NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation and Description of the Business
Corporate Structure
Torrid Holdings Inc. is a Delaware corporation formed on October 29, 2019 and capitalized on February 20, 2020. Sycamore Partners Management, L.P. ("Sycamore") owns a majority of the voting power of Torrid Holdings Inc.'s outstanding common stock. Prior to the IPO (as defined below), Torrid Holdings Inc. was a wholly owned subsidiary of Torrid Holding LLC, which is majority-owned by investment funds managed by Sycamore. Torrid Parent Inc. is a Delaware corporation formed on June 4, 2019 and is a wholly owned subsidiary of Torrid Holdings Inc. Torrid Intermediate LLC, formerly known as Torrid Inc., is a Delaware limited liability company formed on June 18, 2019 and a wholly owned subsidiary of Torrid Parent Inc. Torrid LLC is a wholly owned subsidiary of Torrid Intermediate LLC. Substantially all of Torrid Holdings Inc.'s financial position, operations and cash flows are generated through its wholly owned indirect subsidiary, Torrid LLC.
Throughout these financial statements, the terms "Torrid," "we," "us," "our," the "Company" and similar references refer to Torrid Holdings Inc. and its consolidated subsidiaries.
Reorganization
On July 1, 2021, Torrid Holding LLC, our then parent, completed a reorganization pursuant to which (i) Torrid Holding LLC contributed, assigned, transferred and delivered its issued and outstanding equity interest in Torrid Parent Inc. to Torrid, and (ii) Torrid assumed the obligations of Torrid Holding LLC under the related party promissory notes due to Torrid Parent Inc. (together, the "Reorganization"). The Reorganization was accounted for as a combination of entities under common control in accordance with subsections of Accounting Standards Codification ("ASC") 805-50, Business Combinations ("ASC 805-50"). Consequently, the equity interests of Torrid Parent Inc. contributed by Torrid Holding LLC to Torrid were recorded at historical carrying amounts and our financial position, results of operations and cash flows prior to the Reorganization have been adjusted to reflect the retrospective combination of the entities for all periods presented as if the combination had been in effect since the inception of common control.
Stock Split
On June 22, 2021, Torrid's stockholder approved an amendment to Torrid's certificate of incorporation to (i) effect a 110,000-for-1 stock split of all shares of the issued and outstanding common stock, which was effected on June 22, 2021 and (ii) authorize 5.0 million shares of preferred stock. All share and per-share data in the consolidated financial statements and notes to the consolidated financial statements has been retroactively adjusted to reflect the stock split for all periods presented. The par value of the common stock was not adjusted as a result of the stock split.
Initial Public Offering
Our registration statement on Form S-1 related to our initial public offering ("IPO") was declared effective on June 30, 2021, and our common stock began trading on the New York Stock Exchange on July 1, 2021. On July 6, 2021, subsequent to the Reorganization, we completed the IPO and certain of our shareholders sold 12,650,000 shares of common stock at a public offering price of $21.00 per share, including 1,650,000 shares of common stock after full exercise of the underwriters' option, for net proceeds of $248.4 million, after deducting underwriting discounts of $17.3 million. The offering costs of approximately $6.0 million were borne by us. We did not receive any proceeds from the sale of our shares of common stock by the selling stockholders.
Fiscal Year
Our fiscal year ends on the Saturday nearest to January 31 and each fiscal year is generally comprised of four 13-week quarters (although in years with 53 weeks, the fourth quarter is comprised of 14 weeks). Fiscal years 2022, 2021 and 2020 are 52-week years. Fiscal years are identified according to the calendar year in which they begin. For example, references to "fiscal year 2022" or similar references refer to the fiscal year ended January 28, 2023.
Description of Business
We are a direct-to-consumer brand of apparel, intimates and accessories targeting the 25- to 40-year old woman who wears sizes 10 to 30. We generate revenues primarily through our e-Commerce platform www.torrid.com and our stores in the United States of America, Puerto Rico and Canada.
COVID-19
Our business operations, including net sales, were substantially affected by COVID-19 in fiscal year 2020 and there continues to be uncertainty regarding the extent of future impacts of COVID-19 on our business, including the duration and impact on overall customer demand. A resurgence in the pandemic or the emergence of new variants of the coronavirus could have a negative impact on our business.
Note 2. Summary of Significant Accounting Policies
Change in Accounting Principle
In the fourth quarter of fiscal year 2022, we made a voluntary change in our accounting policy regarding the classification of royalties, profit-sharing and marketing and promotional funds ("PLCC Funds") we receive pursuant to the Credit Card Agreement (as defined below). Historically, we recorded PLCC Funds as a reduction to selling, general and administrative expenses in the consolidated statements of operations and comprehensive income (loss). Under the new policy, we record PLCC Funds in net sales in the consolidated statements of operations and comprehensive income (loss). This reclassification does not have any impact on income from operations, income before provision for income taxes, net income (loss) or earnings (loss) per share and there was no cumulative effect to stockholders’ deficit or net assets. This reclassification has been retrospectively applied to all prior periods presented.
The recognition of PLCC Funds in net sales is preferable because it will enhance the comparability of our financial statements with those of many of our industry peers and provide greater transparency into performance metrics relevant to our industry by showing the gross impact of the funds received as net sales instead of as a reduction to selling, general and administrative expenses.
The impact of this change in accounting principle is reflected in the tables below (in thousands):
| | | | | | | | | | | | | | | | | |
| Fiscal Year Ended January 29, 2022 |
| As Previously Reported | | Change in Accounting Principle | | As Adjusted |
Net sales | $ | 1,278,794 | | | $ | 18,477 | | | $ | 1,297,271 | |
Cost of goods sold | 759,826 | | | — | | | 759,826 | |
Gross profit | 518,968 | | | 18,477 | | | 537,445 | |
Selling, general and administrative expenses | 420,932 | | | 18,477 | | | 439,409 | |
Marketing expenses | 52,654 | | | — | | | 52,654 | |
Income from operations | $ | 45,382 | | | $ | — | | | $ | 45,382 | |
| | | | | | | | | | | | | | | | | |
| Fiscal Year Ended January 30, 2021 |
| As Previously Reported | | Change in Accounting Principle | | As Adjusted |
Net sales | $ | 973,514 | | | $ | 10,656 | | | $ | 984,170 | |
Cost of goods sold | 643,215 | | | — | | | 643,215 | |
Gross profit | 330,299 | | | 10,656 | | | 340,955 | |
Selling, general and administrative expenses | 222,098 | | | 10,656 | | | 232,754 | |
Marketing expenses | 51,382 | | | — | | | 51,382 | |
Income from operations | $ | 56,819 | | | $ | — | | | $ | 56,819 | |
Principles of Consolidation
The accompanying audited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The consolidated financial statements include our accounts and those of our wholly owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.
Segment Reporting
We have determined that we have one reportable segment, which includes the operation of our e-Commerce platform and stores. The single segment was identified based on how the Chief Operating Decision Maker, who we have determined to be our Chief Executive Officer, manages and evaluates performance and allocates resources. Net sales and long-lived assets related to our operations in Canada and Puerto Rico during fiscal years 2022, 2021 and 2020 and as of the end of the same periods were not material, and therefore, are not reported separately from domestic net sales and long-lived assets.
Use of Estimates
We are required to make certain estimates and assumptions in order to prepare consolidated financial statements in conformity with GAAP. Such estimates and assumptions affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities in the consolidated financial statements and accompanying notes. We believe the estimates and assumptions most critical to the preparation of our consolidated financial statements include those made in connection with revenue recognition, including accounting for estimated merchandise returns and loyalty program expenses; estimating the value of inventory; determining operating lease liabilities; and estimating share-based compensation expense. The estimation process required to prepare our consolidated financial statements requires assumptions to be made about future events and conditions, and as such, is inherently subjective and uncertain. Our actual results could differ materially from those estimates.
Concentration Risks
We consider all highly liquid investments with maturities of less than three months when purchased to be cash equivalents. All credit and debit card receivable balances are also classified as cash and cash equivalents. As of the end of fiscal years 2022 and 2021, the amounts due from third party financial institutions for these transactions classified as cash and cash equivalents totaled $8.0 million and $14.1 million, respectively. Cash and cash equivalents used primarily for working capital purposes are maintained with various major third party financial institutions in amounts which are in excess of the Federal Deposit Insurance Corporation ("FDIC") insurance limits. We are potentially exposed to a concentration of credit risk when cash and cash equivalent deposits in these financial institutions are in excess of FDIC limits. We consider the credit risk associated with these financial instruments to be minimal as cash and cash equivalents are held by financial institutions with high credit ratings and we have not historically sustained any credit losses associated with our cash and cash equivalents balances.
In addition, one supplier, MGF Sourcing US, LLC, an entity indirectly controlled by affiliates of Sycamore, accounted for approximately 15% of total net purchases in fiscal year 2022, two suppliers, one of which was MGF Sourcing US, LLC, accounted for approximately 11% of total net purchases in fiscal year 2021 and one supplier accounted for approximately 14% of total net purchases in fiscal year 2020.
Fair Value of Financial Instruments
We carry certain of our assets and liabilities at fair value in accordance with GAAP. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We consider carrying amounts of cash equivalents, accounts payable and accrued and other current liabilities to approximate fair value because of the short maturity of these financial instruments. See "Note 20—Fair Value Measurements" for more details about how we determine the fair value of our financial instruments.
Inventory
Inventory is valued at the lower of moving average cost or net realizable value. We make certain assumptions regarding net realizable value in order to assess whether our inventory is recorded properly at the lower of cost or net realizable value. These assumptions are based on historical average selling price experience, current selling price information and estimated
future selling price information. Physical inventory counts are conducted at least once during the year to determine actual inventory on hand and shrinkage. We accrue our estimated inventory shrinkage for the period between the last physical count and current balance sheet date.
Property and Equipment
Property and equipment are recorded at cost less accumulated depreciation. Major repairs and improvements are capitalized, while routine maintenance and repairs are expensed as incurred. The gross carrying amounts of property and equipment sold or retired and the related accumulated depreciation are eliminated in the year of disposal, and any resulting gains or losses are included in the consolidated statements of operations and comprehensive income (loss). Application and development costs associated with internally developed software such as salaries of employees and payments made to third parties and consultants working on the software development are capitalized. Subsequent additions, modifications or upgrades to internal-use software are capitalized only to the extent that they constitute major enhancements. Capitalized internal-use software costs are amortized using the straight-line method over their estimated useful lives, which are generally three years.
Depreciation expense is calculated using the straight-line method over the following estimated useful lives:
| | | | | | | | |
Leasehold improvements | | shorter of the 3- to 10-year estimated useful life or the respective lease term |
Furniture, fixtures and equipment | | 2 to 10 years |
Software and licenses | | 3 to 7 years |
The carrying value of property and equipment is subject to assessment for potential impairment whenever events or changes in circumstances indicate that an asset’s carrying value may not be recoverable, as further described below.
Definite-Lived Assets
We assess the carrying value of long-lived assets for potential impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. We group and evaluate long-lived assets for impairment at the individual store level, which is the lowest level at which individual cash flows can be identified. Factors we consider important that could trigger an impairment review of our stores or e-Commerce operations include significant underperformance relative to historical or projected future operating results, a significant change in the manner of the use of the asset or a significant negative industry or economic trend. If we determine the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the aforementioned factors, we test for the recoverability of the carrying value of our long-lived assets by comparing the carrying value of the asset groups to our estimated undiscounted future net cash flows attributable to the asset groups. If the carrying value of the long-lived assets is greater than the related undiscounted future net cash flows, the long-lived assets are measured for impairment. We measure the impairment by comparing the difference between the long-lived asset’s carrying value and the discounted future net cash flows attributable to the long-lived asset, which represent its fair value. We calculate the discounted future net cash flows of a store by netting future estimated sales of each store against estimated cost of goods sold, store occupancy costs and other store operating expenses such as payroll, supplies, repairs and maintenance and credit/debit card fees. Changes in these assumptions may cause the fair value to be significantly impacted. In the event future performance is lower than forecasted results, future cash flows may be lower than expected, which could result in future impairment charges. While we believe that recently opened stores will provide sufficient cash flow, material changes in financial performance could result in future store impairment charges.
Indefinite-Lived Intangible Assets
Indefinite-lived intangible assets are not amortized, but are reviewed for impairment at least annually, or more frequently when events or changes in circumstances indicate the carrying value may not be recoverable. Judgments regarding indicators of potential impairment are based on market conditions and operational performance of the business.
At the end of the third quarter of each fiscal year, we perform an impairment analysis of indefinite-lived intangible assets. We assess our indefinite-lived intangible asset for impairment using a qualitative analysis to determine whether it is more likely than not that the fair value of the asset is less than its carrying value. If it is determined that it is more likely than not that the fair value of the asset is less than its carrying amount or if a qualitative assessment is not performed, then we would perform the quantitative analysis to determine the fair value of the asset. If we conclude, based on our assessment, that the asset’s fair value is less than its carrying value, then an impairment charge is recorded in the amount of the excess.
Implementation Costs Incurred in Cloud Computing Arrangements that are Service Contracts
Our cloud computing arrangements that are service contracts primarily consist of arrangements with third party vendors for our internal use of their software applications that they host. We defer implementation costs incurred in relation to such arrangements, including costs for software application coding, configuration, integration and customization, while associated process reengineering, training, maintenance and data conversion costs are expensed. Subsequent implementation costs are deferred only to the extent that they constitute major enhancements. The short-term portion of deferred costs are included in prepaid expenses and other current assets in the consolidated balance sheets, while the long-term portion of deferred costs are included in deposits and other noncurrent assets. Amortized implementation costs incurred in cloud computing arrangements that are service contracts are recognized in selling, general and administrative expenses in the consolidated statements of operations and comprehensive income (loss) using the straight-line method over three to five years, which generally represents the noncancellable terms of the cloud computing arrangements, plus any optional renewal periods that we are reasonably certain to exercise. Deferred implementation costs are subject to assessment for potential impairment whenever events or changes in circumstances indicate that the carrying values may not be recoverable.
Loyalty Program
We operate our loyalty program, Torrid Rewards, in all our stores and on www.torrid.com. Under this program, customers accumulate points based on purchase activity and qualifying non-purchase activity and upon reaching a certain point level, customers can earn awards that may only be redeemed for merchandise. Unredeemed points typically expire after 13 months without additional purchase and qualifying non-purchase activity and unredeemed awards typically expire 45 days after issuance. We use historical redemption rates to estimate the value of future award redemptions and we recognize the estimated value of these future awards as a reduction of revenue in the consolidated statements of operations and comprehensive income (loss) in the period the points are earned by the customer. As of the end of fiscal years 2022 and 2021, we had $13.4 million and $13.5 million, respectively, in accrued loyalty program included in accrued and other current liabilities in the consolidated balance sheets. We recorded $0.1 million as a benefit to net sales in fiscal year 2022. We recorded $1.1 million and $0.3 million as a reduction of net sales in fiscal years 2021 and 2020, respectively. Future updates to the estimated liability may result in changes to net sales.
Self-Insurance
We are self-insured for certain losses related to medical and workers' compensation claims although we maintain stop loss coverage with third party insurers to limit our total liability exposure. In general, our self-insurance reserves are recorded on an undiscounted basis. The estimate of our self-insurance liability involves uncertainty since we must use judgment to estimate the ultimate cost that will be incurred to settle reported claims and unreported claims for incidents incurred but not reported as of the balance sheet date. When estimating our self-insurance liability, we consider a number of factors, which include historical claim experience and valuations provided by independent third party actuaries. While the ultimate amount of claims incurred is dependent on future developments, we believe recorded reserves are adequate to cover the future payment of claims. However, it is possible that recorded reserves may not be adequate to cover the future payment of claims. Adjustments, if any, to estimates recorded resulting from ultimate claim payments will be reflected in our consolidated statements of operations and comprehensive income (loss) in the periods in which such adjustments are known.
Comprehensive Income (Loss)
Comprehensive income (loss) includes all changes in equity during a period except those that resulted from investments by, or distributions to, stockholders. Other comprehensive (loss) income refers to revenues, expenses, gains and losses that, under GAAP, are included in comprehensive income (loss), but excluded from net income (loss) as these amounts are recorded directly as an adjustment to stockholders' deficit. Components of our comprehensive income (loss) include net income (loss) and foreign currency translation adjustments. Foreign currency translation adjustments in fiscal years 2022, 2021 and 2020 were not material.
Foreign Currency Translation
The functional currency for our wholly owned foreign subsidiaries included in these consolidated financial statements that are domiciled outside of the United States is the applicable local currency. Assets and liabilities of our foreign subsidiaries are translated into United States dollars at the exchange rate in effect on the balance sheet date. Revenues and expenses are translated at the average rate in effect during the period. Unrealized translation gains and losses are recorded as a cumulative translation adjustment, which is included in the consolidated statements of stockholders' deficit as a component of accumulated other comprehensive (loss) income. Adjustments that arise from exchange rate changes on transactions denominated in a
currency other than the local currency are included in selling, general and administrative expenses in the consolidated statements of operations and comprehensive income (loss) as incurred.
Share Repurchases
We have elected to retire shares repurchased to date. Shares retired become part of the pool of authorized but unissued shares. We have elected to record the purchase price of the retired shares in excess of par value, including transaction costs, directly as an increase in accumulated deficit.
Revenue Recognition
We recognize revenue when our performance obligations under the terms of a contract or an implied arrangement with a customer are satisfied, which is when the merchandise is transferred to the customer and the customer obtains control of it. The amount of revenue we recognize reflects the total consideration we expect to receive for the merchandise, which is the transaction price. For arrangements that contain multiple performance obligations, we allocate the transaction price to each performance obligation on a relative standalone selling price basis.
At our retail store locations, we satisfy our performance obligation and recognize revenue at the point in time when a customer takes possession of the merchandise and tenders payment at the point-of-sale register. For e-Commerce sales shipped to a customer from our distribution center, or from a retail store location (ship from store), we satisfy our performance obligation and recognize revenue upon shipment, which is the point in time the customer obtains control of the merchandise after payment has been tendered. Income we receive from customers for shipping and handling is recognized as a component of revenue upon shipment of merchandise to the customer. We satisfy our performance obligation and recognize revenue from e-Commerce sales shipped to a retail store location from our distribution center, or fulfilled from merchandise already located at a retail store location (buy-online-pickup-in-store), at the point in time when the customer retrieves the merchandise from within the retail store location or at a retail store curbside.
If a customer earns loyalty program points in connection with the retail store or e-Commerce sales transactions described above, then we have a remaining performance obligation and cannot recognize all the revenue. A portion of the revenue is allocated to the loyalty program points earned during the transaction. We satisfy our performance obligation and recognize revenue allocated to these loyalty program points and the resulting awards at the point in time when the awards are redeemed for merchandise, when we determine that they will not be redeemed, or when the awards and points expire.
We satisfy our performance obligation and recognize revenue from gift cards and store merchandise credits at the point in time when the customer presents the gift cards and store merchandise credits for redemption. Gift card breakage is income recognized due to the non-redemption of a portion of gift cards sold by us for which a liability was recorded in prior periods. We recognize estimated gift card breakage over time as a component of net sales in proportion to the pattern of rights exercised by the customer as reflected in actual gift card redemption patterns over the period. Our estimated gift card breakage rate is approximately 4%. While customer redemption patterns result in estimated gift card breakage, changes in our customers’ behavior could impact the amount that ultimately is unused and could affect the amount recognized as a component of net sales. During fiscal years 2022, 2021 and 2020, we recognized $1.0 million, $1.1 million and $0.9 million, respectively, of estimated gift card breakage as a component of net sales.
We are required to estimate certain amounts included in a contract or an implied arrangement with a customer which add variability to the transaction price. Under certain conditions, we are obligated to accept customer returns for most of our merchandise. Sales returns reduce the revenue we expect to receive for merchandise and therefore add variability to the transaction price. Based on historical return pattern experience, we reasonably estimate the amount of merchandise expected to be returned and exclude it from revenue. Similarly, losses we bear arising from uncollectible customer credit card payments are recorded as a reduction of revenue as they reduce the revenue we expect to receive for the merchandise.
We recognize a contract liability when we receive consideration from a customer before our performance obligations under the terms of a contract or an implied arrangement with the customer are satisfied. Consequently, we consider our remaining performance obligations to be representative of our contract liability, most of which is not expected to last for more than one year and has therefore been classified as current. Our contract liability balances increase as gift cards and store merchandise credits are purchased and received by the customer; and as loyalty points are earned based on purchase activity and qualifying non-purchase activity. Contract liability balances decrease as gift cards and store merchandise credits are redeemed for merchandise or when we determine that they will not be redeemed; as loyalty points expire or when we determine that they will not be converted into a loyalty award; and as loyalty awards are redeemed for merchandise or expire.
Sales taxes collected from customers and remitted directly to governmental authorities are not considered revenue and are excluded from the transaction price.
We have an agreement with a third party to provide customers with private label credit cards ("Credit Card Agreement"). Each private label credit card ("PLCC") bears the logo of the Torrid brand and can only be used at our store locations and on www.torrid.com. A third party financing company is the sole owner of the accounts issued under the PLCC program and absorbs the losses associated with non-payment by the PLCC holders and a portion of any fraudulent usage of the accounts. Pursuant to the Credit Card Agreement, we are eligible to receive royalties, profit-sharing and marketing and promotional funds from the third party financing company ("PLCC Funds") based on usage of the PLCCs. These PLCC Funds are recorded as a component of net sales in the consolidated statements of operations and comprehensive income (loss).
Cost of Goods Sold
Cost of goods sold includes: merchandise costs; freight; inventory shrinkage; payroll expenses associated with the merchandising and distribution departments; distribution center expenses, including rent, common area maintenance ("CAM") charges, real estate taxes, depreciation, utilities, supplies and maintenance; and store occupancy expenses, including rents, CAM charges, heating, ventilation and air conditioning ("HVAC") charges, real estate taxes and depreciation.
Vendor Allowances
We receive certain allowances from our vendors primarily related to damaged merchandise, markdowns and pricing. Allowances received from vendors related to damaged merchandise and pricing are reflected as a reduction of inventory in the period they are received and allocated to cost of goods sold during the period in which the items are sold. Markdown allowances received from vendors are reflected as reductions to cost of goods sold in the period they are received if the goods have been sold or marked down, or as a reduction of inventory if the goods have not yet been sold. During fiscal years 2022, 2021 and 2020, we received vendor allowances of $3.8 million, $3.5 million and $2.8 million, respectively, substantially all of which were accounted for as a reduction of cost of goods sold.
Selling, General and Administrative Expenses
Selling, general and administrative expenses include: payroll expenses associated with stores and e-Commerce; store and e-Commerce operating expenses other than store occupancy; store pre-opening costs; credit card processing fees; share-based compensation; and payroll and other expenses associated with headquarters and administrative functions.
Marketing Expenses
Marketing expenses are expensed as incurred. Costs associated with communicating advertising that has been produced, such as television and webisodes, are recorded in prepaid expenses and other current assets in the consolidated balance sheets and are expensed the first time each advertising event takes place. Marketing expenses include photographic production, television, store and brand marketing and targeted online performance marketing costs such as retargeting, paid search/product listing advertising, and social media advertisements.
Store Pre-Opening Costs
Costs incurred in connection with the opening of new stores, store remodels or relocations are expensed as incurred. We incurred $1.2 million, $0.9 million and $0.1 million of pre-opening costs in fiscal years 2022, 2021 and 2020, respectively, which are recorded in selling, general and administrative expenses in the consolidated statements of operations and comprehensive income (loss).
Shipping and Handling Costs
We classify shipping and handling costs in costs of goods sold in the consolidated statements of operations and comprehensive income (loss). We account for shipping and handling activities that occur after the customer has obtained control of merchandise as a fulfillment cost rather than an additional promised service.
Leases
We consider an agreement to be or contain a lease if it conveys us as the lessee with the right to control the use of an identified property, plant and equipment asset for a period of time in exchange for consideration. Based on these criteria, we as
the lessee have operating lease agreements with lessors for our retail stores, distribution center and headquarter office space; and vehicles and equipment; under primarily non-cancelable leases with terms ranging from approximately two to seventeen years.
Certain of our operating lease agreements contain one or more options to extend the leases at our sole discretion. However, the periods covered by the options to extend the leases of our retail stores, vehicles and equipment are not recognized as part of the associated right of use ("ROU") assets and lease liabilities, as we are not reasonably certain to exercise the options. The periods covered by the options to extend the leases of our distribution center and headquarter office space are recognized as part of the associated ROU assets and lease liabilities, as we are reasonably certain to exercise the options due to the significant effort and investment it would take to move out of these locations. Some of our operating lease agreements contain options to terminate the lease under certain conditions.
The retail space leases provide for rents based upon the greater of the minimum annual rental amounts or a percentage of annual store sales volume. Certain leases provide for increasing minimum annual rental amounts. We consider rents based upon a percentage of annual store sales volume, and other rent-related payments that generally vary because of changes in facts and circumstances (other than due to the passage of time), to be variable lease payments. Variable lease payments associated with retail space leases are recognized as occupancy costs within cost of goods sold in the consolidated statements of operations and comprehensive income (loss) in the period in which the obligation for those payments is incurred. We generally consider all other lease payments to be fixed in nature and the sum of all the discounted remaining fixed payments in the lease terms make up the lease liabilities in our consolidated balance sheet (if the lease terms are longer than 12 months).
Our operating lease agreements do not contain any residual value guarantees or restrictive covenants, and we have not entered into any sublease agreements, lease agreements with related parties, or build-to-suit arrangements that may create significant rights and obligations for us.
We discount the fixed lease payments that make up the lease liabilities using an incremental borrowing rate ("IBR"), as the rates implicit in our leases are not readily determinable. The IBR is the rate of interest that we would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. The determination of the IBR for each lease term incorporates various inputs and assumptions including our publicly available credit rating, credit spreads of other publicly traded debt issued by companies with a similar credit rating to ours and a risk-free interest rate. All inputs and assumptions and corresponding IBRs are highly subjective.
We choose not to separate nonlease components (such as CAM charges and HVAC charges), from lease components (such as fixed minimum rent payments), and instead account for each separate lease component and the nonlease components associated with that lease component as a single lease component. We do not apply Accounting Standards Update ("ASU") 2016-02, Leases, and all related guidance (ASC 842) requirements to leases that have lease terms of 12 months or less upon commencement, and instead recognize short-term lease payments, if applicable, in the consolidated statements of operations and comprehensive income (loss) on a straight-line basis over the lease term.
In response to the COVID-19 pandemic, the Financial Accounting Standards Board ("FASB") issued interpretive guidance in April 2020, which provides entities the option to elect to account for lease concessions as though the enforceable rights and obligations existed in the original lease terms. We elected this option; accordingly, we did not remeasure the lease liabilities or record a change to the ROU assets for any concessions we received for our retail store leases. Rather, deferred lease payments were recorded to operating lease liabilities until paid and lease concessions were recorded in the period they were negotiated or when the lower lease expense was paid.
Income Taxes
We account for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting bases and tax bases of assets and liabilities and are measured using the enacted tax rates expected to apply to taxable income in the periods in which the deferred tax asset or liability is expected to be realized or settled. Deferred tax assets are reduced by valuation allowances if we believe it is more likely than not that some portion or the entire deferred tax asset will not be realized.
Deferred tax assets and liabilities are measured using the enacted tax rates in effect in the years when those temporary differences are expected to reverse. The effect on deferred taxes from a change in tax rate is recognized through continuing operations in the period that includes the enactment date of the change. Changes in tax laws and rates could affect recorded deferred tax assets and liabilities in the future.
We prescribe a recognition threshold and a measurement attribute for the consolidated financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. We include interest and penalties related to uncertain tax positions in income tax expense in the consolidated statements of operations and comprehensive income (loss).
The amount of income taxes we pay may be subject to periodic audits by the Internal Revenue Service ("IRS") and other taxing authorities. These audits may challenge certain of our tax positions, such as the timing and amount of deductions and allocation of taxable income to various jurisdictions.
We recognize tax liabilities for our estimate of the potential outcome of any uncertain tax issue, which is subject to our assessment of the relevant risks, facts and circumstances existing at the time, and we adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from the current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense and the effective tax rate in the period in which the new information becomes available.
As of the end of fiscal year 2022, we had accumulated undistributed earnings and profits of our foreign subsidiary of approximately $8.1 million. We continue to treat undistributed earnings of our foreign subsidiary as indefinitely reinvested according to our current operating plans and no deferred tax liability has been recorded for potential future taxes related to such earnings. According to current tax law, any future dividends paid from our foreign subsidiary will not be subject to income tax in the United States, except for withholding taxes and state taxes, which are not material. We have made a determination on our accounting policy choice to treat taxes related to Global Intangible Low Taxed Income ("GILTI") as a period cost.
Share-Based Compensation
On June 22, 2021, in connection with our IPO, our board of directors adopted the Torrid Holdings Inc. 2021 Long-Term Incentive Plan (the "2021 LTIP"), for employees, consultants and directors. The 2021 LTIP provides for the grant of stock options, restricted stock and restricted stock units ("RSUs"), among other types of awards, all of which are accounted for in accordance with ASC 718, Compensation-Stock Compensation. The Company measures share-based compensation cost at the grant date based on the fair value of the award and recognizes share-based compensation cost as expense over the vesting period. As share-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest, the amount of expense has been reduced for actual forfeitures as they occur.
Stock options are valued utilizing a Black-Scholes option pricing model ("OPM"). The OPM used to value the stock options incorporates various assumptions, including dividend yield, expected volatility, risk-free interest rate and expected term of the stock options. The expected volatility is estimated based on the historical volatility of a select peer group of similar publicly traded companies for a term that is consistent with the expected term of the stock options. The risk-free interest rates are based on the U.S. Treasury constant maturity interest rate whose term is consistent with the expected term of the stock options. The expected term of the stock options represents the estimated period of time until exercise and is calculated using the simplified method which deems the term to be the average of the time-to-vesting and the contractual life of the options. The grant date fair value of restricted stock and RSUs is based on the closing price per share of our common stock on the grant date. We recognize compensation expense for time-based awards on a straight-line basis and for performance-based awards on the graded-vesting method over the vesting period of the awards.
Prior to the IPO, Torrid Holding LLC issued 13,660,000 Class A, Class B, Class C, Class D, Class E, Class F, Class G, Class H and Class J Torrid incentive units, in the aggregate, net of forfeitures, to certain members of our management. These incentive units were intended to constitute profits interests.
We recognized the impact of share-based compensation associated with incentive units issued by Torrid Holding LLC in selling, general and administrative expenses in the consolidated statements of operations and comprehensive income (loss). The share-based compensation expense and related capital contribution are reflected in our consolidated financial statements as these awards were deemed to be for our benefit. The intent of the incentive units was to provide profit-sharing opportunities to management rather than equity ownership in our then parent, Torrid Holding LLC. The incentive units did not have any voting or distribution rights and contained a repurchase feature, whereby upon termination, Torrid Holding LLC had the right to purchase from former employees any or all of the vested incentive units at fair value. In addition, although the fair value of the incentive units was determined through an option pricing methodology that utilized the possible equity values of Torrid Holding LLC, the settlement amounts and method of settlement of the incentive units were at the discretion of our board of
directors. Based on these aforementioned features and characteristics, we determined that the incentive units were in-substance liabilities accounted for as liability instruments in accordance with ASC 710, Compensation. The incentive units were remeasured based on the fair value of the awards at the end of each reporting period. We recorded the expense associated with changes in the fair value of these incentive units as a capital contribution from our former parent, Torrid Holding LLC, as our former parent is the legal obligor for the incentive units.
The incentive units were valued utilizing a contingent claims analysis ("CCA") methodology based on a Black-Scholes OPM. Under the OPM, each class of incentive units was modeled as a call option with a unique claim on the assets of Torrid Holding LLC. The characteristics of each class of incentive units determined the uniqueness of the claim on the assets of Torrid Holding LLC. The OPM used to value the incentive units incorporated various assumptions, including the time to liquidity event, equity volatility and risk-free interest rate of return. Equity volatility was based on the historical volatilities of comparable publicly traded companies for the time horizon equal to the time to the anticipated liquidity event; and the risk-free interest rate was for a term corresponding to the time to liquidity event. The assumptions underlying the valuation of the incentive units represented our best estimates, which involved inherent uncertainties and the application of our judgment. The most recent remeasurement of the fair value of the incentive units utilizing the CCA methodology was performed as of May 1, 2021. Following the pricing of our IPO, the vested portion of the incentive units was exchanged for shares of our common stock of an equivalent fair value as the vested incentive units and the unvested portion was cancelled. As such, the fair value of these incentive units is no longer recognized in our consolidated statements of operations and comprehensive income (loss).
Earnings Per Share
Basic earnings per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted earnings per share is applicable only in periods of net income and is computed by dividing net income by the weighted average number of common shares outstanding for the period and potentially dilutive common share equivalents outstanding for the period. Periods of net loss require the diluted computation to be the same as the basic computation, as all potentially dilutive securities would be anti-dilutive.
Employee Benefit Plan
On August 1, 2015, we adopted the Torrid 401(k) Plan ("401(k) Plan"). All employees who have been employed by us for at least 200 hours and are at least 21 years of age are eligible to participate. Employees may contribute up to 80% of their eligible compensation to the 401(k) Plan, subject to a statutorily prescribed annual limit. We may at our discretion contribute certain amounts to eligible employees' accounts. From March 2020 to July 2020, we suspended our contributions to eligible employees' accounts as a precautionary measure in light of uncertainty resulting from COVID-19. During fiscal years 2022 and 2021, we contributed 50% of the first 4% of participants' eligible contributions into their 401(k) Plan accounts. Except for the period during fiscal year 2020 in which we suspended our contributions to eligible employees' accounts in response to COVID-19, we contributed 50% of the first 4% of participants' eligible contributions into their 401(k) Plan accounts. During fiscal years 2022, 2021 and 2020, we contributed $0.8 million, $0.7 million and $0.4 million, respectively, to eligible employees' Torrid 401(k) Plan accounts.
Deferred Compensation Plan
On August 1, 2015, we established the Torrid Management Deferred Compensation Plan ("Deferred Compensation Plan") for the purpose of providing highly compensated employees a program to meet their financial planning needs. The Deferred Compensation Plan provides participants with the opportunity to defer up to 80% of their base salary and up to 100% of their annual earned bonus, all of which, together with the associated investment returns, are 100% vested from the outset. The Deferred Compensation Plan is designed to be exempt from most provisions of the Employee Retirement Security Act of 1974, as amended. All deferrals and associated earnings are our general unsecured obligations. We may at our discretion contribute certain amounts to eligible employees' accounts. From March 2020 to July 2020, we suspended our contributions to eligible employees' accounts as a precautionary measure in light of uncertainty resulting from COVID-19. During fiscal years 2022 and 2021, to the extent participants were ineligible to receive contributions from participation in our 401(k) Plan, we contributed 50% of the first 4% of participants' eligible contributions into their Deferred Compensation Plan accounts. Except for the period during fiscal year 2020 in which we suspended our contributions to eligible employees' accounts in response to COVID-19, we contributed 50% of the first 4% of participants' eligible contributions into their Deferred Compensation Plan accounts. As of January 28, 2023 and January 29, 2022, we did not have any assets of the Deferred Compensation Plan and the associated liabilities were $5.6 million and $7.2 million, respectively, included in our consolidated balance sheets. As of January 28, 2023, $1.4 million of the $5.6 million Deferred Compensation Plan liabilities were included in accrued and other current liabilities in our consolidated balance sheet. As of January 29, 2022, $0.4 million of the $7.2 million Deferred Compensation Plan liabilities were included in accrued and other current liabilities in our consolidated balance sheet.
Note 3. Accounting Standards
Recently Adopted Accounting Standards in Fiscal Year 2022
In December 2022, the FASB issued Accounting Standards Update ("ASU") No. 2022-06, Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848. This ASU defers the sunset provision originally set forth by ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting for the LIBOR cessation ("Topic 848"). Previously, the FASB had issued accounting guidance set forth by Topic 848 to ease the potential burden in accounting for the effects of reference rate reform on financial reporting as it relates to contracts, hedging relationships and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The sunset provision was set for December 31, 2022 and is now changed to December 31, 2024. The amendments in this update are effective for all entities upon issuance of ASU No. 2022-06. Our adoption of this guidance in the fourth quarter of fiscal year 2022 did not have a material impact on our consolidated financial statements.
Accounting Standards Not Yet Adopted
We have considered all recent accounting pronouncements and have concluded that there are no recent accounting pronouncements not yet adopted that are applicable to us, based on current information.
Note 4. Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consist of the following (in thousands):
| | | | | | | | | | | |
| January 28, 2023 | | January 29, 2022 |
Prepaid and other information technology expenses | $ | 9,048 | | | $ | 5,692 | |
Prepaid advertising | 1,068 | | | 700 | |
Prepaid casualty insurance | 2,557 | | | 3,050 | |
Other | 7,377 | | | 5,244 | |
Prepaid expenses and other current assets | $ | 20,050 | | | $ | 14,686 | |
Note 5. Property and Equipment
Property and equipment are summarized as follows (in thousands):
| | | | | | | | | | | |
| January 28, 2023 | | January 29, 2022 |
Property and equipment, at cost | | | |
Leasehold improvements | $ | 176,222 | | | $ | 168,084 | |
Furniture, fixtures and equipment | 115,618 | | | 108,261 | |
Software and licenses | 14,140 | | | 15,356 | |
Construction-in-progress | 2,956 | | | 4,743 | |
| 308,936 | | | 296,444 | |
Less: Accumulated depreciation and amortization | (195,323) | | | (168,879) | |
Property and equipment, net | $ | 113,613 | | | $ | 127,565 | |
We recorded depreciation and amortization expense related to our property and equipment in the amounts of $36.1 million, $35.2 million and $33.1 million during fiscal years 2022, 2021 and 2020, respectively.
Note 6. Implementation Costs Incurred in Cloud Computing Arrangements that are Service Contracts
We defer implementation costs incurred in cloud computing arrangements that are service contracts. The short-term portion of deferred implementation costs incurred in cloud computing arrangements that are service contracts are included in prepaid expenses and other current assets in the consolidated balance sheets, while the long-term portion of these deferred costs are included in deposits and other noncurrent assets.
Deferred implementation costs incurred in cloud computing arrangements that are service contracts are summarized as follows (in thousands):
| | | | | | | | | | | |
| January 28, 2023 | | January 29, 2022 |
Internal use of third party hosted software, gross | $ | 16,612 | | | $ | 11,877 | |
Less: Accumulated amortization | (6,772) | | | (3,892) | |
Internal use of third party hosted software, net | $ | 9,840 | | | $ | 7,985 | |
During fiscal years 2022, 2021 and 2020, we amortized approximately $2.9 million, $1.7 million and $1.1 million, respectively, of implementation costs incurred in cloud computing arrangements that are service contracts.
Note 7. Intangible Assets
Indefinite-lived intangible assets are summarized as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| January 28, 2023 | | January 29, 2022 |
| Gross | | Accumulated Amortization | | Net Book Value | | Gross | | Accumulated Amortization | | Net Book Value |
Indefinite-lived intangible assets: | | | | | | | | | | | |
Trade name | $ | 8,400 | | | $ | — | | | $ | 8,400 | | | $ | 8,400 | | | $ | — | | | $ | 8,400 | |
Total | $ | 8,400 | | | $ | — | | | $ | 8,400 | | | $ | 8,400 | | | $ | — | | | $ | 8,400 | |
We performed our annual impairment assessment of our trade name at the end of the third quarter of fiscal year 2022. We performed a qualitative assessment and determined that it is not more likely than not that the fair value of our trade name is less than its carrying value, which indicated there was no impairment.
Note 8. Accrued and Other Current Liabilities
Accrued and other current liabilities consist of the following (in thousands):
| | | | | | | | | | | |
| January 28, 2023 | | January 29, 2022 |
Accrued inventory-in-transit | $ | 20,878 | | | $ | 37,156 | |
Accrued payroll and related expenses | 20,232 | | | 31,194 | |
Accrued loyalty program | 13,389 | | | 13,481 | |
Gift cards | 12,300 | | | 11,695 | |
Accrued sales return allowance | 6,562 | | | 4,347 | |
Accrued freight | 5,840 | | | 6,048 | |
Accrued marketing | 4,103 | | | 5,419 | |
Accrued sales and use tax | 3,666 | | | 4,136 | |
Accrued lease costs | 3,593 | | | 5,242 | |
Accrued self-insurance liabilities | 2,853 | | | 2,891 | |
Accrued purchases of property and equipment | 2,825 | | | 2,208 | |
Deferred revenue | 1,471 | | | 2,879 | |
Term loan interest payable | 188 | | | 1,762 | |
Other | 10,947 | | | 10,250 | |
Accrued and other current liabilities | $ | 108,847 | | | $ | 138,708 | |
Note 9. Leases
Our lease costs reflected in the tables below include minimum base rents, CAM charges and HVAC charges. We recognize such lease costs in the applicable expense category in either cost of goods sold, or selling, general and administrative expenses in the consolidated statements of operations and comprehensive income (loss).
Our lease costs consisted of the following (in thousands):
| | | | | | | | | | | | | | | | | |
| Fiscal Year Ended |
| January 28, 2023 | | January 29, 2022 | | January 30, 2021 |
Operating (fixed) lease cost | $ | 52,940 | | | $ | 50,446 | | | $ | 40,192 | |
Short-term lease cost | 186 | | | 82 | | | 124 | |
Variable lease cost | 17,951 | | | 20,655 | | | 17,550 | |
Total lease cost | $ | 71,077 | | | $ | 71,183 | | | $ | 57,866 | |
In response to the COVID-19 pandemic, the FASB issued interpretive guidance in April 2020, which provides entities the option to elect to account for lease concessions as though the enforceable rights and obligations existed in the original lease terms. We elected this option; accordingly, we did not remeasure the lease liabilities or record a change to the ROU assets for any concessions we received for our retail store leases. Rather, deferred lease payments were recorded to operating lease liabilities until paid and lease concessions were recorded in the period they were negotiated or when the lower lease expense was paid.
As of the end of fiscal year 2021, we had received substantially all of the lease concessions negotiated in response to the COVID-19 pandemic and as a result, deferred fixed lease payments during fiscal year 2022 were not material. During fiscal year 2022, we did not record any reduction to lease costs as a result of negotiated lease concessions. During fiscal years 2021 and 2020, we recorded reductions to lease costs of $1.3 million and $18.6 million, respectively, as a result of negotiated lease concessions.
A maturity analysis of our operating lease liabilities, for lease terms that include periods covered by options to extend some of our leases that we are reasonably certain of being executed, for each of the next five years and thereafter, reconciled to our operating lease liabilities recognized in the consolidated balance sheet as of January 28, 2023, is as follows (in thousands):
| | | | | |
Fiscal Year | |
2023 | $ | 56,665 | |
2024 | 55,279 | |
2025 | 45,445 | |
2026 | 34,226 | |
2027 | 22,921 | |
Thereafter | 42,814 | |
Total operating lease liabilities | $ | 257,350 | |
Less: Imputed interest | (40,239) | |
Total operating lease liabilities | $ | 217,111 | |
Less: Current portion of operating lease liabilities | (45,008) | |
Noncurrent operating lease liabilities | $ | 172,103 | |
Other supplementary information related to our leases is reflected in the table below (in thousands except lease term and discount rate data):
| | | | | | | | | | | | | | | | | |
| Fiscal Year Ended |
| January 28, 2023 | | January 29, 2022 | | January 30, 2021 |
Cash paid for amounts included in the measurement of lease liabilities: | | | | | |
Operating cash outflows for operating leases | $ | 58,050 | | | $ | 59,066 | | | $ | 40,025 | |
Right-of-use assets obtained in exchange for new operating lease liabilities | $ | 19,113 | | | $ | 11,912 | | | $ | 3,814 | |
Decrease in right-of-use assets resulting from operating lease modifications or remeasurements | $ | 9,007 | | | $ | 5,190 | | | $ | 6,493 | |
Weighted average remaining lease term - operating leases | 6 years | | 6 years | | 7 years |
Weighted average discount rate - operating leases | 6 | % | | 6 | % | | 6 | % |
Note 10. Revenue Recognition
We recognize revenue when our performance obligations under the terms of a contract or an implied arrangement with a customer are satisfied, which is when the merchandise is transferred to the customer and the customer obtains control of it. The amount of revenue we recognize reflects the total consideration we expect to receive for the merchandise, which is the transaction price.
Our revenue, disaggregated by product category, consists of the following (in thousands):
| | | | | | | | | | | | | | | | | |
| Fiscal Year Ended |
| January 28, 2023 | | January 29, 2022 | | January 30, 2021 |
Apparel | $ | 1,119,336 | | | $ | 1,169,668 | | | $ | 890,511 | |
Non-apparel | 134,800 | | | 109,126 | | | 83,003 | |
Other | 34,008 | | | 18,477 | | | 10,656 | |
Total net sales | $ | 1,288,144 | | | $ | 1,297,271 | | | $ | 984,170 | |
Amounts within Apparel include revenues earned from the sale of tops, bottoms, dresses, intimates, sleep wear, swim wear and outerwear. Amounts within Non-apparel include revenues earned from the sale of accessories, footwear and beauty. Amounts within Other represent PLCC Funds received. During fiscal years 2022, 2021 and 2020, e-Commerce penetration of total net sales was 61%, 63% and 70%, respectively.
Contract Liabilities
During fiscal year 2022, we recognized revenue of $12.2 million and $6.3 million related to our accrued loyalty program and gift cards, respectively, that existed at the beginning of fiscal year 2022. During fiscal year 2021, we recognized revenue of $10.9 million and $5.2 million related to our accrued loyalty program and gift cards, respectively, that existed at the beginning of fiscal year 2021.
Note 11. Related Party Transactions
Services Agreements with Hot Topic
Hot Topic Inc. ("Hot Topic") is an entity indirectly controlled by affiliates of Sycamore. From June 2, 2017 until its termination on March 21, 2019, we had a services agreement ("Third Party Services Agreement") with Hot Topic, pursuant to which Hot Topic provided us (or caused applicable third parties to provide) certain services, including information technology, distribution and logistics management, real estate leasing and construction management and other services as may have been specified. On March 21, 2019, we entered into an amended and restated services agreement ("Amended and Restated Services Agreement") with Hot Topic under which Hot Topic provides us (or causes applicable third parties to provide) substantially similar services to those provided under the Third Party Services Agreement. The term of the Amended and Restated Services Agreement is three years, unless we or Hot Topic extend the agreement, or we terminate the agreement (or certain services under the agreement). We may terminate the various services upon written notice. Rates and costs related to the services provided under the Amended and Restated Services Agreement may change with approval from both parties. Each month, we are committed to pay Hot Topic for these services and reimburse Hot Topic for certain costs it incurs in the course of providing these services. We record payments made to Hot Topic under these service agreements in the applicable expense category in either cost of goods sold, or selling, general and administrative expenses. On August 1, 2019, in connection with the IT Asset Purchase Agreement (as defined below), we entered into a services agreement ("Reverse Services Agreement") with Hot Topic, under which Torrid provided Hot Topic with certain information technology services. The term of the Reverse Services Agreement was three years, unless we or Hot Topic extended the agreement, or Hot Topic terminated the agreement. Torrid provided Hot Topic with the specified information technology services at no cost for the first three years of the Reverse Services Agreement, however Hot Topic bore certain capital and operating expenses that it incurred. Costs incurred in connection with providing the specified information technology services to Hot Topic were expensed as incurred in our consolidated statements of operations and comprehensive income (loss). During fiscal years 2022, 2021 and 2020, we incurred costs of $1.6 million, $3.4 million and $3.0 million, respectively, in connection with providing these information technology services to Hot Topic. In connection with the Reverse Services Agreement, we entered into an amendment to the Amended and Restated Services Agreement ("Amendment to Amended and Restated Services Agreement") with Hot Topic on August 1, 2019, pursuant to which sections pertaining to Hot Topic’s provision of information technology services to Torrid were removed.
During fiscal year 2022, Hot Topic charged us $2.4 million, all of which was recorded as a component of selling, general and administrative expenses. During fiscal years 2021 and 2020, Hot Topic charged us $7.5 million and $12.3 million,
respectively, for various services under the applicable service agreements, of which $4.9 million and $9.6 million, respectively, were recorded as components of cost of goods sold, and the remaining $2.6 million and $2.7 million, respectively, were charged to selling, general and administrative expenses. As of January 28, 2023 and January 29, 2022, we owed $0.2 million and $0.7 million, respectively, to Hot Topic for these services.
On July 31, 2022, we entered into a first amendment to the Reverse Services Agreement ("Amended Reverse Services Agreement") with Hot Topic, under which Torrid provided Hot Topic with certain information technology services for a fixed fee. The term of the Amended Reverse Services Agreement was five months while both parties negotiated a longer-term amendment to the Reverse Services Agreement with modified terms and conditions. On September 30, 2022, we entered into a second amendment to the Reverse Services Agreement ("Second Amended Reverse Services Agreement") with Hot Topic, under which Torrid provided Hot Topic with certain information technology services for a fixed fee. The term of the Second Amended Reverse Services Agreement was two months while both parties negotiate a longer-term amendment to the Reverse Services Agreement with modified terms and conditions. Effective December 1, 2022, we entered into a third amendment to the Reverse Services Agreement ("Third Amended Reverse Services Agreement") with Hot Topic, under which Torrid provides Hot Topic with certain information technology services for a fixed fee. The term of the Third Amended Reverse Services Agreement ends on May 4, 2024, unless we and Hot Topic mutually agree to extend the agreement, or we or Hot Topic terminate the agreement (or certain services under the agreement), upon written notice. During fiscal year 2022, we charged Hot Topic $1.0 million for these services and as of January 28, 2023, Hot Topic owed us $0.1 million for these services.
Hot Topic incurs certain direct expenses on our behalf, such as payments to our non-merchandise vendors and each month, we pay Hot Topic for these pass-through expenses. As of January 28, 2023 and January 29, 2022, the net amount we owed Hot Topic for these expenses was $1.1 million and $1.7 million, respectively, which is included in due to related parties in our consolidated balance sheets.
IT Asset Purchase Agreement with Hot Topic
On June 14, 2019, we entered into an asset purchase agreement ("IT Asset Purchase Agreement") with Hot Topic pursuant to which we purchased certain information technology assets from Hot Topic for $29.5 million on August 1, 2019. Funds obtained from the Term Loan Credit Agreement (as defined in "Note 12—Debt Financing Arrangements") were used to make the purchase. We accounted for the purchase in accordance with subsections of ASC 805-50, related to transactions between entities under common control. Consequently, we recorded the information technology assets we purchased from Hot Topic at their historical carrying amounts totaling $3.5 million and recognized the difference between the historical carrying amounts and the purchase price in equity. In addition, certain information technology-related obligations and personnel, along with associated assets of $1.4 million and liabilities of $0.1 million, were transferred from Hot Topic to Torrid. In connection with the IT Asset Purchase Agreement, we and Hot Topic agreed to enter into the Reverse Services Agreement and Amendment to Amended and Restated Services Agreement upon the closing date of the IT Asset Purchase Agreement, which was August 1, 2019.
Sponsor Advisory Services Agreement
On May 1, 2015, we entered into an advisory services agreement with Sycamore, pursuant to which Sycamore agreed to provide strategic planning and other related services to us. We are obligated to reimburse Sycamore for its expenses incurred in connection with providing such advisory services to us. As of the end of fiscal years 2022 and 2021, there were no amounts due and during fiscal years 2022, 2021 and 2020, no amounts were paid under this agreement.
From time to time, we reimburse Sycamore for certain management expenses it pays on our behalf. As of January 28, 2023, there was no amount due, and as of January 29, 2022, the amount due was not material. During fiscal year 2022, the reimbursements we made to Sycamore for such expenses were not material. During fiscal years 2021 and 2020, the reimbursements we made to Sycamore for such expenses were $0.7 million and $0.1 million, respectively.
Other Related Party Transactions
MGF Sourcing US, LLC, an entity indirectly controlled by affiliates of Sycamore, is one of our suppliers. During fiscal years 2022, 2021 and 2020, cost of goods sold included $70.0 million, $55.4 million and $45.4 million, respectively, related to the sale of merchandise purchased from this supplier. Purchases from this supplier accounted for approximately 15%, 11% and 9% of total net purchases in fiscal years 2022, 2021 and 2020, respectively. As of January 28, 2023 and January 29, 2022, the net amounts we owed MGF Sourcing US, LLC for these purchases were $11.6 million and $12.1 million, respectively. This liability is included in due to related parties in our consolidated balance sheets.
HU Merchandising, LLC, a subsidiary of Hot Topic, is one of our suppliers. During fiscal years 2022, 2021 and 2020, cost of goods sold included $0.5 million, $0.7 million and $0.4 million, respectively, related to the sale of merchandise purchased from this supplier. As of January 28, 2023, there was no amount due and as of January 29, 2022, the amount we owed HU Merchandising, LLC for these purchases was $0.1 million.
Staples, Inc., an entity indirectly controlled by affiliates of Sycamore, is one of our suppliers. During fiscal years 2022, 2021 and 2020, purchases from this supplier were not material. As of January 28, 2023 and January 29, 2022, amounts due to this supplier were not material.
In April 2020, we received a letter of support from Sycamore for up to $20.0 million of additional equity funding which, if necessary and sufficient, would be provided to further prevent noncompliance with the financial covenants in the Amended Term Loan Credit Agreement (as defined in "Note 12—Debt Financing Arrangements") through May 2021. In September 2020, we received an updated letter of support from Sycamore extending the equity funding commitment of up to $20.0 million, if necessary and sufficient, through January 2022. The letter of support was terminated as of May 6, 2021.
In March 2021, Hot Topic entered into a consulting services agreement with our Chief Financial Officer, George Wehlitz, Jr. ("CFO"), pursuant to which Hot Topic agreed to pay our CFO a consulting fee of $10,000 per month. The agreement was effective from January 3, 2021 and terminated on May 31, 2021.
Note 12. Debt Financing Arrangements
Our debt financing arrangements consist of the following (in thousands):
| | | | | | | | | | | |
| January 28, 2023 | | January 29, 2022 |
Existing ABL Facility, as amended | $ | 8,380 | | | $ | — | |
Term loan | | | |
New Term Loan Credit Agreement | 328,125 | | | 350,000 | |
Less: current portion of unamortized original issue discount and debt financing costs | (1,356) | | | (1,356) | |
Less: noncurrent portion of unamortized original issue discount and debt financing costs | (5,928) | | | (7,284) | |
Total term loan outstanding, net of unamortized original issue discount and debt financing costs | 320,841 | | | 341,360 | |
Less: current portion of term loan, net of unamortized original issue discount and debt financing costs | (16,144) | | | (20,519) | |
Total term loan, net of current portion and unamortized original issue discount and debt financing costs | $ | 304,697 | | | $ | 320,841 | |
Fixed mandatory principal repayments due on the outstanding term loan are as follows as of January 28, 2023 (in thousands):
| | | | | |
Fiscal Year | |
2023 | $ | 17,500 | |
2024 | 17,500 | |
2025 | 17,500 | |
2026 | 17,500 | |
2027 | 17,500 | |
2028 | 240,625 | |
| $ | 328,125 | |
New Term Loan Credit Agreement
On June 14, 2021, we entered into a term loan credit agreement ("New Term Loan Credit Agreement") among Bank of America, N.A., as agent, and the lenders party thereto.
The New Term Loan Credit Agreement provides for term loans in an initial aggregate amount of $350.0 million ("Principal"), which is recorded net of an original issue discount ("OID") of $3.5 million and has a maturity date of June 14, 2028. In connection with the New Term Loan Credit Agreement, we paid financing costs of approximately $6.0 million.
The $346.5 million proceeds of the New Term Loan Credit Agreement, net of OID, were used to (i) repay and terminate the Amended Term Loan Credit Agreement (as defined below); (ii) make a $131.7 million distribution to the direct and indirect holders of our equity interests; and (iii) pay for financing costs associated with the New Term Loan Credit Agreement.
Loans made pursuant to the New Term Loan Credit Agreement bear interest at an annual rate equal to, at our option, either (a) a base rate determined by reference to the highest of (1) the prime rate quoted by The Wall Street Journal, (2) the federal funds effective rate plus 0.50% and (3) a LIBOR rate for an interest period of one month, plus 1.00% (in each case, subject to a floor of 1.75%); or (b) at a LIBOR rate for the interest period relevant to such borrowing (subject to a floor of 0.75%), in each case plus an applicable margin of 5.50% for LIBOR borrowings and 4.50% for base rate borrowings.
If we elect the LIBOR rate, interest is due and payable on the last day of each interest period, unless an interest period exceeds three months, then the respective dates that fall every three months after the beginning of the interest period shall also be interest payment dates. If we elect the Base rate loan, interest is due and payable the last day of each calendar quarter. The elected interest rate at the end of fiscal year 2022 was approximately 10%.
In addition to paying interest on the outstanding Principal under the New Term Loan Credit Agreement, we are required to make fixed mandatory repayments of the Principal on the last business day of each fiscal quarter until maturity commencing with the second full fiscal quarter following the closing date ("Repayment"). For each of the fiscal quarters until the maturity date and starting with the fourth fiscal quarter of 2021, Repayments represent 1.25% of the Principal, reduced as a result of the application of prior Prepayments, as defined below.
Under the New Term Loan Credit Agreement, we are also required to make variable mandatory prepayments of the Principal, under certain conditions as described below, approximately 102 days after the end of each fiscal year (each, a "Prepayment"). Prepayments, if applicable, commence at the end of fiscal year 2022 and represent between 0% and 50% (depending on our first lien net leverage ratio) of Excess Cash Flow (as defined in the New Term Loan Credit Agreement) in excess of $10.0 million, minus prepayments of Principal, the Existing ABL Facility, as amended (to the extent accompanied by a permanent reduction in the commitments thereunder) and certain other specified indebtedness and amounts in connection with certain other enumerated items. As of January 28, 2023, we did not meet the Excess Cash Flow threshold to require a Prepayment.
In addition to mandatory Repayment and Prepayment obligations, we may at our option, prepay a portion of the outstanding Principal ("Optional Prepayment"). If we make Optional Prepayments before June 14, 2023, we will be subject to penalties ranging from 1.00% to 2.00% of the aggregate principal amount.
All of Torrid LLC’s existing domestic subsidiaries and Torrid Intermediate LLC unconditionally guarantee all obligations under the New Term Loan Credit Agreement. Substantially all of the assets of Torrid LLC, Torrid LLC’s existing subsidiaries and Torrid Intermediate LLC will secure all such obligations and the guarantees of those obligations, subject to certain exceptions.
The New Term Loan Credit Agreement also contains a number of covenants that, among other things and subject to certain exceptions, will restrict our ability and the ability of our subsidiaries to: create, incur or assume liens on our assets or property; incur additional indebtedness; issue preferred or disqualified stock; consolidate or merge; sell assets; pay dividends or make distributions, make investments, or engage in transactions with our affiliates.
As of the end of fiscal years 2022 and 2021, we were compliant with our financial covenants under the New Term Loan Credit Agreement.
As of the end of fiscal year 2022, the fair value of the New Term Loan Credit Agreement was approximately $267.4 million. The fair value of the New Term Loan Credit Agreement is determined using current applicable rates for similar instruments as of the balance sheet date, a Level 2 measurement (as defined in "Note 20—Fair Value Measurements").
As of the end of fiscal year 2022, total borrowings, net of OID and financing costs, of $320.8 million remain outstanding under the New Term Loan Credit Agreement. During fiscal year 2022, we recognized $26.3 million of interest expense and $1.4 million of OID and financing costs related to the New Term Loan Credit Agreement. During fiscal year 2021, we recognized $14.0 million of interest expense and $0.9 million of OID and financing costs related to the New Term Loan Credit
Agreement. The OID and financing costs are amortized over the New Term Loan Credit Agreement’s seven-year term and are reflected as a direct deduction of the face amount of the term loan in our consolidated balance sheets. We recognize interest payments, together with amortization of the OID and financing costs, in interest expense in our consolidated statements of operations and comprehensive income (loss).
Term Loan Credit Agreement
On June 14, 2019, we entered into a term loan credit agreement ("Term Loan Credit Agreement") with Cortland Capital Market Services LLC, as agent, KKR Credit Advisors (US) LLC, as structuring advisor, and the lenders party thereto (the "Lenders"). On September 17, 2020, we entered into an amended term loan credit agreement ("Amended Term Loan Credit Agreement") with the Lenders, pursuant to which the definition of total debt used in the calculation of Total Net Leverage Ratio (as defined below) was amended. All other material terms of the Term Loan Credit Agreement remained substantially the same. In September 2020, in conjunction with the Amended Term Loan Credit Agreement, we prepaid $35.0 million of the outstanding Amended Term Loan Credit Agreement Principal (as defined below), associated accrued interest of $0.2 million and an amendment fee of $0.5 million. On June 14, 2021, we utilized the proceeds from the New Term Loan Credit Agreement to pay the remaining outstanding Amended Term Loan Credit Agreement Principal (as defined below) of $207.5 million, associated accrued interest of $1.2 million and a prepayment penalty of $2.1 million.
The Amended Term Loan Credit Agreement provided for term loans in an initial aggregate amount of $260.0 million ("Amended Term Loan Credit Agreement Principal"), which was recorded net of OID of $2.9 million and had a maturity date of December 14, 2024. In connection with the Term Loan Credit Agreement, we paid financing costs of approximately $4.6 million.
The $257.1 million proceeds of the Term Loan Credit Agreement, net of OID, were used to i) purchase $213.2 million of senior participating preferred stock from Hot Topic’s parent, HT Intermediate Holdings Corp. for which we subsequently received a promissory note receivable in exchange from our parent; ii) purchase certain information technology assets from Hot Topic for $29.5 million; iii) make a $10.0 million distribution to Torrid Holding LLC; and iv) pay for financing costs associated with the Term Loan Credit Agreement.
Loans made pursuant to the Amended Term Loan Credit Agreement bore interest at an annual rate equal to, at our option, either (a) a base rate determined by reference to the highest of (1) the prime rate quoted by The Wall Street Journal, (2) the federal funds effective rate plus 0.50% and (3) a LIBOR rate for an interest period of one month, plus 1.00% or (b) at a LIBOR rate for the interest period relevant to such borrowing, in each case plus an applicable margin of either 6.75% or 7.00% for LIBOR borrowings and either 5.75% or 6.00% for base rate borrowings, in each case, based upon our total net leverage ratio as of the relevant testing date.
If we elected the LIBOR rate, interest was due and payable on the last day of each interest period, unless an interest period exceeded three months, then the respective dates that fell every three months after the beginning of the interest period would also be interest payment dates. If we elected the Base rate loan, interest was due and payable the last day of each fiscal quarter.
In addition to paying interest on the outstanding Principal under the Amended Term Loan Credit Agreement, we were required to make fixed mandatory repayments of the Principal on the last business day of each fiscal quarter until maturity ("Amended Term Loan Credit Agreement Repayment"). Amended Term Loan Credit Agreement Repayments for the first four fiscal quarters, starting in the third quarter of fiscal year 2019, represented 0.75% of the Amended Term Loan Credit Agreement Principal, reduced as a result of the application of prior Amended Term Loan Credit Agreement Prepayments (as defined below). For each of the eight fiscal quarters thereafter, Amended Term Loan Credit Agreement Repayments represented 1.25% of the Amended Term Loan Credit Agreement Principal, reduced as a result of the application of prior Amended Term Loan Credit Agreement Prepayments (as defined below). For each of the 10 fiscal quarters thereafter until the maturity date, Amended Term Loan Credit Agreement Repayments represented 1.875% of the Amended Term Loan Credit Agreement Principal, reduced as a result of the application of prior Amended Term Loan Credit Agreement Prepayments (as defined below).
Under the Amended Term Loan Credit Agreement, we were also required to make variable mandatory prepayments of the Amended Term Loan Credit Agreement Principal, under certain conditions as described below, approximately 102 days after the end of each fiscal year (each, an "Amended Term Loan Credit Agreement Prepayment"). Amended Term Loan Credit Agreement Prepayments, if applicable, commenced at the end of fiscal year 2018 and represented between 25% and 75% (depending on our first lien net leverage ratio) of Excess Cash Flow (as defined in the Amended Term Loan Credit Agreement) in excess of $2.0 million, minus prepayments of Amended Term Loan Credit Agreement Principal, the Existing ABL Facility,
as amended (as defined below), (to the extent accompanied by a permanent reduction in the commitments thereunder) and certain other specified indebtedness and amounts in connection with certain other enumerated items.
All of Torrid LLC’s existing domestic subsidiaries and Torrid Intermediate LLC unconditionally guaranteed all obligations under the Amended Term Loan Credit Agreement. Substantially all of the assets of Torrid LLC, Torrid LLC’s existing subsidiaries and Torrid Intermediate LLC secured all such obligations and the guarantees of those obligations, subject to certain exceptions.
Our borrowings under the Amended Term Loan Credit Agreement were subject to a financial covenant that required us to maintain a maximum ratio of our total debt to EBITDA (as defined in the Amended Term Loan Credit Agreement) ("Total Net Leverage Ratio"). The maximum ratio was 3.60 for the quarter ended November 2, 2019, 3.35 for the quarters ended February 1, 2020, May 2, 2020, and August 1, 2020, 3.10 for the quarter ended October 31, 2020, 2.50 for the quarter ended January 30, 2021, 2.35 for the quarter ended May 1, 2021, 2.10 for the quarters ended July 31, 2021 and October 30, 2021, and 1.85 for all quarters thereafter. The Amended Term Loan Credit Agreement amended the definition of total debt used in the Total Net Leverage Ratio calculation for the quarters ended October 31, 2020, January 30, 2021, May 1, 2021 and July 31, 2021. The amended definition of total debt permitted us to exclude indebtedness associated with our Existing ABL Facility, as amended, through the quarter ended October 31, 2020, removed the $20.0 million cap from the amount of cash and cash equivalents on-hand that we were permitted to net against our total debt for purposes of the ratio calculation through the quarter ended January 30, 2021, and raised the $20.0 million cap to $40.0 million and $30.0 million for the quarters ended May 1, 2021 and July 31, 2021, respectively, before reverting to $20.0 million for all quarters thereafter.
The Amended Term Loan Credit Agreement contained a limitation on our capital expenditures paid in cash in any fiscal year and such expenditures could not exceed 37.5% of prior year Adjusted EBITDA (as defined by the Amended Term Loan Credit Agreement). If the amount of our capital expenditures paid in cash in any fiscal year was less than the 37.5% threshold, 50% of the difference was to be automatically applied to increase the maximum threshold in the next fiscal year. The Amended Term Loan Credit Agreement also contained a number of other covenants that, among other things and subject to certain exceptions, would restrict our ability and the ability of our subsidiaries to: create, incur or assume liens on our assets or property; incur additional indebtedness; make capital expenditures; issue preferred or disqualified stock; incur hedging obligations; consolidate or merge; sell assets; pay dividends or make distributions, make investments or engage in transactions with our affiliates.
During fiscal year 2021, we recognized $8.2 million of interest expense and recognized $0.4 million of OID and financing costs related to the Amended Term Loan Credit Agreement. During fiscal year 2020, we recognized $19.2 million of interest expense and recognized $1.4 million of OID and financing costs related to the Amended Term Loan Credit Agreement. The OID and financing costs were amortized over the Amended Term Loan Credit Agreement’s five and a half-year term and were reflected as a direct deduction of the face amount of the term loan in our consolidated balance sheets. On June 14, 2021, upon repayment of the outstanding borrowings under the Amended Term Loan Credit Agreement, we wrote off $5.2 million of unamortized OID and financing costs and incurred a $2.1 million prepayment penalty. We recognized interest payments, together with amortization of the OID and financing costs, in interest expense in our consolidated statements of operations and comprehensive income (loss).
Senior Secured Asset-Based Revolving Credit Facility
In May 2015, we entered into a credit agreement for a senior secured asset-based revolving credit facility ("Original ABL Facility") of $50.0 million (subject to a borrowing base), with Bank of America, N.A. On October 23, 2017, we entered into an amended and restated credit agreement ("Existing ABL Facility"), which amended our Original ABL Facility. The Existing ABL Facility increased the aggregate commitments available under the Original ABL Facility from $50.0 million to $100.0 million (subject to a borrowing base); and increased our right to request additional commitments from up to $30.0 million to up to $30.0 million plus the aggregate principal amount of any permanent principal reductions we may take (subject to customary conditions precedent). On June 14, 2019, in conjunction with the Term Loan Credit Agreement, we entered into an amendment to the Existing ABL Facility (the "1st Amendment"). The 1st Amendment decreased the aggregate commitments available under the Existing ABL Facility from $100.0 million to $70.0 million (subject to a borrowing base), permitted indebtedness incurred pursuant to the Term Loan Credit Agreement and made certain other modifications. On September 4, 2019, we entered into another amendment to the Existing ABL Facility (the "2nd Amendment"). The 2nd Amendment permitted parent company financial statements to be used to satisfy reporting requirements and made certain other modifications. On June 14, 2021, in conjunction with the New Term Loan Credit Agreement, we entered into a third amendment to the Existing ABL Facility (the "3rd Amendment"), which amended our Existing ABL Facility, as amended. The 3rd Amendment increased the aggregate commitments available under the Existing ABL facility, as amended, from $70.0 million to $150.0 million (subject to a borrowing base) and extended the date upon which the principal amount
outstanding of the loans would be due and payable in full from October 23, 2022 to June 14, 2026. All other material terms of the Existing ABL Facility, as amended, remain substantially the same as the previous agreements it replaced.
The borrowing base for the Existing ABL Facility, as amended, at any time equals the sum of 90% of eligible credit card receivables, plus 90% of the appraised net orderly liquidation value of eligible inventory and eligible in-transit inventory multiplied by the cost of such eligible inventory and eligible in-transit inventory (to be increased to 92.5% during the period beginning on September 1 of each year and ending on December 31 of each year). The Existing ABL Facility, as amended, includes borrowing capacity for letters of credit and for borrowings on same-day notice, referred to as Swing Line Loans, and is available in U.S. dollars.
Under the Existing ABL Facility, as amended, we have the right to request up to $50.0 million of additional commitments plus the aggregate principal amount of any permanent principal reductions we may take plus the amount by which the borrowing base exceeds the aggregate commitments (subject to customary conditions precedent). The lenders under this facility are not under any obligation to provide any such additional commitments, and any increase in commitments is subject to customary conditions precedent. If we were to request any such additional commitments and the existing lenders or new lenders
were to agree to provide such commitments, the size of the Existing ABL Facility, as amended, could increase to up to $200.0 million, but our ability to borrow under this facility would still be limited by the amount of the borrowing base.
Borrowings under the Existing ABL Facility, as amended, bear interest at an annual rate equal to, at our option, either (a) a base rate determined by reference to the highest of (1) the prime rate of Bank of America, N.A., (2) the federal funds effective rate plus 0.50% and (3) a LIBOR rate for an interest period of one month adjusted for certain costs, plus 1.00%, in each case, plus an applicable margin that ranges from 0.25% to 0.75% based on average daily availability; or (b) at a LIBOR rate for the interest period relevant to such borrowing adjusted for certain costs ("Adjusted LIBOR"), in each case plus an applicable margin that ranges from 1.25% to 1.75%, based on average daily availability. As of the end of fiscal year 2022, the applicable interest rate for borrowings under the Existing ABL Facility, as amended, was approximately 8% per annum.
If we elect the LIBOR rate, interest is due and payable on the last day of each interest period, unless an interest period exceeds three months, then the respective dates that fall every three months after the beginning of the interest period shall also be interest payment dates. If we opt for the base rate (including a Swing Line Loan), interest is due and payable on the first business day of each month and on the maturity date.
In addition to paying interest on outstanding principal under the Existing ABL Facility, as amended, we are required to pay a commitment fee in respect of unutilized commitments. The commitment fee ranges between 0.25% and 0.375% per annum of unutilized commitments and will be subject to adjustment each fiscal quarter based on the amount of unutilized commitments during the immediately preceding fiscal quarter. We must also pay customary letter of credit fees and agent fees.
If at any time the aggregate amount of outstanding loans, unreimbursed letter of credit drawings and undrawn letters of credit under the Existing ABL Facility, as amended, exceeds the lesser of (a) the commitment amount and (b) the borrowing base, we will be required to repay outstanding loans and/or cash collateralize letters of credit in an aggregate amount equal to such excess, with no reduction of the commitment amount.
We may voluntarily reduce the unused portion of the commitment amount and repay outstanding loans at any time. Prepayment of the loans may be made without premium or penalty other than customary “breakage” costs with respect to LIBOR loans.
All obligations under the Existing ABL Facility, as amended, are unconditionally guaranteed by substantially all of Torrid Intermediate LLC’s existing majority-owned domestic subsidiaries and will be required to be guaranteed by certain of Torrid Intermediate LLC’s future domestic majority-owned subsidiaries. All obligations under the Existing ABL Facility, as amended, and the guarantees of those obligations, will be secured, subject to certain exceptions, by substantially all of Torrid Intermediate LLC’s assets.
The Existing ABL Facility, as amended, requires us to maintain a fixed charge coverage ratio of at least 1.00 to 1.00 if we fail to maintain Specified Availability (as defined by the Existing ABL Facility, as amended) of at least the greater of 10% of the Loan Cap, as defined by the Existing ABL Facility, as amended, and $7.0 million. The Existing ABL Facility, as amended, contains a number of other covenants that, among other things and subject to certain exceptions, will restrict our ability and the ability of our subsidiaries to: incur additional indebtedness; pay dividends on our capital stock or redeem, repurchase or retire our capital stock or our other indebtedness; make investments, loans and acquisitions; engage in transactions with our affiliates; sell assets, including capital stock of our subsidiaries; alter the business we conduct; consolidate or merge; and incur liens. As
of the end of fiscal years 2022 and 2021, we were compliant with our debt covenants under the Existing ABL Facility, as amended.
The Existing ABL Facility, as amended, specifically restricts dividends and distributions, aside from amounts to cover ordinary operating expenses and taxes, between our subsidiaries and to us. However, dividends and distributions are permitted at any time that either (1) availability under the Existing ABL Facility, as amended, is equal to or greater than 15% of the maximum borrowing amount on a pro forma basis and we are pro forma compliant with a 1.00 to 1.00 fixed charge coverage ratio or (2) availability under the Existing ABL Facility, as amended, is equal to or greater than 20% of the maximum borrowing amount on a pro forma basis. As of the end of fiscal years 2022 and 2021, the maximum restricted payments utilizing the Existing ABL Facility, as amended, that our subsidiaries could make from its net assets were $127.5 million and $109.8 million, respectively.
We consider the carrying amounts of the Existing ABL Facility, as amended, to approximate fair value because it is carried at a market observable interest rate that resets periodically and is categorized as Level 2 in the fair value hierarchy.
Availability under the Existing ABL Facility, as amended, at the end of fiscal year 2022 was $134.2 million, which reflects borrowings of $8.4 million. Availability under the Existing ABL Facility, as amended, at the end of fiscal year 2021 was $123.9 million, which reflects no borrowings. Standby letters of credit issued and outstanding were $7.4 million and $5.3 million at the end of fiscal years 2022 and 2021, respectively. During the third quarter of fiscal year 2017, we incurred $0.5 million of financing costs for the Existing ABL Facility, which were reduced in fiscal year 2019 by $0.1 million written off to account for the impact of our entry into the 1st Amendment. During the second quarter of fiscal year 2021, we incurred an additional $0.7 million of financing costs in connection with our entry into the 3rd Amendment. These financing costs, together with the unamortized financing costs of $0.1 million associated with the Original ABL Facility, are amortized over the five-year term of the Existing ABL Facility, as amended, and are reflected in prepaid expenses and other current assets and deposits and other noncurrent assets in our consolidated balance sheets. During fiscal years 2022, we amortized financing costs of $0.2 million. During fiscal years 2021 and 2020, we amortized financing costs of $0.1 million in each period. During fiscal years 2022, 2021 and 2020, interest payments were $1.8 million, $0.6 million and $0.6 million, respectively. We recognize amortization of financing costs and interest payments for the revolving credit facilities in interest expense in our consolidated statements of operations and comprehensive income (loss).
Note 13. Income Taxes
Income Before Provision for Income Taxes
The domestic and foreign income before provision for income taxes during fiscal years 2022, 2021 and 2020 is as follows (in thousands):
| | | | | | | | | | | | | | | | | |
| Fiscal Year Ended |
| January 28, 2023 | | January 29, 2022 | | January 30, 2021 |
Domestic | $ | 69,273 | | | $ | 15,010 | | | $ | 38,698 | |
Foreign | 2,409 | | | 819 | | | (3,175) | |
Income before provision | $ | 71,682 | | | $ | 15,829 | | | $ | 35,523 | |
Provision for Income Taxes
The composition of the provision for income taxes during fiscal years 2022, 2021 and 2020 is as follows (in thousands):
| | | | | | | | | | | | | | | | | |
| Fiscal Year Ended |
| January 28, 2023 | | January 29, 2022 | | January 30, 2021 |
Current: | | | | | |
Federal | $ | 14,442 | | | $ | 36,410 | | | $ | 9,528 | |
State | 4,693 | | | 8,051 | | | 2,559 | |
Foreign | 487 | | | — | | | (37) | |
| $ | 19,622 | | | $ | 44,461 | | | $ | 12,050 | |
Deferred: | | | | | |
Federal | $ | 1,632 | | | $ | 785 | | | $ | (157) | |
State | 4 | | | 305 | | | (361) | |
Foreign | 215 | | | 222 | | | (541) | |
| 1,851 | | | 1,312 | | | (1,059) | |
Total income tax provision | $ | 21,473 | | | $ | 45,773 | | | $ | 10,991 | |
Significant components of our deferred tax assets and liabilities are as follows (in thousands):
| | | | | | | | | | | |
| January 28, 2023 | | January 29, 2022 |
Deferred tax assets (liabilities): | | | |
Inventory | $ | 1,671 | | | $ | 2,197 | |
Loyalty reserve | 3,562 | | | 3,591 | |
Accrued bonus | 227 | | | 3,944 | |
Deferred rent | 695 | | | 639 | |
Deferred compensation | 1,046 | | | 1,694 | |
Lease liability | 52,113 | | | 61,112 | |
Equity based compensation | 721 | | | 459 | |
Other deferred tax assets | 5,160 | | | 4,562 | |
ROU assets | (43,950) | | | (52,611) | |
Intangible assets | (2,069) | | | (2,071) | |
Depreciation | (14,367) | | | (16,446) | |
Other deferred tax liabilities | (1,799) | | | (2,197) | |
Total net deferred tax assets | $ | 3,010 | | | $ | 4,873 | |
A reconciliation of the provision for income taxes to the statutory tax rate is as follows:
| | | | | | | | | | | | | | | | | |
| Fiscal Year Ended |
| January 28, 2023 | | January 29, 2022 | | January 30, 2021 |
Statutory federal rate | 21.0 | % | | 21.0 | % | | 21.0 | % |
State and local taxes, net of federal benefit | 5.3 | | | 35.5 | | | 5.5 | |
Share-based compensation | 2.1 | | | 202.9 | | | 4.6 | |
Liability for uncertain tax positions | (0.2) | | | 9.4 | | | (1.2) | |
Information technology services charge | 0.4 | | | 4.5 | | | 1.8 | |
Non-deductible IPO transaction costs | — | | | 11.0 | | | — | |
Limitation on Section 162(m) officers | 1.3 | | | 5.8 | | | — | |
Foreign derived intangible income | (0.2) | | | (2.0) | | | (0.3) | |
Other differences, net | 0.3 | | | 1.1 | | | (0.5) | |
Effective income tax rate | 30.0 | % | | 289.2 | % | | 30.9 | % |
The effective tax rates in fiscal years 2021 and 2020 reflect non-deductible and non-taxable fair market value adjustments to the share-based compensation expense, for which there is no associated income tax benefit or expense. The unconventional effective tax rate in fiscal year 2021 is primarily due to the increase in the amount of non-deductible items associated with share-based compensation, relative to income before provision for income taxes for fiscal year 2021. The increase in the amount of non-taxable items associated with share-based compensation during fiscal year 2021 was driven by the $111.4 million remeasurement adjustment related to the increase in the value of the incentive units as indicated by the Torrid Holding LLC equity value as of June 30, 2021, following the pricing of our IPO. Please refer to "Note 14—Share-Based Compensation" for further discussion regarding the $111.4 million remeasurement adjustment.
Excess tax benefits or detriments associated with share-based payment awards are recognized as income tax benefits or expense in the consolidated statements of operations and comprehensive income (loss). The tax effects of exercised or vested awards are treated as discrete items in the reporting period in which they occur. The income tax detriment resulting from share-based awards was $1.7 million for fiscal year 2022 and is reflected as an increase to the income tax provision.
As of the end of fiscal year 2022, we had accumulated undistributed earnings and profits of our foreign subsidiary of approximately $8.1 million. We continue to treat undistributed earnings of our foreign subsidiary as indefinitely reinvested according to our current operating plans and no deferred tax liability has been recorded for potential future taxes related to such earnings. According to current tax law, any future dividends paid from our foreign subsidiary will not be subject to income tax in the United States, except for withholding taxes and state taxes, which are not material. We have made a determination on our accounting policy choice to treat taxes related to GILTI as a period cost.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was signed into law, and has resulted in significant changes to the U.S. federal corporate tax law. The CARES Act provides numerous tax provisions and other stimulus measures, including temporary changes regarding the prior and future utilization of net operating losses, temporary changes to the prior and future limitations on interest deductions, temporary suspension of certain payment requirements for the employer portion of Social Security taxes, technical corrections from prior tax legislation for tax depreciation of certain qualified improvement property, and the creation of certain refundable employee retention credits. Additionally, several state and foreign jurisdictions have enacted additional legislation to comply with federal changes. On December 27, 2020, the Consolidated Appropriations Act ("CAA") was enacted in further response to the COVID-19 pandemic. The CAA, among other things, revised certain tax measures enacted under the CARES Act, such as the deductibility of payroll tax credits, charitable contributions for corporate taxpayers, certain meals and entertainment expenses paid or incurred in calendar years 2021 and 2020, and employment retention credit claims. On March 11, 2021, the American Rescue Plan Act ("ARPA") was signed into law with additional funding for COVID-19 pandemic relief. The ARPA includes the expansion of employment retention credit claims and other pandemic funding provisions. On August 16, 2022, the Inflation Reduction Act of 2022 (the "IR Act") was enacted to reduce inflation and promote clean energy in the United States. Among other things, the IR Act introduced a 15% alternative minimum tax based on the adjusted financial statement income of corporations or their predecessors with a three-year taxable year average annual adjusted financial statement income in excess of $1 billion and imposes a 1% excise tax on the fair market value of stock repurchases made by covered corporations after December 31, 2022. In addition, the current administration has announced a proposal to increase such excise tax to 4%. The IR Act also includes provisions intended to mitigate climate change by, among others, providing tax credit incentives for reductions in greenhouse gas emissions. We have considered the applicable CARES Act, CAA, ARPA and IR Act tax law changes in our tax provision for the year ended January 28, 2023, and continue to evaluate the impact of these tax law changes on future periods.
Uncertain Tax Positions
The amount of income taxes we pay is subject to ongoing audits by taxing authorities. Our estimate of the potential outcome of any uncertain tax issue is subject to our assessment of the relevant risks, facts and circumstances existing at the time. We believe that we have adequately provided for reasonably foreseeable outcomes related to these matters. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved, which may impact our effective tax rate. As of the end of fiscal year 2022, the total liability for income taxes associated with unrecognized tax benefits, including interest and penalties, was $3.8 million ($3.3 million, net of federal benefit). As of the end of fiscal year 2021, the total liability for income taxes associated with unrecognized tax benefits, including interest and penalties, was $4.0 million ($3.5 million, net of federal benefit). Our effective tax rate will be affected by any portion of this liability we may recognize.
We believe that it is reasonably possible that $1.7 million ($1.6 million net of federal benefit) of our liability for unrecognized tax benefits, of which the associated interest and penalties are not material, may be recognized in the next 12 months due to the expiration of statutes of limitations.
The following table reconciles the amount recorded for the liability for income taxes associated with unrecognized tax benefits as of the end of fiscal years 2022, 2021 and 2020 (in thousands):
| | | | | | | | | | | | | | | | | |
| Fiscal Year Ended |
| January 28, 2023 | | January 29, 2022 | | January 30, 2021 |
Unrecognized tax benefits at the beginning of the fiscal year | $ | 3,293 | | | $ | 2,187 | | | $ | 1,308 | |
Additions: | | | | | |
Tax positions related to the current period | 59 | | | 1,535 | | | 1,455 | |
Tax positions related to the prior period | (356) | | | (429) | | | (576) | |
Unrecognized tax benefits at the end of the fiscal year | $ | 2,996 | | | $ | 3,293 | | | $ | 2,187 | |
Our continuing practice is to recognize interest and penalties related to unrecognized tax benefits as a tax expense. In fiscal years 2022, 2021 and 2020, tax expense related to interest and penalties was $0.8 million, $0.5 million and $0.3 million, respectively.
We operate stores throughout the United States, Puerto Rico and Canada, and as a result, we file income tax returns in the United States federal jurisdiction and various state, local and foreign jurisdictions. In the normal course of business, we are subject to examination by taxing authorities. The federal statute of limitations period is three years and most states follow this limitations period with few exceptions. Consequently, tax years between 2019 and 2021 are open for examination.
IT Asset Purchase Agreement with Hot Topic
In connection with the IT Asset Purchase Agreement we entered into with Hot Topic on August 1, 2019, we generated a tax amortizable basis of the $29.5 million purchase price, amortizable over three years commencing in fiscal year 2019. We recorded the $26.0 million variance between the $3.5 million net book value and $29.5 million tax amortizable basis of the information technology assets in equity, net of $6.7 million deferred tax. As of the end of fiscal year 2022, the tax basis has been fully amortized.
Note 14. Share-Based Compensation
Our share-based compensation expense, by award type, consists of the following (in thousands):
| | | | | | | | | | | | | | | | | |
| Fiscal Year Ended |
| January 28, 2023 | | January 29, 2022 | | January 30, 2021 |
Restricted stock units | $ | 1,818 | | | $ | 4,040 | | | $ | — | |
Restricted stock awards | 6,304 | | | 3,864 | | | — | |
Performance-based restricted stock units | 568 | | | — | | | — | |
Stock options | 972 | | | 514 | | | — | |
Employee stock purchase plan | 318 | | | 170 | | | — | |
Remeasurement adjustments for incentive units | — | | | 151,166 | | | 7,791 | |
Share-based compensation expense before income taxes | 9,980 | | | 159,754 | | | 7,791 | |
Income tax detriment | 340 | | | 293 | | | — | |
Net share-based compensation expense | $ | 10,320 | | | $ | 160,047 | | | $ | 7,791 | |
On June 22, 2021, in connection with our IPO, our board of directors adopted the Torrid Holdings Inc. 2021 Long-Term Incentive Plan (the "2021 LTIP"), for employees, consultants and directors. The 2021 LTIP provides for the grant of non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units ("RSUs") including performance-based restricted stock units ("PSUs"), stock awards, dividend equivalents, other stock-based awards, cash awards and substitute awards intended to align the interests of service providers, with those of our shareholders. As of the end of fiscal year 2022, 10,687,500 shares were authorized for issuance under the 2021 LTIP.
On June 22, 2021, in connection with our IPO, our board of directors adopted the Torrid Holdings Inc. 2021 Employee Stock Purchase Plan (the "ESPP"), intended to qualify under Section 423 of the U.S. Internal Revenue Code of 1986, as amended, in order to provide all of our eligible employees with a further incentive towards ensuring our success and accomplishing our corporate goals. The ESPP allows eligible employees to contribute up to 15% of their base earnings towards
purchases of common stock, subject to an annual maximum. The purchase price is 85% of the lower of (i) the fair market value of the stock on the date of enrollment and (ii) the fair market value of the stock on the last day of the related purchase period. As of the end of fiscal year 2022, 3,650,000 shares were authorized for issuance under the ESPP.
Incentive Units
Prior to the IPO, Torrid Holding LLC issued 13,660,000 Class A, Class B, Class C, Class D, Class E, Class F, Class G, Class H and Class J Torrid incentive units, in the aggregate, net of forfeitures, to certain members of our management.
We recognized the impact of share-based compensation associated with incentive units issued by Torrid Holding LLC in selling, general and administrative expenses in the consolidated statements of operations and comprehensive income (loss). The share-based compensation expense and related capital contribution are reflected in our consolidated financial statements as these awards were deemed to be for our benefit. The intent of the incentive units was to provide profit-sharing opportunities to management rather than equity ownership in our then parent, Torrid Holding LLC. The incentive units did not have any voting or distribution rights and contained a repurchase feature, whereby upon termination, Torrid Holding LLC had the right to purchase from former employees any or all of the vested incentive units at fair value. In addition, although the fair value of the incentive units was determined through an option pricing methodology that utilized the possible equity values of Torrid Holding LLC, the settlement amounts and method of settlement of the incentive units were at the discretion of our board of directors. Based on these aforementioned features and characteristics, we determined that the incentive units were in-substance liabilities accounted for as liability instruments in accordance with ASC 710, Compensation. The incentive units were remeasured based on the fair value of the awards at the end of each reporting period. We recorded the expense associated with changes in the fair value of these incentive units as a capital contribution from our former parent, Torrid Holding LLC, as our former parent is the legal obligor for the incentive units.
The incentive units were valued utilizing a contingent claims analysis ("CCA") methodology based on a Black-Scholes OPM. Under the OPM, each class of incentive units was modeled as a call option with a unique claim on the assets of Torrid Holding LLC. The characteristics of each class of incentive units determined the uniqueness of the claim
on the assets of Torrid Holding LLC. The OPM used to value the incentive units incorporated various assumptions, including the time to liquidity event, equity volatility and risk-free interest rate of return. Equity volatility was based on the historical volatilities of comparable publicly traded companies for the time horizon equal to the time to the anticipated liquidity event; and the risk-free interest rate was for a term corresponding to the time to liquidity event. The assumptions underlying the valuation of the incentive units represented our best estimates, which involved inherent uncertainties and the application of our judgment. The most recent remeasurement of the fair value of the incentive units utilizing the CCA methodology was performed as of May 1, 2021.
During the second quarter of fiscal year 2021, we recorded a share-based compensation expense remeasurement adjustment of $111.4 million related to the increase in the value of the incentive units as indicated by the Torrid Holding LLC equity value as of June 30, 2021, following the pricing of our IPO. The vested portion of the incentive units was exchanged for 13,353,122 shares of our common stock of an equivalent fair value as the vested incentive units and the unvested portion was cancelled. As such, the fair value of these incentive units is no longer recognized in our consolidated statements of operations and comprehensive income (loss).
During fiscal years 2021 and 2020, we recognized share-based compensation expense of $159.8 million and $7.8 million, respectively, primarily due to an increase in the Torrid Holding LLC equity value.
RSUs
RSUs are awarded to certain employees, non-employee directors and consultants and entitle the grantee to receive shares of common stock at the end of a vesting period, subject to the employee's continued employment or service as a director or consultant. In general, RSUs vest in equal installments each year over 4 years.
Pursuant to the agreements we entered into with certain members of our management, upon completion of the IPO, such employees received one-time grants of RSUs ("IPO Awards") in an aggregate amount equal to $5.7 million. 50% of the IPO Awards were fully vested on the date of grant, and the remaining 50% will vest in equal installments on the first, second and third anniversaries of the date of our IPO. These members of our management must remain employed by us through each vesting date in order to vest in the applicable portions of their IPO Awards. Consequently, we recognized $2.8 million of share-based compensation expense related to these IPO Awards upon the consummation of our IPO with the remainder recognized over the three-year vesting period.
PSUs are awarded to certain employees, non-employee directors and consultants and entitle the grantee to receive shares of common stock based on the achievement of various company performance targets and market conditions. In general, PSUs vest in equal installments over a three-year period subject to the achievement of the performance targets or market conditions.
RSU activity, including IPO Awards and PSUs, during fiscal year 2022 under the 2021 LTIP consists of the following (in thousands except per share amounts):
| | | | | | | | | | | |
| Shares | | Weighted average grant date value per share |
Nonvested, January 29, 2022 | 278 | | | $ | 26.75 | |
Granted | 1,371 | | | $ | 5.07 | |
Vested | (66) | | | $ | 25.65 | |
Forfeited | (197) | | | $ | 18.07 | |
Nonvested, January 28, 2023 | 1,386 | | | $ | 6.55 | |
As of the end of fiscal year 2022, unrecognized compensation expense related to unvested RSUs, including PSUs, was $7.2 million, which is expected to be recognized over a weighted average period of approximately 2.5 years. The total vesting date fair value of RSUs which vested during fiscal year 2022 was $0.3 million.
The weighted average grant date fair value of PSUs granted during fiscal year 2022 was $4.15 per share and was estimated at the grant date using a Monte Carlo simulation following a Geometric Brownian Motion with the following weighted average assumptions:
| | | | | |
Dividend yield | — | % |
Expected volatility(1) | 70.7 | % |
Risk-free interest rate(2) | 3.2 | % |
Expected term(3) | 3.00 years |
Grant date fair value per share | $ | 4.15 | |
(1) The expected volatility is estimated based on the historical volatility of a select peer group of similar publicly traded companies for a term that is consistent with the expected term of the PSUs.
(2) The risk-free interest rates are based on the U.S. Treasury constant maturity interest rate whose term is consistent with the expected term of the PSUs.
(3) The expected term of the PSUs represents the time period from the grant date and the full vesting date.
Restricted Stock Awards
Restricted stock awards are awarded to certain employees, non-employee directors and consultants, subject to the employee's continued employment or service as a director or consultant. Restricted stock awards vest over periods ranging from 2 to 4 years, subject to the employee's continued employment or service as an employee, non-employee director or consultant, as applicable, on each vesting date.
Restricted stock award activity during fiscal year 2022 under the 2021 LTIP consists of the following (in thousands except per share amounts):
| | | | | | | | | | | |
| Shares | | Weighted average grant date fair value per share |
Nonvested, January 29, 2022 | 532 | | | $ | 27.00 | |
Granted | — | | | |
Vested | (241) | | | $ | 27.00 | |
Forfeited | (80) | | | $ | 27.00 | |
Nonvested, January 28, 2023 | 211 | | | $ | 27.00 | |
As of the end of fiscal year 2022, unrecognized compensation expense related to unvested restricted stock awards was $5.0 million, which is expected to be recognized over a weighted average period of approximately 1.3 years. The total vesting date fair value of restricted stock awards which vested during fiscal year 2022 was $1.4 million.
Stock Options
Stock options generally vest in equal installments each year over 4 years and generally expire 10 years from the grant date.
Stock option activity under the 2021 LTIP consists of the following (in thousands except per share and contractual life amounts):
| | | | | | | | | | | | | | | | | | | | | | | |
| Shares | | Weighted average exercise price per share | | Weighted average remaining contractual life (years) | | Aggregate intrinsic value |
Outstanding, January 29, 2022 | 337 | | | $ | 21.03 | | | 9.4 | | $ | — | |
Granted | 1,420 | | | $ | 5.58 | | | | | |
Exercised | — | | | | | | | |
Expired / forfeited | (313) | | | $ | 13.90 | | | | | |
Outstanding, January 28, 2023 | 1,444 | | | $ | 7.38 | | | 9.4 | | $ | 114.6 | |
Exercisable, January 28, 2023 | 44 | | | $ | 21.03 | | | | | |
The weighted average grant date fair value of stock option awards granted during fiscal year 2022 was $3.25 per option and was estimated at the grant date using the Black-Scholes OPM with the following weighted average assumptions:
| | | | | |
Dividend yield | — | % |
Expected volatility(1) | 59.0 | % |
Risk-free interest rate(2) | 3.1 | % |
Expected term(3) | 6.25 years |
Grant date fair value per share | $ | 3.25 | |
(1) The expected volatility is estimated based on the historical volatility of a select peer group of similar publicly traded companies for a term that is consistent with the expected term of the stock options.
(2) The risk-free interest rates are based on the U.S. Treasury constant maturity interest rate whose term is consistent with the expected term of the stock options.
(3) The expected term of the stock options represents the estimated period of time until exercise and is calculated using the simplified method.
As of the end of fiscal year 2022, unrecognized compensation expense related to unvested stock options was $4.8 million, which is expected to be recognized over a weighted average period of approximately 3.4 years.
Note 15. Other Noncurrent Liabilities
Other noncurrent liabilities consist of the following (in thousands):
| | | | | | | | | | | |
| January 28, 2023 | | January 29, 2022 |
Noncurrent portion of lease incentives | $ | 1,097 | | | $ | 1,053 | |
Noncurrent income taxes payable | 3,769 | | | 3,991 | |
Deferred PLCC Funds | 3,958 | | | — | |
Other | 291 | | | — | |
Other noncurrent liabilities | $ | 9,115 | | | $ | 5,044 | |
Note 16. Commitments and Contingencies
Operating Lease Agreements
We have entered into operating lease agreements for retail, distribution and office space; and vehicles and equipment, under primarily non-cancelable leases with terms ranging from approximately two to seventeen years. Please refer to "Note 9—Leases" for further discussion regarding our leases.
Litigation
In November 2022, a class action complaint was filed against us in the U.S. District Court for the Central District of California, captioned Sandra Waswick v. Torrid Holdings Inc., et al. The complaint alleges that certain statements in our registration statement on Form S-1 related to our IPO were allegedly false and misleading. We believe that these allegations are without merit and intend to vigorously defend ourselves against these claims. We are currently unable to determine the probability of the outcome of this matter or the range of reasonably possible loss, if any.
From time to time, we are involved in other matters of litigation that arise in the ordinary course of business. Though significant litigation or awards against us could seriously harm our business and financial results, we do not at this time expect these other matters of litigation to have a material adverse effect on our consolidated financial statements.
Indemnities, Commitments and Guarantees
During the ordinary course of business, we have made certain other indemnities, commitments and guarantees under which we may be required to make payments in relation to certain transactions. These indemnities include those given to various lessors in connection with facility leases for certain claims arising from such facility or lease and indemnities to our board of directors and officers to the maximum extent permitted. Commitments include those given to various merchandise vendors and suppliers. From time to time, we have issued guarantees in the form of standby letters of credit as security for workers’ compensation claims. (Our letters of credit are discussed in more detail in "Note 12—Debt Financing Arrangements"). The durations of these indemnities, commitments and guarantees vary. Some of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments we could be obligated to make. We have not recorded any liability for these indemnities, commitments and guarantees in the accompanying consolidated financial statements as no demands have been made upon us to provide indemnification under such agreements and there are no claims that we are aware of that could have a material effect on our consolidated financial statements.
Note 17. Stockholders' Deficit
Torrid was formed on October 29, 2019 and capitalized on February 20, 2020. Torrid is authorized to issue 1.0 billion shares of common stock at $0.01 par value, and 5.0 million shares of preferred stock at $0.01 par value. Torrid had 103,774,813 shares of common stock and no shares of preferred stock issued and outstanding as of January 28, 2023. Historical periods prior to the formation of Torrid have been revised to reflect our current capital structure.
On June 22, 2021, Torrid's stockholder approved an amendment to Torrid's certificate of incorporation to (i) effect a 110,000-for-1 stock split of all shares of the issued and outstanding common stock, which was effected on June 22, 2021 and (ii) authorize 5.0 million shares of preferred stock. All share and per-share data in the financial statements and notes to the financial statements has been retroactively adjusted to reflect the stock split for all periods presented. The par value of the common stock was not adjusted as a result of the stock split.
Note 18. Share Repurchases
On December 6, 2021, our board of directors authorized a share repurchase program under which we may purchase up to $100.0 million of our outstanding common stock. Repurchases may be made from time to time, depending upon a variety of factors, including share price, corporate and regulatory requirements, and other market and business conditions, as determined by us. We may purchase shares of our common stock in the open market at current market prices at the time of purchase, in privately negotiated transactions, or by other means. The authorization does not, however, obligate us to acquire any particular amount of shares, and the share repurchase program may be suspended or terminated at any time at our discretion. As of January 28, 2023, we had approximately $44.9 million remaining under the share repurchase program.
Share repurchase activity consists of the following (in thousands except share and per share amounts):
| | | | | | | | | | | |
| Fiscal Year Ended |
| January 28, 2023 | | January 29, 2022 |
Number of shares repurchased | 4,464,367 | | | 2,315,266 | |
Total cost | $ | 31,700 | | | $ | 23,352 | |
Average per share cost including commissions | $ | 7.10 | | | $ | 10.09 | |
Note 19. Earnings Per Share
Basic earnings per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted earnings per share is applicable only in periods of net income and is computed by dividing net income by the weighted average number of common shares outstanding for the period, inclusive of potentially dilutive common shares outstanding for the period. Periods of net loss require the diluted computation to be the same as the basic computation. During fiscal year 2022, there were approximately 0.1 million potentially dilutive common share equivalents outstanding that were included in the computation of diluted earnings per share. During fiscal years 2021 and 2020, there were no potentially dilutive common share equivalents outstanding that were included in the computation of diluted earnings per share. During fiscal year 2022, there were approximately 0.9 million restricted stock awards and RSUs, including PSUs, and approximately 0.9 million stock options outstanding, which were excluded from the computation of diluted earnings per share as those awards would have been anti-dilutive or were PSUs with performance conditions that had not yet been achieved. During fiscal year 2021 there were approximately 0.9 million restricted stock awards and RSUs and approximately 0.3 million stock options outstanding, which were excluded from the computation of diluted earnings per share as those awards would have been anti-dilutive.
Note 20. Fair Value Measurements
We carry certain of our assets and liabilities at fair value in accordance with GAAP. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
Valuation techniques used to measure fair value require us to maximize the use of observable inputs and minimize the use of unobservable inputs. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Financial assets and liabilities carried at fair value are to be classified and disclosed in one of the following three levels of the fair value hierarchy, of which the first two are considered observable and the last is considered unobservable:
Level 1: Quoted prices in active markets for identical assets or liabilities.
Level 2: Observable inputs, other than Level 1 prices, such as quoted prices for similar assets or liabilities in active markets; quoted prices for similar assets or liabilities in markets that are not active; or other inputs other than quoted prices that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities, including interest rates and yield curves, and market corroborated inputs.
Level 3: Unobservable inputs for the asset or liability that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. These are valued based on our estimates and assumptions that market participants would use in pricing the asset or liability.
Financial assets and liabilities measured at fair value on a recurring basis as of the end of fiscal year 2022 consisted of the following (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| January 28, 2023 | | Quoted Prices in Active Markets for Identical Items (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) |
Assets: | | | | | | | |
Money market funds (cash equivalent) | $ | 29 | | | $ | 29 | | | $ | — | | | $ | — | |
Total assets | $ | 29 | | | $ | 29 | | | $ | — | | | $ | — | |
Liabilities: | | | | | | | |
Deferred compensation plan liability (noncurrent) | $ | 4,246 | | | $ | — | | | $ | 4,246 | | | $ | — | |
Total liabilities | $ | 4,246 | | | $ | — | | | $ | 4,246 | | | $ | — | |
Financial assets and liabilities measured at fair value on a recurring basis as of the end of fiscal year 2021 consisted of the following (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| January 29, 2022 | | Quoted Prices in Active Markets for Identical Items (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) |
Assets: | | | | | | | |
Money market funds (cash equivalent) | $ | 11,411 | | | $ | 11,411 | | | $ | — | | | $ | — | |
Total assets | $ | 11,411 | | | $ | 11,411 | | | $ | — | | | $ | — | |
Liabilities: | | | | | | | |
Deferred compensation plan liability (noncurrent) | $ | 6,873 | | | $ | — | | | $ | 6,873 | | | $ | — | |
Total liabilities | $ | 6,873 | | | $ | — | | | $ | 6,873 | | | $ | — | |
The fair value of our money market funds is based on quoted prices in active markets. The deferred compensation plan liability represents the amount that would be earned by participants if the funds were invested in securities traded in active markets. The fair value of the deferred compensation plan liability is determined based on quoted prices of similar assets that are traded in observable markets, or represents the cash withheld by participants prior to any investment activity.
Note 21. Quarterly Financial Data (Unaudited)
In the fourth quarter of fiscal year 2022, we made a voluntary change in our accounting policy regarding the classification of PLCC Funds. Historically, we recorded PLCC Funds as a reduction to selling, general and administrative expenses in the consolidated statements of operations and comprehensive income (loss). Under the new policy, we record PLCC Funds in net sales in the consolidated statements of operations and comprehensive income (loss). This reclassification does not have any impact on income from operations, income before provision for income taxes, net income (loss) or earnings (loss) per share and there was no cumulative effect to stockholders’ deficit or net assets. This reclassification has been retrospectively applied to all prior periods presented.
The recognition of PLCC Funds in net sales is preferable because it will enhance the comparability of our financial statements with those of many of our industry peers and provide greater transparency into performance metrics relevant to our industry by showing the gross impact of the funds received as net sales instead of as a reduction to selling, general and administrative expenses.
The following table shows the impact of this change in accounting policy for all previously reported fiscal quarters during fiscal years 2022 and 2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended |
As Previously Reported | January 28, 2023(A) | | October 29, 2022 | | July 30, 2022 | | April 30, 2022 | | January 29, 2022 | | October 30, 2021 | | July 31, 2021 | | May 1, 2021 |
Net sales | $ | 294,817 | | | $ | 290,034 | | | $ | 340,876 | | | $ | 328,409 | | | $ | 313,936 | | | $ | 306,241 | | | $ | 332,870 | | | $ | 325,747 | |
Cost of goods sold | 205,049 | | | 198,263 | | | 222,030 | | | 203,263 | | | 214,767 | | | 181,094 | | | 183,150 | | | 180,815 | |
Gross profit | 89,768 | | | 91,771 | | | 118,846 | | | 125,146 | | | 99,169 | | | 125,147 | | | 149,720 | | | 144,932 | |
Selling, general and administrative expenses | 71,426 | | | 59,180 | | | 65,928 | | | 67,431 | | | 65,579 | | | 66,399 | | | 179,041 | | | 109,913 | |
Marketing expenses | 15,827 | | | 12,638 | | | 13,502 | | | 17,974 | | | 17,378 | | | 15,023 | | | 10,728 | | | 9,525 | |
Income (loss) from operations | $ | 2,515 | | | $ | 19,953 | | | $ | 39,416 | | | $ | 39,741 | | | $ | 16,212 | | | $ | 43,725 | | | $ | (40,049) | | | $ | 25,494 | |
| | | | | | | | | | | | | | | |
Adjustment | | | | | | | | | | | | | | | |
Net sales | $ | 6,411 | | | $ | 10,167 | | | $ | 12,646 | | | $ | 4,784 | | | $ | 4,713 | | | $ | 4,649 | | | $ | 4,637 | | | $ | 4,478 | |
Cost of goods sold | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Gross profit | 6,411 | | | 10,167 | | | 12,646 | | | 4,784 | | | 4,713 | | | 4,649 | | | 4,637 | | | 4,478 | |
Selling, general and administrative expenses | 6,411 | | | 10,167 | | | 12,646 | | | 4,784 | | | 4,713 | | | 4,649 | | | 4,637 | | | 4,478 | |
Marketing expenses | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Income (loss) from operations | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| | | | | | | | | | | | | | | |
As Adjusted | | | | | | | | | | | | | | | |
Net sales | $ | 301,228 | | | $ | 300,201 | | | $ | 353,522 | | | $ | 333,193 | | | $ | 318,649 | | | $ | 310,890 | | | $ | 337,507 | | | $ | 330,225 | |
Cost of goods sold | 205,049 | | | 198,263 | | | 222,030 | | | 203,263 | | | 214,767 | | | 181,094 | | | 183,150 | | | 180,815 | |
Gross profit | 96,179 | | | 101,938 | | | 131,492 | | | 129,930 | | | 103,882 | | | 129,796 | | | 154,357 | | | 149,410 | |
Selling, general and administrative expenses | 77,837 | | | 69,347 | | | 78,574 | | | 72,215 | | | 70,292 | | | 71,048 | | | 183,678 | | | 114,391 | |
Marketing expenses | 15,827 | | | 12,638 | | | 13,502 | | | 17,974 | | | 17,378 | | | 15,023 | | | 10,728 | | | 9,525 | |
Income (loss) from operations | $ | 2,515 | | | $ | 19,953 | | | $ | 39,416 | | | $ | 39,741 | | | $ | 16,212 | | | $ | 43,725 | | | $ | (40,049) | | | $ | 25,494 | |
(A) The amounts for the three months ended January 28, 2023 have not been previously reported but are presented based on the previous classification.