NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. NATURE OF BUSINESS
Pacific Sunwear of California, Inc. (together with its wholly-owned subsidiaries, the “Company” or “PacSun”) is a leading specialty retailer rooted in the action sports, fashion and music influences of the California lifestyle. The Company sells a combination of branded and proprietary casual apparel, accessories and footwear designed to appeal to teens and young adults. It operates a nationwide, primarily mall-based chain of retail stores under the names “Pacific Sunwear” and “PacSun.” In addition, the Company operates an e-commerce website at www.pacsun.com which sells PacSun merchandise online, provides content and community for its target customers and provides information about the Company. The Company, a California corporation, was incorporated in August 1982. As of
May 3, 2014
, the Company leased and operated
618
stores in each of the
50
states and Puerto Rico.
2. BASIS OF PRESENTATION
The accompanying Condensed Consolidated Financial Statements are unaudited and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted.
These Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended February 1, 2014 (“fiscal 2013”) filed with the SEC. The Condensed Consolidated Financial Statements include the accounts of Pacific Sunwear of California, Inc. and its wholly-owned subsidiaries (Pacific Sunwear Stores Corp., a California corporation (“PacSun Stores”) and Miraloma Borrower Corporation, a Delaware corporation (“Miraloma”)). All intercompany transactions have been eliminated in consolidation.
In the opinion of management, all adjustments consisting only of normal recurring entries necessary for a fair presentation have been included. The preparation of Condensed Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the Condensed Consolidated Financial Statements as well as the reported revenues and expenses during the reporting period. Actual results could differ from these estimates. The results of operations for the Company’s fiscal quarter ended
May 3, 2014
are not necessarily indicative of the results that may be expected for the fiscal year ending January 31, 2015 (“fiscal 2014”).
The results of continuing operations for all periods presented in these Condensed Consolidated Financial Statements exclude the financial impact of discontinued operations. See Note 13, “Discontinued Operations” for further discussion related to discontinued operations presentation.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Information regarding significant accounting policies is contained in Note 1, “Nature of Business and Summary of Significant Accounting Policies,” of the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for fiscal 2013. Presented below in the following notes is supplemental information that should be read in conjunction with “Notes to Consolidated Financial Statements” included in that Report.
Income Taxes
The Company calculates its interim income tax provision in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 270, “Interim Reporting” (“ASC 270”) and ASC Topic 740, “Accounting for Income Taxes” (“ASC 740”). At the end of each interim period, the Company estimates the annual effective tax rate and applies that rate to its ordinary quarterly earnings. The tax expense or benefit related to significant, unusual, or extraordinary items is recognized in the interim period in which those items occur. In addition, the effect of changes in enacted tax laws, rates or tax status is recognized in the interim period in which the change occurs. The computation of the annual estimated effective tax rate at each interim period requires certain estimates and significant judgment including the expected operating income for the year, permanent and temporary differences as a result of differences between amounts measured and recognized in accordance with tax laws and financial accounting standards, and the likelihood of recovering deferred tax assets generated in the current fiscal year. The accounting estimates used to compute the provision for income taxes may change as new events occur, additional information is obtained or the tax environment changes.
Earnings Per Share
Basic earnings per share is computed using the weighted-average number of common shares outstanding. Diluted earnings per share is computed using the weighted-average number of common shares outstanding adjusted for the incremental shares attributed to outstanding options to purchase common stock and nonvested restricted stock using the treasury stock method, if dilutive. In periods where a net loss is reported, incremental shares are excluded as their effect would be anti-dilutive. In such circumstances, the weighted-average number of shares outstanding in the basic and diluted earnings per common share calculations will be the same. Anti-dilutive options and nonvested shares are excluded from the computation of diluted earnings per share because either the option exercise price or the grant date fair value of the nonvested share is greater than the market price of the Company’s common stock. Options to purchase
5.9
million and
3.9
million shares of common stock in the
first
quarter of fiscal 2014 and 2013, respectively, were excluded from the computation of diluted earnings per share as their effect would have been anti-dilutive.
Recent Accounting Pronouncements
In April 2014, the FASB issued Accounting Standards Update ("ASU") No. 2014-08,
Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360) and Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity." The ASU amendment changes the requirements for reporting discontinued operations in Subtopic 205-20. The amendment is effective on a prospective basis for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2014. E
arly adoption is permitted for disposals that have not been reported in financial statements previously issued.
Based on the Company's evaluation of the ASU, its adoption of this update is not expected to have a material impact on the Company's financial position or results of operation.
4. IMPAIRMENT OF LONG-LIVED ASSETS
The Company assesses long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of such assets (or asset group) may not be recoverable. Based on management’s review of the historical operating performance, including sales trends, gross margin rates, current cash flows from operations and the projected outlook for each of the Company’s stores, the Company determined that certain stores would not be able to generate sufficient cash flows over the remaining term of the related leases to recover the Company’s investment in the respective stores. As a result, the Company recorded the following non-cash impairment charges related to its retail stores within the accompanying Condensed Consolidated Statements of Operations and Comprehensive Operations, to write-down the carrying value of its long-lived store assets to their estimated fair values.
|
|
|
|
|
|
|
|
|
|
For the First Quarter Ended
|
|
(In thousands)
|
|
May 3, 2014
|
|
May 4, 2013
|
Impairment charges from continuing operations
|
$
|
783
|
|
|
$
|
861
|
|
|
|
|
|
|
|
|
|
|
|
May 3, 2014
|
|
May 4, 2013
|
|
(In thousands)
|
Carrying value of assets tested for impairment
|
$
|
4,028
|
|
|
$
|
4,208
|
|
Carrying value of assets with impairment
|
$
|
1,024
|
|
|
$
|
1,714
|
|
Fair value of assets impaired
|
$
|
241
|
|
|
$
|
853
|
|
Number of stores tested for impairment
|
54
|
|
|
75
|
|
Number of stores with impairment
|
17
|
|
|
14
|
|
The long-lived assets disclosed above that were written down to their respective fair values consisted primarily of leasehold improvements, furniture, fixtures and equipment. The Company recognized impairment charges of
$0.8 million
and
$0.9 million
, respectively, during the first quarters ended
May 3, 2014
and
May 4, 2013
. The decrease in the number of stores tested for impairment year-over-year was primarily related to the Company’s closure of certain underperforming stores and the improved financial performance of the remaining store base. Based on historical operating performance and the projected outlook for a subset of the stores tested for impairment as of
May 3, 2014
, the Company believes that the remaining asset value of approximately
$0.2 million
, is recoverable. See Note 10, "Fair Value Measurements" for further discussion related to impairment of long-lived assets.
5. DERIVATIVE LIABILTY
As disclosed in Note 9, "Shareholders' Equity," the Company issued
1,000
shares of its Convertible Series B Preferred Stock (the “Series B Preferred”) in connection with the
5
-year,
$60 million
senior secured term loan (the “Term Loan”), funded by an affiliate of Golden Gate Capital. The fair value of the Series B Preferred at issuance was approximately
$15 million
which was recorded as a derivative liability. As of
May 3, 2014
and
February 1, 2014
, the fair value of the derivative liability was approximately
$29 million
and
$31 million
, respectively. See Note 10, “Fair Value Measurements” for further discussion on the derivative liability.
6. OTHER CURRENT LIABILITIES
Other current liabilities consisted of the following:
|
|
|
|
|
|
|
|
|
|
May 3, 2014
|
|
February 1, 2014
|
|
(In thousands)
|
Accrued compensation and benefits
|
$
|
9,392
|
|
|
$
|
7,858
|
|
Accrued gift cards
|
7,398
|
|
|
9,036
|
|
Sales taxes payable
|
2,754
|
|
|
1,549
|
|
Other
|
21,488
|
|
|
18,843
|
|
Total other current liabilities
|
$
|
41,032
|
|
|
$
|
37,286
|
|
7. DEBT
Credit Facility
On December 7, 2011, the Company entered into a new
five
-year,
$100 million
revolving credit facility with Wells Fargo Bank, N.A (the “Wells Credit Facility”), which replaced the Company’s previous revolving credit facility with JPMorgan Chase (the “Former Credit Facility”). Borrowings under the Wells Credit Facility bear interest at a floating rate which, at the Company’s option, may be determined by reference to a LIBOR Rate or a Base Rate (as defined in the Wells Credit Facility,
1.90%
as of
May 3, 2014
). Extensions of credit under the Wells Credit Facility are limited to a borrowing base consisting of specified percentages of eligible categories of assets. The Wells Credit Facility is available for direct borrowings and allows for the issuance of letters of credit, and up to
$12.5 million
is available for swing-line loans. The Wells Credit Facility is secured by liens and security interests with (a) a first priority security interest in the current and certain related assets of the Company including cash, cash equivalents, deposit accounts, securities accounts, credit card receivables and inventory, and (b) a second priority security interest in all assets and properties of the Company that are not secured by a first lien and security interest. The Wells Credit Facility also contains covenants that, subject to specified exceptions, restrict the Company’s ability to, among other things, incur additional indebtedness, incur liens, liquidate or dissolve, sell, transfer, lease or dispose of assets, or make loans, investments or guarantees. The Wells Credit Facility is scheduled to mature on
December 7, 2016
. Although the Company made progress with respect to its comparable store net sales and gross margins in fiscal 2013 and fiscal 2012, if the Company were to experience a decline in same-store sales and gross margins in the future, it may be required to access most, if not all, of the Wells Credit Facility and would potentially require other sources of financing to fund its operations, which sources might not be available. Based on current forecasts, the Company believes that its cash flows from operations and working capital will be sufficient to meet its operating and capital expenditure needs for the next twelve months. At
May 3, 2014
, the Company had
no
direct borrowings and
$10 million
in letters of credit outstanding under the Wells Credit Facility. The remaining availability under the Wells Credit Facility at
May 3, 2014
was approximately
$42 million
. The Company is not subject to any financial covenant restrictions under the Wells Credit Facility.
Term Loan
On December 7, 2011, the Company obtained the Term Loan funded by an affiliate of Golden Gate Capital. The Term Loan bears interest at a rate of
5.50%
per annum to be paid in cash, due and payable quarterly in arrears, and
7.50%
per annum, due and payable in kind (“PIK”) annually in arrears, with such PIK interest then due and payable being added to the outstanding principal balance of the Term Loan at the end of each fiscal year, and with adjustments to the cash and PIK portion of the interest rate in accordance with the Term Loan agreement, following principal prepayments. Annual cash interest for fiscal 2014 is expected to be approximately
$4 million
. The Term Loan is guaranteed by each of the Company’s subsidiaries and will be guaranteed by any future domestic subsidiaries of the Company. The Term Loan is secured by liens and security interests with (a) a first priority security interest in all long-term assets of the Company and PacSun Stores and all other assets not subject to a first lien and security interest pursuant to the Wells Credit Facility, (b) a first priority pledge of the equity interests of Miraloma and (c) a second priority security interest in all assets of the Company and PacSun Stores subject to a first lien and security interest pursuant to the Wells Credit Facility. The Term Loan also contains covenants substantially identical to those in the Wells Credit Facility. The principal balance and any unpaid interest related to the Term Loan is due on
December 7, 2016
. The Company is not subject to any financial covenant restrictions under the Term Loan.
Mortgage Debt
On August 20, 2010, the Company, through its wholly-owned subsidiaries, Miraloma and PacSun Stores, executed
two
promissory notes pursuant to which borrowings in an aggregate amount of
$29.8 million
from American National Insurance Company (“Anico”) were incurred. The note executed by Miraloma (the “Miraloma Note”) is in the amount of
$16.8 million
and bears interest at the rate of
6.50%
per annum. Monthly principal and interest payments under the Miraloma Note commenced on
October 1, 2010
, and are
$113,435
. The principal and interest payments are based on a
25
-year amortization schedule. The remaining principal balance of the Miraloma Note, and any accrued but unpaid interest thereon (estimated to be
$14.4 million
), will be due in full on
September 1, 2017
. The Miraloma Note is secured by a deed of trust on the building and land comprising the Company’s principal executive offices in Anaheim, California and is non-recourse to the Company. The Miraloma Note does not contain any financial covenants. In connection with this transaction, the Company transferred the building and related land securing the Miraloma Note to Miraloma and entered into a lease for the building and land with Miraloma. Miraloma paid a prepayment fee to Anico equal to
1.00%
of the principal amount of the Miraloma Note on the closing date of the transaction. As a result, Miraloma may prepay the Miraloma Note, in whole, but not in part, at any time without penalty upon
30 days
prior written notice to Anico.
The note executed by PacSun Stores (the “PacSun Stores Note”) is in the amount of
$13.0 million
and bears interest at the rate of
6.50%
per annum. Monthly principal and interest payments under the PacSun Stores Note commenced on
October 1, 2010
, and are
$87,777
. The principal and interest payments are based on a
25
-year amortization schedule. The remaining principal balance of the PacSun Stores Note, and any accrued but unpaid interest thereon (estimated to be
$11.2 million
), will be due in full on
September 1, 2017
. The PacSun Stores Note is secured by a mortgage on the Company’s leasehold interest in the building and land comprising the Company’s distribution center in Olathe, Kansas, and is unconditionally guaranteed by the Company. The PacSun Stores Note does not contain any financial covenants. PacSun Stores paid a prepayment fee to Anico equal to
1.00%
of the principal amount of the PacSun Stores Note on the closing date of the transaction. As a result, PacSun Stores may prepay the PacSun Stores Note, in whole, but not in part, at any time without penalty upon
30 days
prior written notice to Anico.
As of
May 3, 2014
, the remaining aggregate principal payments due under the Term Loan and the Mortgage Debt are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2014
|
|
2015
|
|
2016
|
|
2017
|
|
Total
|
Mortgage Debt
|
$
|
464
|
|
|
$
|
655
|
|
|
$
|
699
|
|
|
$
|
26,010
|
|
|
$
|
27,828
|
|
Term Loan
(1)
|
—
|
|
|
—
|
|
|
70,293
|
|
|
—
|
|
|
70,293
|
|
Total
|
$
|
464
|
|
|
$
|
655
|
|
|
$
|
70,992
|
|
|
$
|
26,010
|
|
|
$
|
98,121
|
|
|
|
|
Less: Term Loan discount
|
|
(10,858
|
)
|
|
|
|
Less: current portion of long-term debt
|
|
(624
|
)
|
|
|
|
Total long-term debt
|
|
$
|
86,639
|
|
(1)
Upon maturity of the Term Loan,
$26.7 million
of PIK interest will become due and payable, of which
$11.6 million
is accrued and included in other current liabilities as of
May 3, 2014
.
The Company recorded interest expense of
$3.9 million
and
$3.5 million
during the
first
quarter of fiscal 2014 and 2013, respectively.
8. INCOME TAXES
The provisions codified within ASC 740 require companies to assess whether valuation allowances should be established against their deferred tax assets based on consideration of all available evidence using a “more likely than not” standard. In accordance with ASC 740, a
full valuation allowance was established during the fourth quarter of fiscal 2009 and continues to be maintained on all federal and the majority of state deferred tax assets
. Remaining net state deferred tax assets of approximately
$4 million
were not reserved as the Company concluded it is more likely than not that these net deferred tax assets would be utilized before expiration. The Company has discontinued recognizing federal and certain state income tax benefits until it is determined that it is more likely than not that the Company will generate sufficient taxable income to realize the deferred income tax assets.
The Company continues to monitor whether an ownership change has occurred under Internal Revenue Code Section 382 (“Section 382”). Based on available information at the reporting date, the Company believes it has not experienced an ownership change through the quarter ended
May 3, 2014
. The determination of whether or not an ownership change under Section 382 has occurred requires the Company to evaluate certain acquisitions and dispositions of ownership interests over a rolling
three
-year period. As a result, future acquisitions and dispositions could result in an ownership change of the Company under Section 382. If an ownership change were to occur, the Company’s ability to utilize federal net operating loss carryforwards could be significantly limited.
9. SHAREHOLDERS’ EQUITY
Preferred Stock
In conjunction with the Term Loan, the Company issued the Series B Preferred to an affiliate of Golden Gate Capital which, based on the initial conversion ratio, gives that affiliate the right to purchase up to
13.5 million
shares of the Company’s common stock. The Series B Preferred shares have an exercise price initially equal to
$1.75
per share of the Company’s underlying common stock. The initial holder of the Series B Preferred is entitled to customary registration rights with respect to the underlying common stock. See Note 10, “Fair Value Measurements – Recurring Fair Value Measurements” for further discussion on the accounting treatment of the Series B Preferred.
Stock-Based Compensation
The Company maintains
two
stock-based incentive plans: (1) the 2005 Performance Incentive Plan (the “Performance Plan”) and (2) the amended and restated Employee Stock Purchase Plan (the “ESPP”). The types of awards that may be granted under the Performance Plan include stock options, stock appreciation rights, restricted stock, and other forms of awards granted or denominated in the Company’s common stock or units of the Company’s common stock. Persons eligible to receive awards under the Performance Plan include officers or employees of the Company or any of its subsidiaries, directors of the Company and certain consultants and advisors to the Company or any of its subsidiaries. The vesting of awards under the Performance Plan is determined at the date of grant. Each award expires on a date determined at the date of grant; however, the maximum term of options and stock appreciation rights under the Performance Plan is
ten
years after the grant date of the award. As of
May 3, 2014
, the maximum number of shares of the Company’s common stock that was available for award grants under the Performance Plan was
2.7 million
shares. Any shares subject to awards under prior stock plans that are canceled, forfeited or otherwise terminate without having vested or been exercised, as applicable, will become available for future award grants under the Performance Plan. The Performance Plan will terminate on
March 22, 2015
, unless terminated earlier by the Company’s Board of Directors.
The Company accounts for stock-based compensation expense in accordance with ASC Topic 718, “Stock Compensation” (“ASC 718”). The Company uses the Black-Scholes option-pricing model to estimate the grant date fair value of its stock options. Forfeitures are estimated at the date of grant based on historical rates and reduce the compensation expense to be recognized during the vesting period. The expected term of options granted is derived primarily from historical data on employee exercises adjusted for expected changes to option terms, if any. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the date of grant. Expected volatility is based primarily on the historical volatility of the Company’s common stock. The Company records stock-based compensation expense using the straight-line method over the vesting period, which is generally
three
to
four years
. The Company’s stock-based awards generally begin vesting
one year
after the grant date and, for stock options, expire in
seven
to
ten years
or
three months
after termination of employment with the Company. The Company’s stock-based compensation expense resulted from awards of stock options, restricted stock, and stock appreciation rights, as well as from shares issued under the ESPP.
Stock Options
Under the Performance Plan, incentive and nonqualified stock options have been granted to employees and directors to purchase common stock at prices equal to the fair value of the Company’s shares at the respective grant dates. No stock options were granted by the Company during the
first quarter
of fiscal 2014 or fiscal 2013. A summary of stock option (incentive and nonqualified) activity for the
first quarter
of fiscal 2014 is presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
Weighted-
Average
Exercise
Price
|
|
Weighted-
Average
Remaining
Contractual
Term (Yrs.)
|
|
Aggregate
Intrinsic
Value
($000s)
|
Outstanding at February 1, 2014
|
2,209,379
|
|
|
$
|
5.11
|
|
|
|
|
|
Granted
|
—
|
|
|
—
|
|
|
|
|
|
Exercised
|
—
|
|
|
—
|
|
|
|
|
|
Forfeited or expired
|
(92,303
|
)
|
|
13.32
|
|
|
|
|
|
Outstanding at May 3, 2014
|
2,117,076
|
|
|
$
|
4.75
|
|
|
2.4
|
|
$
|
150
|
|
Vested and expected to vest at May 3, 2014
|
2,114,720
|
|
|
$
|
4.76
|
|
|
2.4
|
|
$
|
148
|
|
Exercisable at May 3, 2014
|
2,051,112
|
|
|
$
|
4.82
|
|
|
2.4
|
|
$
|
128
|
|
There were
4,500
stock options exercised during the
first quarter
of fiscal 2013 and
none
exercised during the first quarter of fiscal 2014, respectively. The total intrinsic value of options exercised during the
first quarter
of fiscal 2013 was immaterial.
Restricted Stock Awards
A summary of service-based restricted stock awards activity under the Performance Plan for the
first quarter
of fiscal 2014 is presented in the following table. Except as described below, such restricted stock awards contain a service-based restriction as to vesting. These awards generally vest over
4 years
with
25%
of the grant vesting each year on the anniversary of the grant date.
|
|
|
|
|
|
|
|
|
Shares
|
|
Weighted-
Average
Grant-Date
Fair Value
|
Outstanding at February 1, 2014
|
1,319,571
|
|
|
$
|
2.13
|
|
Granted
|
50,000
|
|
|
2.99
|
|
Vested
|
(378,484
|
)
|
|
2.26
|
|
Forfeited
|
(59,638
|
)
|
|
2.57
|
|
Outstanding at May 3, 2014
|
931,449
|
|
|
$
|
2.10
|
|
The weighted-average grant-date fair value per share of service-based restricted stock awards granted during the
first quarter
of fiscal 2014 and 2013 was
$2.99
and
$2.16
, respectively. The total fair value of awards vested during the
first quarter
of fiscal 2014 and 2013 was
$1.2 million
and
$1.0 million
, respectively.
During the
first quarter
of fiscal 2012, the Company granted
675,000
performance-based restricted stock awards which only vest upon the achievement of certain financial targets. The weighted-average grant-date fair value per share of performance-based restricted stock awards granted during fiscal 2012 was
$1.77
. There were no performance-based restricted stock awards granted in the
first quarter
of fiscal 2014.
Restricted Stock Units
A summary of restricted stock units activity under the Performance Plan for the
first quarter
of fiscal 2014 is presented below. Restricted stock units contain a service-based restriction as to vesting. These awards generally vest
100%
on the first anniversary of the grant date.
|
|
|
|
|
|
|
|
|
Shares
|
|
Weighted-
Average
Grant-Date
Fair Value
|
Outstanding at February 1, 2014
|
122,480
|
|
|
$
|
3.47
|
|
Granted
|
—
|
|
|
—
|
|
Vested
|
—
|
|
|
—
|
|
Forfeited
|
—
|
|
|
—
|
|
Outstanding at May 3, 2014
|
122,480
|
|
|
$
|
3.47
|
|
Stock-based compensation expense recognized related to nonvested stock options, restricted stock awards and restricted stock units during the
first
quarter of fiscal 2014 and 2013 was
$0.5 million
and
$1.0 million
, respectively. At
May 3, 2014
, the Company had approximately
$2.0 million
of stock-based compensation cost related to nonvested stock options, service-based restricted stock awards, performance-based restricted stock awards, and restricted stock units expected to be recognized over a weighted-average period of approximately
2.2 years
.
Employee Stock Purchase Plan (“ESPP”)
The Company’s ESPP provides a method for Company employees to voluntarily purchase Company common stock at a
10%
discount from fair market value as of the beginning or the end of each purchasing period, whichever is lower. Historically, the Company's purchase period has been equal to
six months
; however, following the June 2013 ESPP purchase, the Company extended the purchase period to
one year
. The ESPP covers substantially all employees who have
three months
of service with the Company, excluding senior executives. The ESPP is intended to constitute an “employee stock purchase plan” within the meaning of Section 423 of the Internal Revenue Code of 1986, as amended. On March 20, 2014, the Board of Directors approved an amendment to the ESPP to increase the number of authorized shares thereunder from 2.1 million shares to 2.5 million shares. Such amendment was approved by the shareholders at the 2014 annual meeting of shareholders.
10. FAIR VALUE MEASUREMENTS
The Company measures its financial assets and liabilities at fair value on a recurring basis and measures its nonfinancial assets and liabilities at fair value as required or permitted.
Fair value is defined as the price that would be received pursuant to the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. In order to determine the fair value of certain assets and liabilities, the Company applies the three-level hierarchy of valuation techniques based upon whether the inputs reflect assumptions other market participants would use based upon market data obtained from independent sources (observable inputs) or reflect the Company’s assumptions of market participant valuation (unobservable inputs) and requires the use of observable inputs if such data is available without undue cost and effort. The hierarchy is as follows:
|
|
•
|
Level 1
— quoted prices for identical instruments in active markets.
|
|
|
•
|
Level 2
— inputs other than Level 1 inputs, which are observable either directly or indirectly.
|
|
|
•
|
Level 3
— unobservable inputs.
|
Level 3 assumptions are, by their nature, inherently uncertain and the effect of changes in estimates may result in a significantly lower or higher fair value measurement.
Recurring Fair Value Measurements
Derivative Liability
The Series B Preferred shares are required to be measured at fair value each reporting period. The fair value of the Series B Preferred shares was estimated using an option-pricing model that requires Level 3 inputs, which are highly subjective and determined using the following significant assumptions:
|
|
|
|
|
|
May 3, 2014
|
|
May 4, 2013
|
Stock price
|
$2.79
|
|
$2.81
|
Conversion price
|
$1.75
|
|
$1.75
|
Expected volatility
|
75%
|
|
69%
|
Expected term (in years)
|
7.6
|
|
8.6
|
Risk free interest rate
|
2.20%
|
|
1.48%
|
Expected dividends
|
$—
|
|
$—
|
The following table presents the activity recorded for the derivative liability during the
first quarter
s ended:
|
|
|
|
|
|
|
|
|
|
May 3, 2014
|
|
May 4, 2013
|
|
(In thousands)
|
Beginning balance
|
$
|
30,720
|
|
|
$
|
20,082
|
|
(Gain) loss on change in fair value
|
(1,225
|
)
|
|
9,290
|
|
Ending balance
|
$
|
29,495
|
|
|
$
|
29,372
|
|
Changes in the fair value of the derivative liability are included in (gain) loss on derivative liability in the accompanying Condensed Consolidated Statement of Operations and Comprehensive Operations.
Non-Recurring Fair Value Measurements
On a non-recurring basis, using a discounted cash flow model, the Company measures certain of its long-lived assets at fair value based on Level 3 inputs including, but not limited to, comparable store sales and margin growth, projected operating costs based primarily on historical trends, and an estimated weighted-average cost of capital rate. During the
first quarter
of fiscal 2014 and 2013 the Company recorded
$0.8 million
and
$0.9 million
of impairment charges, respectively, in the accompanying Condensed Consolidated Statements of Operations and Comprehensive Operations.
11. COMMITMENTS AND CONTINGENCIES
Litigation
Charles Pfeiffer, individually and on behalf of other aggrieved employees vs. Pacific Sunwear of California, Inc. and Pacific Sunwear Stores Corp., Superior Court of California, County of Riverside, Case No. 1100527.
On January 13, 2011, the plaintiff in this matter filed a lawsuit against the Company under California’s private attorney general act alleging violations of California’s wage and hour, overtime, meal break and rest break rules and regulations, among other things. The complaint seeks an unspecified amount of damages and penalties. The Company has filed an answer denying all allegations regarding the plaintiff’s claims and asserting various defenses. The Company is currently in the discovery phase of this case. As the ultimate outcome of this matter is uncertain, no amounts have been accrued by the Company as of the date of this report. Depending on the actual outcome of this case, provisions could be recorded in the future which may have a material adverse effect on the Company’s operating results.
Tamara Beeney, individually and on behalf of other members of the general public similarly situated vs. Pacific Sunwear of California, Inc. and Pacific Sunwear Stores Corporation, Superior Court of California, County of Orange, Case No. 30-2011-00459346-CU-OE-CXC.
On March 18, 2011, the plaintiff in this matter filed a putative class action lawsuit against the Company alleging violations of California’s wage and hour, overtime, meal break and rest break rules and regulations, among other things. The complaint seeks class certification, the appointment of the plaintiff as class representative, and an unspecified amount of damages and penalties. The Company has filed an answer denying all allegations regarding the plaintiff’s claims and asserting various defenses. On February 21, 2014, the plaintiff filed her motion to certify a class with respect to several claims. The Company’s opposition to such motion must be filed on or before June 30, 2014. A hearing on the plaintiff’s motion will be held on August 27, 2014. As the ultimate outcome of this matter is uncertain, no amounts have been accrued by the Company as of the date of this report. Depending on the actual outcome of this case, provisions could be recorded in the future which may have a material adverse effect on the Company’s operating results.
The Company is also involved from time to time in other litigation incidental to its business. The Company currently cannot assess whether the outcome of current litigation will likely have a material adverse effect on its results of operations or financial condition and, from time to time, the Company may make provisions for probable litigation losses. Depending on the actual outcome of pending litigation, charges in excess of any provisions could be recorded in the future, which may have a material adverse effect on the Company’s operating results.
Indemnities, Commitments and Guarantees
During the normal course of business, the Company agreed to certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These indemnities, commitments and guarantees include those given to various lessors in connection with facility leases for certain claims arising from such facility or lease and indemnities to directors and officers of the Company to the maximum extent permitted under the laws of the State of California. The duration of these indemnities, commitments and guarantees varies, and in certain cases, is indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments the Company could be obligated to make. The Company has not recorded any liability for these indemnities, commitments and guarantees in the accompanying Condensed Consolidated Balance Sheets other than as disclosed below.
Letters of Credit
The Company has issued guarantees in the form of commercial letters of credit, of which there were approximately
$10 million
and
$11 million
outstanding at
May 3, 2014
and
May 4, 2013
respectively, as security for merchandise shipments from overseas. All in-transit merchandise covered by letters of credit is accrued for in accounts payable.
12. SEGMENT REPORTING
The Company operates exclusively in the retail apparel industry. The Company designs, produces and distributes clothing and related products catering to teens and young adults through its primarily mall-based PacSun retail stores. The Company has identified
three
operating segments: PacSun stores, PacSun Outlet stores and pacsun.com. The three operating segments have been aggregated into
one
reportable segment based on the similar nature of products sold, production, merchandising and distribution processes involved, target customers, and economic characteristics among the three operating segments.
13. DISCONTINUED OPERATIONS
In accordance with ASC Topic 205, “Presentation of Financial Statements- Discontinued Operations” (“ASC 205”), the Company has presented the results of operations of its closed stores as discontinued operations for all periods presented. The Company closed
one
and
seven
underperforming stores in the
first
quarters of fiscal 2014 and 2013, respectively. If the cash flow of the closed store was determined not to be significant to ongoing operations, and the cash inflows of nearby stores were not expected to increase significantly, the results of operations of the closed store are included in discontinued operations. The following table details the operating results included in discontinued operations for the periods presented:
|
|
|
|
|
|
For the First Quarter Ended
|
|
May 4, 2013
|
Net sales
|
$
|
3,486
|
|
Cost of goods sold, including buying, distribution and occupancy costs
|
2,563
|
|
Gross margin
|
923
|
|
Selling, general and administrative expenses
|
1,048
|
|
Operating loss
|
(125
|
)
|
Income taxes
|
2
|
|
Loss from discontinued operations
|
$
|
(127
|
)
|