INS
 
XBRL Instance Document.*
101. SCH
 
XBRL Taxonomy Extension Schema.*
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase.*
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase.*
101.LAB
 
XBRL Taxonomy Extension Label Linkbase.*
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase.*
____________
*
Filed herewith.
**
Furnished herewith.
***
Incorporated herein by reference.





 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
Aéropostale, Inc.
 
 
 
/s/ JULIAN R. GEIGER
 
Julian R. Geiger
 
Chief Executive Officer
 
(Principal Executive Officer)
 
 
 
/s/ MARC D. MILLER
 
Marc D. Miller
 
Executive Vice President — Chief Financial Officer
 
(Principal Financial Officer)



Dated: December 8, 2014
 

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