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 66,934,474 shares of common stock issued and outstanding as of November 30, 2007.

 

 

AÉROPOSTALE, INC.

 

TABLE OF CONTENTS

 

 

PART I — FINANCIAL INFORMATION

 

 

AÉROPOSTALE, INC.

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements

AÉROPOSTALE, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements

AÉROPOSTALE, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

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 November 3, 2007, we operated 823 stores, consisting of 798 Aeropostale stores in 47 states, 11 Aeropostale stores in Canada, and 14 Jimmy’Z stores in 11 states, 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 third quarter of 2007” mean the thirteen-week period ended November 3, 2007, and references to “the third quarter of 2006” mean the thirteen-week period ended October 28, 2006. Accordingly, the fiscal 2006 calendar contained a 53^rd week and this additional week in the fiscal calendar resulted in a one-week shift in the applicable fiscal period end dates for fiscal 2007.

 

 

On July 11, 2007, the Company announced a three-for-two stock split on all shares of its common stock that was distributed on August 21, 2007 in the form of a stock dividend to all shareholders of record on August 6, 2007. All share and per share amounts presented in this report were retroactively adjusted for the common stock split, and all previously reported periods were restated for such.

 

 

Sales revenue is recognized at the “point of sale” in the Company’s stores and at the time its e-commerce customers take possession of merchandise. Allowances for sales returns are recorded as a reduction of net sales in the periods in which the related sales are recognized. Sales revenue related to gift cards and the issuance of store credits are recognized when they are redeemed. The Company recognizes no revenue at the time gift cards are sold. Rather, a liability is established for the amount of the gift card. The liability is relieved, and revenue is recognized, when gift cards are redeemed for merchandise. The liability is also relieved when the Company escheats non-redeemed gift cards under unclaimed property laws.

 

AÉROPOSTALE, INC.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

4.  Cost of Sales and Selling, General and Administrative Expenses

 

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. It also includes payroll for the Company’s 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, 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.

 

 

The following table sets forth the components of other comprehensive income:

 

 

 

 

 

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

 

 

Options to purchase 734,000 shares during the third quarter of 2007 and 844,000 shares during the third 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. Options to purchase 295,000 shares during the first thirty-nine weeks of 2007 and 719,000 shares during the first thirty-nine weeks of 2006 were not included in the

 

AÉROPOSTALE, INC.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

computation of diluted earnings per share because the exercise price of the options was greater than the average market price of the common shares.

 

 

At November 3, 2007, the Company had no outstanding balance under its Loan and Security Agreement, dated October 7, 2003, as amended by the First Amendment to the Loan and Security Agreement dated as of April 22, 2005, by and between the Company and Bank of America, as agent for the lenders (the “Prior Credit Facility”). In addition, at November 3, 2007, the Company had no stand-by or commercial letters of credit issued under the Prior Credit Facility.

 

On November 13, 2007, the Company entered into a Second Amended and Restated Loan and Security Agreement with Bank of America, N.A., as Lender which expanded its availability from a maximum of $75.0 million to $150.0 million (the “New Credit Facility”). The Prior Credit Facility, which was scheduled to expire in April 2010, was terminated concurrently with the entering into of the New Credit Facility.

 

The New Credit Facility provides for a $150.0 million revolving credit line. The New Credit Facility is available for working capital and general corporate purposes, including the repurchase of the Company’s capital stock and for its capital expenditures. A portion of the availability under the New Credit Facility was used to fund the Company’s accelerated share repurchase program (“ASR”) to repurchase $125.0 million of its common shares (see Note 9 to the Notes to Unaudited Condensed Consolidated Financial Statements). The New Credit Facility is scheduled to mature on November 13, 2012. At November 13, 2007, the Company had $31.3 million outstanding under the New Credit Facility that was repaid in full on November 27, 2007.

 

Loans under the New Credit Facility are secured by all of the assets of the Company and are guaranteed by all of the domestic subsidiaries of the Company (the “Guarantors”). Upon the occurrence of a Cash Dominion Event (as defined in the New Credit Facility) among other limitations, the Company’s ability to borrow funds, make investments, pay dividends and repurchase shares of its common stock would be limited.

 

Except for the use of a portion of the credit under the New Loan Facility to fund the Company’s repurchase of shares as described below, as of the date hereof, the Company had no direct borrowings outstanding under its prior credit facility with Bank of America, N.A.. Direct borrowings under the New Credit Facility bear interest at a margin over either LIBOR or a Base Rate (as each such term is defined in the New Credit Facility).

 

The New Credit Facility also contains covenants that, subject to specified exceptions, restrict the Company’s ability to, among other things:

 

 

Upon the occurrence of an event of default under the New Credit Facility, the lenders may cease making loans, terminate the New Credit Facility, and declare all amounts outstanding to be immediately due and payable.

 

Events of default under the New 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 legal process or proceedings under federal, state or civil statutes, legal challenges to loan documents, and a change in control. If an event of default occurs, the Lender will be entitled to take various actions, including the acceleration of amounts due under the New Credit Facility and

 

AÉROPOSTALE, INC.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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.

 

 

The Company maintains a qualified, defined contribution retirement plan with a 401(k) salary deferral feature that covers substantially all of its employees who meet certain requirements. Under the terms of the plan, employees may contribute up to 14% of gross earnings and the Company will provide a matching contribution of 50% of the first 5% of gross earnings contributed by the participants. The Company also has the option to make additional contributions. 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 year five.

 

The Company maintains a supplemental executive retirement plan, or SERP, which is a non-qualified 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:

 

 

The Company maintains 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 the Company 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 participants’ accounts will be fully vested upon retirement after completing five years of service and attaining age 55.

 

The Company maintains a postretirement benefit plan for certain officers. The Company had liabilities of $0.6 million as of November 3, 2007 and $0.1 million at October 28, 2006 in connection with this plan.

 

 

The Company repurchases its common stock from time to time under a stock repurchase program. 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.

 

During the third quarter of 2007, and separate and apart from the Company’s ASR program, the Company repurchased $125.1 million, or 6,291,878 shares of common stock, as compared to 462,000 shares for $8.3 million

 

AÉROPOSTALE, INC.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

during the third quarter of 2006. Likewise, the Company repurchased 6,878,378 shares of its common stock for $141.5 million during the first thirty-nine weeks of 2007 and 3,209,100 shares for $56.0 million during the first thirty-nine weeks of 2006. The total dollar amount of shares repurchased under the Company’s share repurchase program is $341.2 million or 18.4 million shares of common stock.

 

On November 12, 2007, our Board of Directors approved a $250.0 million increase in repurchase availability under the program, bringing total repurchase authorization, since inception of the program, to $600.0 million. The Company has used a portion of the additional authorization to execute the ASR.

 

On November 13, 2007, the Company entered into a confirmation agreement with Bank of America, N.A. (“Bank of America”). Pursuant to the ASR, Bank of America is expected to purchase shares of the Company’s common stock in the open market in connection with the ASR over a period not to exceed three months. The final number of shares to be repurchased by the Company from Bank of America under the ASR will be determined at the conclusion of the transaction, based upon the volume weighted average share price of the Company’s common shares during the term of the ASR. The ASR is subject to collar provisions that establish the minimum and maximum price for the shares, which will in turn determine the final number of shares being repurchased under the ASR. The initial price of the shares purchased by the Company from Bank of America is subject to a price adjustment based on the volume weighted average price of the shares during this period.

 

With the latest increase in repurchase authorization, and after taking into account the $125.0 million ASR, total Company share repurchases since inception of the program are $466.2 million. Accordingly, the Company has approximately $133.8 million of repurchase authorization remaining under the Company’s share repurchase program as of November 13, 2007, after taking into account the $125.0 million ASR.

 

 

At the beginning of fiscal 2006, the Company 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, or SAB 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 recognized in the income statement. Previous to the adoption of SFAS No. 123(R), the Company 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 the Company’s consolidated financial statements. The Company adopted the modified prospective transition method provided under SFAS No. 123(R), and consequently, did not retroactively adjust results from prior periods.

 

The fair value of options 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 the Company’s common stock price over the expected term and the number of options that will ultimately not complete their vesting requirements (“forfeitures”). 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 consolidated statements of income.

 

The Company determined expected volatilities based on median results of a peer group analysis of companies similar in size and financial leverage to the Company. The Company has elected to use the simplified method for estimating its expected term as allowed by SAB 107 to determine expected life. The risk-free rate is indexed to the five-year Treasury note interest at the date of grant and expected forfeiture rate is based on the Company’s historical forfeiture information.

 

AÉROPOSTALE, INC.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

In accordance with SFAS No. 123(R), the fair value of each option grant is estimated on the date of grant based on the following assumptions for grants in the respective periods:

 

 

The Company has elected to adopt the simplified method to establish the beginning balance of the additional paid-in capital pool (“APIC Pool”) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC Pool and condensed consolidated statements of cash flows of the tax effects of employee and director share-based awards that were outstanding upon adoption of SFAS No. 123(R).

 

The effects of applying SFAS No. 123(R) and the results obtained through the use of the Black-Scholes option-pricing model are not necessarily indicative of future values.

 

During the third quarter of 2007, the Company granted 21,000 stock options at a weighted-average grant-date fair value of $9.42. During the first thirty-nine weeks of 2007, the Company granted 580,516 stock options at a weighted-average grant-date fair value of $12.36.

 

A summary of stock option activity during the first thirty-nine weeks of 2007 is as follows:

 

 

During the third quarter of 2007, the Company granted 4,984 shares of non-vested stock at a weighted-average grant-date fair value of $20.67. During the first thirty-nine weeks of 2007, the Company granted 308,287 shares of non-vested stock at a weighted-average grant-date fair value of $26.76.

 

A summary of non-vested stock activity during the first thirty-nine weeks of 2007 is as follows:

 

 

AÉROPOSTALE, INC.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

The Company is party to various litigation matters and proceedings in the ordinary course of business. In the opinion of the Company’s management, dispositions of these matters are not expected to have a material adverse affect on its financial position, results from operations or cash flows. As of November 3, 2007, the Company has not issued any third party guarantees.

 

 

Effective at the beginning of the first quarter of 2007, the Company adopted 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, the Company recorded a decrease to beginning retained earnings of approximately $0.2 million and increased its net liabilities for uncertain tax positions and related interest and penalties by a corresponding amount. As of the adoption date, the Company recorded liabilities of $10.7 million for uncertain tax positions, which includes interest and penalties. Also as of the adoption date, the Company 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 the Company’s effective tax rate if these net liabilities were reversed.

 

The Company expects 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.

 

The Company files income tax returns in the U.S. federal jurisdiction and in various states. Its U.S. federal filings for the years 2002 through 2005 are under routine examination and the Company expects that process will be completed before the end of 2007. For state tax purposes, the Company’s 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.

 

The Company recognizes 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. The Company recorded approximately $0.2 million in interest and penalties, before federal and, if applicable, state effect for the third quarter of 2007 and $0.5 million for the first thirty-nine weeks of fiscal 2007.

 

 

In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115. This statement permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective at the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company expects that the adoption of SFAS No. 159 will not have a material impact on its consolidated financial statements.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having concluded in those other accounting pronouncements that fair value is the relevant measurement attribute. This statement is effective for financial assets and liabilities in financial statements issued for fiscal years beginning after November 15, 2007. It is effective for non-financial assets and liabilities in financial statements issued for fiscal years beginning after November 15, 2008. The Company expects that the adoption of SFAS No. 157 will not have a material impact on its consolidated financial statements.

 

AÉROPOSTALE, INC.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

On November 30, 2007, the Company entered into an agreement (the “Agreement”) with Christopher L. Finazzo, its former Executive Vice President and Chief Merchandising Officer, settling all disputes between them (see Note 5 to the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended February 3, 2007 for a further discussion). Pursuant to the terms of the Agreement, Mr. Finazzo has agreed to pay the Company $5.0 million on or before January 15, 2008. In turn, the Company has agreed to pay to Mr. Finazzo, simultaneously with his payment to the Company, approximately $0.9 million, which represents the value of Mr. Finazzo’s benefits under the Company’s Supplemental Executive Retirement Plan. At the time of such payments, the Company anticipates recording net other income of approximately $4.1 million.

 

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. 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 November 3, 2007, we operated 823 stores, consisting of 798 Aeropostale stores in 47 states, 11 Aeropostale stores in Canada, and 14 Jimmy’Z stores in 11 states, 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.

 

On July 11, 2007, we announced a three-for-two stock split on all shares of our common stock that was completed on August 21, 2007 in the form of a stock dividend to all shareholders of record on August 6, 2007. All share and per share amounts presented in this report were retroactively adjusted for the common stock split, and all previously reported periods were restated for such.

 

The discussion in the following section is on a consolidated basis, unless indicated otherwise. In addition, comparable store sales data included in this section are compared to the corresponding period in the prior year, due to the 53rd week in the fiscal 2006 calendar. We believe that the disclosure of comparable store sales data on a pro-forma basis due to the 53rd week in fiscal 2006, which is a non-GAAP financial measure, provides investors useful information to help them better understand our results.

 

Results of Operations

 

Overview

 

We achieved net sales of $412.6 million for the third quarter of 2007, or a 7.0% increase when compared to the third quarter of 2006. Our fiscal 2006 calendar included an additional 53rd week that resulted in a fiscal calendar shift for fiscal 2007. The increase in net sales for the third quarter of 2007 was driven primarily by average square footage growth of 11% and an increase in comparable store sales of 1.9%, which was partially offset by the impact of the above mentioned fiscal calendar shift. Gross profit, as a percentage of net sales, increased by 2.8 percentage points for the third quarter of 2007 primarily due to increased merchandise margin. The increase in merchandise

margin primarily reflects lower graphic tee shirt costs and improved composition and levels of our merchandise assortment. SG&A, as a percentage of net sales, increased by 2.3 percentage points for the third quarter of 2007, which is primarily attributable to higher store-line expenses, higher e-commerce transaction costs and corporate expenses. Interest income increased by $0.4 million for the third quarter of 2007 compared to the same period in 2006, primarily due to higher interest rates. The effective income tax rate was 39.6% for the third quarter of 2007 compared to 39.0% for the third quarter of 2006. Net income for the third quarter of 2007 was $36.0 million, or $0.48 per diluted share, compared to net income of $32.6 million, or $0.41 per diluted share, for the third quarter of 2006. Earnings per share increased by 17.1% for the third quarter of 2007 due to both an increase in net income and less weighted average shares outstanding resulting from the Company’s repurchase of its common stock.

 

As of November 3, 2007, we had working capital of $138.3 million, cash and cash equivalents of $122.6 million and no short-term investments. Merchandise inventories increased by 14.8%, and by 2.7% on a per square foot basis, at November 3, 2007, compared to the third quarter of 2006.

 

We operated 823 stores at November 3, 2007, an increase of 11.5% from the same period last year.

 

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:

 

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:

 

 

Comparison of the 13 weeks ended November 3, 2007 to the 13 weeks ended October 28, 2006

 

Net Sales — Net sales for the third quarter of 2007 increased by $27.1 million, or by 7.0% compared to the same period last year. The increase in net sales was driven primarily by average square footage growth of 11% and an increase in comparable store sales of 1.9%, which was partially offset by the impact from the above mentioned fiscal calendar shift. Comparable store sales increased in our young women’s and young men’s categories which were offset by a decrease in accessories. The overall comparable store sales increase reflected a 3.9% increase in the number of sales transactions, a 3.6% increase in units per sales transaction and a 5.3% decrease in average unit retail. Non-comparable store sales increased by $20.3 million, or by 5.1%, primarily due to 85 more stores open at the end of the third quarter of 2007 compared to the end of the third quarter of 2006.

 

Gross Profit — Cost of sales include costs related to merchandise sold, including inventory valuation adjustments, distribution and warehousing, freight from the distribution center and warehouse to the stores. It also includes 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 by 2.8 percentage points for the third quarter of 2007 compared to the same period last year. Merchandise margin increased by 3.3 percentage points primarily due to lower unit costs from graphic tee shirts and improved levels and composition of our merchandise assortment. The improvement in merchandise margin was partially offset by 0.6 percentage points of higher occupancy costs and depreciation costs.

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, 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 increased by $14.4 million, or 2.3 percentage points, as a percentage of net sales, for the third quarter of 2007 compared to the third quarter of 2006. The increase in SG&A was primarily attributable to a $6.3 million increase in store-line expenses, $3.8 million of higher store transaction costs and store operations costs resulting primarily from new store growth and higher sales, a $3.4 million increase in corporate expenses, consisting of incentive, stock-based compensation and other corporate expenses and a $1.6 million increase in benefits, partially offset by a savings of $0.8 million in marketing costs. As a percentage of net sales, the increases in store-line expenses, e-commerce transaction costs, corporate expenses and benefits resulted in 0.9 percentage points, 0.6 percentage points, 0.6 percentage points and 0.3 percentage points, respectively, of the increase in SG&A.

 

Interest income and income taxes — Interest income increased by $0.4 million for the third quarter of 2007 compared to the same period in 2006, primarily due to higher interest rates.

 

The effective income tax rate was 39.6% for the third quarter of 2007 and 39.0% for 2006. The increase in the effective tax rate was primarily due to the adoption of FIN No. 48 (see Note 12 to the Notes to Unaudited Condensed Consolidated Financial Statements) and a change in the mix of investments.

 

Net income — Net income was $36.0 million, or $0.48 per diluted share, for the third quarter of 2007, compared to net income of $32.6 million, or $0.41 per diluted share, for the third quarter of 2006. Earnings per share increased by 17.1% for the third quarter of 2007 due to both an increase in net income and less weighted average shares outstanding resulting from the Company’s repurchase of its common stock.

 

Consolidated net income included net losses from the Company’s Jimmy’Z subsidiary of $1.5 million, or $0.02 per diluted share, for the third quarter of 2007 compared to losses of $1.6 million, or $0.02 per diluted share for the third quarter of 2006.

 

Comparison of the 39 weeks ended November 3, 2007 to the 39 weeks ended October 28, 2006

 

Net Sales — Net sales for the first thirty-nine weeks of 2007 increased by $93.2 million, or by 10.3% compared to the same period last year. The increase in net sales was driven primarily by average square footage growth of 10%, an increase in comparable store sales of 0.1% and the impact from the above mentioned fiscal calendar shift.

 

Gross Profit — Gross profit, as a percentage of net sales, increased by 3.6 percentage points for the first thirty-nine weeks of 2007 compared to the same period last year. Merchandise margin increased 3.9 percentage points partially due to lower unit costs from graphic tee shirts and improved levels and composition of our merchandise assortment. The improvement in merchandise margin was partially offset by 0.4 percentage points of higher occupancy costs and depreciation costs.

 

SG&A — SG&A increased by $36.7 million, or by 1.7 percentage points, as a percentage of net sales, for the first thirty-nine weeks of 2007 compared to the same period last year. The increase in SG&A was primarily attributable to a $16.6 million increase in store-line expenses, a $10.5 million increase in corporate expenses, consisting of incentive, stock-based compensation and other corporate expenses, $8.0 million of higher store transaction costs and store operations costs resulting primarily from new store growth and higher sales, a $1.0 million increase in benefits and higher marketing expenses of $0.6 million. As a percentage of net sales, the increases in corporate expenses, e-commerce transaction costs and store-line expenses resulted in 0.7 percentage points, 0.5 percentage points and 0.6 percentage points, respectively, of the increase in SG&A.

 

Interest income and income taxes — Interest income increased by $1.5 million for the first thirty-nine weeks of 2007 compared to the same period in 2006. Increases in interest rates and higher investment balances were the primary drivers of the increase in net interest income.

 

The effective income tax rate was 39.4% for 2007 and 39.0% for 2006. The increase in the effective tax rate was primarily due to the adoption of FIN No. 48 (see Note 12 to the Notes to Unaudited Condensed Consolidated Financial Statements) and a change in the mix of investments.

Net income — Net income was $64.5 million, or $0.84 per diluted share, for the first thirty-nine weeks of 2007, compared to net income of $49.4 million, or $0.61 per diluted share, for the first thirty-nine weeks of 2006. Earnings per share increased by 37.7% for the first thirty-nine weeks of 2007 due to both an increase in net income and less weighted average shares outstanding resulting from the Company’s repurchase of its common stock.

 

Consolidated net income included net losses from the Company’s Jimmy’Z subsidiary of $5.2 million, or $0.07 per diluted share, for the first thirty-nine weeks of 2007 compared to losses of $4.6 million, or $0.06 per diluted share for the first thirty-nine weeks 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, existing cash and cash equivalents and our credit facility. In addition, on November 13, 2007, we amended and restated our revolving credit facility (the “New Credit Facility”) with Bank of America, N.A., which expanded its availability from a maximum of $75.0 million to $150.0 million (see Note 7 to the Notes to Unaudited Condensed Consolidated Financial Statements). A portion of the availability under the New Credit Facility was used to fund the accelerated share repurchase program (“ASR”) to repurchase $125.0 million of our common shares (see Note 9 to the Notes to Unaudited Condensed Consolidated Financial Statements). At November 3, 2007, we had working capital of $138.3 million and cash and cash equivalents of $122.6 million.

 

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

 

 

Operating activities — Cash flows provided by operating activities, our primary form of liquidity on a full-year basis, decreased by $17.6 million for the first thirty-nine weeks of 2007 compared to the same period in 2006. Cash used for accrued expenses and other assets and liabilities increased by $33.7 million due primarily to timing of income tax payments resulting from the timing of tax deductions. This use of cash was partially offset by an increase in cash provided from net income of $15.1 million. Merchandise inventories increased by 14.8%, and by 2.7% on a per square foot basis, as of November 3, 2007, as compared to October 28, 2006.

 

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 opened 83 Aeropostale stores in our new store format during the first thirty-nine weeks of 2007, and we plan to open five additional Aeropostale stores during the fourth quarter of 2007. This included opening 11 stores in Canada, with plans to open one additional store during the fourth quarter of 2007. In addition, we have remodeled and renovated 12 existing Aeropostale stores. Capital expenditures for the full year of 2007 are

expected to approximate $82.0 million for these new and remodeled stores, a second distribution facility, rollout of the upgraded point of sale systems to our store chain, and supply chain management investments.

 

We had no short-term investments at November 3, 2007. We had $55.2 million and $76.2 million in short-term investments as of October 28, 2006 and February 3, 2007, respectively, 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 — The Company repurchases its common stock from time to time under a stock repurchase program. On November 12, 2007, our Board of Directors approved a $250.0 million increase in repurchase availability under the program, bringing total repurchase authorization, since inception of the program, to $600.0 million. The Company used a portion of the additional authorization to execute the ASR program.

 

On November 13, 2007, the Company entered into a confirmation agreement with Bank of America, N.A. (“Bank of America”). Pursuant to the ASR, Bank of America is expected to purchase shares of the Company in the open market in connection with the ASR over a period not to exceed three months. The final number of shares to be repurchased from Bank of America under the ASR will be determined at the conclusion of the transaction, based upon the volume weighted average share price of the Company’s common shares during the term of the ASR. The ASR is subject to collar provisions that establish the minimum and maximum price for the shares, which will in turn determine the final number of shares being repurchased under the ASR. The initial price of the shares purchased by the Company from Bank of America is subject to a price adjustment based on the volume weighted average price of the shares during this period. The foregoing description of the ASR and the transactions contemplated thereby does not purport to be complete and is qualified in its entirety by reference to the complete text of the ASR attached as Exhibit 10.2 to the Company’s Form 8-K filed with the Securities and Exchange Commission on November 15, 2007.

 

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.

 

During the third quarter of 2007, and separate and apart from the ASR program, the Company repurchased $125.1 million, or 6,291,878 shares of common stock, as compared to 462,000 shares for $8.3 million during the third quarter of 2006. Likewise, the Company repurchased 6,878,378 shares of its common stock for $141.5 million during the first thirty-nine weeks of 2007 and 3,209,100 shares for $56.0 million during the first thirty-nine weeks of 2006. The total dollar amount of shares repurchased under the Company’s share repurchase program is $341.2 million or 18.4 million shares of common stock. With the latest increase in repurchase authorization, and after taking into account the $125.0 million ASR, total Company share repurchases since inception of the program are $466.2 million. Accordingly, the Company has approximately $133.8 million of repurchase authorization remaining under the Company’s share repurchase program as of November 13, 2007, after taking into account the $125.0 million ASR.

 

On November 13, 2007, the Company entered into an amended and restated revolving credit facility with Bank of America, N.A., as Lender which expanded its availability from a maximum of $75.0 million to $150.0 million (the “New Credit Facility”). The New Credit Facility provides for a $150.0 million revolving credit line. The New Credit Facility is available for working capital and general corporate purposes, including the repurchase of the Company’s capital stock and for its capital expenditures. A portion of the availability under the New Credit Facility was used to fund the Company’s ASR to repurchase $125.0 million of its common shares. The New Credit Facility is scheduled to mature on November 13, 2012. At November 13, 2007, the Company had $31.3 million outstanding under the New Credit Facility that was repaid in full on November 27, 2007 (see Note 7 to the Notes to Unaudited Condensed Consolidated Financial Statements). The foregoing description of the New Credit Facility and the transactions contemplated thereby does not purport to be complete and is qualified in its entirety by reference to the complete text of the Second Amended and Restated Loan and Security Agreement

attached as Exhibit 10.1 to the Company’s Form 8-K filed with the Securities and Exchange Commission on November 15, 2007.

 

Contractual Obligations

 

The following table summarizes our contractual obligations as of November 3, 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 at any time prior to our receipt of the applicable goods without penalty to us, and were therefore not included in the above table.

 

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 November 3, 2007. We had no commercial commitments outstanding as of November 3, 2007.

 

Effective at the beginning of the first quarter of 2007, we adopted FIN No. 48 as described in Note 11 to the Notes to Unaudited Condensed Financial Statements. Our total liabilities for unrecognized tax benefits were $11.6 million at November 3, 2007. We cannot make a reasonable estimate of the amount and period of related future payments for $3.9 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 November 3, 2007, 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 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 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 the Company’s 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. The Company’s

most critical accounting policies have been discussed in the Company’s Annual Report on Form 10-K for the fiscal year ended February 3, 2007. 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.

 

As of November 3, 2007, except as noted below, there have been no material changes to any of the critical accounting policies as disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended February 3, 2007.

 

We adopted FIN No. 48 as of the beginning of fiscal 2007. See Note 12 to the Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

At November 13, 2007, the Company had $31.3 million outstanding under the New Credit Facility that was repaid in full on November 27, 2007. Prior to November 13, 2007 the Company had no outstanding borrowings under the Prior Credit Facility since November 2002. In addition, the Company had no stand-by or commercial letters of credit issued under the New Credit Facility. To the extent that the Company may borrow pursuant to the New Credit Facility in the future, it may be exposed to market risk related to interest rate fluctuations.

 

The Company is exposed to foreign currency risk as a result of entering the Canadian market in July 2007. The Company is subject to changes in the foreign currency exchange rates in the Canadian dollar, which could impact its financial condition. Foreign exchange risk arises from the Company’s exposure to fluctuation in foreign currency exchange rates because its reporting currency is the U.S. dollar. The Company also faces transactional currency exposures relating to merchandise that its Canadian subsidiary purchases using U.S. dollars. The Company does not hedge its exposure to this currency exchange fluctuation. A 10 percent movement in quoted foreign currency exchange rates could result in a fair value translation fluctuation of approximately $1.8 million in the Company’s net investment, which would be recorded in other comprehensive income as an unrealized gain or loss.

 

 

(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 third quarter ended November 3, 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.

 

PART II — OTHER INFORMATION

 

 

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 historic levels of comparable store sales. 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. Failure 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. In 2007, we ceased doing business with South Bay Apparel Inc. We have replaced 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.

 

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.

 

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 $5.2 million or $0.07 per diluted share for first thirty-nine weeks of 2007, $6.7 million or $0.08 per diluted share for fiscal 2006, $4.7 million or $0.06 per diluted share for fiscal 2005 and none in fiscal 2004.

 

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 83 Aeropostale stores in the U.S. and 11 Aeropostale stores in Canada during the first thirty-nine weeks of 2007, 74 Aéropostale stores in the U.S. in fiscal 2006, 105 Aéropostale in the U.S. and 14 Jimmy’Z stores in the U.S. in fiscal 2005, and 103 Aéropostale stores in the U.S. in fiscal 2004. We plan to open approximately five new Aéropostale stores in the fourth quarter of 2007, including one additional store 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. 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.

 

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

 

During the first thirty-nine weeks of 2007, we opened 11 Aeropostale stores in Canada and plan to open one additional store in the fourth quarter of 2007. There can be no assurance 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, since entering 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. There can be no assurance 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.

 

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 two distribution centers.

 

We currently maintain two distribution centers, one on the East Coast and one on the West Coast of the United States, which began operations in September 2007, to receive, store and distribute merchandise to all of our stores. Any significant interruption in the operation of either of our distribution centers 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.

 

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

 

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 two distribution and warehouse facilities. 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 separate third party transportation companies to deliver our merchandise from our warehouse to our stores. Any failure by any 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 host our e-commerce website, warehouse all of the inventory sold through our e-commerce website, and 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 November 12, 2007, our Board of Directors approved a $250.0 million increase in repurchase availability under the program, bringing total repurchase authorization, since inception of the program, to $600.0 million. The Company used a portion of this authorization to execute the ASR program to repurchase $125.0 million of its common shares (see Note 9 to the Notes to Unaudited Condensed Consolidated Financial Statements). 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 third quarter of 2007 and remaining availability pursuant to our share repurchase program were as follows:

 

 

 

 

 

Not applicable.

 

 

Not applicable.

 

 

Not applicable.

 

 

 

 

 

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.

 

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: December 7, 2007