UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

Form 10-Q

 

 

Commission file number: 001-31314

 

Aéropostale, Inc.

(Exact name of registrant as specified in its charter)

 

 

(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 o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Act).

 

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

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

 

The Registrant had 51,704,448 shares of common stock issued and outstanding as of June 1, 2007.

 

 

AÉROPOSTALE, INC.

 

TABLE OF CONTENTS

 

 

 

See notes to unaudited condensed consolidated financial statements.

AÉROPOSTALE, INC.

 

 

 

See notes to unaudited condensed consolidated financial statements.

AÉROPOSTALE, INC.

 

 

See notes to unaudited condensed consolidated financial statements.

AÉROPOSTALE, INC.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

 

References to the “Company,” “we,” “us,” or “our” means Aéropostale, Inc. and its subsidiaries, except as expressly indicated to the contrary or unless the context otherwise requires. We are a mall-based, specialty retailer of casual apparel and accessories for young women and men. We design, market and sell our own brand of merchandise principally targeting 14 to 17 year-old young women and men. Jimmy’Z Surf Co., Inc., a wholly owned subsidiary of Aéropostale, Inc., is a California lifestyle-oriented brand targeting trend-aware young women and men aged 18 to 25. As of May 5, 2007, we operated 765 stores in 47 states, consisting of 751 Aeropostale stores and 14 Jimmy’Z stores, in addition to our Aeropostale e-commerce website, www.aeropostale.com (this and any other references in this Quarterly Report on Form 10-Q to aeropostale.com is solely a reference to a uniform resource locator, or URL, and is an inactive textual reference only, not intended to incorporate the website into this Quarterly Report on Form 10-Q).

 

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. However, in the opinion of our management, all known 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, net income, and cash flow in the second half of the year, driven by the impact of the back-to-school selling season in the third quarter and the holiday selling season in the fourth quarter. Therefore, our interim period consolidated financial statements will not be indicative of our full-year results of operations, financial condition or cash flows. These financial statements should be read in conjunction with our Annual Report on Form 10-K for our fiscal year ended February 3, 2007.

 

References to “2007” mean the 52-week period ending February 2, 2008, and references to “2006” mean the 53-week period ended February 3, 2007. References to “the first quarter of 2007” mean the thirteen-week period ended May 5, 2007, and references to “the first quarter of 2006” mean the thirteen-week period ended April 29, 2006.

 

 

Cost of sales includes costs related to: merchandise sold, including inventory valuation adjustments, distribution and warehousing, freight from the distribution center and warehouse to the stores; 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, maintenance and all depreciation.

 

Selling, general and administrative expenses, or “SG&A”, include costs related to selling expenses, store management and corporate expenses such as payroll and employee benefits, marketing expenses, employment taxes, maintenance costs and expenses, insurance and legal expenses, and store pre-opening and other corporate level expenses. Store pre-opening expenses include store level payroll, grand opening event marketing, travel, supplies and other store pre-opening expenses.

 

AÉROPOSTALE, INC.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

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

 

 

Options to purchase 153,000 shares during the first quarter of 2007 and 287,000 shares during the first quarter of 2006 were not included in the computation of diluted earnings per share because the exercise price of the options was greater than the average market price of the common shares.

 

 

We have a revolving credit facility (the “credit facility”) with Bank of America, N.A., which allows us to borrow or obtain letters of credit up to an aggregate of $50.0 million, with letters of credit having a sub-limit of $15.0 million. The amount of available credit can be increased to an aggregate of $75.0 million if we so request. The credit facility matures in April 2010, and our assets collateralize indebtedness under the credit facility. Borrowings under the credit facility bear interest at our option, either at (a) the lender’s prime rate or (b) the Euro Dollar Rate plus 0.75% to 1.25%, dependent upon our financial performance. We are required to pay an annual credit facility fee of $25,000. There are no covenants in the credit facility requiring us to achieve certain earnings levels and there are no capital spending limitations. There are certain negative covenants under the credit facility including, but not limited to, limitations on our ability to incur other indebtedness, encumber our assets, or undergo a change of control. Additionally, we are required to maintain a ratio of 2:1 for the value of our inventory to the amount of the loans under the credit facility. As of May 5, 2007, we were in compliance with all covenants under the credit facility. Events of default under the credit facility include, subject to grace periods and notice provisions in certain circumstances, failure to pay principal amounts when due, breaches of covenants, misrepresentation, default of leases or other indebtedness, excess uninsured casualty loss, excess uninsured judgment or restraint of business, business failure or application for bankruptcy, institution of any legal process or proceeding under federal, state, municipal or civil statutes, legal challenges to loan documents, and a change in control. If an event of default occurs, the lenders under the credit facility will be entitled to take various actions, including the acceleration of amounts due there under and requiring that all such amounts be immediately paid in full as well as possession and sale of all assets that have been used as collateral. At May 5, 2007, we had no amount outstanding under the credit facility, and no stand-by or commercial letters of credit issued under the credit facility. In addition, we have not had outstanding borrowings under the credit facility since November 2002.

 

 

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 up to 14% of gross earnings and we will provide 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. Matching

 

AÉROPOSTALE, INC.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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 year five.

 

We maintain a supplemental executive retirement plan, or SERP, which is a nonqualified defined benefit plan for certain officers. The plan is non-contributory and not funded and provides benefits based on years of service and compensation during employment. Participants are vested upon entrance in the plan. Pension expense is determined using various actuarial cost methods 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.

 

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

 

 

We maintain a long-term incentive deferred compensation plan for the purpose of providing long-term incentive to a select group of management. The plan is a non-qualified, 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, who are not participants in the SERP. Annual monetary credits are recorded 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 participant’s accounts will be fully vested upon retirement after completing five years of service and attaining age 55.

 

We maintain a postretirement benefit plan for certain officers. At May 5, 2007, we had a liability of $0.6 million in connection with this plan.

 

 

We repurchase our common stock from time to time under a stock repurchase program. On March 14, 2007, our Board of Directors approved a $100.0 million increase in repurchase availability under the program, bringing total repurchase authorization, since inception of the program, to $350.0 million. 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 our stock trading window, and liquidity and capital resource requirements going forward. We repurchased 140,000 shares of our common stock for $5.7 million during the first quarter of 2007 and 80,000 shares for $2.3 million during the first quarter of 2006. We repurchased 7.8 million shares for $205.2 million since the inception of the repurchase program through May 5, 2007, and had $144.8 million of repurchase availability remaining under the program as of that date.

 

 

At the beginning of fiscal 2006, we adopted the provisions of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, a revision of SFAS No. 123, Accounting for Stock-Based Compensation, or SFAS No. 123(R), as interpreted by SEC Staff Accounting Bulletin No. 107. Under SFAS No. 123(R), all forms of share-based payment to employees and directors, including stock options, must be treated as compensation and

 

AÉROPOSTALE, INC.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

recognized in the income statement. Previous to the adoption of SFAS No. 123(R), we accounted for stock options under the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and, accordingly, did not recognize compensation expense in our consolidated financial statements. We adopted the modified prospective transition method provided under SFAS No. 123(R), and consequently, had not retroactively adjusted results from prior periods. During the first quarter of 2007, we granted 361,010 stock options at a weighted-average grant-date fair value of $18.67. In addition, we granted 199,755 shares of non-vested stock at a weighted-average grant-date fair value of $40.25.

 

 

We are 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 affect on our financial position, results from operations or cash flows. As of May 5, 2007, we have not issued any third party guarantees.

 

 

Effective at the beginning of the first quarter of 2007, we adopted Financial Accounting Standards Board (FASB) Interpretation No. 48 (FIN No. 48), Accounting for Uncertainty in Income Taxes, which clarifies the accounting and disclosure for uncertainty in income taxes. As a result of the adoption, we recorded a decrease to beginning retained earnings of approximately $0.2 million and increased our net liabilities for uncertain tax positions and related interest and penalties by a corresponding amount. As of the adoption date, we recorded liabilities of $10.7 million for uncertain tax positions, which includes interest and penalties. Also as of the adoption date, we recorded deferred tax assets of $7.9 million for federal and, if applicable, state benefits related to the uncertain tax positions. Net uncertain tax positions of $2.8 million as of the adoption date would favorably impact our effective tax rate if these net liabilities were reversed.

 

We expect to pay approximately $7.6 million of the uncertain tax position liabilities within the following twelve months. This liability related to the timing of taxable revenue from non-redeemed gift cards.

 

We file income tax returns in the U.S. federal jurisdiction and in various states. Our U.S. federal filings for the years 2002 through 2005 are under routine examination and we expect that process will be completed before the end of 2007. For state tax purposes, our 2002 through 2006 tax years remain open for examination by the tax authorities under a four-year statute of limitations. However, certain states may keep their statute open for six to ten years.

 

We recognize interest and, if applicable, penalties, which could be assessed, related to uncertain tax positions in income tax expense. As of the adoption date, the total amount of accrued interest and penalties was $1.7 million before federal and, if applicable, state effect. For the quarter ended May 5, 2007, we recorded approximately $0.2 million in interest and penalties, before federal and, if applicable, state effect.

 

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. Certain factors, including factors outside of our control, may cause actual results to differ materially from those contained in the forward-looking statements. The risk factors included in Part II, Item 1A should be read in connection with evaluating our business and future prospects. 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

 

References to the “Company,” “we,” “us,” or “our” means Aéropostale, Inc. and its subsidiaries, except as expressly indicated to the contrary or unless the context otherwise requires. We are a mall-based, specialty retailer of casual apparel and accessories for young women and men. We design, market and sell our own brand of merchandise principally targeting 14 to 17 year-old young women and men. Jimmy’Z Surf Co., Inc., a wholly owned subsidiary of Aéropostale, Inc., is a California lifestyle-oriented brand targeting trend-aware young women and men aged 18 to 25. As of May 5, 2007, we operated 765 stores in 47 states, consisting of 751 Aeropostale stores and 14 Jimmy’Z stores, in addition to our Aeropostale e-commerce website, www.aeropostale.com (this and any other references in this Quarterly Report on Form 10-Q to aeropostale.com is solely a reference to a uniform resource locator, or URL, and is an inactive textual reference only, not intended to incorporate the website into this Quarterly Report on Form 10-Q).

 

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, net income, 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 consolidated financial statements will not be indicative of our full-year results of operations, financial condition or cash flows. We recommend that you read this section along with our condensed consolidated financial statements included in this report and along with our Annual Report on Form 10-K for the year ended February 3, 2007.

 

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

 

Overview

 

We achieved net sales of $275.8 million for the first quarter of 2007, or a 12.0% increase over the first quarter of 2006. The sales increase was driven by average square footage growth of 9.4% and a 2.5% comparable store sales increase. Gross profit, as a percentage of net sales, increased 3.6 percentage points for the first quarter of 2007, primarily due to a 3.9 percentage point increase in merchandise margin. SG&A, as a percentage of net sales, increased 1.1 percentage points for the first quarter of 2007. The increase in SG&A was primarily attributable to increased expenses to support our strategic initiatives and increased store expenses, primarily payroll. Interest income increased by $0.6 million for the first quarter of 2007. Net income for the first quarter of 2007 was $13.8 million, or $0.26 per diluted share, versus net income of $8.4 million, or $0.15 per diluted share for the first quarter of 2006.

 

As of May 5, 2007, we had working capital of $233.9 million, cash and cash equivalents of $154.1 million, short-term investments of $56.6 million, and no third party debt outstanding. Merchandise inventories decreased by 1%, and decreased by 9% on a square foot basis, at May 5, 2007, compared to April 29, 2006. We operated 765 stores at May 5, 2007, an increase of 9% from April 29, 2006.

 

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:

 

 

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:

 

 

Results of Operations

 

Sales — Net sales consist of sales from comparable stores and non-comparable stores. A store is included in comparable store sales after fourteen months of operation. 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, nor are sales from our e-commerce business.

 

Net sales for the first quarter of 2007 increased by $29.5 million, or by 12.0% versus the same period last year. Average square footage growth of 9.4% drove the net sales increase for the quarter, as well as an increase in comparable store sales. Comparable store sales increased by $5.9 million, or by 2.5% for the first quarter of 2006,

versus a comparable store sales decrease of 2.9% for the first quarter of 2006. Comparable store sales increased in our young women’s category and decreased in our young men’s and accessories categories. The overall comparable store sales increase reflected a 5.2% increase in the number of sales transactions, a 2.2% decrease in average unit retail due to mix shift, and a 0.6% decrease in units per sales transaction. Non-comparable store sales increased by $23.6 million, or by 9.5%, primarily due to 61 more stores open at the end of the first quarter of 2007 versus the end of the first quarter of 2006.

 

Gross profit — Cost of sales includes costs related to merchandise sold, including inventory valuation adjustments, distribution and warehousing; freight from the distribution center and warehouse to the stores; 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, maintenance and all depreciation.

 

Gross profit, as a percentage of net sales, increased 3.6 percentage points for the first quarter of 2007 versus the same period last year. Merchandise margin increased 3.9 percentage points due primarily to an improvement in our merchandise assortment and our planning processes and inventory management, and lower unit costs from graphic tee shirts. These improvements were partially offset by a 0.3 percentage point increase in depreciation.

 

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, maintenance costs and expenses, insurance and legal expenses, and store pre-opening and other corporate level expenses. Store pre-opening expenses include store level payroll, grand opening event marketing, travel, supplies and other store pre-opening expenses.

 

SG&A increased by $10.0 million, or 1.1 percentage points, as a percentage of net sales, for the first quarter of 2007 versus the first quarter of 2006. The increase in SG&A was attributable to a $6.5 million increase in store payroll and benefits and store transaction costs resulting primarily from new store growth, a $2.6 million increase in technology investments (see the section “Capital requirements” below for further details) and consulting fees related to our supply chain management investments, and a $0.6 million increase in stock-based compensation expense.

 

As a percentage of net sales, the increase in technology investments and consulting fees contributed 0.6 percentage points of the increase in SG&A, store related expenses, primarily payroll, contributed 0.5 percentage points of the increase, and stock-based compensation contributed 0.2 percentage points of the increase.

 

Interest income and income taxes — Interest income increased by $0.6 million for the first quarter of 2007. Increases in cash and cash equivalents and higher interest rates were the primary drivers of the increase in net interest income.

 

The effective income tax rate was 39.2% for the first quarter of 2007 and 39.0% for the first quarter of 2006.

 

Net income — Net income was $13.8 million, or $0.26 per diluted share, for the first quarter of 2007, versus net income of $8.4 million, or $0.15 per diluted share, for the first quarter of 2006.

 

Consolidated net income included net losses from the Company’s Jimmy’Z subsidiary of $1.9 million, or $0.04 per diluted share, for the first quarter of 2007 versus losses of $1.5 million, or $0.03 per diluted share for the first quarter of 2006.

 

Liquidity and Capital Resources

 

Our cash requirements are primarily for working capital, construction of new stores, remodeling of existing stores, and the improvement and 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. Most recently, 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 continue to meet our cash requirements for the next twelve months primarily through cash flows from operations and existing cash and cash equivalents. In addition, we have a revolving credit facility (the “credit facility”) that provides for a $50.0 million base borrowing availability, and can be increased to an aggregate of $75.0 million if we so request (see Note 4 to the Notes to Unaudited Condensed Consolidated Financial Statements for a further description). We have not had outstanding borrowings under the credit facility since November 2002.

At May 5, 2007, we had working capital of $233.9 million, cash and cash equivalents of $154.1 million, short-term investments of $56.6 million, and no third party debt outstanding.

 

The following table sets forth our cash flows for the period indicated:

 

 

Operating activities — Cash flows used in operating activities, our primary form of liquidity on a full-year basis, decreased by $34.9 million for the first quarter of 2007, versus the first quarter of 2006. Cash used for accounts payable, accrued expenses and other liabilities increased by $55.8 million due primarily to a shift in the fiscal calendar. The increase reflects payment for earlier receipt of seasonal merchandise this year and timing of rent and income tax payments resulting from the fiscal calendar shift. Merchandise inventories decreased by 9% on a square foot basis, as of May 5, 2007, as compared to April 29, 2006, primarily due to a mix shift and lower unit costs from graphic tee shirts.

 

Due to the seasonality of our business, we have historically generated a significant portion of our cash flows from operating activities in the second half of the year, and we expect this trend to continue through the balance of this year.

 

Capital requirements — Investments in capital expenditures are principally for the construction of new stores, remodeling of existing stores, and investments in information technology. 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. We plan to invest approximately $85.0 million in capital expenditures in fiscal 2007. These plans include investments of approximately $44.0 million to open approximately 85 new Aéropostale stores, including approximately 10 Aéropostale stores in Canada, in our new store format and approximately $12.0 million to remodel approximately 22 existing stores to our new store format. These plans also include investments of approximately $11.0 million to open a second distribution facility, approximately $6.0 million to complete the rollout of upgraded point of sale systems to our store chain, and $6.0 million for supply chain management investments.

 

We had $56.6 million in short-term investments at May 5, 2007, consisting of auction rate debt and preferred stock securities. Auction rate securities are term securities that earn income at a rate that is periodically reset, typically within 35 days, to reflect current market conditions through an auction process. Although these securities have long-term contractual maturities, they are classified as “available-for-sale” securities and are included in short-term investments in the current asset section of our condensed consolidated balance sheets.

 

Financing activities and capital resources — We repurchase our common stock from time to time under a stock repurchase program. On March 14, 2007, our Board of Directors approved a $100.0 million increase in repurchase availability under the program, bringing the total repurchase authorization, since inception of the program, to $350.0 million. 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 our stock trading window, and liquidity and capital resource requirements going forward. We repurchased 140,000 shares of our common stock for $5.7 million during the first quarter of 2007 and 80,000 shares for $2.3 million during the first quarter of 2006. We repurchased 7.8 million shares for $205.2 million since the inception of the repurchase program through May 5, 2007, and had $144.8 million of repurchase availability remaining under the program as of that date.

 

We have a credit facility that provides for a $50.0 million base borrowing availability, and can be increased to an aggregate of $75.0 million if we so request (see note 4 to the notes to unaudited condensed consolidated financial statements for a further description). We are required to pay an annual credit facility fee of $25,000. At May 5, 2007,

there were no amounts outstanding under the credit facility, and no stand-by or commercial letters of credit issued under the credit facility. As of May 5, 2007, we were in compliance with all covenants under the credit facility. We have not had outstanding borrowings under the credit facility since November 2002.

 

Contractual Obligations

 

The following table summarizes our contractual obligations as of May 5, 2007:

 

 

The operating leases included in the above table do not include contingent rent based upon sales volume, which represented approximately 17% of minimum lease obligations in fiscal 2006, or variable costs such as maintenance, insurance and taxes, which represented approximately 62% of minimum lease obligations in fiscal 2006.

 

Our open purchase orders are cancelable without penalty and were therefore not included in the above table.

 

In December 2006, we entered into an agreement with South Bay Apparel, Inc., who had been a vendor to us since 1996. The agreement resolved certain outstanding matters between us (See our Annual Report on Form 10-K for the fiscal year ended February 3, 2007 for a further discussion). In addition, we have agreed to continue purchasing merchandise from South Bay Apparel, Inc. through July 2, 2007, the date the agreement with them terminates. As of May 5, 2007, there was approximately $9.5 million in Aeropostale inventory remaining at South Bay Apparel, Inc.

 

In addition to the above table, we project making a benefit payment of approximately $13.3 million from our supplementary executive retirement plan in 2010, which reflects expected future service of our Chief Executive Officer through an assumed retirement age of 65.

 

There were no financial guarantees outstanding as of May 5, 2007. We had no commercial commitments outstanding as of May 5, 2007.

 

Effective at the beginning of the first quarter of 2007, we adopted FIN No. 48 as described in Note 9 to the Notes to Unaudited Condensed Consolidated Financial Statements. Our total liabilities for unrecognized tax benefits were $10.9 million at May 5, 2007. We cannot make a reasonable estimate of the amount and period of related future payments for $3.3 million of these liabilities. Therefore these liabilities were not included in the above table.

 

Off-Balance Sheet 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 May 5, 2007, we have not issued any letters of credit for the purchase of merchandise inventory or any capital expenditures.

 

Critical Accounting Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires the appropriate application of certain accounting policies, many of which require us to make

estimates and assumptions about future events and their impact on amounts reported in our financial statements and related notes. We believe the application of our accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are constantly reevaluated, and adjustments are made when facts and circumstances dictate a change. However, since future events and their impact cannot be determined with certainty, actual results may differ from our estimates, and such differences could be material to the consolidated financial statements. Historically, we have found our application of accounting policies to be appropriate, and actual results have not differed materially from those determined using necessary estimates. A summary of our significant accounting policies and a description of accounting policies that we believe are most critical may be found in the MD&A included in our Annual Report on Form 10-K for the year ended February 3, 2007.

 

The Company adopted Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, as of the beginning of fiscal 2007. See Note 9 to Notes to Unaudited Condensed Consolidated Financial Statements.

 

At May 5, 2007, we had no borrowings outstanding under our credit facility and we have not had any borrowings outstanding under our credit facility since November 2002. To the extent that we may borrow pursuant to our credit facility in the future, we may be exposed to market risk related to interest rate fluctuations. Additionally, we have not entered into financial instruments for hedging purposes.

 

(a) Evaluation of Disclosure Controls and Procedures:  Pursuant to Exchange Act 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 Chairman and Chief Executive Officer along with our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls (as defined in Rule 13a-15(e) of the Exchange Act) and procedures. Based upon that evaluation, our Chief Executive Officer along with our Chief Financial Officer concluded that as of the end of our 2007 first quarter, ended May 5, 2007, our disclosure controls and procedures are effective.

 

(b) Changes in internal controls:  During the period covered by this quarterly report, 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.

 

We are 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 affect on our financial position, results of operations or cash flows.

 

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. Certain factors, including factors outside of our control, may cause actual results to differ materially from those contained in the forward-looking statements. The following risk factors should be read in connection with evaluating our business and future prospects. 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. Such uncertainties include, among others, the following factors:

 

Fluctuations in comparable store sales and quarterly results of operations may cause the price of our common stock to decline substantially.

 

Our comparable store sales and quarterly results of operations have fluctuated in the past and are likely to continue to fluctuate in the future. In addition, there can be no assurance that we will be able to maintain our recent levels of comparable store sales as our business continues to expand. Our comparable store sales and quarterly results of operations are affected by a variety of factors, including:

 

 

If our future comparable store sales fail to meet the expectations of investors, then the market price of our common stock could decline substantially. You should refer to the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information.

 

If we were unable to identify and respond to consumers’ fashion preferences in a timely manner, our profitability would decline.

 

We may not be able to keep pace with the rapidly changing fashion trends and consumer tastes inherent in the teen apparel industry. Accordingly, we produce casual, comfortable apparel, a majority of which displays either the “Aéropostale” or “Aéro” logo. There can be no assurance that fashion trends will not move away from casual clothing or that we will not have to alter our design strategy to reflect changes in consumer preferences. Failing to anticipate, identify or react appropriately to changes in styles, trends, desired images or brand preferences, could have a material adverse effect on our sales, financial condition and results of operations.

 

We rely on a small number of vendors to supply a significant amount of our merchandise.

 

During fiscal 2006, we sourced approximately 30% of our merchandise from our top three suppliers; one company, South Bay Apparel, Inc., supplied approximately 12% of our merchandise, and two others each supplied approximately 9% of our merchandise. We will cease doing business with South Bay Apparel Inc. in July 2007. We are in the process of replacing this business with new vendors and with our existing vendor base. In addition, approximately 64% of our merchandise was directly sourced from our top ten suppliers, and one company acted as our agent with respect to the sourcing of approximately 19% of our merchandise. Our relationships with our suppliers generally are not on a long-term contractual basis and do not provide assurances on a long-term basis as to adequate supply, quality or acceptable pricing. Most of our suppliers could discontinue selling to us at any time. If one or more of our significant suppliers were to sever their relationship with us, we could be unable to obtain replacement products in a timely manner, which could have a material adverse effect on our sales, financial condition and results of operations.

 

Our business could suffer as a result of a manufacturer’s inability to produce merchandise on time and to our specifications.

 

We do not own or operate any manufacturing facilities and therefore we depend upon independent third parties to manufacture all of our merchandise. We utilize both domestic and international manufacturers to produce our merchandise. The inability of a manufacturer to ship orders in a timely manner or meet our quality standards could cause delivery date requirements to be missed, which could result in lost sales.

 

Our business could suffer if a manufacturer fails to use acceptable labor practices.

 

Our sourcing agents and independent manufacturers are required to operate in compliance with all applicable foreign and domestic laws and regulations. While our vendor operating guidelines promote ethical business practices for our vendors and suppliers, we do not control these manufacturers or their labor practices. The violation of labor or other laws by an independent manufacturer, or by one of the sourcing agents, or the divergence of an independent manufacturer’s or sourcing agent’s labor practices from those generally accepted as ethical in the United States, could interrupt, or otherwise disrupt the shipment of finished products or damage our reputation. Any of these, in turn, could have a material adverse effect on our financial condition and results of operations. To help mitigate this risk, we engage a third party independent contractor to visit the production facilities from which we receive our products. This independent contractor assesses the compliance of the facility with, among other things, local and United States labor laws and regulations as well as foreign and domestic fair trade and business practices.

 

Foreign suppliers manufacture most of our merchandise and the availability and costs of these products may be negatively affected by risks associated with international trade.

 

Trade restrictions such as increased tariffs or quotas, or both, could affect the importation of apparel generally and increase the cost and reduce the supply of merchandise available to us. Much of our merchandise is sourced directly from foreign vendors in Europe, Asia and Central America. In addition, many of our domestic vendors maintain production facilities overseas. Some of these facilities are also located in regions that may be affected by political instability that could cause a disruption in trade. Any reduction in merchandise available to us or any increase in its cost due to tariffs, quotas or local political issues could have a material adverse effect on our results of operations.

 

Our growth strategy relies on the continued addition of a significant number of new stores each year, which could strain our resources and cause the performance of our existing stores to suffer.

 

Our growth will largely depend on our ability to open and operate new stores successfully. We opened 74 Aéropostale stores in fiscal 2006, 105 Aéropostale and 14 Jimmy’Z stores in fiscal 2005, and 103 Aéropostale stores in fiscal 2004. We plan to open approximately 85 new Aeropostale stores in fiscal 2007, including approximately 10 stores in Canada. We expect to continue to open a significant number of new stores in future years, while also remodeling a portion of our existing store base. Our planned expansion will place increased demands on our operational, managerial and administrative resources. These increased demands could cause us to operate our business less effectively, which in turn could cause deterioration in the financial performance of our individual stores. In addition, to the extent that our new store openings are in existing markets, we may experience reduced net sales volumes in previously existing stores in those same markets.

 

Our continued expansion plan is dependent on a number of factors which, if not implemented, could delay or prevent the successful opening of new stores and penetration into new markets.

 

Unless we continue to do the following, we may be unable to open new stores successfully and, in turn, our continued growth would be impaired:

 

 

 

In addition, we will open new stores in markets in which we currently have few or no stores. Our experience in these markets is limited and there can be no assurance that we will be able to develop our brand in these markets or adapt to competitive, merchandising and distribution challenges that may be different from those in our existing markets. Our inability to open new stores successfully and/or penetrate new markets would have a material adverse effect on our revenue and earnings growth.

 

The loss of the services of key personnel could have a material adverse effect on our business.

 

Our key executive officers have substantial experience and expertise in the retail industry and have made significant contributions to the growth and success of our brands. The unexpected loss of the services of one or more of these individuals could adversely affect us. Specifically, if we were to lose the services of Julian R. Geiger, our Chairman and Chief Executive Officer or Mindy Meads, our President and Chief Merchandising Officer, our business could be adversely affected.

 

A substantial interruption in our information systems could have a material adverse effect on our business.

 

We depend on our management information systems for many aspects of our business. We will be materially adversely affected if our management information systems are disrupted or we are unable to improve, upgrade, maintain, and expand our management information systems.

 

Failure of new business concepts would have a negative effect on our results of operations.

 

We expect that the introduction of new brand concepts and other business opportunities will play an important role in our overall growth strategy. The operation of the Jimmy’Z stores is subject to numerous risks, including unanticipated operating problems, lack of prior experience, lack of customer acceptance, new vendor relationships, competition from existing and new retailers, and could also be a diversion of management’s attention from our core Aéropostale business. The Jimmy’Z concept involves, among other things, implementation of a retail apparel concept which is subject to many of the same risks as Aéropostale, as well as additional risks inherent with a more fashion-driven concept, including risks of difficulty in merchandising, uncertainty of customer acceptance, fluctuations in fashion trends and customer tastes, as well as the attendant markdown risks. Risks inherent in any new concept are particularly acute with respect to Jimmy’Z because this is the first significant new venture by us, and the nature of the Jimmy’Z business differs in certain respects from that of our core Aéropostale business. There can be no assurance that the Jimmy’Z stores will achieve sales and profitability levels justifying our investments in this business. If those sales levels are not achieved we may be required to impair the carrying value of our investments, and/or may decide to close stores, which would have a negative impact on our results of operations. Consolidated net income included net losses from our Jimmy’Z subsidiary of $1.9 million, or $0.04 per diluted share, for the first quarter of 2007, $6.7 million, or $0.12 per diluted share, for fiscal 2006, $4.7 million, or $0.08 per diluted share for fiscal 2005, and none in fiscal 2004.

 

There is an increased risk in operating stores in foreign countries.

 

During the second half of fiscal 2007, we will open our first 10 Aeropostale stores in Canada. We cannot assure you that we will be able to address in a timely fashion the risks of operating stores in foreign countries, such as governmental requirements over merchandise importation, employment, taxation and multi-lingual requirements. Additionally, when we enter Canada, we will have to obtain suitable store locations, hire personnel, establish distribution methods, and advertise our brand and its distinguishing characteristics to consumers who may not be

familiar with them. We cannot assure you that we will be able to open and operate new stores in Canada on a timely and profitable basis. The costs associated with opening these new stores in Canada may negatively affect our profitability.

 

Our net sales and inventory levels fluctuate on a seasonal basis.

 

Our net sales and net income are disproportionately higher from August through January each year due to increased sales from back-to-school and holiday shopping. Sales during this period cannot be used as an accurate indicator for our annual results. Our net sales and net income from February through July are typically lower due to, in part, the traditional retail slowdown immediately following the winter holiday season. Any significant decrease in sales during the back-to-school and winter holiday seasons would have a material adverse effect on our financial condition and results of operations. In addition, in order to prepare for the back-to-school and holiday shopping seasons, we must order and keep in stock significantly more merchandise than we would carry during other parts of the year. Any unanticipated decrease in demand for our products during these peak shopping seasons could require us to sell excess inventory at a substantial markdown, which could reduce our net sales and gross margins and negatively impact our profitability.

 

A downturn in the United States economy may affect consumer-spending habits.

 

Consumer purchases of discretionary items and retail products, including our products, may decline during recessionary periods and also may decline at other times when disposable income is lower. A downturn in the economy may adversely affect our sales.

 

Our ability to attract customers to our stores depends heavily on the success of the shopping malls in which we are located.

 

In order to generate customer traffic, we must locate our stores in prominent locations within successful shopping malls. We cannot control the development of new shopping malls, the availability or cost of appropriate locations within existing or new shopping malls, or the success of individual shopping malls. A significant decrease in shopping mall traffic would have a material adverse effect on our results of operations.

 

We currently rely on a single distribution center.

 

We currently maintain one distribution center to receive, store and distribute merchandise to all of our stores. Any significant interruption in the operation of the distribution center due to natural disasters, accidents, system failures or other unforeseen causes could have a material adverse effect on our financial condition and results of operations. In January 2007, we entered into a lease agreement for a second 360,000 square foot distribution facility in Ontario, California. We plan to begin operating this distribution facility in the second half of 2007.

 

We rely on a third party to manage our distribution center.

 

The efficient operation of our stores is dependent on our ability to distribute, in a timely manner, merchandise to our store locations throughout the United States. An independent third party operates our distribution and warehouse facility. We depend on this third party to receive, sort, pack and distribute substantially all of our merchandise. This third party employs personnel represented by a labor union. Although there have been no work stoppages or disruptions since the inception of our relationship with this third party provider beginning in 1991, there can be no assurance that work stoppages or disruptions will not occur in the future. We also use a separate third party transportation company to deliver our merchandise from our warehouse to our stores. Any failure by either of these third parties to respond adequately to our warehousing and distribution needs would disrupt our operations and negatively impact our profitability.

 

We rely on a third party to manage the warehousing and order fulfillment for our E-Commerce business.

 

We rely on one third party, GSI Commerce, pursuant to an e-commerce agreement, to warehouse all of the inventory sold through our e-commerce website, as well as to fulfill all of our e-commerce sales to our customers.

Any significant interruption in the operations of GSI Commerce, over which we have no control, would have a material adverse effect on our e-commerce business.

 

Failure to protect our trademarks adequately could negatively impact our brand image and limit our ability to penetrate new markets.

 

We believe that our key trademarks AÉROPOSTALE^® and, to a lesser extent, AERO^® are integral to our logo-driven design strategy. We have obtained a federal registration of the AÉROPOSTALE^® trademark in the United States and have applied for or obtained registrations in most foreign countries in which our vendors are located. We use the AERO mark in many constantly changing designs and logos even though we have not applied to register every variation or combination thereof for adult clothing. We also believe that the JIMMY’Z and Woody Car Design marks are an important part of our growth strategy and expansion of our business. We have acquired federal registrations in the United States and in Canada and have expanded the scope of our filings in the United States Patent and Trademark Office for a greater number of apparel and accessory categories. There can be no assurance that the registrations we own and have obtained will prevent the imitation of our products or infringement of our intellectual property rights by others. If any third party imitates our products in a manner that projects lesser quality or carries a negative connotation, our brand image could be materially adversely affected. Because we have not registered the AERO mark in all forms and categories and have not registered the “AÉROPOSTALE”, “JIMMY’Z” and Woody Car Design marks in all categories or in all foreign countries in which we now or may in the future source or offer our merchandise, international expansion and our merchandising of non-apparel products using these marks could be limited.

 

In addition, there can be no assurance that others will not try to block the manufacture, export or sale of our products as a violation of their trademarks or other proprietary rights. Other entities may have rights to trademarks that contain the word “AERO” or may have registered similar or competing marks for apparel and accessories in foreign countries in which our vendors are located. Our applications for international registration of the AÉROPOSTALE^® mark have been rejected in several countries in which our products are manufactured because third parties have already registered the mark for clothing in those countries. There may also be other prior registrations in other foreign countries of which we are not aware. In addition, we do not own the Jimmy’Z brand outside of the United States and Canada. Accordingly, it may be possible, in those few foreign countries where we were not been able to register the AÉROPOSTALE^® mark, or in the countries where the Jimmy’Z brand is owned by a third party, for a third party owner of the national trademark registration for “AÉROPOSTALE”, “JIMMY’Z” or the Woody Car Design to enjoin the manufacture, sale or exportation of Aéropostale or Jimmy’Z branded goods to the United States. If we were unable to reach a licensing arrangement with these parties, our vendors may be unable to manufacture our products in those countries. Our inability to register our trademarks or purchase or license the right to use our trademarks or logos in these jurisdictions could limit our ability to obtain supplies from or manufacture in less costly markets or penetrate new markets should our business plan change to include selling our merchandise in those jurisdictions outside the United States.

 

The effects of war or acts of terrorism could have a material adverse effect on our operating results and financial condition.

 

The continued threat of terrorism and the associated heightened security measures and military actions in response to acts of terrorism has disrupted commerce and has intensified uncertainties in the U.S. economy. Any further acts of terrorism or a future war may disrupt commerce and undermine consumer confidence, which could negatively impact our sales revenue by causing consumer spending and/or mall traffic to decline. Furthermore, an act of terrorism or war, or the threat thereof, or any other unforeseen interruption of commerce, could negatively impact our business by interfering with our ability to obtain merchandise from foreign vendors. Inability to obtain merchandise from our foreign vendors or substitute other vendors, at similar costs and in a timely manner, could adversely affect our operating results and financial condition.

 

We repurchase our common stock from time to time under a stock repurchase program. On March 14, 2007, our Board of Directors approved a $100.0 million increase in repurchase availability under the program, bringing total repurchase authorization, since inception of the program, to $350.0 million. 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 our stock trading window, and liquidity and capital resource requirements going forward. Our purchases of treasury stock for the first quarter of 2007 and remaining availability pursuant to our share repurchase program were as follows:

 

 

 

 

Not applicable.

 

Not applicable.

 

Not applicable.

 

 

 

 

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.

 

Aeropostale, Inc.  

 

Julian R. Geiger

Chairman of the Board and Chief Executive Officer

(Principal Executive Officer)

 

Michael J. Cunningham

Executive Vice President — Chief Financial Officer

(Principal Financial Officer)

 

Dated: June 13, 2007