10-Q 1 aro-2016730x10q.htm 10-Q Document
 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

Form 10-Q

(Mark One)
 
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 30, 2016
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-31314

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

Delaware
31-1443880
(State of incorporation)
(I.R.S. Employer Identification No.)
 
 
125 Chubb Avenue, Lyndhurst, NJ
07071
(Address of Principal Executive Offices)
(Zip Code)

(201) 508-4500
(Registrant’s Telephone Number, Including Area Code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

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

The Registrant had 80,643,212 shares of common stock outstanding as of September 1, 2016.

 



AÉROPOSTALE, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
TABLE OF CONTENTS
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2



PART I — FINANCIAL INFORMATION

Item 1.  Financial Statements

AÉROPOSTALE, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)

 
July 30,
2016
 
January 30,
2016
 
August 1,
2015
 
(Unaudited)
 
 
 
(Unaudited)
ASSETS
 
 
 
 
 
Current Assets:
 
 
 
 
 
Cash and cash equivalents
$
25,440

 
$
65,097

 
$
86,515

Receivables, less allowance of $784; $0; and $23
22,350

 
9,262

 
13,411

Merchandise inventory
175,088

 
119,821

 
170,679

Income taxes receivable
3,587

 
3,912

 
4,006

Prepaid expenses and other current assets
28,934

 
29,314

 
28,929

Total current assets
255,399

 
227,406

 
303,540

Fixtures, equipment and improvements, net
69,929

 
96,377

 
118,941

Goodwill
13,919

 
13,919

 
13,919

Intangible assets, net
7,880

 
8,123

 
8,432

Restricted cash
23,833

 
1,509

 
1,760

Other assets
8,685

 
7,049

 
6,791

TOTAL ASSETS
$
379,645

 
$
354,383

 
$
453,383

 
 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

 
 

Current Liabilities:
 

 
 

 
 

Accounts payable
$
67,094

 
$
96,196

 
$
136,236

Accrued expenses and other current liabilities
66,841

 
74,519

 
81,185

Indebtedness to related party

 
5,000

 

Debtor in Possession Credit Agreement
108,034

 

 

Total current liabilities
241,969

 
175,715

 
217,421

Indebtedness to related party - non-current

 
137,960

 
142,687

Other non-current liabilities
50,480

 
76,354

 
84,421

Liabilities subject to compromise (Note 1)
191,905

 

 

Commitments and contingent liabilities


 


 


 
 
 
 
 
 
Stockholders’ (Deficit) Equity:
 

 
 

 
 

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

 

 

Common stock, $0.01 par value; 200,000 shares authorized; 81,703; 81,045 and 80,221 shares issued
817

 
810

 
802

Additional paid-in capital
257,402

 
255,805

 
252,258

Accumulated other comprehensive income
3,812

 
3,389

 
3,239

Accumulated deficit
(362,975
)
 
(291,908
)
 
(243,892
)
Treasury stock 1,050; 923 and 615 shares, at cost
(3,765
)
 
(3,742
)
 
(3,553
)
Total stockholders’ (deficit) equity
(104,709
)
 
(35,646
)
 
8,854

TOTAL LIABILITIES AND STOCKHOLDERS’ (DEFICIT) EQUITY
$
379,645

 
$
354,383

 
$
453,383


See Notes to Unaudited Condensed Consolidated Financial Statements

3



AÉROPOSTALE, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)

    
 
13 weeks ended
 
26 weeks ended
 
July 30,
2016
 
August 1,
2015
 
July 30,
2016
 
August 1,
2015
Net sales
$
320,889

 
$
326,861

 
$
619,530

 
$
645,504

Cost of sales (includes certain buying, occupancy and warehousing expenses) 1
225,113

 
268,532

 
479,604

 
528,052

Gross profit
95,776

 
58,329

 
139,926

 
117,452

Selling, general and administrative expenses
81,719

 
101,826

 
170,886

 
201,347

Restructuring (benefit) charges

 
(6,066
)
 

 
(6,008
)
Income (Loss) from operations
14,057

 
(37,431
)
 
(30,960
)
 
(77,887
)
Interest expense 2
4,042

 
2,848

 
8,351

 
6,235

Income (Loss) before reorganization items and income taxes
10,015

 
(40,279
)
 
(39,311
)
 
(84,122
)
Reorganization items, net
23,210

 
 
 
30,733

 
 
Income tax expense (benefit)
(544
)
 
3,380

 
1,023

 
4,805

Net loss
$
(12,651
)
 
$
(43,659
)
 
$
(71,067
)
 
$
(88,927
)
Basic loss per share
$
(0.16
)
 
$
(0.55
)
 
$
(0.88
)
 
$
(1.12
)
Diluted loss per share
$
(0.16
)
 
$
(0.55
)
 
$
(0.88
)
 
$
(1.12
)
Weighted average basic shares
80,634

 
79,570

 
80,473

 
79,423

Weighted average diluted shares
80,634

 
79,570

 
80,473

 
79,423


1 Includes cost of merchandise from related party of $45.9 million during the second quarter of 2016 and $73.8 million during the first twenty-six weeks of fiscal 2016.

2 Includes interest expense to related party of $2.2 million during the second quarter of 2016 and $4.7 million during the first twenty-six weeks of fiscal 2016.


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

 
13 weeks ended
 
26 weeks ended
 
July 30,
2016
 
August 1,
2015
 
July 30,
2016
 
August 1,
2015
Net loss
$
(12,651
)
 
$
(43,659
)
 
$
(71,067
)
 
$
(88,927
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Pension liability adjustment, net of income taxes of $0 for all periods presented
13

 
16

 
21

 
(917
)
Foreign currency translation adjustment (See Note 7)
(109
)
 
1,236

 
402

 
1,058

Other comprehensive income (loss)
$
(96
)
 
$
1,252

 
$
423

 
$
141

Comprehensive loss
$
(12,747
)
 
$
(42,407
)
 
$
(70,644
)
 
$
(88,786
)



4


See Notes to Unaudited Condensed Consolidated Financial Statements

5


AÉROPOSTALE, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
26 weeks ended
 
July 30,
2016
 
August 1,
2015
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net loss
$
(71,067
)
 
$
(88,927
)
Adjustments to reconcile net loss to net cash used in operating activities:
 

 
 

Depreciation and amortization
13,589

 
19,882

Asset impairment charges
16,085

 

Amortization of deferred rent expense
(15,385
)
 
(1,049
)
Amortization of intangible assets
243

 
377

Stock-based compensation
1,533

 
5,982

Other
3,926

 
1,862

Changes in operating assets and liabilities:
 

 
 

Merchandise inventory
(56,322
)
 
(41,545
)
Income taxes receivable and other assets
(12,278
)
 
20,745

Accounts payable
6,369

 
48,055

Advance volume purchase discount

 
17,500

Accrued expenses and other liabilities
300

 
(38,885
)
Net cash used in operating activities
$
(113,007
)
 
$
(56,003
)
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 

 
 

Capital expenditures
(3,220
)
 
(8,546
)
Change in restricted cash
(24,691
)
 

Net cash used in investing activities
$
(27,911
)
 
$
(8,546
)
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 

 
 

Net proceeds from debtor-in-possession financing
389,508

 

Repayments under debtor-in-possession financing
(281,474
)
 

Borrowings under revolving credit facility
224,346

 

Repayments under revolving credit facility
(224,346
)
 

Fees related to debtor-in-possession financing
(6,875
)
 

Purchase of treasury stock
(23
)
 
(401
)
Net cash provided by (used in) financing activities
$
101,136

 
$
(401
)
 
 
 
 
Effect of exchange rate changes
$
125

 
$
(285
)
 
 
 
 
Net decrease in cash and cash equivalents
(39,657
)
 
(65,235
)
Cash and cash equivalents, beginning of year
65,097

 
151,750

Cash and cash equivalents, end of period
$
25,440

 
$
86,515






6


See Notes to Unaudited Condensed Consolidated Financial Statements

7


AÉROPOSTALE, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.  Description of Business

Aéropostale, Inc. and its subsidiaries (“we”, “us”, “our”, the “Company” or “Aéropostale”) is a specialty retailer of casual apparel and accessories, principally serving young women and men through its Aéropostale stores and website and 4 to 12 year-olds through its P.S. from Aéropostale stores and website.  The Company provides customers with a focused selection of high quality fashion and fashion basic merchandise at compelling values through its retail stores and e-commerce channel. Aéropostale maintains control over its proprietary brands by designing, sourcing, marketing and selling all of its own merchandise, other than in licensed stores outside the United States. Aéropostale products can be purchased in Aéropostale stores and online at www.aeropostale.com (this and any other references in this Quarterly Report on Form 10-Q to www.aeropostale.com, www.ps4u.com or www.gojane.com are solely references to a uniform resource locator, or URL, and are inactive textual references only, not intended to incorporate the websites into this Quarterly Report on Form 10-Q).  P.S. from Aéropostale products can be purchased in P.S. from Aéropostale stores, in certain Aéropostale stores and online at www.ps4u.com and www.aeropostale.com.  We also operate GoJane.com, an online women's fashion footwear and apparel retailer. GoJane products can be purchased online at www.gojane.com. As of July 30, 2016, we operated 652 stores, consisting of 628 Aéropostale stores in 46 states and in Puerto Rico, as well as 24 P.S. from Aéropostale stores in 12 states. In addition, pursuant to various licensing agreements, our licensees operated 328 Aéropostale and P.S. from Aéropostale locations in the Middle East, Asia, Europe and Latin America as of July 30, 2016. See below for information on Chapter 11 Cases and Sale Transactions.

Recent Developments

Bankruptcy Proceedings, DIP Financing and Sale Transactions

On May 4, 2016, (the “Petition Date”), Aéropostale, Inc. and each of its subsidiaries (collectively, the “Debtors”) filed voluntary petitions for relief under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) and the filings therein (the “Chapter 11 Filings”). The chapter 11 cases (the “Chapter 11 Cases”) have been consolidated for procedural purposes only and are being administered jointly under the caption “In re Aéropostale, Inc., et al.,” Case No. 16-11275.

In connection with the Chapter 11 Filings, Aéropostale, Inc., as borrower, certain Debtors as guarantors, the lenders party thereto from time to time, and Crystal Financial, LLC, entered into an asset-based credit facility in an aggregate principal amount of up to $160 million (the “DIP Facility”). On May 6, 2016, the Bankruptcy Court granted interim approval to the Company to draw $100 million in financing from the DIP Facility, which the Company is using for general purposes and also has utilized to pay off the Credit Facility (as defined below). On June 10, 2016, the DIP Facility was approved by the Bankruptcy Court for the full amount of $160 million. On September 15, 2016, the DIP Facility was repaid in full using the proceeds from the Sale Transactions (as described below).

On September 13, 2016, the Bankruptcy Court entered orders (“Orders”) approving (i) an Asset Purchase Agreement (the “Asset Purchase Agreement”), dated as of September 12, 2016, by and among the Company, the other direct and indirect subsidiaries of the Company signatory thereto (together with the Company, the “Sellers”), and Aero OpCo LLC (“OpCo LLC”). OpCo LLC, together with ABG-Aero IPCO, LLC (“IPCO”) were formed by a consortium comprised of Authentic Brands Group, Simon Property Group, General Growth Properties, Hilco Merchant Resources (“Hilco”) and Gordon Brothers Retail Partners (“Gordon Brothers”, and together with Hilco, the “Agent”), and (ii) an Agency Agreement (the “Agency Agreement”), dated as of September 12, 2016, by and among the Sellers, OpCo LLC, and the Agent (the transactions contemplated by the Asset Purchase Agreement and Agency Agreement, collectively, the “Sale Transactions”). Pursuant to the Sale Transactions, in consideration for a payment equal to $243.3 million (subject to certain post-closing adjustments), (a) the Agent entered into the Agency Agreement, pursuant to which it agreed to sell, in its capacity as agent, certain inventory located at the Debtors’ stores, certain inventory subject to open purchase orders, as well as certain furnishings and equipment located at the stores, (b) Aero Operations LLC (a wholly-owned subsidiary of OpCo LLC to which OpCo LLC assigned certain of its rights under the Asset Purchase Agreement) obtained the right to acquire leases for certain of the Sellers’ stores in connection with designation rights described below, (c) IPCO (to which OpCo LLC assigned certain of its rights under the Asset Purchase Agreement) acquired certain intellectual property of the Sellers, and (d) OpCo LLC acquired the balance of the assets to be acquired under the Asset Purchase Agreement, including the leases for those stores assigned and assumed at closing. The parties consummated the Sale Transactions on September 15, 2016.


8


Under the Asset Purchase Agreement, subject to certain limited exceptions, until the earlier of (i) the confirmation of a plan of reorganization or liquidation in the Chapter 11 Cases (the “Chapter 11 Plan”) and (ii) November 30, 2016, OpCo LLC will have the right to designate additional contracts and leases of the Sellers for assignment and assumption (to the extent not previously rejected).

In connection with the closing of the Sale Transactions, the Company entered into a transition services agreement with OpCo LLC, pursuant to which OpCo LLC will provide the Company with certain services, at cost, in connection with the wind-down of the Company’s business operations. The Company also entered into a transferred employee agreement with OpCo LLC, pursuant to which the Company’s employees will be seconded to OpCo LLC for a period of time following the closing. No later than January 1, 2017 and subject to certain exceptions, any remaining store employees and any non-store employees who have been offered and accept employment with OpCo LLC will become employees of OpCo LLC.

For further discussion see “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Additional information about the Chapter 11 Cases can be found at http://cases.primeclerk.com/Aeropostale.
Financial Reporting in Reorganization

As a result of the Chapter 11 Cases, we have adopted the provisions of reorganization accounting, which does not change the application of US GAAP with respect to the preparation of our financial statements. However, this guidance requires that financial statements, for periods including and subsequent to a Chapter 11 filing, distinguish between transactions and events that are directly associated with the reorganization proceedings and the ongoing operations of the business, and requires additional disclosures. Effective May 4, 2016, expenses, gains and losses directly associated with the reorganization proceedings are reported as reorganization items, net in the accompanying Consolidated Statements of Operations for the thirteen and twenty-six weeks ended July 30, 2016. In addition, liabilities subject to compromise in the Chapter 11 Cases are distinguished from fully secured liabilities not expected to be compromised and from liabilities in existence after the Petition Date ("post-petition liabilities") in the accompanying consolidated balance sheet as of July 30, 2016. Where there is uncertainty about whether a secured claim is undersecured or will be impaired under the Chapter 11 Plan, we have classified the entire amount of the claim as a Liability Subject to Compromise. Such liabilities are reported at amounts expected to be allowed, even if they settle for lesser amounts. These liabilities remain subject to future adjustments, which may result from: negotiations; actions of the Bankruptcy Court; disputed claims; rejection of executory contracts and unexpired leases; the determination as to the value of any collateral securing claims; proofs of claim; or other events.

Liabilities Subject to Compromise

As described above, certain claims against the Debtors in existence prior to the Chapter 11 Cases (“pre-petition liabilities”) may be subject to compromise or other treatment under the Chapter 11 Plan and are reflected as liabilities subject to compromise in the accompanying consolidated balance sheet. These amounts reflect our current estimates of pre-petition liabilities that are subject to restructuring in the Chapter 11 Cases. A summary of liabilities subject to compromise as of July 30, 2016 is presented in the following table:
 
 
 
 
 
Indebtedness to related party
 
$
146,409

 
Accounts payable
 
 
35,714

 
Occupancy related accruals
 
 
1,901

 
Retirement benefit plan liabilities
 
 
6,014

 
Other accrued liabilities
 
 
1,867

 
 
 
 
 
 
Liabilities subject to compromise
 
$
191,905

 
 
 
 
 
 

The Chapter 11 Filings triggered an event of default of (a) our pre-petition debt obligation to Sycamore Partners and an automatic acceleration of the Term Loans (See Note 4) and (b) our pre-petition revolving credit facility with Bank of America, N.A. and an automatic acceleration of loans thereunder (See Note 13).


9


Reorganization Items, Net

Reorganization items, net include expenses, gains and losses directly related to the Debtors’ reorganization proceedings. A summary of reorganization items, net for the thirteen and twenty-six weeks ended July 30, 2016 is presented in the following table:
 
 
 
 
 
 
13 weeks ended July 30, 2016
 
26 weeks ended July 30, 2016
 
 
(In thousands)
 
DIP Credit Agreement financing fees
3,437

 
3,437

 
Additional insurance coverage during bankruptcy
380

 
380

 
Severance Pay
2,680

 
2,680

 
Professional fees
16,713

 
24,236

 
 
 
 
 
 
Reorganization items, net
$
23,210

 
$
30,733

 
 
 
 
 
 

Pre-Petition Claims

On June 18, 2016 the Debtors filed statements and schedules (the “Statements and Schedules”) with the Bankruptcy Court setting forth the assets and liabilities of each of the Debtors as of the Petition Date. The statements and schedules are available at https://cases.primeclerk.com/aeropostale. On June 22, 2016, the Bankruptcy Court entered an order approving July 25, 2016 as the “Bar Date” in the Chapter 11 Cases for general creditor, non-governmental claims, which is the legal deadline by which any creditor must file a proof of claim in the Chapter 11 Cases. In accordance with that order, the Debtors have mailed proofs of claim forms to all known creditors, including, without limitation, their current and former employees, vendors and other parties with whom the Debtors have previously conducted business. Recipients disagreeing with the Debtors’ valuation of claims as set forth on the Statements and Schedules may have filed discrepancies with the Bankruptcy Court and differences between amounts recorded by the Debtors and claims filed by creditors will be evaluated and resolved as a part of the Chapter 11 Cases. However, the Bankruptcy Court will ultimately determine liability amounts, if any, that will be allowed for all claims.

The resolution of such claims could result in a material adjustment to our financial statements. Additionally, a confirmed plan of reorganization could also materially change the amounts and classifications reported in the consolidated financial statements, which do not give effect to any adjustments to the carrying value of assets or amounts of liabilities that might be necessary as a consequence of confirmation of a plan of reorganization.

Financial Performance and Liquidity

Amongst other things, declining mall traffic due to a shift in customer demand away from apparel to technology and personal experiences, a highly promotional and competitive retail environment and a change in our customers' taste and preference have contributed to unfavorable financial performance. We experienced declining comparable store sales and incurred net losses from operations. This led to cash outflows from operations of $68.5 million in fiscal 2015, $55.7 million in fiscal 2014 and $38.4 million in fiscal 2013.

Over the last several years, we took numerous steps to enhance our liquidity position, including, among other things, amending our Credit Facility with Bank of America N.A. on August 18, 2015 to increase borrowing availability and extend the maturity date (see Note 13), effectuating our plan to restructure the P.S. from Aéropostale business and to reduce costs and close under-performing Aéropostale stores in the United States and Canada, focusing on merchandising and operational initiatives described throughout this Report, and taking various other strategic actions directed toward improving our profitability and liquidity. During fiscal 2015, we reduced our capital expenditures to $15.7 million from $23.8 million in fiscal 2014. Through July 30, 2016, capital expenditures were reduced to $3.2 million. See “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.”

In addition, following a strategic business review in the fourth quarter of 2015, we instituted an aggressive cost reduction program targeting both direct and indirect spending across the organization (“2015 Cost Reduction Program”).  The Company expected this program to generate approximately $35.0 million to $40.0 million in annualized pre-tax savings which was expected to be fully achieved in fiscal 2016. As part of this program, we reduced our corporate headcount by approximately 100 positions, or

10


13%, at the end of fiscal 2015. In fiscal 2014, we reduced our corporate headcount by 100 open or occupied corporate positions (“2014 Cost Reduction Program”).

In March 2016, we announced that the Company was engaged in a dispute with MGF Sourcing relating to the Sourcing Agreement (as defined in Note 4). This caused a disruption in the supply of merchandise and resulted in both a liquidity constraint and lost sales. On May 11, 2016, the Company reached an agreement in principle with MGF Sourcing to resolve the dispute which has been approved by the Bankruptcy Court. Under the terms of this agreement, outstanding purchase orders will be fulfilled under revised terms and no further purchase orders will be written. Upon fulfillment of open purchase orders and payment of post-bankruptcy petition invoices, the agreement shall terminate.

In the first quarter of 2016, our Board of Directors authorized management to explore a full range of strategic alternatives, including a potential sale or restructuring of the Company. The Company retained financial and other advisors to assist in a review of alternatives.

On May 4, 2016, the Company filed the Chapter 11 Filings and entered into the DIP Facility to assist with financing its ongoing operations. The Company announced the closure of 113 U.S. locations, as well as all 41 stores in Canada. The Company also announced that it was reviewing its leases and other contracts to ensure they are competitive with current market dynamics and other financial considerations, which may lead to additional store closings.

Unless otherwise authorized by the Bankruptcy Court, the Bankruptcy Code prohibits us from making payments to creditors on account of pre-petition claims, except pursuant to a Chapter 11 plan. See “pre-petition claims” above. On September 13, 2016, we consummated the Sale Transactions and the DIP was repaid using the proceeds therefrom. (See Note 1).

While our financial statements do not include any adjustments relating to the recovery of the recorded assets that might be necessary should we be unable to continue as a going concern, our liquidity constraints have raised substantial doubt about our ability to continue as a going concern.
.


2.  Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with Rule 10-01 of Regulation S-X and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America. However, in the opinion of our management, all adjustments necessary for a fair presentation of the results of the interim periods have been made. These adjustments consist primarily of normal recurring accruals and estimates that impact the carrying value of assets and liabilities. Actual results may differ materially from these estimates. The consolidated balance sheet as of January 30, 2016 was derived from audited financial statements.

Our business is highly seasonal, and historically, we have realized a significant portion of our sales and cash flows in the second half of the year, attributable to the impact of the back-to-school selling season in the third quarter and the holiday selling season in the fourth quarter.  As a result, our working capital requirements fluctuate during the year, increasing in mid-summer in anticipation of the third and fourth quarters. Our business is also subject, at certain times, to calendar shifts which may occur during key selling times such as school holidays, Easter and regional fluctuations in the calendar during the back-to-school selling season. Therefore, our interim period unaudited condensed consolidated financial statements may not be indicative of our full-year results of operations, financial condition or cash flows.  These unaudited condensed consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for our fiscal year ended January 30, 2016 (“Fiscal 2015 10-K”).

References to “2016” or “fiscal 2016” mean the 52-week period ending January 28, 2017 and references to “2015” or “fiscal 2015” mean the 52-week period ended January 30, 2016.  References to “the second quarter of 2016” mean the thirteen-week period ended July 30, 2016 and references to “the second quarter of 2015” mean the thirteen-week period ended August 1, 2015.

3.  Supplier Agreement

On February 2, 2015, we revised and renewed a master sourcing agreement (“Supplier Agreement”) with one of our suppliers. On April 19, 2016, we amended and restated the Supplier Agreement. This amendment decreased the annual purchase commitment and removed the opportunity to receive additional purchase discounts. Under the ten-year agreement, we received an advance volume purchase discount equivalent to approximately $1.75 million per annum throughout the life of the Supplier Agreement, or a total cash payment of $17.5 million, in return for a commitment of meeting certain minimum thresholds.

11



In connection with the Supplier Agreement, we earned $5.5 million in rebates which reduced our liability from $17.5 million to $12.0 million, of which $1.8 million is classified in accrued expenses as of July 30, 2016. This liability is amortized upon receipt of merchandise.

In connection with the Chapter 11 Cases and pursuant to the Asset Purchase Agreement, until the earlier of the confirmation of a Chapter 11 Plan or November 30, 2016, OpCo LLC has the right to direct the Company to either assume or reject the Supplier Agreement. If assumed, OpCo LLC will be required to pay any cure costs related to such assumption.


4.  Sycamore Transactions

On May 23, 2014, we entered into (i) a Loan and Security Agreement (the "Loan Agreement") with affiliates of Sycamore Partners, (ii) a Stock Purchase Agreement (the "Stock Purchase Agreement") with Aero Investors LLC, an affiliate of Sycamore Partners for the purchase of 1,000 shares of Series B Convertible Preferred Stock of the Company, $0.01 par value (the "Series B Preferred Stock") and (iii) an Investor Rights Agreement with Sycamore Partners. Simultaneously with entering into the Loan Agreement, we amended our existing revolving credit facility with Bank of America, N.A. to allow for the incurrence of the additional debt under the Loan Agreement.

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

As of February 9, 2016, Lemur LLC ceased to be the beneficial owner of more than five percent of the Company's common stock.

Loan Agreement

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

On May 23, 2014, the Term Loans were disbursed in full and we received net proceeds of $137.6 million from affiliates of Sycamore Partners, after deducting the first year interest payment and certain issuance fees.

The Tranche A Loan bears interest at a rate equal to 10% per annum and, at our election, up to 50% of the interest can be payable-in-kind during the first three years and up to 20% of the interest can be payable-in-kind during the final two years. The first year of interest under the Tranche A Facility in the amount of $10.0 million was prepaid in cash in full on May 23, 2014, and no other interest payments were required to be paid during the first year of the Tranche A Loan. The Tranche A Loan has no annual scheduled repayment requirements. The Tranche A Loan was scheduled to mature on May 23, 2019. The Tranche B Loan does not accrue any interest and is to be repaid in equal annual installments of 10% per annum beginning in fiscal 2016.

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

12


under its existing revolving credit facility, and a first priority security interest in our, and certain of our subsidiaries', remaining assets.

Prior to the Chapter 11 Filings, the Tranche A Loan was scheduled to mature on May 23, 2019 and the Tranche B Loan was scheduled to mature on the earlier of (a) tenth anniversary of the end of the Start-Up Period (as such term is defined in the Sourcing Agreement described below) and (b) the expiration or termination of the Sourcing Agreement. Additionally, the Loan Agreement contains representations, covenants and events of default that are substantially consistent with our revolving credit facility with Bank of America, N.A. However, the Chapter 11 Filings triggered events of default and an automatic acceleration of the Term Loans.

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

We recorded liabilities for the Term Loans using imputed interest based on our best estimate of its incremental borrowing rates. The effective interest rate used for the Tranche A Loan was 7.24%, resulting in an initial present value of $101.7 million and a resulting debt premium of $1.7 million. The premium is being amortized to interest expense over the expected term of the debt using the effective interest method. The effective interest rate for the Tranche B Loan used was 7.86%, resulting in an initial present value of $30.0 million and a debt discount of $20.0 million, which is also being amortized to interest expense over the expected term of the debt. Additionally, we recorded deferred financing fees of $5.9 million related to the Term Loans which are being amortized to interest expense over the expected terms of the debt.

We had fair values of $146.4 million in borrowings outstanding under the Loan Agreement, with face value of $150.0 million as of July 30, 2016. Fair value outstanding for the Tranche A Loan was $111.1 million, with a face value of $100.0 million. Fair value outstanding for the Tranche B Loan was $35.3 million, with a face value of $50.0 million. Total interest associated with this transaction was $2.2 million for the second quarter of 2016 and $4.7 million for the first twenty-six weeks of fiscal 2016.

In connection with the Chapter 11 Filings, these Term Loans had been reclassified to current liabilities on the Balance Sheet as of the first quarter of fiscal 2016.

Pursuant to the provisions of reorganization accounting, this liability was included in Liabilities Subject to Compromise(See Note 1).

Series B Convertible Preferred Stock

Concurrent with, and as a condition to, entering into the Loan Agreement, we issued 1,000 shares of Series B Preferred Stock to affiliates of Sycamore Partners at an aggregate offer price of $0.1 million. Each share of Series B Preferred Stock is convertible at any time at the option of the holder on or prior to May 23, 2024 into shares of common stock at an initial conversion rate of 3,932.018 for each share of Series B Preferred Stock. The common stock underlying the Series B Preferred Stock represented 5% of our issued and outstanding common stock as of May 23, 2014. The Series B Preferred Stock was convertible into shares of the common stock at an initial cash conversion price of $7.25 per share of the underlying common stock. We expect that upon effectiveness of the Chapter 11 Plan, all equity of the Company, including the Series B Preferred Stock, will be canceled without any distribution thereon.

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

Non-Exclusive Sourcing Agreement

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


13


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

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

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

In March 2016, we announced that the Company was engaged in a dispute with MGF Sourcing relating to the Sourcing Agreement. On May 11, 2016, the Company reached an agreement with MGF Sourcing to resolve the dispute as evidenced by the amendment to the Sourcing Agreement dated May 16, 2016, which has been approved by the Bankruptcy Court. Under the terms of this agreement, outstanding purchase orders will be fulfilled under revised terms and no further purchase orders will be written. Upon fulfillment of open purchase orders and payment of post-bankruptcy petition invoices, the agreement shall terminate. See Note 21 for Subsequent Events.

5.  Restructuring Program

On April 30, 2014, following an assessment of changing consumer shopping patterns, management and the Board of Directors approved a comprehensive plan to restructure the P.S. from Aéropostale business, which is included in our retail store and e-commerce segment, and to reduce costs. As of January 31, 2015, we closed 126 P.S. from Aéropostale stores, primarily in mall locations, and streamlined and improved the Company's expense structure. The 2014 Cost Reduction Program also targeted direct and indirect spending across the organization during fiscal 2014.

The following is a summary of (benefit) expense recognized in restructuring charges in the statement of operations associated with this program:

 
13 weeks ended
 
26 weeks ended
 
July 30, 2016
 
August 1, 2015
 
July 30, 2016
 
August 1, 2015
 
(In thousands)
 
 
 
 
Asset impairment charges
$

 
$

 

 

Severance costs

 

 

 

Lease costs, net of liability reversals

 
(6,149
)
 

 
(6,386
)
Other exit costs

 
83

 


 
378

Total
$

 
$
(6,066
)
 
$

 
$
(6,008
)


14


 
Impairments
 
Severance
 
Lease Costs
 
Unamortized Tenant Allowance and Deferred Rent
 
Other Exit Costs
 
Total
 
(In thousands)
Liability/Charge at Program Inception
$
30,497

 
$
1,060

 
$
1,046

 
$
(17,718
)
 
$
1,886

 
$
16,771

Additions

 
3,054

 
18,355

 

 
2,435

 
23,844

Paid or Utilized
(30,497
)
 
(4,114
)
 
(13,042
)
 

 
(4,321
)
 
(51,974
)
Adjustments

 

 
(6,359
)
 
17,718

 

 
11,359

Liability as of July 30, 2016
$

 
$

 
$

 
$

 
$

 
$


We closed 115 P.S. from Aéropostale stores during the fourth quarter of fiscal 2014 related to the above mentioned restructuring program. We elected to early adopt the provisions of ASU 2014-08, "Discontinued Operations and Disclosures of Disposals of Components of an Entity", as of the beginning of the fourth quarter of fiscal 2014. We assessed the disposal group under this guidance and concluded the closure of the disposal group to be a "strategic shift". However, this strategic shift was not determined to be a "major" strategic shift based on the portion of our consolidated business that the disposal group represented. Accordingly the disposal group was not presented in the financial statements as discontinued operations. However, we have concluded that this disposal group was an individually significant disposal group. There were no pretax losses for this disposal group of stores for the first twenty-six weeks of fiscal 2016 and a benefit from the reversal of accrued lease exit costs of $6.1 million for the first twenty-six weeks of fiscal 2015.

6.  Fair Value Measurements

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

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

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

In accordance with the fair value hierarchy described above, the following table shows the fair value of our financial assets and liabilities that are required to be remeasured at fair value on a recurring basis:
 
Level 1
 
Level 2
 
Level 3
 
July 30,
2016
 
January 30,
2016
 
August 1,
2015
 
July 30,
2016
 
January 30,
2016
 
August 1,
2015
 
July 30,
2016
 
January 30,
2016
 
August 1,
2015
 
(In thousands)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents 1
$

 
$
41,509

 
$
41,060

 
$

 
$

 
$

 
$

 
$

 
$

Total
$

 
$
41,509

 
$
41,060

 
$

 
$

 
$

 
$

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
GoJane performance plan liability 2
$

 
$

 
$

 
$

 
$

 
$

 
$
745

 
$
723

 
$
1,490

Total
$

 
$

 
$

 
$

 
$

 
$

 
$
745

 
$
723

 
$
1,490


15



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

2 Under the terms of the fiscal 2012 GoJane acquisition agreement, the purchase price also includes contingent cash payments of up to an aggregate of $8.0 million if certain financial metrics are achieved by the GoJane business during the five year period beginning on the acquisition date (the "GJ Performance Plan"). These performance payments are not contingent upon continuous employment by the two individual former stockholders of GoJane. The GJ Performance Plan liability is measured at fair value using Level 3 inputs as defined in the fair value hierarchy. The fair value of the contingent payments as of the acquisition date was estimated to be $7.0 million. This was based on a weighted average expected achievement probability and a discount rate over the expected payment stream. Each quarter, we remeasure the GJ Performance Plan liability at fair value. During the fourth quarter of 2015 and 2014, we remeasured the liability and reversed $0.8 million and $4.5 million, respectively, based on the probability of achieving the payment targets.

The following table provides a reconciliation of the beginning and ending balances of the GJ Performance Plan measured at fair value using significant unobservable inputs (Level 3):
 
 
26 weeks ended
 
 
July 30, 2016
 
August 1, 2015
 
 
(In thousands)
Balance at beginning of period
 
$
723

 
$
1,446

Accretion of interest expense
 
22

 
44

GoJane consideration payment
 

 

Balance at end of period
 
$
745

 
$
1,490


The $0.7 million liability as of July 30, 2016 was included in non-current liabilities. The $1.5 million liability as of August 1, 2015 was included in non-current liabilities.

Non-Financial Assets
 
We recorded asset impairment charges of approximately $1.2 million during the second quarter of 2016 and $16.1 million during the twenty-six weeks of fiscal 2016. The impairment charges for the second quarter of 2016 relate to 6 stores that were not previously impaired in addition to previously impaired stores. The impairment charges for the twenty-six weeks of fiscal 2016 relate to 51 stores that were not previously impaired in addition to previously impaired stores. These impairment charges were included in cost of sales. We did not record any asset impairment charges during the twenty-six weeks of fiscal 2015.

These amounts included the write-down of long-lived assets at stores that were assessed for impairment because of (a) changes in circumstances that indicated the carrying value of assets may not be recoverable, or (b) management’s intention to relocate or close stores.  Impairment charges were primarily related to revenues and/or gross margins not meeting targeted levels at the respective stores as a result of macroeconomic conditions, location related conditions and other factors that were negatively impacting the sales and cash flows of these locations.

The table below sets forth by level within the fair value hierarchy the fair value of long-lived assets for which impairment was recognized for the first twenty-six weeks of fiscal 2016:

 
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
 
 
 
Total Fair Value
 
Total Losses
 
 
(In thousands)
July 30, 2016:
 
 
 
 
 
 
 
 
 
 
Long-lived assets held and used
 
$

 
$

 
$

 
$

 
$
16,086



7.  Stockholders’ Equity


16


Accumulated Other Comprehensive Income (Loss)

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

 
July 30,
2016
 
January 30,
2016
 
August 1,
2015
 
(In thousands)
Pension liability, net of tax
$
1,169

 
$
1,148

 
$
1,020

Cumulative foreign currency translation adjustment
2,643

 
2,241

 
2,219

Total accumulated other comprehensive income
$
3,812

 
$
3,389

 
$
3,239



The changes in components in accumulated other comprehensive income (loss) are as follows:
 
26 weeks ended
 
July 30, 2016
 
Pension Liability
 
Foreign Currency Translation
 
Total
 
(In thousands)
Beginning balance at January 30, 2016
$
1,148

 
$
2,241

 
$
3,389

Other comprehensive income before reclassifications
21

 
402

 
423

Reclassified from accumulated other comprehensive income

 

 

Net current-period other comprehensive income
$
21

 
$
402

 
$
423

Ending balance at July 30, 2016
$
1,169

 
$
2,643

 
$
3,812


 
26 weeks ended
 
August 1, 2015
 
Pension Liability
 
Foreign Currency Translation
 
Total
 
(In thousands)
Beginning balance at February 1, 2015
$
1,937

 
$
1,161

 
$
3,098

Other comprehensive income (loss) before reclassifications
(917
)
 
1,058

 
141

Reclassified from accumulated other comprehensive loss

 

 

Net current-period other comprehensive income (loss)
$
(917
)
 
$
1,058

 
$
141

Ending balance at August 1, 2015
$
1,020

 
$
2,219

 
$
3,239




Stock Repurchase Program

Our Board of Directors had previously approved a stock repurchase program. During each of the first twenty-six weeks of fiscal 2016 and 2015, we did not repurchase shares of our common stock under our stock repurchase program. Under the program to date, we have repurchased 60.1 million shares of our common stock for $1.0 billion.  As of July 30, 2016, we have approximately $104.4 million of repurchase authorization remaining under our $1.15 billion share repurchase program. We expect that upon effectiveness of the Chapter 11 Plan, all equity of the Company will be canceled without any distribution thereon.

In addition to the above program, we also withheld 0.1 million shares for minimum statutory withholding taxes of $23,000 related to the vesting of stock awards during the first twenty-six weeks of fiscal 2016 and 0.1 million shares for minimum statutory withholding taxes of $0.4 million during the first twenty-six weeks of fiscal 2015.


17


8.  Loss Per Share

The following table sets forth the computations of basic and diluted loss per share:
 
13 weeks ended
 
26 weeks ended
 
July 30,
2016
 
August 1,
2015
 
July 30,
2016
 
August 1,
2015
 
(In thousands, except per share data)
Net loss
$
(12,651
)
 
$
(43,659
)
 
$
(71,067
)
 
$
(88,927
)
Weighted average basic shares
80,634

 
79,570

 
80,473

 
79,423

Impact of dilutive securities

 

 

 

Weighted average diluted shares
80,634

 
79,570

 
80,473

 
79,423

Basic loss per share
$
(0.16
)
 
$
(0.55
)
 
$
(0.88
)
 
$
(1.12
)
Diluted loss per share
$
(0.16
)
 
$
(0.55
)
 
$
(0.88
)
 
$
(1.12
)

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

9.  Receivables

Receivables, net consist of the following:

 
July 30, 2016
 
January 30, 2016
 
August 1, 2015
 
(In thousands)
Due from licenses
$
10,423

 
$
7,223

 
$
8,770

Due from Canadian Trustee
7,361

 

 

Other receivables
4,566

 
2,039

 
4,641

Total receivables
$
22,350

 
$
9,262

 
$
13,411


10.  Restricted Cash

Restricted cash consists of the following:

 
July 30, 2016
 
January 30, 2016
 
August 1, 2015
 
(In thousands)
Store lease assignments
$
1,229

 
$
1,509

 
$
1,760

Utility deposits
893

 
 
 
 
Escrow relating to professional fees in bankruptcy
21,711

 
 
 
 
Total restricted cash
$
23,833

 
$
1,509

 
$
1,760



11.  Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consist of the following:

18


 
July 30, 2016
 
January 30, 2016
 
August 1, 2015
 
(In thousands)
Accrued gift cards
$
14,047

 
$
19,969

 
$
17,288

Accrued compensation and retirement benefit plan liabilities
11,349

 
12,839

 
14,937

Accrued rent
2,574

 
4,519

 

Current portion of exit cost obligations

 

 
1,692

Other
38,871

 
37,192

 
47,268

Total accrued expenses and other current liabilities
$
66,841

 
$
74,519

 
$
81,185

 
12.  Other Non-Current Liabilities

Other non-current liabilities consist of the following:

 
July 30, 2016
 
January 30, 2016
 
August 1, 2015
 
(In thousands)
Deferred rent
$
22,573

 
$
37,810

 
$
37,647

Deferred tenant allowance
11,803

 
17,419

 
20,259

Advance volume purchase discount
10,252

 
10,215

 
12,626

Non-current portion of exit cost obligations

 

 
2,645

Other
5,852

 
10,910

 
11,244

Total other non-current liabilities
$
50,480

 
$
76,354

 
$
84,421


13.  Revolving Credit Facility

In September 2011, we entered into an amended and restated revolving credit facility with Bank of America, N.A. (as further amended, the “Credit Facility”), which was guaranteed by all of our domestic subsidiaries (the "Guarantors") and secured by substantially all of our assets. The Credit Facility originally provided for a revolving credit line up to $175.0 million. The Credit Facility was available for working capital and general corporate purposes. The Credit Facility was scheduled to expire on September 22, 2016.

In June 2012, Bank of America, N/A, issued to us a stand-by letter of credit in the amount of approximately $250,000.

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

We also amended the Credit Facility with Bank of America N.A. to allow for the incurrence of this additional debt under the Loan Agreement.

On August 18, 2015, the Company entered into a Fourth Amendment to the Credit Facility and Amendment to Certain Other Loan Documents (the “Fourth Amendment”). Among other things, the Fourth Amendment extended the maturity date of the Credit Facility, until at least February 21, 2019, with automatic extensions, under certain circumstances set forth in the Fourth Amendment, to August 18, 2020; provided for a reduction in the maximum principal amount of extensions of credit that may be made under the Credit Facility from $230 million to $215 million; provided for a seasonal increase in the advance rate on inventory under the borrowing base formula for the revolving credit facility contained in the Credit Facility; increased to $40 million the maximum

19


aggregate principal amount of loans that may be borrowed under the FILO loan facility contained in the Credit Facility and provided for an annual decrease, commencing in 2017, in the advance rate under the borrowing base formula for FILO loans; and reflected the addition of General Electric Capital Corporation as an additional lender under the Credit Facility. The reduction in the maximum principal amount of extensions of credit under the Credit Facility was primarily driven by the Company’s strategic decision to close underperforming stores, thus reducing inventory levels.

Loans under the Credit Facility were secured by substantially all of our assets and were guaranteed by the Guarantors. Direct borrowings under the Credit Facility bore interest at a margin over either LIBOR or the Prime Rate (as each such term is defined in the Credit Facility).

The Credit Facility also contained covenants that required us to have a specified minimum amount of cash and availability on hand and to have obtained an unqualified audit opinion.

The Chapter 11 Filings triggered an event of default and an automatic acceleration of our loans under the Credit Facility. On May 9, 2016, we repaid $73.4 million outstanding, using the funds available under our DIP Facility, and terminated the Credit Facility. We also cash collateralized the standby letter of credit, which currently remains outstanding. As of January 30, 2016 and August 1, 2015, we had no borrowings under the Credit Facility.


14.  Retirement Benefit Plans

Retirement benefit plan liabilities consisted of the following:

 
July 30,
2016
 
January 30,
2016
 
August 1,
2015
 
(In thousands)
Supplemental Executive Retirement Plan (“SERP”)
$
1,229

 
$
1,394

 
$
1,439

Other retirement plan liabilities
4,785

 
4,273

 
4,374

Total
6,014

 
$
5,667

 
$
5,813

Less amount classified in accrued expenses related to SERP

 

 

Less amount classified in accrued expenses related to other retirement plan liabilities
1,922

 
1,196

 
682

Long-term retirement benefit plan liabilities
$
4,092

 
$
4,471

 
$
5,131


401(k) Plan

We maintain a qualified, defined contribution retirement plan with a 401(k) salary deferral feature that covers substantially all of our employees who meet certain requirements.  Under the terms of the plan, employees may contribute, subject to statutory limitations, up to 100% of gross earnings and historically, we have provided a matching contribution of 50% of the first 5% of gross earnings contributed by the participants.  We also have the option to make additional contributions or to suspend the employer contribution at any time. The employer's matching contributions vest over a five-year service period with 20% vesting after two years and 50% vesting after year three.  Vesting increases thereafter at a rate of 25% per year so that participants will be fully vested after five years of service. During fiscal 2011, we established separate defined contribution plans for eligible employees in both Canada and Puerto Rico who meet certain requirements. Contribution expense for all plans was not material to the unaudited condensed consolidated financial statements for any period presented.

Supplemental Executive Retirement Plan

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

The liability related to the SERP was $1.2 million as of July 30, 2016, 1.4 million as of January 30, 2016 and 1.4 million as of August 1, 2015. During March 2015, we paid Thomas P. Johnson, our former Chief Executive Officer, $6.0 million from our SERP.

20


In conjunction with the payment to Mr. Johnson, we recorded a benefit of $1.0 million in SG&A, with a corresponding amount recorded to relieve accumulated other comprehensive loss included in our stockholders' equity. This accounting treatment is in accordance with settlement accounting procedures under the provisions of ASC Topic 715, "Compensation - Retirement Benefits".

Pursuant to the provisions of reorganization accounting, this liability was included in Liabilities Subject to Compromise. (See Note 1).
 
Other Retirement Plan Liabilities

We have a long-term incentive deferred compensation plan established for the purpose of providing long-term incentives to a select group of management. The plan is a non-qualified, non-contributory defined contribution plan and is not funded. Participants in this plan include all employees designated by us as Vice President, or other higher-ranking positions that are not participants in the SERP. We record annual monetary credits to each participant's account based on compensation levels and years as a participant in the plan. Annual interest credits are applied to the balance of each participant's account based upon established benchmarks. Each annual credit is subject to a three-year cliff-vesting schedule, and participants' accounts will be fully vested upon retirement after completing five years of service and attaining age 55. The liabilities related to this plan were $4.5 million as of July 30, 2016, $4.2 million as of January 30, 2016 and $4.4 million as of August 1, 2015. Compensation expense related to this plan was not material to our unaudited condensed consolidated financial statements for any period presented.

Pursuant to the provisions of reorganization accounting, this liability was included in Liabilities Subject to Compromise. (See Note 1).

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


15.  Stock-Based Compensation

Under the provisions of ASC 718, all forms of share-based payment to employees and directors, including stock options, must be treated as compensation and recognized in the statement of operations.

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

We expect that, upon effectiveness of the Chapter 11 Plan, all stock-based compensation, including all stock-based awards described below, will be cancelled and no payment will be made thereunder.

Restricted Stock Units

Beginning in fiscal 2013, certain of our employees have been awarded restricted stock units, pursuant to restricted stock unit agreements. The restricted stock units awarded to employees cliff vest at varying times, most typically following between one and three years of continuous service from the award date. Certain shares awarded may also vest upon a qualified retirement at or following age 65, or upon a qualified early retirement under the provisions adopted in 2012 whereby the awardee completes 10 years of service, attains age 55 and retires. All restricted stock units awarded under the 2002 Plan immediately vest upon a change in control of the Company. 

The following table summarizes restricted stock units outstanding as of July 30, 2016:


21


 
 
 
Shares
 
Weighted Average
Grant-Date Fair Value
 
(In thousands)
 
 
Outstanding as of January 30, 2016
631

 
$
3.28

Granted
2,226

 
0.24

Vested
(49
)
 
4.44

Cancelled
(210
)
 
1.87

Outstanding as of July 30, 2016
2,598

 
$
0.77


Total compensation expense is being amortized over the shorter of the achievement of retirement or early retirement status, or the vesting period.  Compensation expense related to restricted stock unit activity was $0.1 million for the second quarter of 2016 and $0.2 million for the second quarter of 2015.  Compensation expense related to restricted stock unit activity was $0.3 million for the first twenty-six weeks of fiscal 2016 and $0.8 million for the first twenty-six weeks of fiscal 2015. As of July 30, 2016, there was $0.9 million of unrecognized compensation cost related to restricted stock units that is expected to be recognized over the weighted average period of 1.3 years.  The total fair value of restricted stock units vested was $1.2 million during the second quarter of 2016. The total fair value of units vested was $0.0 million during the first quarter of 2015.

Additionally, beginning in the first quarter of fiscal 2014, certain of our employees have been awarded cash-settled restricted stock units, pursuant to cash-settled restricted stock unit agreements. The cash-settled restricted stock units awarded to employees cliff vest at varying times up to approximately three years of continuous service. Certain shares awarded may also vest upon a qualified retirement at or following age 65, or upon a qualified early retirement under the provisions adopted in 2012 whereby the awardee completes 10 years of service, attains age 55 and retires. All cash-settled restricted stock units immediately vest upon a change in control of the Company.  We may, in our sole discretion, at any time during the term, convert the cash-settled restricted stock units into stock-settled restricted stock units. The cash-settled restricted stock units are treated as liability awards in accordance with ASC 718. During January 2015, we converted 262,000 shares of cash-settled restricted stock units to stock-settled restricted stock units.
  
The following table summarizes cash-settled restricted stock units outstanding as of July 30, 2016:

 
 
 
Shares
 
Weighted Average
Grant-Date Fair Value
 
(In thousands)
 
 
Outstanding as of January 30, 2016
468

 
$
0.26

Granted

 

Vested
(22
)
 
0.11

Cancelled
(77
)
 
0.10

Outstanding as of July 30, 2016
369

 
$
0.03


Total compensation expense is being amortized over the shorter of the achievement of retirement or early retirement status, or the vesting period.  Compensation expense related to restricted shares activity was a benefit of $0.0 million for the second quarter of 2016 and an expense of $0.4 million for the second quarter of 2015. Compensation expense related to restricted shares activity was
$0.1 million for the first twenty-six weeks of fiscal 2016 and $0.1 million for the first twenty-six weeks of fiscal 2015. As of July 30, 2016, there was no unrecognized compensation cost related to cash-settled restricted stock units that is expected to be recognized over the weighted average period of 0.67 years.

We expect that, upon effectiveness of the Chapter 11 Plan, all outstanding restricted stock unit awards will be cancelled and no payment will be made thereunder.


22


Restricted Shares

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

The following table summarizes non-vested shares of stock outstanding as of July 30, 2016:

 
 
 
Shares
 
Weighted Average
Grant-Date Fair Value
 
(In thousands)
 
 
Outstanding as of January 30, 2016
717

 
$
7.72

Granted

 

Vested
(609
)
 
8.36

Cancelled
(98
)
 
3.19

Outstanding as of July 30, 2016
10

 
$
13.22


Total compensation expense is being amortized over the shorter of the achievement of retirement or early retirement status, or the vesting period.  Compensation expense related to restricted shares activity was $0.0 million for the second quarter of 2016 and $0.5 million for the second quarter of 2015. Compensation expense related to restricted shares activity was $0.2 million for the first
twenty-six weeks of 2016 and $2.0 million for the first twenty-six weeks of 2015. As of July 30, 2016, the unrecognized compensation expense related to restricted share awards that is expected to be recognized over the weighted average period of less than one year is immaterial.  The total fair value of shares vested was $0.0 million during the second quarter of 2016 and $0.3 million during the second quarter of 2015. The total fair value of shares vested was $5.1 million during the first twenty-six weeks of fiscal 2016 and $1.6 million during the twenty-six weeks of fiscal 2015.

In connection with the GoJane acquisition, we granted restricted shares based on the stock price on the date granted to the two individual stockholders of GoJane, with compensation expense recognized over the three year cliff vesting period. If the aggregate dollar value of the restricted shares on the vesting date is less than $8.0 million, then we shall pay to the two individual stockholders an amount in cash equal to the difference between $8.0 million and the fair market value of the restricted shares on the vesting date. During the second quarter of 2016, we paid out the balance due of $7.6 million that was recorded as of January 30, 2016. For the second quarter of 2015, we recorded compensation expense of $0.2 million and had a corresponding liability of $5.0 million based on the Company's stock price as of August 1, 2015.

We expect that, upon effectiveness of the Chapter 11 Plan, all outstanding restricted share awards will be cancelled and no payment will be made thereunder.

 
Performance Shares

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

23


measure for the Company and its peer group. Compensation expense for market based awards is recognized over the vesting period regardless of whether the market conditions are expected to be achieved.

The following table summarizes performance shares of stock outstanding as of July 30, 2016:

 
Performance-based
 
Market-based
 
Performance Shares
 
Performance Shares
 
 
 
Shares
 
Weighted Average
Grant-Date Fair Value
 
Shares
 
Weighted Average
Grant-Date Fair Value
 
(In thousands)
 
 
 
(In thousands)
 
 
Outstanding as of January 30, 2016

 
$

 
220

 
$
9.65

Granted

 

 

 

Vested

 

 

 

Cancelled

 

 
(69
)
 
19.18

Outstanding as of July 30, 2016

 
$

 
151

 
$
5.34


Total compensation expense is being amortized over the vesting period. During the first quarter of 2016, we recorded compensation expense of $0.1 million related to the market-based performance shares which we granted, and $0.4 million related to market-based performance shares for the second quarter of 2015. Compensation expense related to the market-based performance shares which we granted was a benefit of $0.2 million for the first twenty-six weeks of fiscal 2016 and an expense of $0.1 million for the first twenty-six weeks of fiscal 2015. No compensation expense related to performance-based shares was recognized during the second quarter of fiscal 2016 and for the first twenty-six weeks of fiscal 2016.

The following table summarizes unrecognized compensation cost and the weighted-average years expected to be recognized related to performance share awards outstanding as of July 30, 2016:
 
Performance-based
 
Market-based
 
Performance Shares
 
Performance Shares
Total unrecognized compensation (in thousands)
$

 
$
180

Weighted-average years expected to recognize compensation cost (years)
0

 
1 year


We expect that, upon effectiveness of the Chapter 11 Plan, all performance share awards will be cancelled and no payment will be made thereunder.

Cash-Settled Stock Appreciation Rights ("CSARs")

In conjunction with the execution of the employment agreement with Mr. Johnson, our former CEO, on May 3, 2013, we granted him an award of CSARs, with an award date value of $5.6 million. The number of CSARs granted was determined in accordance with the agreement by dividing $5.6 million by the Black Scholes value of the closing price of a share of the Company's common stock on the award date. As of July 30, 2016, there was no unrecognized compensation cost related to CSARs.  As a result of the departure of Mr. Johnson after the end of the second quarter of 2014, 2/3 of these CSARs were forfeited. The remaining vested shares expired on August 29, 2015. During fiscal 2015 we did not record any expense or benefit related to this incentive award.

We expect that, upon effectiveness of the Chapter 11 Plan, all CSAR awards will be cancelled and no payment will be made thereunder.

Performance Based Bonus

The Employment Agreement with Julian R. Geiger, our Chief Executive Officer, provides for a special performance based bonus. If, during any consecutive 90 calendar day period during the third year of the term of the Employment Agreement the average closing price per share of the Company’s common stock is $15.93 or higher, Mr. Geiger will be entitled to a performance-based cash bonus equal to 2% of the amount, if any, by which the Company’s average market capitalization during the period with

24


the highest 90 day average stock price during the third year of the term of the Employment Agreement exceeds $255.4 million (the “Effective Date Market Cap”). If prior to the achievement of such performance metric, Mr. Geiger’s employment is terminated by the Company without Cause, by Mr. Geiger for Good Reason, upon Mr. Geiger’s death or by the Company due to his Disability, or there is a Change of Control (each a “Qualifying Event”), and as of the date of such Qualifying Event the common stock price exceeds $3.24, then, the amount of the performance-based cash bonus will instead be 2% of the amount, if any, by which the Company’s average market capitalization over the 30 calendar day period immediately preceding the Qualifying Event exceeds the Effective Date Market Cap.

We have recorded a liability for this award that was immaterial to the unaudited condensed financial statements as of July 30, 2016.

We expect that, upon effectiveness of the Chapter 11 Plan, this award will be cancelled and no payment will be made thereunder.
 
Stock Options

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

For the first twenty-six weeks of fiscal 2016, the weighted average assumptions used in our Black-Scholes option pricing model were expected volatility of 64.4%, expected term of 4.16 years, a risk-free interest rate of 1.32%, and an expected forfeiture rate of 0%.
 
The following table summarizes stock option transactions for common stock during the second quarter of 2016:

 
 
 
Number of Shares
 
Weighted Average Exercise Price
 
Weighted-Average Remaining Contractual Term
 
Aggregate Intrinsic Value
 
(In thousands)
 
 
 
(In years)
 
(In millions)
Outstanding as of January 30, 2016
2,554

 
$
3.34

 
 
 
 
Granted

 

 
 
 
 
Exercised

 

 
 
 
 
Cancelled1 
(24
)
 
11.54

 
 
 
 
Outstanding as of July 30, 2016
2,530

 
$
3.26

 
5.58
 
$

Options vested as of July 30, 2016 and expected to vest
2,530

 
$
3.26

 
5.58
 
$

Exercisable as of July 30, 2016
1,187

 
$
3.33

 
5.55
 
$


1 The number of options cancelled represents approximately 24,000 expired shares.

In accordance with his employment agreement, Mr. Geiger was granted an award of options to purchase 1.5 million shares of our common stock during the first quarter of 2015. These stock options have a strike price of $3.17 per share, vest over two years on a pro-rata basis, and have a seven year life. During fiscal 2014, and also in accordance with his employment agreement, Mr. Geiger was granted an award of options to purchase 2.0 million shares that had a strike price of $3.24 and vest over three years on a pro-rata basis with a seven year life. During the fourth quarter of 2015 Mr. Geiger voluntarily relinquished 1.0 million in stock options previously granted.

We recognized $0.4 million in compensation expense related to stock options during the second quarter of 2016 and $0.7 million during the second quarter of 2015. We recognized $0.9 million in compensation expense related to stock options during the first twenty-six weeks of fiscal 2016 and $1.2 million during the first twenty-six weeks of fiscal 2015. For the first twenty-six
weeks of 2016 and the first twenty-six weeks of 2015, the intrinsic value of options exercised was zero.


25


The following table summarizes information regarding non-vested outstanding stock options as of July 30, 2016:
 
 
 
 
Shares
 
Weighted Average
Grant-Date Fair Value
 
(In thousands)
 
 
Non-vested as of January 30, 2016
1,360

 
$
1.57

Granted

 

Vested
(7
)
 
6.39

Canceled
(10
)
 
0.71

Non-vested as of July 30, 2016
1,343

 
$
1.56


As of July 30, 2016, there was $0.4 million of total unrecognized compensation cost related to non-vested options that we expect will be recognized over the remaining weighted-average vesting period of 1 year.

We expect that, upon effectiveness of the Chapter 11 Plan, all stock option awards will be cancelled and no payment will be made thereunder.


16.  Commitments and Contingent Liabilities

Legal Proceedings - During the pendency of the Chapter 11 Cases, all pending litigation wherein we are named as a defendant is generally stayed by operation of federal bankruptcy law, absent further order by the Bankruptcy Court. We are party to various litigation matters and proceedings in the ordinary course of business.  In the opinion of our management, as of July 30, 2016, dispositions of these matters are not expected to have a material adverse effect on our financial position, results of operations or cash flows.

Contingencies - On May 23, 2014, we entered into a $150.0 million secured credit facility with affiliates of Sycamore Partners. In connection with this agreement, we also entered into a sourcing agreement with an affiliate of Sycamore Partners that requires us to purchase a minimum volume of product for 10 years. This purchase commitment commenced during the first quarter of fiscal 2016 and was between $240.0 million and $280.0 million per annum depending on the year. In March 2016, we announced that the Company was engaged in a dispute with this affiliate of Sycamore Partners (MGF Sourcing) relating to the Sourcing Agreement. On May 11, 2016, the Company reached an agreement with MGF Sourcing to resolve the dispute as evidenced by the amendment to the Sourcing Agreement dated May 16, 2016, which has been approved by the Bankruptcy Court. Under the terms of this agreement, outstanding purchase orders will be fulfilled under revised terms and no further purchase orders will be written. Upon fulfillment of open purchase orders and payment of post-bankruptcy petition invoices, the agreement shall terminate. On July 22, 2016, the Company filed a motion with the Bankruptcy Court seeking an order determining that (i) affiliates of Sycamore Partners are not entitled to credit bid their claims arising under the Loan Agreement in a sale of the Company’s assets, (ii) equitably subordinating such claims, and (iii) re-characterizing certain claims under the Loan Agreement. The Bankruptcy Court held a trial from August 15, 2016 to August 23, 2016 and on August 26, 2016, entered a decision denying the relief requested by the company in the motion. (see Note 4).

On February 2, 2015, we revised and renewed a Supplier Agreement with one of our suppliers.

On April 19, 2016, we amended and restated the Supplier Agreement. This amendment decreased the annual purchase commitment and removed the opportunity to receive additional purchase discounts (see Note 3).

In June 2012, Bank of America, N.A. issued a stand-by letter of credit under the Credit Facility. On May 9, 2016, we cash collateralized the stand-by letter of credit which expires on June 30, 2017. We do not have any other stand-by or commercial letters of credit as of July 30, 2016.

We have not issued any third party guarantees or commercial commitments as of July 30, 2016.

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


26


Key Employee Retention Plan - In connection with the Chapter 11 Plan, the Company adopted, and the Bankruptcy Court approved, a Key Employee Retention Plan (“KERP”) for certain non-senior management employees of the Company (which does not include executive officers of the Company) who are not eligible to participate in other post-petition incentive plans. KERP participants will be paid in cash and will receive and keep 100% of the payout under the KERP only if they remain employed with the Company through October 25, 2016. Individual payouts under the KERP range from 6.6% to 23.5% of base salary. The total amount of the KERP is approximately $1.4 million.


17.  Income Taxes

We review the annual effective tax rate on a quarterly basis and make necessary changes if information or events merit.  The estimated annual effective tax rate is forecasted quarterly using actual historical information and forward-looking estimates.  The estimated annual effective tax rate may fluctuate due to changes in forecasted annual operating income; changes to the valuation allowance for deferred tax assets; changes to actual or forecasted permanent book to tax differences (non-deductible expenses); impacts from future tax settlements with state, federal or foreign tax authorities (such changes would be recorded discretely in the quarter in which they occur), or impacts from tax law changes.  To the extent such changes impact our deferred tax assets or liabilities, these changes would generally be recorded discretely in the quarter in which they occur.

Uncertain tax positions, inclusive of interest and penalties were $6.9 million as of July 30, 2016, $6.9 million at January 30, 2016, and $7.2 million at August 1, 2015.  Of these amounts, $4.8 million was recorded as a direct reduction of the related deferred tax assets as of July 30, 2016 and January 30, 2016 and $5.3 million was recorded as of August 1, 2015. Reversal of uncertain tax positions, net of related deferred tax assets, would favorably impact our effective tax rate. These uncertain tax positions are subject to change based on future events, the timing of which is uncertain, however the Company does not anticipate that the balance of such uncertain tax positions will significantly change during the next twelve months.

We file income tax returns in the U.S. and in various states, Canada and Puerto Rico. All tax returns remain open for examination generally for our 2012 through 2015 tax years by various taxing authorities. However, certain states may keep their statute of limitations open for six to ten years. Our U.S. federal filings for the years 2010 to 2014 are currently under examination by the Internal Revenue Service.

18.  Segment Information

FASB ASC Topic 280, “Segment Reporting” (“ASC 280”), establishes standards for reporting information about a company’s operating segments. We have two reportable segments: a) retail stores and e-commerce; and b) international licensing. Our reportable segments were identified based on how our business is managed and evaluated. The reportable segments represent the Company’s activities for which discrete financial information is available and which is utilized on a regular basis by our chief operating decision maker (“CODM”), our Chief Executive Officer, to evaluate performance and allocate resources. The retail stores and e-commerce segment includes the aggregation of the Aéropostale U.S., Aéropostale Canada, P.S. from Aéropostale and GoJane operating segments. In identifying our reportable segments, the Company considers economic characteristics, as well as products, customers, sales growth potential and long-term profitability. The accounting policies of the Company’s reportable segments are consistent with those described in Note 1 of our Annual Report on Form 10-K for the fiscal year ended January 30, 2016. All intercompany transactions are eliminated in consolidation. We do not rely on any customer as a major source of revenue.

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

        
 
 
13 weeks ended
 
26 weeks ended
 
 
July 30, 2016
 
August 1, 2015
 
July 30, 2016
 
August 1, 2015
Net sales:
 
 
 
 
 
 
 
 
Retail stores and e-commerce net sales                                                                                               
 
$
313,649

 
$
316,687

 
$
604,429

 
$
627,583

International licensing revenue                                                                                                   
 
7,240

 
10,174

 
15,101

 
17,921

Total net sales                                                                                                             
 
$
320,889

 
$
326,861

 
$
619,530

 
$
645,504


        

27


 
 
13 weeks ended
 
26 weeks ended
 
 
July 30, 2016
 
August 1, 2015
 
July 30, 2016
 
August 1, 2015
Income (Loss) from operations:
 
 
 
 
 
 
 
 
Retail stores and e-commerce 1                                                                                                    
 
$
8,878

 
$
(47,823
)
 
$
(27,832
)
 
$
(93,591
)
International licensing                                                                                                      
 
6,390

 
9,195

 
12,958

 
15,771

Other 2
 
(1,211
)
 
1,197

 
(16,086
)
 
(67
)
Total income (loss) from operations                                                                                             
 
$
14,057

 
$
(37,431
)
 
$
(30,960
)
 
$
(77,887
)

1 Such amounts include all corporate overhead and shared service function costs and we have not allocated a portion of these costs to international licensing in this presentation.

2 Other items for all periods presented above, which are all related to the retail stores and e-commerce segment, included store closing costs, restructuring charges (See Note 5), store asset impairment charges and other income (charges) that are not included in the segment income (loss) from operations reviewed by the CODM.

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

 
 
July 30, 2016
 
January 30, 2016
 
August 1, 2015
Total assets:
 
 
 
 
 
 
Retail stores and e-commerce                                                                                               
 
$
367,598

 
$
345,429

 
$
440,085

International licensing                                                                                                     
 
12,047

 
8,954

 
13,298

Total assets                                                                                                          
 
$
379,645

 
$
354,383

 
$
453,383


19.  Related Parties

On May 23, 2014, we entered into a strategic sourcing relationship with an affiliate of Sycamore Partners, which included $150.0 million in secured credit facilities (see Note 4). As of May 23, 2014 and December 31, 2015, Lemur LLC, an affiliate of Sycamore Partners owned approximately 8% of our outstanding common stock. Sycamore Partners and its affiliates were considered related parties due to these agreements combined with their ownership interest in us. In addition to the related party transactions presented on the Consolidated Statement of Operations during the second quarter of 2016, we had the following transactions with these related parties:

Merchandise purchased from an affiliate of Sycamore Partners was $40.2 million during the second quarter of 2016 and $105.0 million during the twenty-six weeks of fiscal 2016, of which $30.9 million was included in our merchandise inventories as of July 30, 2016,

Accounts payable of $9.3 million to an affiliate of Sycamore Partners as of July 30, 2016, and

Payments of $43.7 million to an affiliate of Sycamore Partners during the first twenty-six weeks of fiscal 2016.

Additionally, Scopia Capital Management, LLC owned approximately 9.0% of our common stock as of December 31, 2015, and was considered a related party due to their ownership interest in us. We did not have any transactions with this related party during the second quarter of 2016. As of March 3, 2016, Scopia Capital Management, LLC ceased to be the beneficial owners of more than five percent of the Company's common stock.

As of February 9, 2016, Lemur LLC ceased to be the beneficial owner or more than five percent of the Company's common stock.

20.  Recent Accounting Developments

In May 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. The update amends certain guidance in Accounting Standards

28


Update 2014-09, Revenue from Contracts with Customers (Topic 606). These amendments are intended to improve revenue recognition in the areas of collectability; presentation of sales tax and other similar taxes collected from customers; non-cash consideration; contract modifications and completed contracts at transition. The update also makes a transition technical correction stating that entities who elect to use the full retrospective transition method to adopt the new revenue standard would no longer be required to disclose the effect of the change in accounting principle on the period of adoption (as is currently required by ASC 250-10-50-1(b)(2)); however, entities would still be required to disclose the effects on pre-adoption periods that were retrospectively adjusted. The ASU's effective date and transition provisions are aligned with the requirements in the new revenue standard ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which is effective for annual periods beginning after December 15, 2017 and interim periods within those annual periods. Management is still assessing the impact of the adoption to our consolidated financial statements.

In April 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. The update amends certain guidance in Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606). These amendments relate to identifying performance obligations as they pertain to 1) immaterial promised goods or services 2) shipping and handling activities and 3) identifying when promises represent performance obligations; and licensing implementation guidance as it pertains to 1) determining the nature of an entity's promise in granting a license 2) sales-based and usage-based royalties 3) restrictions of time, geographic location, and use and 4) renewals of licenses that provide a right to use IP. The ASU's effective date and transition provisions are aligned with the requirements in the new revenue standard ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which is effective for annual periods beginning after December 15, 2017 and interim periods within those annual periods. Management is still assessing the impact of the adoption to our consolidated financial statements.

In March 2016, the FASB issued Accounting Standards Update No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"). The update simplifies several aspects of accounting for employee share-based payment transactions for both public and nonpublic entities, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The ASU is effective for annual reporting periods beginning after December 15, 2016, including interim periods within those annual reporting periods. The adoption of ASU 2016-09 is not expected to have a material effect on our consolidated financial statements.

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) ("ASU 2016-02"). ASU 2016-02 is intended to improve the reporting of leasing transactions to provide users of financial statements with more decision-useful information. The standard requires organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. Management is still assessing the impact of the adoption to our consolidated financial statements.

In November 2015, the FASB issued Accounting Standards Update No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes ("ASU 2015-17"), to simplify the presentation of deferred taxes in the statement of financial position. Under ASU 2015-17, entities will no longer be required to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classified statement of financial position. Rather, the standard requires deferred tax liabilities and assets to be classified as noncurrent in a classified statement of financial position. The amendments in this update are effective for financial statements issued for annual periods beginning after December 15, 2016, and early application is permitted as of the beginning of an interim or annual reporting period. Management has retroactively adopted this ASU for the year ended January 30, 2016, which did not have a material effect.

In July 2015, the FASB issued Accounting Standards Update No. 2015-11, Inventory, Simplifying the Measurement of Inventory ("ASU 2015-11") which requires an entity to measure in scope inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The adoption of ASU 2015-11 is not expected to have a material effect on our consolidated financial statements.
 
In April 2015, the FASB issued Accounting Standards Update No. 2015-05, Customers' Accounting for Fees Paid in a Cloud Computing Arrangement ("ASU 2015-05"). ASU 2015-05 will help entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement by providing guidance as to whether an arrangement includes the sale or license of software. ASU 2015-05 is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2015. The adoption of ASU 2015-05 is not expected to have a material effect on our consolidated financial statements.

In April 2015, the FASB issued Accounting Standards Update No. 2015-04, Compensation—Retirement Benefits (Topic 715) ("ASU 2015-04"). This update provides a practical expedient for employers with fiscal year-ends that do not fall on a month-end by

29


permitting those employers to measure defined benefit plan assets and obligations as of the month-end that is closest to the entity's fiscal year-end. ASU 2015-04 is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. The adoption of ASU 2015-04 is not expected to have a material effect on our consolidated financial statements.

In April 2015, the FASB issued Accounting Standards Update No. 2015-03, Interest - Imputation of Interest ("ASU 2015-03"). ASU 2015-03 requires that debt issuance costs related to a recognized liability be presented in the balance sheet as a direct reduction from the carrying amount of debt liability, consistent with debt discounts or premiums. ASU 2015-03 is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. The adoption of ASU 2015-03 is not expected to have a material effect on our consolidated financial statements.





21. Subsequent Events

On July 22, 2016, the Company filed a motion with the Bankruptcy Court seeking an order determining that (i) affiliates of Sycamore Partners are not entitled to credit bid their claims arising under the Loan Agreement in a sale of the Company’s assets, (ii) equitably subordinating such claims, and (iii) re-characterizing certain claims under the Loan Agreement. The Bankruptcy Court held a trial from August 15, 2016 to August 23, 2016 and on August 26, 2016, entered a decision denying the Company's relief requested in the motion.

On September 13, 2016, the Bankruptcy Court entered orders (“Orders”) approving (i) an Asset Purchase Agreement (the “Asset Purchase Agreement”), dated as of September 12, 2016, by and among the Company, the other direct and indirect subsidiaries of the Company signatory thereto (together with the Company, the “Sellers”), and Aero OpCo LLC (“OpCo LLC”). OpCo LLC, together with ABG-Aero IPCO, LLC (“IPCO”) were formed by a consortium comprised of Authentic Brands Group, Simon Property Group, General Growth Properties, Hilco Merchant Resources (“Hilco”) and Gordon Brothers Retail Partners (“Gordon Brothers”, and together with Hilco, the “Agent”), and (ii) an Agency Agreement (the “Agency Agreement”), dated as of September 12, 2016, by and among the Sellers, OpCo LLC, and the Agent (the transactions contemplated by the Asset Purchase Agreement and Agency Agreement, collectively, the “Sale Transactions”). Pursuant to the Sale Transactions, in consideration for a payment equal to $243.3 million (subject to certain post-closing adjustments, (a) the Agent entered into the Agency Agreement, pursuant to which it agreed to sell, in its capacity as agent, certain inventory located at the Debtors’ stores, certain inventory subject to open purchase orders, as well as certain furnishings and equipment located at the stores, (b) Aero Operations LLC (a wholly-owned subsidiary of OpCo LLC to which OpCo LLC assigned certain of its rights under the Asset Purchase Agreement) obtained the right to acquire leases for certain of the Sellers’ stores in connection with designation rights described below, (c) IPCO (to which OpCo LLC assigned certain of its rights under the Asset Purchase Agreement) acquired certain intellectual property of the Sellers, and (d) OpCo LLC acquired the balance of the assets to be acquired under the Asset Purchase Agreement, including the leases for those stores assigned and assumed at closing. The parties consummated the Sale Transactions on September 15, 2016. On September 15, 2016, the DIP Facility was repaid in full using the funds from the Sale Transactions.

Under the Asset Purchase Agreement, subject to certain limited exceptions, until the earlier of (i) the confirmation of a plan of reorganization or liquidation in the Chapter 11 Cases and (ii) November 30, 2016, OpCo LLC will have the right to designate additional contracts and leases of the Sellers for assignment and assumption (to the extent not previously rejected).

In connection with the closing of the Sale Transactions, the Company entered into a transition services agreement with OpCo LLC, pursuant to which OpCo LLC will provide the Company with certain services, at cost, in connection with the wind-down of the Company’s business operations. The Company also entered into a transferred employee agreement with OpCo LLC, pursuant to which the Company’s employees will be seconded to OpCo LLC for a period of time following the closing. No later than January 1, 2017 and subject to certain exceptions, any remaining store employees and any non-store employees who have been offered and accept employment with OpCo LLC will become employees of OpCo LLC.

As of the date of this filing, in connection with the Bankruptcy, the Company has closed an additional 30 store locations and the corporate offices located at 112 West 34th Street, New York, NY, during the third quarter of fiscal 2016. The Company anticipates closing additional store locations during the fourth quarter of fiscal 2016 pending the outcome of negotiations with landlords.


30





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

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, included in this filing that address activities, events or developments that the Company expects, believes, targets or anticipates will or may occur in the future are forward-looking statements. The Company’s actual results may differ materially from those anticipated in these forward-looking statements as a result of certain risks and other factors which could include the following: the ability to operate and reorganize under the Chapter 11 Cases (as hereinafter defined), including but not limited to, the Company’s ability to obtain Bankruptcy Court approval with respect to motions in the Chapter 11 Cases, the effects of the Chapter 11 Cases on the Company and on the interests of various constituents, Bankruptcy Court rulings in the Chapter 11 Cases and the outcome of the Chapter 11 Cases in general, the length of time the Company will operate under the Chapter 11 Cases, risks associated with third-party motions in the Chapter 11 Cases, the Company’s future financial condition, results of operations, plans and prospects, expectations, operating improvements and cost savings, and the timing of any of the foregoing, and the Company’s ability to make debt payments to remain in compliance with financial covenants under post-petition financing arrangements, and to obtain appropriate court approval, waivers or amendments with respect to any noncompliance or other actions under such arrangements; the Company's ability to complete its restructuring process, and confirm a plan of reorganization on its anticipated timeline; the impact of the dispute with MGF Sourcing US, LLC and the successful implementation of the settlement; changes in the economy; risks associated with changes in social, political, economic and other conditions and the possible adverse impact of changes in import restrictions; as well as other risk factors set forth in the Company’s Form 10-K and Quarterly Reports on Form 10-Q filed with the Securities and Exchange Commission.

The Company therefore cautions readers against relying on these forward-looking statements. All forward-looking statements attributable to the Company or persons acting on the Company’s behalf are expressly qualified in their entirety by the foregoing cautionary statements. All such statements speak only as of the date made, and, except as required by law, the Company undertakes no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

Introduction

Management’s Discussion and Analysis of Financial Condition and Results of Operations, or “MD&A,” is intended to provide information to help you better understand our financial condition and results of operations.  Our business is highly seasonal, and historically we realize a significant portion of our sales and cash flow in the second half of the year, driven by the impact of the back-to-school selling season in our third quarter and the holiday selling season in our fourth quarter.  Therefore, our interim period unaudited condensed consolidated financial statements may not be indicative of our full-year results of operations, financial condition or cash flows. We recommend that you read this section along with the unaudited condensed consolidated financial statements and notes included in this report and along with our Annual Report on Form 10-K for the year ended January 30, 2016.

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

Overview

Chapter 11 Bankruptcy Proceedings, DIP Financing and Sale Transactions

On May 4, 2016 (the “Petition Date”), Aéropostale, Inc. and each of its subsidiaries (collectively, the “Debtors”) filed voluntary petitions for relief under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) and the filings therein (the “Chapter 11 Filings”). The Chapter 11 cases (the "Chapter 11 Cases") have been consolidated for procedural purposes only and are being administered jointly under the caption “In re Aéropostale, Inc., et al.,” Case No. 16-11275. Additional information about the Chapter 11 Cases can be found at http://cases.primeclerk.com/Aeropostale.

In connection with the Chapter 11 Filings, Aéropostale, Inc., as borrower, certain Debtors as guarantors, the lenders party thereto from time to time, and Crystal Financial, LLC, entered into an asset-based credit facility in an aggregate principal amount of up to $160 million (the “DIP Facility”). On May 6, 2016, the Bankruptcy Court granted approval to the Company to draw $100 million in interim financing from the DIP Facility, which the Company used for general purposes and also to pay off the Credit Facility (as defined below). On June 10, 2016, the Bankruptcy Court granted final approval for the Company to access the full

31


$160 million of the DIP Facility. On September 15, 2016, the DIP Facility was repaid in full using the proceeds from the Sale Transactions (as described below).

On September 13, 2016, the Bankruptcy Court entered orders (“Orders”) approving (i) an Asset Purchase Agreement (the “Asset Purchase Agreement”), dated as of September 12, 2016, by and among the Company, the other direct and indirect subsidiaries of the Company signatory thereto (together with the Company, the “Sellers”), and Aero OpCo LLC (“OpCo LLC”). OpCo LLC, together with ABG-Aero IPCO, LLC (“IPCO”) were formed by a consortium comprised of Authentic Brands Group, Simon Property Group, General Growth Properties, Hilco Merchant Resources (“Hilco”) and Gordon Brothers Retail Partners (“Gordon Brothers”, and together with Hilco, the “Agent”), and (ii) an Agency Agreement (the “Agency Agreement”), dated as of September 12, 2016, by and among the Sellers, OpCo LLC, and the Agent (the transactions contemplated by the Asset Purchase Agreement and Agency Agreement, collectively, the “Sale Transactions”). Pursuant to the Sale Transactions, in consideration for a payment equal to $243.3 million (subject to certain post-closing adjustments, (a) the Agent entered into the Agency Agreement, pursuant to which it agreed to sell, in its capacity as agent, certain inventory located at the Debtors’ stores, certain inventory subject to open purchase orders, as well as certain furnishings and equipment located at the stores, (b) Aero Operations LLC (a wholly-owned subsidiary of OpCo LLC to which OpCo LLC assigned certain of its rights under the Asset Purchase Agreement) obtained the right to acquire leases for certain of the Sellers’ stores in connection with designation rights described below, (c) IPCO (to which OpCo LLC assigned certain of its rights under the Asset Purchase Agreement) acquired certain intellectual property of the Sellers, and (d) OpCo LLC acquired the balance of the assets to be acquired under the Asset Purchase Agreement, including the leases for those stores assigned and assumed at closing. The parties consummated the Sale Transactions on September 15, 2016.

Under the Asset Purchase Agreement, subject to certain limited exceptions, until the earlier of (i) the confirmation of a plan of reorganization or liquidation in the Chapter 11 Cases (the “Chapter 11 Plan”) and (ii) November 30, 2016, OpCo LLC will have the right to designate additional contracts and leases of the Sellers for assignment and assumption (to the extent not previously rejected).

In connection with the closing of the Sale Transactions, the Company entered into a transition services agreement with OpCo LLC, pursuant to which OpCo LLC will provide the Company with certain services, at cost, in connection with the wind-down of the Company’s business operations. The Company also entered into a transferred employee agreement with OpCo LLC, pursuant to which the Company’s employees will be seconded to OpCo LLC for a period of time following the closing. No later than January 1, 2017 and subject to certain exceptions, any remaining store employees and any non-store employees who have been offered and accept employment with OpCo LLC will become employees of OpCo LLC.

Further information on the terms of the DIP Facility is included below under “Liquidity and Capital Resources.”

Financial Performance and Liquidity

Amongst other things, declining mall traffic due to a shift in customer demand away from apparel to technology and personal experiences, a highly promotional and competitive retail environment and a change in our customers' taste and preference have contributed to unfavorable financial performance. We experienced declining comparable store sales and incurred net losses from operations. This led to cash outflows from operations of $68.5 million in fiscal 2015, $55.7 million and in fiscal 2014.

Over the last several years, we took numerous steps to enhance our liquidity position, including, among other things, effectuating our plan to reduce costs and close under-performing Aéropostale stores in the United States and Canada and to restructure the P.S. from Aéropostale business, focusing on merchandising and operational initiatives described throughout this Report, and taking various other strategic actions directed toward improving our profitability and liquidity.

Following a strategic business review in the fourth quarter of 2015, we instituted an aggressive cost reduction program targeting both direct and indirect spending across the organization ("2015 Cost Reduction Program").  The Company expected this program to generate approximately $35.0 million to $40.0 million in annualized pre-tax savings which was expected to be fully achieved in fiscal 2016. As part of this program, we have reduced our corporate headcount by approximately 100 positions, or 13%, at the end of fiscal 2015. In fiscal 2014, we reduced our corporate headcount by 100 open or occupied corporate positions ("2014 Cost Reduction Program").

In March 2016, we announced that the Company was engaged in a dispute with MGF Sourcing relating to the Sourcing Agreement. This caused a disruption in the supply of merchandise and resulted in both a liquidity constraint and lost sales. On May 11, 2016, the Company reached an agreement in principle with MGF Sourcing to resolve the dispute, which was approved by the Bankruptcy Court. Under the terms of this agreement, outstanding purchase orders will be fulfilled under revised terms and no

32


further purchase orders will be written. Upon fulfillment of open purchase orders and payment of post-bankruptcy petition invoices, the agreement shall terminate.

In the first quarter of 2016, our Board of Directors authorized management to explore a full range of strategic alternatives, including a potential sale or restructuring of the Company. The Company retained financial and other advisors to assist in a review of alternatives.

On May 4, 2016, the Company filed the Chapter 11 Filings and entered into the DIP Facility to assist with financing its ongoing operations subject to final Bankruptcy Court approval. The Company also announced that as a part of its effort to position the Company for long-term success, it is reviewing its leases and other contracts to ensure they are competitive with current market dynamics and is closing an additional 113 U.S. locations, as well as all 41 stores in Canada.

Unless otherwise authorized by the Bankruptcy Court, the Bankruptcy Code prohibits us from making payments to creditors on account of pre-petition claims. On September 13, 2016, we consummated the Sale Transactions and the DIP Facility was repaid in full using the proceeds therefrom. See Note 1 to the Consolidated Financial Statements.

Aéropostale Common Stock

On April 21, 2016, the Company was notified that the NYSE had suspended trading in our common stock, effective immediately, and had commenced proceedings to de-list the stock from the NYSE pursuant to Section 802.01D of the NYSE’s Listed Company Manual due to an “abnormally low” trading price. From April 22, 2016 through May 4, 2016, the Company’s common stock was traded on the OTCQX® Best Market, which is operated by OTC Markets Group, Inc., under the symbol “AROP.” In connection with the Chapter 11 Cases, as of May 5, 2016, the Company’s common equity was transferred to the Pink market, operated by OTC Markets Group, Inc., under the symbol "AROPQ."

We expect that, upon effectiveness of the Chapter 11 Plan, all equity of the Company will be cancelled without any distribution thereon.

Sourcing Arrangements

During May 2014, we entered into a non-exclusive sourcing agreement with MGF Sourcing US, LLC, an affiliate of Sycamore Partners (the “Sourcing Agreement”), which included $150.0 million in secured credit facilities (see Note 4 to the Consolidated Financial Statements). As discussed above, in March 2016, we announced that the Company was engaged in a dispute with MGF Sourcing relating to the Sourcing Agreement. On May 11, 2016, the Company reached an agreement in principle with MGF Sourcing to resolve the dispute, which was approved by the Bankruptcy Court. Under the terms of this agreement, outstanding purchase orders will be fulfilled under revised terms and no further purchase orders will be written. Upon fulfillment of open purchase orders and payment of post-bankruptcy petition invoices, the agreement shall terminate. On July 22, 2016, the Company filed a motion with the Bankruptcy Court seeking an order determining that (i) affiliates of Sycamore Partners are not entitled to credit bid their claims arising under the Loan Agreement in a sale of the Company’s assets, (ii) equitably subordinating such claims, and (iii) re-characterizing certain claims under the Loan Agreement. The Bankruptcy Court held a trial from August 15, 2016 to August 23, 2016 and on August 26, 2016, entered a decision denying the relief requested in the motion. See Notes 4 and 19 to the Consolidated Financial Statements.

On February 2, 2015, we revised and renewed a master sourcing agreement (the “Supplier Agreement”) with another one of our suppliers. On April 19, 2016, we amended and restated the Supplier Agreement. This amendment decreased the annual purchase commitment and removed the opportunity to receive an additional purchase discount. Under the ten-year agreement, we received an advance volume purchase discount equivalent to approximately $1.75 million per annum throughout the life of the Supplier Agreement as commitment of meeting certain minimum thresholds. See Note 3 to the Consolidated Financial Statements.

Merchandising and Operational Initiatives

During the period ended July 30, 2016, we continued to implement the following merchandising and operational initiatives:

Redefining our merchandising model to emphasize updated classic merchandise enhanced with contemporary additions that we believe will result in an exciting and unique total store assortment and presentation.
Dividing our store base into two chains, the Factory Chain and the Mall Chain, to better serve our core customers and differentiating the product assortments between Factory Chain exclusives and Mall Chain exclusives, suited specifically to the customer preferences we had identified.

33


Refining the manner in which we promote merchandise and our use of in-store marketing, tailoring the messages for each customer group of the two store chains.
Becoming more targeted in our patterns of merchandise allocation and distribution, allocating merchandise based on our Factory and Mall Chain strategy rather than universally allocating product.
Focusing on the growth of our international licensing business.


Results of Operations

The following table sets forth our results of operations as a percentage of net sales. We also use this information to evaluate the performance of our business:
 
13 weeks ended
 
26 weeks ended
 
July 30,
2016
 
August 1,
2015
 
July 30,
2016
 
August 1,
2015
Net sales
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Gross profit
29.8
 %
 
17.8
 %
 
22.6
 %
 
18.2
 %
Selling, general and administrative expenses
25.4
 %
 
31.2
 %
 
27.6
 %
 
31.2
 %
Restructuring charge (benefit)
 %
 
(1.9
)%
 
 %
 
(0.9
)%
Loss from operations
4.4
 %
 
(11.5
)%
 
(5.0
)%
 
(12.1
)%
Interest expense
1.3
 %
 
0.9
 %
 
1.3
 %
 
0.9
 %
Reorganization items, net
7.2
 %
 
 %
 
5.0
 %
 
 %
Loss before income taxes
3.1
 %
 
(12.4
)%
 
(6.3
)%
 
(13.0
)%
Income tax (benefit) expense
7.0
 %
 
1.0
 %
 
5.2
 %
 
0.8
 %
Net loss
(3.9
)%
 
(13.4
)%
 
(11.5
)%
 
(13.8
)%


34


Key Performance Indicators

We use a number of key indicators of financial condition and operating performance to evaluate the performance of our business, some of which are set forth in the following table. Comparable changes for the quarter ended July 30, 2016 are compared to the quarter ended August 1, 2015.
 
13 weeks ended
 
26 weeks ended
 
July 30,
2016
 
August 1,
2015
 
July 30,
2016
 
August 1,
2015
Net sales (in millions)
$320.9
 
$326.9
 
$
619.5

 
$
645.5

Retail stores and e-commerce net sales
$313.6
 
$316.7
 
604.4

 
627.6

International licensing revenue
$7.2
 
$10.2
 
15.1

 
17.9

Total store count at end of period
652
 
826
 
652

 
826

Comparable store count at end of period
645
 
805
 
645

 
805

Net sales change
(2)%
 
(17)%
 
(4
)%
 
(18
)%
Comparable sales change (including the e-commerce channel)
—%
 
(8)%
 
(2
)%
 
(9
)%
Comparable average unit retail change (including the e-commerce channel)
—%
 
(7)%
 
(3
)%
 
(4
)%
Comparable units per sales transaction change (including the e-commerce channel)
3%
 
—%
 
3
 %
 
(2
)%
Comparable sales transaction change (including the e-commerce channel)
(3)%
 
(1)%
 
(2
)%
 
(4
)%
Net sales per average square foot
$97
 
$88
 
$
180

 
$
172

Gross profit (in millions)
$95.8
 
58.3
 
$
139.9

 
$
117.5

Income (Loss) from operations (in millions)
$14.1
 
$(37.4)
 
$
(31.0
)
 
$
(77.9
)
Retail stores and e-commerce income (loss) from operations
$8.9
 
$(47.8)
 
$
(27.8
)
 
$
(93.6
)
International licensing income from operations
$6.4
 
$9.2
 
$
13.0

 
$
15.8

Other 1
$(1.2)
 
$1.2
 
$
(16.1
)
 
$
(0.1
)
Diluted loss per share
$(0.16)
 
$(0.55)
 
$
(0.88
)
 
$
(1.12
)
Average square footage change
(20)%
 
(20)%
 
(20
)%
 
(19
)%
Change in total inventory
3%
 
(20)%
 
3
 %
 
(20
)%
Change in store inventory per retail square foot
29%
 
—%
 
29
 %
 
 %
Percentages of net sales by category:
 
 
 
 
 

 
 

Young Women’s
64%
 
65%
 
65
 %
 
66
 %
Young Men’s
36%
 
35%
 
35
 %
 
34
 %

1 Other items include income (charges) that are not included in the segment income (loss) from operations reviewed by the Company’s chief operating decision maker, our Chief Executive Officer. See Note 18 to the Notes to the Unaudited Condensed Consolidated Financial Statements for a further discussion.

Comparison of the 13 weeks ended July 30, 2016 to the 13 weeks ended August 1, 2015

Net Sales

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

Net sales decreased by $6.0 million, or 2%, for the second quarter of 2016. This was due to a decline in average square footage of 20% resulting from store closures, offset, in part, by slightly positive comparable sales compared to the same period last year. The net sales decrease reflects:

35



an increase of $0.5 million in comparable sales (including the e-commerce channel)
a decrease of $3.5 million in non-comparable sales
a decrease of $2.9 million in international licensing revenue

Consolidated comparable sales, including the e-commerce channel, increased by 3% in our young men's category and decreased by 1% in our young women's category. The overall comparable sales, including the e-commerce channel, reflected a flat average unit retail along with a 3% decrease in the number of sales transactions which was offset by a 3% increase in units per sales transaction.

Cost of Sales and Gross Profit

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

Gross profit increased by $37.4 million for the second quarter of 2016 compared to the same period last year. The increase was due to a $17.0 million improvement comprised of an increase in net merchandise margins along with reduced occupancy and depreciation expenses. Additionally, the reversal of deferred allowances and rent liabilities related to the previously announced store closings netted a $19.0 million increase to gross profit. These increases were partially offset by asset impairment charges of $1.2 million related to the previously announced store closings. Gross profit for the second quarter of 2015 was unfavorably impacted by store closing costs of $2.6 million.

As a percentage of net sales, gross profit increased by 12.0 percentage points. Excluding the effect of the asset impairment charges and the net store closing liability reversal discussed above, gross profit for the second quarter of 2016 improved by 5.6 percentage points. The improvement compared to prior year was driven by an increase of 2.3 percentage points in net merchandise margin, leverage from reduced occupancy costs of 1.6 percentage points, and leverage from reduced depreciation costs of 1.1 percentage points.

SG&A

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

SG&A decreased by $20.1 million, or by 20%, for the second quarter of 2016 compared to the second quarter of 2015. The decrease was primarily due to $5.1 million of lower corporate expenses, $7.9 million of lower marketing expenses, and $4.5 million of lower store expenses due to reduced store count. Additionally, SG&A for the second quarter of 2015 included $2.5 million in non-recurring consulting costs.

As a percentage of net sales, SG&A was 25.4% for the second quarter of 2016 compared to 31.2% the same period last year.

Restructuring Charges

There were no restructuring charges for the second quarter of 2016 compared to the benefit of $6.1 million for the second quarter of 2015. The restructuring benefit for the second quarter of 2015 was due to reversals of exit cost obligation liabilities resulting from subsequent lease terminations.

Income (Loss) from Operations

As a result of the above, consolidated income from operations was $14.1 million for the second quarter of 2016, compared to a loss of $37.4 million for the second quarter of 2015. The consolidated income from operations included income from our international licensing segment of $6.4 million for the second quarter of 2016 compared to $9.2 million for the prior period.


36


Reorganization Items, Net

Reorganization items, net include expenses, gains and losses directly related to the Debtors’ reorganization proceedings. These costs total $23.2 million for the second quarter of 2016. See table presented in Note 1 to the Consolidated Financial Statements for details of the reorganization items.

Income taxes

We recorded a tax benefit of $.5 million for the second quarter of 2016 and a tax expense of $3.4 million for the second quarter of 2015.

Net loss

As a result of the above, net loss was $12.7 million, or $0.16 per diluted share, for the second quarter of 2016, compared to net loss of $43.7 million, or $0.55 per diluted share, for the second quarter of 2015.

Comparison of the 26 weeks ended July 30, 2016 to the 26 weeks ended August 1, 2015

Net Sales

Net sales decreased by $26.0 million, or 4%, for the first twenty-six weeks of 2016. This was due to a decline in average
square footage of 20% resulting from store closures and a comparable sales decrease of 2% when compared to the same period last
year. The net sales decrease reflects:

• a decrease of $10.6 million in comparable sales (including the e-commerce channel)
• a decrease of $12.6 million in non-comparable sales
• a decrease of $2.8 million in international licensing revenue

Consolidated comparable sales, including the e-commerce channel, increased by 1% in our young men's category and decreased 2% in our young women's category. The overall comparable sales, including the e-commerce channel, reflected decreases of 2% in the number of sales transactions and 3% in average unit retail, were partially offset by an increase of 3% in units per sales transaction.

Cost of Sales and Gross Profit

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

Gross profit increased by $22.5 million for the first twenty-six weeks of 2016 compared to the same period last year. The increase was due to a $14.7 million improvement comprised of an increase in net merchandise margins along with reduced occupancy and depreciation expense. Additionally, the reversal of deferred allowances and rent liabilities related to the previously announced store closings netted a $19.0 million increase to gross profit. These increases were partially offset by asset impairment charges of $16.1 million related to the store closings. Gross profit for the first twenty-six weeks of 2015 was unfavorably impacted by store closing related costs of $4.9 million.

Gross profit increased by 4 percentage points for the first twenty-six weeks of 2016 compared to the same period last year. The increase from last year was primarily driven by a 1.3 percentage point increase in net merchandise margin, leverage from reduced occupancy costs of 0.5 percentage points, and leverage from reduced depreciation costs of 0.9 percentage points.

SG&A

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


37


SG&A decreased by $30.5 million for the first twenty-six weeks of fiscal 2016 compared to the first twenty-six weeks of fiscal 2015. The decrease was primarily due to $5.4 million of lower store-line expenses resulting from store closings and cost savings initiatives, lower corporate expenses of $12.1 million, lower marketing expenses of $10.6 million.

As a percentage of net sales, SG&A was 27.6% for the first twenty-six weeks of fiscal 2016 compared to 31.2% for the same period last year. The decrease in SG&A, as a percentage of sales, was due primarily to the leverage impact of reduced corporate and marketing expenses.

Restructuring Charges

There were no restructuring charges related to the cost reduction program discussed above for the first twenty-six weeks of fiscal 2016 compared to a benefit of $6.0 million the first twenty-six weeks of fiscal 2015. The restructuring benefit for the first twenty-six weeks of fiscal 2016 is due to reversals of exit cost obligation liabilities resulting from subsequent lease terminations.

Loss from Operations

As a result of the above, consolidated loss from operations was $71.1 million for the first twenty-six weeks of fiscal 2016, compared to $88.9 million for the first twenty-six weeks of fiscal 2015. The consolidated loss from operations included income from operations from our international licensing segment of $13.0 million for the first twenty-six weeks of fiscal 2016 compared with $15.8 million for the first twenty-six weeks of fiscal 2015. In addition, consolidated loss from operations included net restructuring and other charges of $6.0 million for the first twenty-six weeks of fiscal 2015.

Income taxes

We recorded tax expense at a rate of 1.5% for the first twenty-six weeks of fiscal 2016 versus 5.7% for the first
twenty-six weeks of fiscal 2015. The tax rate differential was due to certain discrete tax items recorded in 2015.

Net loss

Net loss was $71.1 million, or $0.88 per diluted share, for the first twenty-six weeks of fiscal 2016, compared to net loss of $88.9 million, or $1.12 per diluted share, for the first twenty-six weeks of fiscal 2015.

Liquidity and Capital Resources

Our cash requirements have historically been primarily for working capital, remodeling or updating existing stores, the improvement or enhancement of our information technology systems and the construction of a limited number of new stores. Due to the seasonality of our business, we have historically realized a significant portion of our cash flows from operations during the second half of the year.

Amongst other things, declining mall traffic due to a shift in customer demand away from apparel to technology and personal experiences, a highly promotional and competitive retail environment and a change in our customers' taste and preference has contributed to unfavorable financial performance. We have incurred declining comparable sales and net losses from operations. This led to cash outflows from operations of $68.5 million in fiscal 2015 and $55.7 million in fiscal 2014. As a result, over the past years, we took the following steps to enhance our liquidity position, reduce costs and increase sales:

In connection with the Chapter 11 Filings, on May 4, 2016, the Company announced the closure of 113 U.S. locations, as well as all 41 stores in Canada. These store closures were substantially completed during the second quarter of fiscal 2016.
During the second quarter of fiscal 2016, in order to align the size and composition of the Company’s workforce with its expected future operating and capital plans, the Company reduced its workforce by 121 open or occupied full-time corporate positions, representing approximately 19% of the employees in the Company’s corporate staff.
The Company instituted the 2015 Cost Reduction Program.  The Company expected this program to generate approximately $35.0 million to $40.0 million in annualized pre-tax savings which was expected to be fully achieved in fiscal 2016. As part of its cost reduction program, Aéropostale has reduced corporate headcount by approximately 100 positions, or 13%, by the end of fiscal 2015. This is in addition to the corporate headcount reduction of 100 open or occupied corporate positions effectuated in connection with the 2014 Cost Reduction Program.
In August 2015, we amended our Credit Facility to increase borrowing availability and extend the maturity date, among other things (see Note 13 to the Consolidated Financial Statements). 

38


In February 2015, we received an advance volume purchase discount of $17.5 million from a supplier (see Note 3 to the Consolidated Financial Statements for a further discussion).
As part of our plan to restructure the P.S. from Aéropostale business and to reduce costs, we closed 126 P.S. from Aéropostale stores in fiscal 2014, primarily in mall locations.
We also closed 171 under-performing Aéropostale stores in the United States and Canada during fiscal 2014 and 2015.
During fiscal 2015, we reduced our capital expenditures to $15.7 million from $23.8 million in fiscal 2014, and reduced capital expenditures to $3.2 million during the twenty-six weeks ended July 30, 2016.
We have focused on strategic initiatives to improve our financial performance as discussed above.

In May 2014, we received net proceeds of $137.6 million from the $150.0 million debt facilities with affiliates of Sycamore Partners. We used the proceeds of this financing transaction for working capital and other general corporate purposes. See Note 4 to the Consolidated Financial Statements for further discussion of these arrangements.

In conjunction with this arrangement, we also entered into a sourcing agreement with MGF Sourcing US, LLC, an affiliate of Sycamore Partners. As previously disclosed, the Company was engaged in a dispute with MGF Sourcing relating to the Sourcing Agreement. This caused a disruption in the supply of merchandise and resulted in both a liquidity constraint and lost sales. On May 11, 2016, the Company reached an agreement in principle with MGF Sourcing to resolve the dispute, which was approved by the Bankruptcy Court.

On May 4, 2016, we filed the Chapter 11 Filings and entered into the DIP Facility to assist with financing our ongoing operations. The Chapter 11 Filings constituted an event of default and automatic acceleration of our prepetition loans. Notwithstanding the defaults and automatic acceleration, the lenders cannot exercise any remedies because of an automatic stay that is in place under Bankruptcy Laws in connection with the Chapter 11 Filings.

On May 6, 2016, the Bankruptcy Court granted approval for us to draw $100 million in interim financing from the DIP Facility, which we are using for general purposes and also have utilized to pay off the Credit Facility (as defined above). The DIP Facility requires that we maintain minimum excess availability of at least (a) $25 million during the month of May 2016 and (b) $13 million at all times thereafter. In addition, the DIP Facility includes a covenant that requires us to limit expenditures to amounts provided in an agreed DIP budget, subject to certain permitted variances. Furthermore, the DIP Facility includes a series of milestones related to the Chapter 11 Cases. While these milestones allow us to simultaneously pursue both a plan of reorganization and a sale process, either path requires us to achieve a series of intermediate process benchmarks and, in any event, requires that a plan become effective or a sale be consummated, in either case, within 145 days after the Petition Date. Failure to comply with these covenants or milestones would result in an event of default under the DIP Facility and permit the lenders thereunder to accelerate the loans and otherwise exercise remedies under the loan documentation for the DIP Facility.

On May 25, 2016, the parties to the DIP Facility entered into the First Amendment to the Secured Superpriority Debtor-in-Possession Loan, Security and Guaranty Agreement pursuant to which the DIP Facility was amended to, among other things, extend the dates by which a final order approving the DIP Facility and an order extending the date by which the Company must assume or reject leases must be entered into the docket by the Bankruptcy Court. Also on May 25, 2016, the parties to the DIP Facility entered into the Second Amendment to the Secured Superpriority Debtor-in-Possession Loan, Security and Guaranty Agreement (pursuant to which the lenders provided their consent for entry by the Company into an agreement to settle the previously disclosed dispute with MGF Sourcing US, LLC, subject to certain conditions described therein).

On June 9, 2016, the DIP Facility was further amended pursuant to the Third Amendment to the Secured Superpriority Debtor-in-Possession Loan, Security and Guaranty Agreement (the “Third Amendment") to extend the date by which the final order approving the DIP Facility must be entered into the docket by the Bankruptcy Court.

On June 10, 2016, the Bankruptcy Court granted final approval of $160 million in interim financing under the DIP Facility.

On July 1, 2016, the DIP Facility was amended pursuant to the Fourth Amendment to the Secured Superpriority Debtor-in-Possession Loan, Security and Guaranty Agreement (the “Fourth Amendment”) to, among other things, amend certain milestone dates with respect to the Chapter 11 Cases consistent with the agreement reflected in the DIP Order.

At July 30, 2016, we had cash and cash equivalents of $25.4 million, and the DIP Facility revolving credit facility had availability of $52.0 million with $108.0 million in borrowings outstanding.

On September 13, 2016, the Bankruptcy Court entered orders (“Orders”) approving (i) an Asset Purchase Agreement (the “Asset Purchase Agreement”), dated as of September 12, 2016, by and among the Company, the other direct and indirect subsidiaries of the

39


Company signatory thereto (together with the Company, the “Sellers”), and Aero OpCo LLC (“OpCo LLC”). OpCo LLC, together with ABG-Aero IPCO, LLC (“IPCO”) were formed by a consortium comprised of Authentic Brands Group, Simon Property Group, General Growth Properties, Hilco Merchant Resources (“Hilco”) and Gordon Brothers Retail Partners (“Gordon Brothers”, and together with Hilco, the “Agent”), and (ii) an Agency Agreement (the “Agency Agreement”), dated as of September 12, 2016, by and among the Sellers, OpCo LLC, and the Agent (the transactions contemplated by the Asset Purchase Agreement and Agency Agreement, collectively, the “Sale Transactions”). The parties consummated the Transactions on September 15, 2016. On September 15, 2016, the DIP was repaid using the proceeds from the Sale Transactions (as described below).

Under the Asset Purchase Agreement, subject to certain limited exceptions, until the earlier of (i) the confirmation of a plan of reorganization or liquidation in the Chapter 11 Cases and (ii) November 30, 2016, OpCo LLC will have the right to designate additional contracts and leases of the Sellers for assignment and assumption (to the extent not previously rejected).

In connection with the closing of the Sale Transactions, the Company entered into a transition services agreement with OpCo LLC, pursuant to which OpCo LLC will provide the Company with certain services, at cost, in connection with the wind-down of the Company’s business operations. The Company also entered into a transferred employee agreement with OpCo LLC, pursuant to which the Company’s employees will be seconded to OpCo LLC for a period of time following the closing. No later than January 1, 2017 and subject to certain exceptions, any remaining store employees and any non-store employees who have been offered and accept employment with OpCo LLC will become employees of OpCo LLC.

The following table sets forth our cash flows for the period indicated:
 
26 weeks ended
 
July 30,
2016
 
August 1,
2015
 
(In thousands)
Net cash used in operating activities
$
(113,007
)
 
$
(56,003
)
Net cash used in investing activities
(27,911
)
 
(8,546
)
Net cash (used in) provided by financing activities
101,136

 
(401
)
Effect of exchange rate changes
125

 
(285
)
Net decrease in cash and cash equivalents
$
(39,657
)
 
$
(65,235
)

Operating activities - Net cash used in operating activities increased by $42.7 million for the first twenty-six weeks of fiscal 2016 compared to the same period in 2015. Net cash used in operations for the first quarter of 2015 included the previously discussed advance volume purchase discount. Cash used for accounts payable increased primarily due to accelerated payment terms for certain critical merchandise vendors.
     
Investing activities - Investments in capital expenditures are principally for the construction of new stores, remodeling of existing stores and investments in information technology. Our future capital requirements will depend primarily on the number of new stores we open, the number of existing stores we remodel and other strategic investments. During fiscal 2016, we plan to invest not more than $9.0 million in capital expenditures. Net cash used in investing activities increased by $19.4 million for the first twenty-six weeks of fiscal 2016 compared to the same period in 2015. During the first twenty-six weeks of fiscal 2016, we funded $24.7 million in restricted cash primarily related to professional fees associated with the Chapter 11 Cases. Additionally, we invested $3.2 million in capital expenditures, which excludes accruals related to purchases of property and equipment. During the first twenty-six weeks of fiscal 2016, we remodeled 7 Aéropostale stores. During the first twenty-six weeks of fiscal 2015, we invested $8.5 million in capital expenditures, primarily to open one Aéropostale store and remodel 6 Aéropostale stores.

Financing activities - Net cash used in financing activities for the first quarter of 2016 increased via net borrowings of $108.0 million to fund operations.

Transaction with Affiliates of Sycamore Partners

On May 23, 2014, we entered into (i) a Loan and Security Agreement (the "Loan Agreement") with affiliates of Sycamore Partners, (ii) a Stock Purchase Agreement (the "Stock Purchase Agreement") with Aero Investors LLC, an affiliate of Sycamore Partners for the purchase of 1,000 shares of Series B Convertible Preferred Stock of the Company, $0.01 par value (the "Series B Preferred Stock") and (iii) an Investor Rights Agreement with Sycamore Partners (collectively "Sycamore Transactions"). See Notes 3 and 4 to the Consolidated Financial Statements for a further discussion.


40


Sycamore Partners was considered a related party due to the agreements with its affiliates described above combined with its ownership interest in us. As of May 23,2014 and December 31,2015, Lemur LLC, an affiliate of Sycamore Partners, owned approximately 8% of our outstanding common stock. As of February 9, 2016, Lemur LLC ceased to be the beneficial owner of more than five percent of the Company's common stock.

The Loan Agreement made term loans available to us in the principal amount of $150.0 million, consisting of two tranches: a five-year $100.0 million term loan facility (the "Tranche A Loan") and a 10-year $50.0 million term loan facility (the "Tranche B Loan" and, together with the Tranche A Loan, the "Term Loans"). The Loan Agreement also contained a $70.0 million minimum liquidity covenant.

On May 23, 2014, the Term Loans were disbursed in full and we received net proceeds of $137.6 million from affiliates of Sycamore Partners, after deducting the first year interest payment and certain issuance fees. The proceeds of the Term Loans were used for working capital and other general corporate purposes.

The Tranche A Loan bears interest at a rate equal to 10% per annum and, at our election, up to 50% of the interest can be payable-in-kind during the first three years and up to 20% of the interest can be payable-in-kind during the final two years. The first year of interest under the Tranche A Facility in the amount of $10.0 million was prepaid in cash in full on May 23, 2014, and no other interest payments were required to be paid during the first year of the Tranche A Loan. The Tranche A Loan has no annual scheduled repayment requirements. The Tranche B Loan does not accrue any interest and is to be repaid in equal annual installments of 10% per annum beginning in fiscal 2016. As of May 6, 2016, there was an aggregate outstanding principal amount of $151.25 million: $101.25 million in Tranche A and $50 million in Tranche B.

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

Prior to the Chapter 11 Filings, the Tranche A Loan was scheduled to mature on May 23, 2019 and the Tranche B Loan was scheduled to mature on the earlier of (a) tenth anniversary of the end of the Start-Up Period (as such term is defined in the Sourcing Agreement described in Note 4 to the Notes to the Unaudited Condensed Consolidated Financial Statements) and (b) the expiration or termination of the Sourcing Agreement described below in the “Contractual Obligations” section. However, the Chapter 11 Filings triggered events of default and an automatic acceleration of the Term Loans. Notwithstanding the defaults and automatic acceleration, the counterparties to the Term Loans may not exercise any remedies due to the automatic stay under Bankruptcy Laws resulting from the Chapter 11 Cases.

As discussed above, the Company was engaged in a dispute with MGF Sourcing relating to the Sourcing Agreement. On May 11, 2016, the Company reached an agreement in principle with MGF Sourcing to resolve the dispute which was approved by the Bankruptcy Court. The Sourcing Agreement will terminate when the parties comply with their respective obligations under outstanding orders.

Please see Note 4 to the Consolidated Financial Statements for a further discussion.

Revolving Credit Facility

On August 18, 2015, the Company entered into a Fourth Amendment to the Credit Facility and Amendment to Certain Other Loan Documents (the “Fourth Amendment”). Among other things, the Fourth Amendment extended the maturity date of the Credit Facility, until at least February 21, 2019, with automatic extensions, under certain circumstances set forth in the Fourth Amendment, to August 18, 2020; provided for a reduction in the maximum principal amount of extensions of credit that may have been made under the Credit Facility from $230 million to $215 million; provided for a seasonal increase in the advance rate on inventory under the borrowing base formula for the revolving credit facility contained in the Credit Facility; increased to $40 million the maximum aggregate principal amount of loans that may have been borrowed under the FILO loan facility contained in the Credit Facility and provided for an annual decrease, commencing in 2017, in the advance rate under the borrowing base formula for FILO loans; and reflected the addition of General Electric Capital Corporation as an additional lender under the Credit Facility. The reduction in the maximum principal amount of extensions of credit under the Credit Facility was primarily driven by the Company’s strategic decision to close underperforming stores, thus reducing inventory levels.


41


The Chapter 11 Filings triggered an event of default and an automatic acceleration of our loans under the Credit Facility. On May 9, 2016, we repaid the $73.4 million outstanding, using the funds available under our DIP Facility, and terminated the Credit Facility. We also cash collateralized the standby letter of credit, which currently remains outstanding.

Please see Note 13 to the Consolidated Financial Statements for a further discussion.

Contractual Obligations

The following table summarizes our contractual obligations as of July 30, 2016:

 
 
 
Payments Due
 
Total
 
Balance of
2016
 
In 2017
and 2018
 
In 2019
and 2020
 
After
2020
 
(In thousands)
Contractual Obligations
 
 
 
 
 
 
 
 
 
Real estate operating leases
$
389,639

 
$
50,246

 
$
141,915

 
$
103,111

 
$
94,367

Sycamore Tranche A Loan principal 1
101,250

 

 

 
101,250

 

Sycamore Tranche B Loan principal 2
50,000

 
10,000

 
10,000

 
10,000

 
20,000

Sycamore Tranche A Loan interest
31,861

 
7,500

 
20,000

 
4,361

 

Employment agreement 3
1,500

 
750

 
750

 

 

Equipment operating leases
4,692

 
1,440

 
3,252

 

 

Total contractual obligations
$
578,942

 
$
69,936

 
$
175,917

 
$
218,722

 
$
114,367


1 All debt related to Sycamore has been classified as Liabilities Subject to Compromise on the Balance Sheet as of July 30, 2016. See Note 1 for additional information. Tranche A Loan principal include $1.3 million in PIK interest.

2 Although interest is imputed on the Tranche B Loan and recorded as interest expense, the Tranche B Loan does not require any contractual interest payments. The Tranche B Loan was scheduled to be paid off in equal annual installments of 10% per annum. The Tranche B Loan is scheduled to mature on the earlier of (a) the tenth anniversary of the end of the Start-Up Period (as such term is defined in the Sourcing Agreement) and (b) the expiration or termination of the Sourcing Agreement. Under the Sourcing Agreement, beginning in 2016 an affiliate of Sycamore Partners was required to pay to us an annual rebate equal to a fixed amount multiplied by the percentage of annual purchases made by us (including purchases deemed to be made by virtue of payment of the shortfall commission) relative to the Minimum Volume Commitment that would have been applied towards the payment of the required amortization on the Tranche B Loan. The Minimum Volume Commitment was between $240.0 million and $280.0 million per annum depending on the year. If we had failed to purchase the applicable Minimum Volume Commitment in any given year, we would have paid a shortfall commission to an affiliate of Sycamore Partners, based on a scaled percentage of the applicable Minimum Volume Commitment shortfall during the applicable period. The Sourcing Agreement also provided for certain carryover credits if we purchased a volume of product above the Minimum Volume Commitment during the applicable Minimum Volume Commitment Period. The Minimum Volume Commitment is not included in the above table. Additionally, no potential rebates or shortfall commissions are included in the above table. In March 2016, we announced that the Company was engaged in a dispute with MGF Sourcing relating to the Sourcing Agreement. On May 11, 2016, the Company reached an agreement with MGF Sourcing to resolve the dispute which has been approved by the Bankruptcy Court. Under the terms of this agreement, outstanding purchase orders will be fulfilled under revised terms and no further purchase orders will be written. Upon fulfillment of open purchase orders and payment of post-bankruptcy petition invoices, the agreement shall terminate. See Note 4 to the Consolidated Financial Statements for a further discussion.

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

The real estate operating leases included in the above table do not include contingent rent based upon sales volume, which amounted to approximately 4% of minimum lease obligations in fiscal 2015. In addition, the above table does not include variable costs paid to landlords such as maintenance, insurance and taxes, which represented approximately 56% of minimum lease obligations in fiscal 2015.


42


As discussed in Note 14 to the Notes to the Unaudited Condensed Consolidated Financial Statements, we have a SERP liability of $1.2 million and other retirement plan liabilities of $4.8 million at July 30, 2016.  Such liability amounts are not reflected in the table above. The Bankruptcy Code may restrict payments of such liabilities.

Our total liabilities for unrecognized tax benefits were $6.9 million at July 30, 2016. Of this amount, $4.8 million was recorded as a direct reduction of the related deferred tax assets.  We cannot make a reasonable estimate of the amount and timing of related future payments for these non-current liabilities. Therefore these liabilities were not included in the above table.

In 2012, Bank of America, N.A. issued a stand-by letter of credit under the Credit Facility. On May 9, 2016, we cash collateralized the standby letter of credit, which currently remains outstanding. We do not have any other stand-by or commercial letters of credit as of July 30, 2016.

The above table also does not include contingent bonus compensation agreements with certain of our employees. The bonuses become payable if the individual is employed by us on the future payment date. The amount of conditional bonuses that may be paid is $0.1 million during fiscal 2016 and $1.1 million during fiscal 2017.

The above table does not reflect contingent purchase consideration related to the fiscal 2012 acquisition of GoJane that is discussed in Note 6 to the Notes to the Unaudited Condensed Consolidated Financial Statements. The purchase price includes contingent cash payments of up to an aggregate of $8.0 million if certain financial metrics are achieved by the GoJane business during the five year period beginning on the acquisition date. The fair value of the contingent payments as of July 30, 2016 was estimated to be $0.7 million based on expected probability of payment and we have recorded such liability on a discounted basis. In addition, we granted restricted shares to the two individual former stockholders of GoJane, with compensation expense recognized over the three year cliff vesting period. If the aggregate dollar value of the restricted shares on the vesting date is less than $8.0 million, then we shall pay to the two individual former stockholders an amount in cash equal to the difference between $8.0 million and the fair market value of the restricted shares on the vesting date. The balance due of $7.6 million that was recorded as of January 30, 2016 was paid during the first quarter of 2016. There are no further amounts due related to these restricted shares.

On February 2, 2015, we revised and renewed a Supplier Agreement with one of our suppliers, which was further amended on April 19, 2016. Under the agreement, we have a ten-year commitment. We have not recorded any shortfall payments or included any in the table above (see Note 3 to the Consolidated Financial Statements for a further discussion). In connection with the Chapter 11 Cases and pursuant to the Asset Purchase Agreement, until the earlier of the confirmation of a Chapter 11 Plan or November 30, 2016, OpCo LLC has the right to direct the Company to either assume or reject the Supplier Agreement. If assumed, OpCo LLC will be required to pay any cure costs related to such assumption.
  
The above table does not include a product license agreement that obligates us to pay the licensor at least the guaranteed minimum royalty amount based on sales of their products.

We have not issued any third party guarantees or commercial commitments as of July 30, 2016.

Off-Balance Sheet Arrangements

Other than operating lease commitments set forth in the table above, and an immaterial outstanding letter of credit, we are not party to any material off-balance sheet financing arrangements.  We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating our business.  We do not have any arrangements or relationships with entities that are not consolidated into the unaudited condensed consolidated financial statements that are reasonably likely to materially affect our liquidity or the availability of capital resources.  As of July 30, 2016, we have not issued any letters of credit for the purchase of merchandise inventory or any capital expenditures.

Critical Accounting Policies and Estimates

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


43


Critical accounting policies are those that are most important to the portrayal of our financial condition and the results of operations and require management's most difficult, subjective and complex judgments as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our most critical accounting policies have been discussed in our Annual Report on Form 10-K for the fiscal year ended January 30, 2016.  In applying such policies, management must use significant estimates that are based on its informed judgment. Because of the uncertainty inherent in these estimates, actual results could differ from estimates used in applying the critical accounting policies. Changes in such estimates, based on more accurate future information, may affect amounts reported in future periods.

As of July 30, 2016, there have been no material changes to any of the critical accounting policies as disclosed in our Annual
Report on Form 10-K for the fiscal year ended January 30, 2016.

44


Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

Unrealized foreign currency gains and losses, resulting from the translation of our Canadian subsidiary financial statements into our U.S. dollar reporting currency, are reflected in the equity section of our unaudited condensed consolidated balance sheet in accumulated other comprehensive income (loss). The unrealized gain of approximately $2.6 million is included in accumulated other comprehensive loss as of July 30, 2016. A 10% movement in quoted foreign currency exchange rates could result in a fair value translation fluctuation of approximately $0.1 million, which would be recorded in other comprehensive income (loss) as an unrealized gain or loss.

We also faced transactional currency exposures relating to merchandise that our Canadian subsidiary purchases using U.S. dollars.  These foreign currency transaction gains and losses were charged or credited to earnings as incurred. We did not hedge our exposure to this currency exchange fluctuation and transaction gains and losses to date have not been significant. During the second quarter of fiscal 2016 we closed all locations of our Canadian subsidiary and ceased operations. Additionally, our international licensees also may be exposed to foreign currency transaction gains and losses.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures: Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), our management carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer along with our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act). Based upon that evaluation, our Chief Executive Officer along with our Chief Financial Officer concluded that as of the end of our second quarter ended July 30, 2016, our disclosure controls and procedures are effective.

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


45


PART II — OTHER INFORMATION

Item 1. Legal Proceedings

For a description of our legal proceedings, please see the description set forth in the “Legal Proceedings” section in Note 16 to the Notes to the Unaudited Condensed Consolidated Financial Statements.

Item 1A. Risk Factors

There are no material changes from the Risk Factors as previously disclosed in our Form 10-K for the fiscal year ended January 30, 2016.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits

46


Exhibit No.       
 
 
Description
10.1
 
Secured Superpriority Debtor-in-Possession Loan, Security and Guaranty Agreement, dated as of May 4, 2016 (incorporated by reference to Current Report on Form 8-K filed with the SEC on May 6, 2016).
10.2
 
First Amendment to the Secured Superpriority Debtor-in-Possession Loan, Security and Guaranty Agreement, dated as of May 25, 2016 (incorporated by reference to Current Report on Form 8-K filed with the SEC on May 31, 2016).
10.3
 
Second Amendment to the Secured Superpriority Debtor-in-Possession Loan, Security and Guaranty Agreement, dated as of May 25, 2016 (incorporated by reference to Current Report on Form 8-K filed with the SEC on May 31, 2016).
10.4
 
Third Amendment to the Secured Superpriority Debtor-in-Possession Loan, Security and Guaranty Agreement, dated as of June 9, 2016 (incorporated by reference to Current Report on Form 8-K filed with the SEC on June 14, 2016).
10.5
 
Fourth Amendment to the Secured Superpriority Debtor-in-Possession Loan, Security and Guaranty Agreement, dated as of July 1, 2016 (incorporated by reference to Current Report on Form 8-K filed with the SEC on July 7, 2016).
31.1
 
Certification by Julian R. Geiger, Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31.2
 
Certification by David J. Dick, Senior Vice President and Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
32.1
 
Certification by Julian R. Geiger pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**
32.2
 
Certification by David J. Dick pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**
101.INS
 
XBRL Instance Document.*
101. SCH
 
XBRL Taxonomy Extension Schema.*
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase.*
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase.*
101.LAB
 
XBRL Taxonomy Extension Label Linkbase.*
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase.*
____________
*
Filed herewith.
**
Furnished herewith.



47


SIGNATURES

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

 
Aéropostale, Inc.
 
 
 
/s/ JULIAN R. GEIGER
 
Julian R. Geiger
 
Chief Executive Officer
 
(Principal Executive Officer)
 
 
 
/s/ DAVID J. DICK
 
David J. Dick
 
Senior Vice President — Chief Financial Officer
 
(Principal Financial Officer)



Dated: October 21, 2016
 

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Exhibit Index

Exhibit No.       
 
 
Exhibit
10.1
 
Secured Superpriority Debtor-in-Possession Loan, Security and Guaranty Agreement, dated as of May 4, 2016 (incorporated by reference to Current Report on Form 8-K filed with the SEC on May 6, 2016).
10.2
 
First Amendment to the Secured Superpriority Debtor-in-Possession Loan, Security and Guaranty Agreement, dated as of May 25, 2016 (incorporated by reference to Current Report on Form 8-K filed with the SEC on May 31, 2016).
10.3
 
Second Amendment to the Secured Superpriority Debtor-in-Possession Loan, Security and Guaranty Agreement, dated as of May 25, 2016 (incorporated by reference to Current Report on Form 8-K filed with the SEC on May 31, 2016).
10.4
 
Third Amendment to the Secured Superpriority Debtor-in-Possession Loan, Security and Guaranty Agreement, dated as of June 9, 2016 (incorporated by reference to Current Report on Form 8-K filed with the SEC on June 14, 2016).
10.5
 
Fourth Amendment to the Secured Superpriority Debtor-in-Possession Loan, Security and Guaranty Agreement, dated as of July 1, 2016 (incorporated by reference to Current Report on Form 8-K filed with the SEC on July 7, 2016).
31.1
 
Certification by Julian R. Geiger, Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31.2
 
Certification by David J. Dick, Senior Vice President and Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
32.1
 
Certification by Julian R. Geiger pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**
32.2
 
Certification by David J. Dick pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**
101.INS
 
XBRL Instance Document.*
101. SCH
 
XBRL Taxonomy Extension Schema.*
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase.*
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase.*
101.LAB
 
XBRL Taxonomy Extension Label Linkbase.*
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase.*


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