S-1/A 1 y37428a5sv1za.htm FORM S-1/A sv1za
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As filed with the Securities and Exchange Commission on November 10, 2009
No. 333-161850
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
AMENDMENT NO. 5
TO
FORM S-1
REGISTRATION STATEMENT UNDER
THE SECURITIES ACT OF 1933
 
 
rue21, inc.
(Exact name of registrant as specified in its charter)
 
         
Delaware   5600   25-1311645
(State or other jurisdiction of
incorporation or organization)
  (Primary Standard Industrial
Classification Code Number)
  (I.R.S. Employer
Identification No.)
 
800 Commonwealth Drive
Suite 100
Warrendale, Pennsylvania 15086
(724) 776-9780
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
 
 
Robert N. Fisch
President and Chief Executive Officer
rue21, inc.
800 Commonwealth Drive
Suite 100
Warrendale, Pennsylvania 15086
(724) 776-9780
(Name, address, including zip code, and telephone number, including area code, of agent for service)
 
 
Copies of all communications, including communications sent to agent for service, should be sent to:
 
     
Joshua N. Korff, Esq.
Jason K. Zachary, Esq.
Kirkland & Ellis LLP
601 Lexington Avenue
New York, New York 10022
(212) 446-4800
  William F. Gorin, Esq.
Jeffrey D. Karpf, Esq.
Cleary Gottlieb Steen & Hamilton LLP
One Liberty Plaza
New York, New York 10006
(212) 225-2000
 
Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective.
 
 
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act, check the following box: o
 
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
 
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities act registration statement number of the earlier effective registration statement for the same offering. o
 
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
 
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 (Check one):
 
Large accelerated filer o Accelerated filer o Non-accelerated filer þ Smaller reporting company o
                                       (Do not check if a smaller reporting company)
 
CALCULATION OF REGISTRATION FEE
 
                                         
            Proposed Maximum
           
Title of Each Class of Securities
    Amount to be
    Offering Price
    Proposed Maximum Aggregate
    Amount of
to be Registered     Registered(1)     Per Share(2)     Offering Price(1)(2)     Registration Fee(2)(3)
Common Stock, $0.001 par value per share
      7,780,252 shares       $ 18.00       $ 140,044,536       $ 7,815  
                                         
(1) Includes shares of common stock that the underwriters may purchase, including pursuant to the option to purchase additional shares, if any, from the selling stockholders.
(2) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(a) under the Securities Act of 1933, as amended.
(3) Previously paid.
 
The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until this Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.
 


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The information in this preliminary prospectus is not complete and may be changed. We and the selling stockholders may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.
 
(WATERMARK)
 
6,765,437 Shares
 
rue21, inc.
 
Common Stock
 
 
 
 
This is the initial public offering of shares of common stock of rue21, inc.
 
rue21, inc. is offering 1,650,000 shares of common stock. The selling stockholders identified in this prospectus are offering an additional 5,115,437 shares of common stock. We will not receive any proceeds from the sale of shares by the selling stockholders.
 
Prior to this offering, there has been no public market for our common stock. It is currently estimated that the initial public offering price per share will be between $16.00 and $18.00.
 
We intend to apply to list our common stock on The NASDAQ Global Select Market under the symbol ‘‘rue”.
 
 
 
 
See “Risk Factors” beginning on page 9 to read about factors you should consider before buying shares of our common stock.
 
 
 
 
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.
 
 
 
 
                 
    Per Share     Total  
 
Initial public offering price
  $           $        
Underwriting discount
  $       $    
Proceeds, before expenses, to rue21, inc. 
  $       $    
Proceeds, before expenses, to the selling stockholders
  $       $  
 
To the extent that the underwriters sell more than 6,765,437 shares of common stock, the underwriters have the option to purchase up to an additional 1,014,815 shares of common stock from certain of the selling stockholders at the initial public offering price less the underwriting discount.
 
 
 
 
The underwriters expect to deliver the shares against payment in New York, New York on          , 2009.
BofA Merrill Lynch Goldman, Sachs & Co. J.P.Morgan
 
Piper Jaffray
 
Prospectus dated          , 2009.

Subject to Completion, Dated November 10, 2009


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 EX-4.1
 EX-23.1
 
 
You should rely only on the information contained in this prospectus or in any free-writing prospectus we may specifically authorize to be delivered or made available to you. We have not, the selling stockholders have not, and the underwriters have not authorized anyone to provide you with additional or different information. We and the selling stockholders are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where such offers and sales are permitted. The information in this prospectus or a free-writing prospectus is accurate only as of its date, regardless of its time of delivery or of any sale of shares of our common stock. Our business, financial condition, results of operations and prospects may have changed since that date.
 
 
Until          , 2009 (25 days after the commencement of the offering), all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This delivery requirement is in addition to the dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to unsold allotments or subscriptions.


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PROSPECTUS SUMMARY
 
This summary highlights information contained elsewhere in this prospectus. This summary does not contain all of the information that you should consider in making your investment decision. You should read the following summary together with the entire prospectus, including the more detailed information regarding us, the common stock being sold in this offering and our financial statements and the related notes appearing elsewhere in this prospectus. You should carefully consider, among other things, the matters discussed in the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this prospectus before deciding to invest in our common stock. Some of the statements in this prospectus constitute forward-looking statements. See “Forward-Looking Statements.”
 
Except where the context otherwise requires or where otherwise indicated, the terms “rue21,” “we,” “us,” “our,” “our company” and “our business” refer to rue21, inc. and its consolidated subsidiary as a combined entity. Certain differences in the numbers in the tables and text throughout this prospectus may exist due to rounding.
 
We operate on a fiscal calendar widely used by the retail industry that results in a given fiscal year consisting of a 52- or 53-week period ending on the Saturday closest to January 31 of the following year. For example, references to “fiscal year 2008” refer to the fiscal year ended January 31, 2009. Our fiscal year 2006 consisted of a 53-week period and ended on February 3, 2007.
 
Our Company
 
rue21 is a fast growing specialty apparel retailer offering the newest fashion trends for girls and guys at value prices. We operate over 500 stores in 43 states. Our merchandise is designed to appeal to 11 to 17 year olds who aspire to be “21” and adults who want to look and feel “21”. We react quickly to market trends and our daily shipments to our stores ensure there is always new merchandise for our customers to discover. In addition, we offer our own brands, such as rue21 etc!, Carbon, tarea and rueKicks, to create merchandise excitement and differentiation in our stores. The energy in our stores and our focus on customer service, combined with our great value products, keep our customers returning to us. Through viral marketing and our interactive website, we continue to build a rueCommunity with a loyal customer base that will drive our growth into the future. The company and customer culture we have created invoke only one simple thought in the minds of most... Do you rue? I do!
 
We pursue a three-pronged strategy that focuses on diversification and growth. The key elements of our strategy are:
 
  •  Diversified Product — girls, guys, rue21 etc! We offer a broad range of girls and guys apparel, accessories, footwear, jewelry and fragrances. Over the last few years, we have expanded and developed a number of product categories to complement our extensive apparel offerings, including rue21 etc!, our girls jewelry and accessories category; tarea by rue21, our intimate apparel category; Carbon, our guys apparel and accessories category; rueKicks, one of our footwear lines; and a full line of fragrances for both girls and guys.
 
  •  Flexible Real Estate — strip centers, regional malls, outlet centers. As of October 3, 2009, approximately 51% of our stores were located in strip centers, 27% in regional malls and 22% in outlet centers. Our stores are located primarily in small- and middle-market communities that we believe have been underserved by traditional specialty apparel retailers. As a result, we are often the only junior and young men’s specialty apparel retailer in such communities. In these markets, our limited competition comes from large value retailers and department stores.
 
  •  Balanced Growth — new stores, store conversions, comparable store sales. We drive sales growth through opening new stores, converting existing stores into our new, larger rue21 etc! layout and increasing our comparable store sales. In fiscal year 2009, we plan to open 88 new stores, including 78 new stores opened as of October 3, 2009. We also plan to convert 26 stores, including 24 stores converted as of October 3, 2009, to a larger layout that includes a separate rue21 etc! store-in-store. We believe our merchandising initiatives and new category introductions will further enhance our comparable store sales growth.


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Under the leadership of Bob Fisch, our President and Chief Executive Officer, we have experienced consistent growth in net sales and net income over the seven prior years. We have continued these strong results in recent quarters despite the difficult economic environment. Our comparable store sales increases were 4.1% in the twenty-six weeks ended August 1, 2009 and 3.7% in fiscal year 2008. In the twenty-six weeks ended August 1, 2009, our net sales were $233.1 million, which represents a 33.3% increase over the twenty-six weeks ended August 2, 2008. Our net income was $8.3 million in the twenty-six weeks ended August 1, 2009, which represents a 61.4% increase over the twenty-six weeks ended August 2, 2008. We believe our compelling value proposition and trend-right merchandise have contributed to our strong operating results.
 
Our Competitive Strengths
 
We attribute our success as a specialty apparel retailer to the following competitive strengths:
 
  •  Compelling “fashion meets value” proposition.  We offer the newest fashion for girls and guys at prices lower than many other similar apparel retailers. Our broad product assortment, ranging from apparel to accessories to footwear, enables our customers to create a complete look. In addition, we provide our customers with a distinctive shopping experience in a fun-to-shop environment, further enhancing our branded value proposition.
 
  •  Flexible, fast-fashion business model.  Our merchandising model allows us to quickly identify and respond to trends and bring proven concepts and styles to our stores. Our sourcing model is designed to achieve lower cost, faster turnaround and lower inventory levels. Our vendor network consists of domestic importers and domestic suppliers. Our collaborative relationship with our vendors allows us to test small quantities of new products in select stores before broadly distributing them to our stores which, in turn, reduces markdown risk. By carrying the newest styles and regularly updating our floor sets, we provide our customers with a reason to frequently shop our stores.
 
  •  Presence in locations with limited direct competition.  We focus on small- and middle-market communities, which we define as communities with populations between 25,000 and 200,000 people, where household incomes do not typically support higher-priced retailers. As a result, we often are the only junior and young men’s specialty apparel retailer in a shopping center and face limited direct competition in these communities.
 
  •  Attractive new store economics.  We operate a proven and efficient store model that delivers strong cash flow. Not only do our stores provide a distinctive shopping experience and compelling merchandise assortment, but with low store build-out costs, competitive lease terms and a low-cost operating model, our stores also generate a strong return on investment. All of our new stores feature our rue21 etc! store-in-store layout, showcasing an expanded accessories offering. Our new stores average approximately 4,700 square feet, which is larger than our historical store layout, and pay back our investment in less than one year.
 
  •  Distinct company and customer culture.  We have a strong core culture that emanates from our employees, many of whom are high school and college students who live in the community and are rue21 customers. Through our viral marketing efforts and the support of our online rueCommunity, we bring the rue21 culture to our customer base. We believe our culture enables us to connect to our employees and customers, differentiate our in-store shopping experience and ultimately strengthen our brand image and drive customer loyalty.
 
  •  Strong and experienced management team.  Our senior management team has extensive experience across a broad range of disciplines in the specialty retail industry, including merchandising, real estate, supply chain and finance. Bob Fisch, our President and Chief Executive Officer, has more than 30 years of experience in the apparel industry. Upon completion of this offering, our executive officers will own     8.5% of our common stock and will own options that will enable them to own, in the aggregate, up to 11.3% of our common stock.


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Our Growth Strategy
 
We believe we are positioned to take advantage of significant opportunities to increase net sales and net income. We have recently invested significant capital to build the infrastructure necessary to support our growth. This investment includes an upgrade of our distribution facility and related systems, which we expect to complete by the end of the first quarter of fiscal year 2010. Upon completion, the distribution facility will be able to support approximately 1,300 stores. Key elements of our growth strategy include the following:
 
  •  Increase Square Footage.  We intend to drive our square footage growth by opening new stores and converting existing stores to our larger rue21 etc! layout. We believe there is a significant opportunity to expand our store base from 527 locations as of October 3, 2009 to more than 1,000 stores within five years. In fiscal year 2009, we plan to open 88 new stores, including 78 new stores opened as of October 3, 2009, and convert 26 stores, including 24 stores converted as of October 3, 2009. In fiscal year 2010, we plan to open approximately 100 new stores.
 
  •  Drive Comparable Store Sales.  We seek to maximize our comparable store sales by increasing the penetration of our diversified product categories, increasing our rue21 brand awareness, continuing to provide our distinctive store experience and converting existing stores to our larger rue21 etc! layout. We believe that our fashionable merchandise selections and affordable prices create shopping excitement for our customers, increase our brand loyalty and drive sales.
 
  •  Improve Profit Margins.  We believe we have the opportunity to drive margin expansion through scale efficiencies, continued cost discipline and changes in merchandise mix. We believe our expected strong store growth will permit us to take advantage of economies of scale in sourcing and to leverage our existing infrastructure, corporate overhead and fixed costs. We believe the expansion of our higher margin categories, such as accessories and footwear, will increase our overall margins over time.
 
Recent Developments
 
Management has prepared the estimated net sales and comparable store sales information below in good faith based upon our internal reporting for the thirteen weeks ended October 31, 2009. The estimate employs assumptions based upon historical sales return information and represents the most current information available to management. Such estimate has not been subject to our normal quarterly financial closing processes and interim condensed financial statement preparation. As a result, our actual financial results could be different and those differences could be material. Our consolidated interim condensed financial statements for the thirteen weeks ended October 31, 2009 are not expected to be filed with the SEC until after this offering is completed.
 
We believe that the recent net sales data, even when unaccompanied by net income data that is not yet available, is important to an investor’s understanding of our performance. The net sales information presented below for the thirteen weeks ended October 31, 2009 is estimated based upon currently available information relating to net sales and estimates of sales returns which are subject to change. However, we do not expect actual sales return data for the thirteen weeks ended October 31, 2009 to be different by more than 0.04% from the sales return information used, in part, to estimate net sales data for the thirteen weeks ended October 31, 2009.
 
For the thirteen weeks ended October 31, 2009, our net sales increased 40.7%, or $39.6 million, to $137.1 million from $97.5 million for the thirteen weeks ended November 1, 2008. This increase in net sales was due to an increase of approximately 40% in the number of transactions, primarily driven by new store openings and an increase of approximately 0.2% in the average dollar value of transactions per store. Our comparable store sales increased 13.5% for the thirteen weeks ended October 31, 2009 compared to an increase of 6.6% for the thirteen weeks ended November 1, 2008. Comparable store sales increased by $11.8 million and non-comparable store sales increased by $27.8 million. There were 386 comparable stores and 148 non-comparable stores open at October 31, 2009 compared to 303 and 130, respectively, at November 1, 2008.


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Net sales of girls apparel, girls accessories and guys apparel and accessories represented 58.3%, 22.3% and 19.4%, respectively, of total net sales for the thirteen weeks ended October 31, 2009 compared to 59.6%, 22.2% and 18.2%, respectively, for the thirteen weeks ended November 1, 2008. The increase in the guys apparel and accessories category and the approximate corresponding decrease in the girls apparel category as a percentage of net sales was reflective of varying category sales growth rates. The girls accessories and guys apparel and accessories categories grew by approximately 41% and 50%, respectively. The girls apparel category grew by approximately 38%. The increase in the guys apparel and accessories category as a percentage of net sales was due to management efforts to expand the number of items in the guys apparel and accessories category. The girls accessories category net sales as a percentage of net sales change was minimal as category growth was closer to total net sales growth.
 
Although we are unable at this time to provide any additional estimates with respect to our financial position, we have not identified any unusual or unique events or trends that occurred during the thirteen weeks ended October 31, 2009 which might materially affect our results of operations. The final financial results for the thirteen weeks ended October 31, 2009 may be different from the preliminary estimates we are providing above due to completion of quarterly close and review procedures, final adjustments and other developments that may arise between now and the time the financial results for this period are finalized.
 
Risk Factors
 
We are subject to a number of risks, including risks that may prevent us from achieving our business objectives or may adversely affect our business, financial condition, results of operations, cash flows and prospects. You should carefully consider these risks, including the risks discussed in the section entitled “Risk Factors” beginning on page 9 of this prospectus, before investing in our common stock. Risks relating to our business include:
 
  •  we may not be able to effectively identify and respond to changing fashion trends and customer preferences in a timely manner or at all;
 
  •  we may not be able to execute on our growth strategy because we are unable to identify suitable locations to open new stores or convert existing stores into our rue21 etc! layout, obtain favorable lease terms, attract customers to our stores, hire and retain personnel and maintain sufficient levels of cash flow and any necessary financing to support our expansion;
 
  •  we may not be able to effectively manage our operations, which have grown rapidly, or our future growth;
 
  •  we may not be able to maintain and enhance our brand image, which could adversely affect our business;
 
  •  we may not be able to maintain or improve levels of comparable store sales;
 
  •  we may lose key personnel, which could adversely impact our business;
 
  •  we may face increased competition, which could adversely affect our business; and
 
  •  we rely on key relationships with numerous vendors and we may not be able to maintain or add to these relationships by identifying vendors that appeal to our customer base or obtain sufficient inventory from these vendors to support our growth.
 
Our Principal Stockholders
 
Following completion of this offering, funds advised by Apax Partners, L.P., and BNP Paribas North America, Inc., will own approximately 57.9% and 4.2%, respectively, of our outstanding common stock, or 57.9% and 0.0%, respectively, if the underwriters’ option to purchase additional shares is fully exercised. As a result, funds advised by Apax Partners, L.P. and BNP Paribas North America, Inc. will be able to have a significant effect relating to votes over fundamental and significant corporate matters and transactions. See “Risk Factors—Risks Related to this Offering and Ownership of Our Common Stock.”


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Apax Partners, L.P. is the United States subsidiary of Apax Partners LLP. We refer to Apax Partners L.P. and Apax Partners LLP together as Apax Partners. Apax Partners is an independent global private equity advisory firm with approximately $37 billion under management. Funds advised by Apax Partners invest in five global growth sectors: Retail & Consumer; Technology & Telecommunications; Media; Healthcare and Financial & Business Services. Apax Partners has an established global platform with nine offices in nine countries across three continents.
 
BNP Paribas North America, Inc. is a subsidiary of BNP Paribas, one of the largest banks in the world. With a presence in 84 countries and more than 205,000 employees, of which 162,500 are in Europe, BNP Paribas is a global-scale European leader in financial services. It holds key positions in its three activities: Retail Banking, Investment Solutions and Corporate and Investment Banking.
 
Conflicts of Interest
 
Bank of America, N.A., an affiliate of Merrill Lynch, Pierce, Fenner & Smith Incorporated, an underwriter in this offering, is acting as the administrative agent, collateral agent, swing line lender, letter of credit issuer and a lender with respect to our senior secured credit facility. We intend to obtain a waiver of certain notice provisions and an amendment of certain other provisions of our senior secured credit facility, including the restricted payments covenant, in connection with this offering. In addition, we intend to use the net proceeds from this offering for the repayment of approximately $22.1 million of our senior secured credit facility. See “Use of Proceeds,” “Description of Certain Indebtedness,” and “Underwriting.”
 
Corporate and Other Information
 
We were incorporated in Pennsylvania in October 1976. We changed our name to rue21, inc. in May 2003. We have reincorporated in Delaware in connection with this offering. Our principal executive office is located at 800 Commonwealth Drive, Suite 100, Warrendale, Pennsylvania 15086 and our telephone number is (724) 776-9780. Our corporate website address is www.rue21.com. We do not incorporate the information contained on, or accessible through, our corporate website into this prospectus, and you should not consider it part of this prospectus.
 
The trademarks rue21 and rue21 etc!, tarea by rue21, Carbon, Carbon Black, the CJ logo, CJ Black, rue by rue21, revert eco, sparkle rue21, Pink Ice rue21 and rueKicks are the property of rue21, inc. This prospectus contains additional trade names, trademarks and service marks of ours and of other companies. We do not intend our use or display of other companies’ trade names, trademarks or service marks to imply a relationship with, or endorsement or sponsorship of us by, any other companies.


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The Offering
 
Common stock offered by us 1,650,000 shares
 
Common stock offered by the selling stockholders 5,115,437 shares
 
Common stock to be outstanding immediately after this offering 24,160,662 shares
 
Use of proceeds We estimate that the net proceeds to us from this offering, after deducting underwriting discounts and commissions and estimated offering expenses, will be approximately $22.1 million, assuming the shares are offered at $17.00 per share, the midpoint of the price range set forth on the cover of this prospectus.
 
We will not receive any proceeds from the sale of shares by the selling stockholders.
 
We intend to use the net proceeds from this offering for the repayment of approximately $22.1 million of our outstanding indebtedness. We intend to use any remaining proceeds, if any, for working capital and other general corporate purposes. See “Use of Proceeds” and “Description of Certain Indebtedness.”
 
Principal Stockholders Upon completion of this offering, funds advised by Apax Partners, L.P. will own a controlling interest in us. We currently intend to avail ourselves of the controlled company exemption under the corporate governance rules of The NASDAQ Stock Market.
 
Dividend policy We have not declared or paid any dividends on our common stock. We currently expect to retain future earnings, if any, for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. Our ability to pay dividends on our common stock is limited by the covenants of our senior secured credit facility and may be further restricted by the terms of any of our future debt or preferred securities. See “Dividend Policy.”
 
Risk factors Investing in our common stock involves a high degree of risk. See “Risk Factors” beginning on page 9 of this prospectus for a discussion of factors you should carefully consider before deciding to invest in our common stock.
 
Proposed symbol for
trading on The NASDAQ Global Select Market
“rue”
 
Unless otherwise indicated, all information in this prospectus:
 
  •  excludes 3,626,000 shares of common stock reserved for future grants under our equity compensation plan, which we plan to adopt in connection with this offering;
 
  •  excludes shares of common stock issuable upon exercise of stock options by management in connection with this offering;
 
  •  assumes no exercise by the underwriters of their option to purchase up to an additional 1,014,815 shares from certain of the selling stockholders to cover their option to purchase additional shares; and
 
  •  assumes that we have reincorporated in Delaware.


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Summary Consolidated Financial and Other Data
 
The following table sets forth our summary consolidated financial and other data for the periods and at the dates indicated. The summary consolidated financial data for each of the years in the three-year period ended January 31, 2009 and as of January 31, 2009 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The historical financial data for the twenty-six weeks ended August 2, 2008 and the twenty-six weeks ended August 1, 2009 and as of August 1, 2009 have been derived from our unaudited condensed consolidated financial statements included elsewhere in this prospectus. The unaudited condensed consolidated financial statements have been prepared on the same basis as our audited consolidated financial statements and, in the opinion of our management, reflect all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of this data. The results for any interim period are not necessarily indicative of the results that may be expected for a full year. The consolidated financial statements for each of the fiscal years in the three-year period ended January 31, 2009 and as of the end of each such year have been audited.
 
The historical results presented below are not necessarily indicative of the results to be expected for any future period. This information should be read in conjunction with “Risk Factors,” “Selected Consolidated Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements and the related notes included elsewhere in this prospectus.
 
                                         
    Fiscal Year Ended     Twenty-Six Weeks Ended  
    February 3,
    February 2,
    January 31,
    August 2,
    August 1,
 
    2007     2008     2009     2008     2009  
                      (unaudited)  
    (in thousands, except per share and operating data)  
 
Statement of Income Data:
                                       
Net sales
  $ 225,559     $ 296,887     $ 391,414     $ 174,837     $ 233,104  
Cost of goods sold(1)
    150,163       195,034       257,853       114,904       150,194  
                                         
Gross profit
    75,396       101,853       133,561       59,933       82,910  
Selling, general and administrative expense
    57,575       76,039       99,886       45,280       61,082  
Depreciation and amortization expense
    5,926       8,241       11,532       5,274       7,774  
                                         
Income from operations
    11,895       17,573       22,143       9,379       14,054  
Interest expense, net
    2,645       2,520       1,477       904       297  
Provision for income taxes
    1,452       5,920       8,027       3,322       5,440  
                                         
Net income
  $ 7,798     $ 9,133     $ 12,639     $ 5,153     $ 8,317  
                                         
Net income per common share:
                                       
Basic
  $ 0.39     $ 0.42     $ 0.58     $ 0.24     $ 0.38  
Diluted
  $ 0.36     $ 0.40     $ 0.55     $ 0.23     $ 0.36  
Weighted average shares outstanding:
                                       
Basic
    19,782       21,705       21,914       21,880       22,090  
Diluted
    21,888       22,842       22,814       22,845       23,004  
 


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    Fiscal Year Ended     Twenty-Six Weeks Ended  
    February 3,
    February 2,
    January 31,
    August 2,
    August 1,
 
    2007     2008     2009     2008     2009  
 
Operating Data (unaudited):
                                       
Sales per gross square foot
  $ 234     $ 236     $ 235     $ 238     $ 233  
Comparable store sales change(2)
    (4.7 )%     7.8 %     3.7 %     (2.0 )%     4.1 %
                                         
Number of stores open at end of period
    278       352       449       403       505  
Total gross square feet at end of
period (in thousands)
    1,095       1,448       1,949       1,729       2,229  
Store conversions during period
    18       20       21       11       18  
Capital expenditures (in thousands)
  $ 16,586     $ 20,265     $ 26,464     $ 9,526     $ 16,656  
 
                         
          August 1, 2009  
    January 31,
          As Adjusted
 
    2009     Actual     (3)(4)(5)  
          (unaudited)  
    (in thousands)  
 
Balance Sheet Data:
                       
Cash and cash equivalents
  $ 4,611     $ 8,668     $ 8,668  
Working capital
    798       14,830       14,830  
Total assets
    141,200       184,275       184,275  
Total long-term debt
    19,476       29,234       7,148  
Stockholders’ equity
  $ 18,393     $ 26,930     $ 49,017  
 
 
(1) Includes certain buying, freight, distribution facility and store occupancy expenses.
 
(2) Comparable store sales in fiscal years 2006 and 2007 are adjusted for the 53rd week in fiscal year 2006.
 
(3) Reflects the balance sheet data as further adjusted for (a) our receipt of the estimated net proceeds from the sale of shares of common stock by us at an assumed initial public offering price of $17.00 per share, the midpoint of the price range set forth on the cover of this prospectus, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us and (b) the repayment of outstanding indebtedness as described in “Use of Proceeds.” See “Capitalization” and “Use of Proceeds.”
 
(4) A $1.00 increase (decrease) in the assumed initial public offering price of $17.00 per share, the midpoint of the price range set forth on the cover of this prospectus, would increase (decrease) each of cash and cash equivalents, total assets and total stockholders’ equity by approximately $1.5 million, assuming that the number of shares offered by us, as set forth on the cover of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. Similarly, if we change the number of shares offered by us, the net proceeds we receive will increase or decrease by the increase or decrease in the number of shares sold, multiplied by the offering price per share, less the incremental estimated underwriting discounts and commissions and estimated offering expenses payable by us.
 
(5) Reflects 22,510,662 shares of common stock outstanding as of October 27, 2009, which includes the exercise of options to purchase an aggregate of 419,620 shares of common stock between August 1, 2009 and October 27, 2009.

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RISK FACTORS
 
This offering and an investment in our common stock involve a high degree of risk. You should consider carefully the risks described below, together with the financial and other information contained in this prospectus, before you decide to purchase shares of our common stock. If any of the following risks actually occurs, our business, financial condition, results of operations, cash flow and prospects could be materially and adversely affected. As a result, the trading price of our common stock could decline and you could lose all or part of your investment in our common stock.
 
Risks Related to Our Business
 
Our business is highly dependent upon our ability to identify and respond to new and changing fashion trends, customer preferences and other related factors.
 
Fashion trends and customer tastes are volatile and can change rapidly. Our success depends in large part upon our ability to effectively identify and respond to changing fashion trends and consumer demands, and to translate market trends into appropriate, saleable product offerings in a timely manner. A small number of our employees, including our divisional merchandise managers, our Senior Vice President and General Merchandise Manager and our President and Chief Executive Officer, are primarily responsible for performing this analysis and making related product purchase decisions. Failure of these employees to identify and react appropriately to new and changing trends or tastes or to accurately forecast demand for certain product offerings could lead to, among other things, excess inventories, markdowns and write-offs, which could materially adversely affect us and our brand image. Because our success depends significantly on our brand image, damage to our brand in particular would have a negative impact on us. There can be no assurance that our new product offerings will be met with the same level of acceptance as our past product offerings or that we will be able to adequately and timely respond to the preferences of our customers. The failure of any new product offerings could have a material adverse effect on our business plan, results of operations and financial condition.
 
Our growth strategy depends upon our ability to successfully open and operate a significant number of new stores each year in a timely and cost-effective manner without affecting the success of our existing store base.
 
Our net sales have grown appreciably during the past several years, primarily as a result of the opening of new stores. We intend to continue to pursue our growth strategy of opening new stores for the foreseeable future, and our future operating results will depend largely upon our ability to successfully open and operate a significant number of new stores each year in a timely and cost-effective manner, and to profitably manage a significantly larger business. We believe there is a significant opportunity to expand our store base from 527 locations as of October 3, 2009 to more than 1,000 stores within five years. In fiscal year 2009, we plan to open 88 new stores, including 78 new stores opened as of October 3, 2009, and convert 26 stores, including 24 stores converted as of October 3, 2009. In fiscal year 2010, we plan to open approximately 100 new stores.
 
Our ability to successfully open and operate new stores depends on many factors including, among others, our ability to:
 
  •  identify suitable store locations primarily in strip centers and regional malls, the availability of which is largely outside of our control;
 
  •  negotiate acceptable lease terms, desired tenant allowances and assurances from operators and developers that they can complete the project, which depend in part on the financial resources of the operators and developers;
 
  •  obtain or maintain adequate capital resources on acceptable terms;
 
  •  source sufficient levels of inventory at acceptable costs;
 
  •  hire, train and retain an expanded workforce of store managers and other personnel;


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  •  successfully integrate new stores into our existing control structure and operations, including information system integration;
 
  •  maintain adequate distribution facility, information system and other operational system capabilities;
 
  •  identify and satisfy the merchandise and other preferences of our customers in new geographic areas and markets; and
 
  •  address competitive, merchandising, marketing, distribution and other challenges encountered in connection with expansion into new geographic areas and markets.
 
In addition, as the number of our stores increases, we may face risks associated with market saturation of our product offerings. To the extent our new store openings are in markets where we have existing stores, we may experience reduced net sales in existing stores in those markets. Finally, there can be no assurance that any newly opened stores will be received as well as, or achieve net sales or profitability levels comparable to those of, our existing stores in the time periods estimated by us, or at all. If our stores fail to achieve, or are unable to sustain, acceptable net sales and profitability levels, our business may be materially harmed and we may incur significant costs associated with closing those stores.
 
Our failure to effectively address challenges such as these could adversely affect our ability to successfully open and operate new stores in a timely and cost-effective manner, and could have a material adverse effect on our business, results of operations and financial condition. In addition, our current expansion plans are only estimates. The actual number of new stores we open each year and actual number of suitable locations for our new stores could differ significantly from these estimates. Any failure to successfully open and operate new stores in the time frames and at the costs estimated by us could have a material adverse effect on our business and result in a decline in the price of our common stock.
 
Our growth strategy will require us to expand and improve our operations and could strain our existing resources and cause the performance of our existing stores to suffer.
 
Our operating complexity will increase as our store base grows. Such increased complexity will require that we continue to expand and improve our operating capabilities, and grow, train and manage our employee base. We will need to continually evaluate the adequacy of our information and distribution systems and controls and procedures related to financial reporting. Implementing new systems, controls and procedures and any changes to existing systems, controls and procedures could present challenges we do not anticipate and could negatively impact us.
 
In addition, we may be unable to hire, train and retain a sufficient number of personnel or successfully manage our growth; moreover, our planned expansion will place increased demands on our existing operational, managerial, administrative and other resources. These increased demands could cause us to operate our business less effectively, which in turn could cause deterioration in the financial performance of our individual stores or our overall business.
 
Our rapid growth also makes it difficult for us to adequately predict the expenditures we will need to make in the future. This growth may also place increased burdens on our vendors, as we will likely increase the size of our merchandise orders. In addition, increased orders may negatively impact our approach of generally striving to minimize the time from purchase order to product delivery, and may increase our markdown risk. If we do not make the necessary capital or other expenditures necessary to accommodate our future growth, we may not be successful in our growth strategy. We cannot anticipate all of the demands that our expanding operations will impose on our business, personnel, systems and controls and procedures, and our failure to appropriately address such demands could have a material adverse effect on us.


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Our business depends in part on a strong brand image, and if we are not able to maintain and enhance our brand, particularly in new markets where we have limited brand recognition, we may be unable to attract a sufficient number of customers to our stores or sell sufficient quantities of our products.
 
We believe that the brand image we have developed has contributed significantly to the success of our business. We also believe that maintaining and enhancing our brand image, particularly in new markets where we have limited brand recognition, is important to maintaining and expanding our customer base. Maintaining and enhancing our brand image may require us to make substantial investments in areas such as merchandising, marketing, store operations, community relations, store promotions and employee training, and these investments may not be successful. Moreover, we do not utilize some of the advertising and marketing media used by some of our competitors, including advertising through the use of newspapers, magazines, billboards, television and radio. We believe our customers rely on word-of-mouth and social media marketing. As a result, we employ a viral approach to marketing that is designed to capture the interest of our customers and drive them into our stores. For example, we offer promotions and contests through our website, we provide product knowledge, trend statements and fashion blogs through Facebook, MySpace, Twitter and YouTube and we send regular “e-blasts” to customers to highlight key trends, new products and promotional events.
 
Because we do not rely on traditional advertising channels, such as newspaper or television advertisements, if our viral marketing efforts are not successful, there may be no immediately available alternative marketing channel for us to build awareness of our products in a manner that we think will be successful. This may impair our ability to successfully integrate new stores into the surrounding communities, to expand into new markets or to maintain the strength or distinctiveness of our brand image in our existing markets. In addition, if our viral marketing efforts are unsuccessful or we are otherwise required to use traditional advertising channels in our overall marketing strategy, then we will incur additional expenses associated with the transition to and operation of traditional advertising channels. Failure to successfully market our products and brand in new and existing markets could harm our business, results of operations and financial condition.
 
As of October 3, 2009, our 527 stores are located in 504 cities in 43 states. A primary component of our strategy involves expanding into new geographic markets. As we expand into new geographic markets, we may be unable to develop, and consumers in these markets may not accept, our brand without significant additional expenditures or at all. Maintaining and enhancing our brand image will depend largely on our ability to offer a differentiated in-store experience to our customers and to continue to provide high quality products, which we may not continue to do successfully. In addition, our brand image may also be adversely affected if our public image or reputation is tarnished by negative publicity. The strength of our brand image is also dependent on our ability to successfully market our brand and product offerings to our customer demographic. To the extent the store and merchandise preferences of these customers change, the popularity of our brand may decline and our business may suffer.
 
Our inability to maintain or improve levels of comparable store sales could cause our stock price to decline.
 
We may not be able to maintain or improve the levels of comparable store sales that we have experienced in the recent past. Although we have sustained net sales growth since fiscal year 2005, our quarter-to-quarter comparable store sales have ranged from a decrease of 8.1% to an increase of 14.2%. We have recently experienced strong comparable store sales, which we may not be able to sustain. If our future comparable store sales decline or fail to meet market expectations, the price of our common stock could decline. In addition, the aggregate results of operations of our stores have fluctuated in the past and will fluctuate in the future. A variety of factors affect comparable store sales, including fashion trends, competition, current national and regional economic conditions, pricing, inflation, the timing of the release of new merchandise and promotional events, changes in our merchandise mix, inventory shrinkage, the success of our multi-channel marketing programs, the timing and level of markdowns and weather conditions. In addition, many retailers have been unable to sustain high levels of comparable store sales growth during and after periods of substantial expansion. These factors may cause our comparable store sales results to be materially lower than in recent periods and our expectations, which could harm our business and result in a decline in the price of our common stock.


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Our business is sensitive to global, national and regional consumer spending and economic conditions.
 
Consumer purchases of discretionary retail items and specialty retail products, including our products, may be affected by economic conditions such as employment levels, salary and wage levels, the availability of consumer credit, inflation, high interest rates, high tax rates, high fuel prices and consumer confidence in future economic conditions. These consumer purchases may decline during recessionary periods or at other times when disposable income is lower. These risks may be exacerbated for retailers such as us that focus on selling discretionary fashion merchandise. Consumer sentiment has recently declined and may decline further due to national and regional economic conditions, which has resulted in a general decrease in discretionary purchases. Our financial performance is particularly susceptible to economic and other conditions in regions or states where we have a significant number of stores, such as Texas or Georgia. Current economic conditions and further slowdown in the economy could further adversely affect strip center and regional mall traffic and new strip center and regional mall development and could materially adversely affect us and our growth plans.
 
Our plans to convert our existing stores and expand our product offerings may not be successful, and implementation of these plans may divert our operational, managerial and administrative resources, which could impact our competitive position.
 
In addition to our store growth strategy, we plan to convert many of our existing stores and grow our business by expanding some of our existing product categories, including our rue21 etc! girls jewelry and accessories category, our footwear category and our Carbon guys apparel and accessories category. These plans involve various risks discussed elsewhere in these risk factors, including:
 
  •  implementation of these plans may be delayed or may not be successful;
 
  •  we may be unable to identify locations for conversion of existing stores to our larger rue21 etc! layout;
 
  •  if our expanded product offerings fail to maintain and enhance our distinctive brand identity, our brand image may be diminished and our sales may decrease;
 
  •  if we fail to expand our infrastructure, including by securing desirable store locations at reasonable costs and hiring and training employees, we may be unable to manage our expansion successfully; and
 
  •  implementation of these plans may divert management’s attention from other aspects of our business and place a strain on our management, operational and financial resources, as well as our information systems.
 
In addition, our ability to successfully carry out our plans to expand our product offerings may be affected by, among other things, inventory shrinkage that can result from an inventory that consists of smaller and easily concealable items such as jewelry, economic and competitive conditions, changes in consumer spending patterns and changes in consumer preferences and style trends. Our expansion plans could be delayed or abandoned, could cost more than anticipated or could divert resources from other areas of our business, any one of which could negatively impact our competitive position and reduce our revenue and profitability.
 
We could face increased competition from other retailers that could adversely affect us and our growth strategy.
 
We face competition in the specialty retail industry. We compete on the basis of a combination of factors, including among others, price, breadth, quality and style of merchandise offered, in-store experience, level of customer service, ability to identify and respond to new and emerging fashion trends, brand image and scalability. We compete with a wide variety of large and small retailers for customers, vendors, suitable store locations and personnel. We face competition from major specialty apparel retailers that offer their own private label assortment, including Aéropostale, American Eagle Outfitters, Charlotte Russe, Forever 21, the Gap, J. Crew, Metropark, Old Navy and Wet Seal, as well as national off-price apparel chains such as TJX Companies, Burlington Coat Factory, and Ross Stores. We also face competition from department stores such as Dillard’s, and JC Penney, and large value retailers such as Walmart, Target and Kohl’s. We also compete against local off-price and specialty retail stores, regional retail chains, web-based retail stores and other direct retailers that engage in the retail sale of junior and young men’s apparel, accessories, footwear and similar merchandise,


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which offer a variety of products, including apparel, for the value-conscious consumer. The competitive landscape we face, particularly among specialty retailers, is subject to rapid change which can affect customer preferences.
 
Many of our competitors have substantially greater name recognition as well as financial, marketing and other resources and therefore may be able to adapt to changes in customer preferences more quickly, devote greater resources to marketing and sale of their products, generate national brand recognition or adopt more aggressive pricing policies than we can. Many of our competitors also utilize advertising and marketing media which we do not, including advertising through use of newspapers, magazines, billboards, television and radio, which may provide them with greater brand recognition than we have.
 
Our competitors may also sell certain products or substantially similar products through the Internet or through outlet centers or discount stores, increasing the competitive pricing pressure for those products. We cannot assure you that we will continue to be able to compete successfully against existing or future competitors. Our expansion into markets served by our competitors and entry of new competitors or expansion of existing competitors into our markets could have a material adverse effect on us. Competitive forces and pressures may intensify as our presence in the retail marketplace grows.
 
We do not possess exclusive rights to many of the elements that comprise our in-store experience and product offerings. Some specialty retailers offer a personalized shopping experience that in some ways is similar to the one we strive to provide to our customers. Our competitors may seek to emulate facets of our business strategy and in-store experience, which could result in a reduction of any competitive advantage or special appeal that we might possess. In addition, some of our product offerings are sold to us on a non-exclusive basis. As a result, our current and future competitors may be able to duplicate or improve upon some or all of our in-store experience or product offerings that we believe are important in differentiating our stores and our customers’ shopping experience, especially those competitors with significantly greater financial, marketing and other resources than ours. If our competitors were to duplicate or improve upon some or all of our in-store experience or product offerings, our competitive position and our business could suffer.
 
We depend on key personnel and may not be able to retain or replace these individuals or recruit additional personnel, which could harm our business.
 
We believe that we have benefited substantially from the leadership and experience of our key personnel, including our President and Chief Executive Officer, Robert N. Fisch, and our Senior Vice President and General Merchandise Manager, Kim A. Reynolds. The loss of the services of any of our key personnel could have a material adverse effect on our business and prospects, as we may not be able to find suitable individuals to replace such personnel on a timely basis. In addition, any such departure could be viewed in a negative light by investors and analysts, which could cause our common stock price to decline. None of our employees are subject to non-compete obligations at the present time. In addition, except for our President and Chief Executive Officer and employees subject to stock option award agreements, our employees are not subject to non-solicitation obligations. Moreover, we do not have employment agreements with any of our employees and we do not maintain “key man” or “key woman” insurance policies on the lives of these individuals, except for our President and Chief Executive Officer. As a result, their employment may be terminated by us or them at any time. We do, however, anticipate entering into an employment agreement with certain members of senior management. As our business expands, our future success will depend greatly on our continued ability to attract and retain highly skilled and qualified personnel. We are also currently in search of qualified and experienced individuals to fill several open senior management and finance positions, as we do not currently have an internal audit department. There is a high level of competition for experienced, successful personnel in the retail industry. Our inability to meet our staffing requirements in the future could impair our growth and harm our business.


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Our ability to attract customers to our stores that are located in strip centers, regional malls and outlet centers depends heavily on the success of the shopping centers in which our stores are located, and any decrease in customer traffic in these shopping centers could cause our net sales to be less than expected.
 
Our stores are located in strip centers, regional malls and outlet centers and our expansion is expected to be predominantly focused on strip centers and regional malls. Net sales at these stores are derived, to a significant degree, from the volume of traffic in those shopping centers and the surrounding area. Our stores benefit from the ability of shopping centers’ other tenants, particularly anchor stores such as Walmart, Target and Kohl’s, to generate consumer traffic in the vicinity of our stores and the continuing popularity of the strip centers, regional malls and outlet centers as shopping destinations. Our sales volume and traffic may be adversely affected by, among other things, economic downturns nationally or regionally, high fuel prices, increased competition, changes in consumer demographics, a decrease in popularity of shopping centers or of stores in the shopping centers in which our stores are located, the closing of anchor stores important to our business, or a deterioration in the financial condition of shopping center operators or developers which could, for example, limit their ability to finance tenant improvements for us and other retailers. A reduction in consumer traffic as a result of these or any other factors, or our inability to obtain or maintain prominent store locations within shopping centers, could have a material adverse effect on us. Although we do not have specific information in respect to the strip centers, regional malls and outlet centers in which we locate or plan to locate our stores, we believe strip center, regional mall and outlet center vacancy rates have been rising and traffic has been decreasing nationally.
 
We plan to use cash from operations to fund our expanding business and execute on our growth strategy and may require additional financing, which may not be available to us.
 
We have grown rapidly, with our net sales increasing from $146.9 million for fiscal year 2004 to $391.4 million for fiscal year 2008. During fiscal year 2008, capital expenditures, net of tenant allowances, were $17.6 million, of which $8.5 million was related to the 99 new stores we opened during fiscal year 2008. In addition, we spent approximately $2.4 million to convert our existing stores during fiscal year 2008. We plan to continue our growth and expansion, including opening a significant number of additional stores, as well as converting existing stores. Our plans to expand our store base may not be successful and the implementation of these plans may not result in expected increases in our net sales even though they increase our costs.
 
To support our expanding business and execute on our growth strategy, we will need significant amounts of cash from operations, including funds to pay our lease obligations, build out new store space, purchase inventory, pay personnel, further invest in our infrastructure and facilities, and pay for the increased costs associated with operating as a public company. In particular, payments under the operating leases associated with our stores and our distribution facility account for a significant portion of our operating expenses.
 
We primarily depend on cash flow from operations and our senior secured credit facility to fund our business and growth plans. If our business does not generate sufficient cash flow from operations to fund these activities, and sufficient funds are not otherwise available to us from the net proceeds we receive from this offering and under our senior secured credit facility, we may need additional equity or debt financing. If such financing is not available to us on satisfactory terms, our ability to run and expand our business or to respond to competitive pressures would be limited and we could be required to delay, significantly curtail or eliminate planned store openings or operations or other elements of our growth strategy. If we raise additional capital by issuing equity securities or securities convertible into equity securities, your ownership may be diluted. Our senior secured credit facility and any additional debt financing we may incur may impose upon us covenants that restrict our operations, including limitations on our ability to incur liens or additional debt, pay dividends, redeem our common stock, make certain investments and engage in certain merger, consolidation or asset sale transactions. Moreover, any borrowings under any future debt financing will require interest payments and need to be repaid or refinanced, and would create additional cash demands and financial risk for us, which could be exacerbated by then-existing business or prevailing financial market conditions.


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We have many important vendor relationships and our ability to obtain merchandise at competitive prices could suffer as a result of any deterioration or change in those relationships or events that adversely affect our vendors or their ability to obtain financing for their operations.
 
We have many important vendor relationships that we believe provide us with a competitive advantage. We do not own or operate any manufacturing facilities. We instead purchase all of our merchandise from third-party vendors. Over the last twelve months, we sourced a majority of our merchandise from our various merchandise vendors, with no single vendor accounting for more than 8% of our merchandise. Our financial performance depends in large part on our ability to purchase desired merchandise in sufficient quantities at competitive prices from these and other vendors. In some cases, we obtain exclusive use of select products from our vendors for a period of time. Moreover, from time to time, some of our vendors, with their prior consent, allow us to return certain merchandise purchased from them. In addition, we are typically able to return merchandise that does not meet our preset specifications. However, we generally have no long-term purchase contracts or other contractual assurances of continued supply, pricing or access to new products. Any of our vendors could discontinue supplying us with desired products in sufficient quantities for a variety of reasons. The benefits we currently experience from our vendor relationships could be adversely affected if our vendors:
 
  •  choose to discontinue selling non-exclusive or exclusive products to us;
 
  •  refuse to allow us to return merchandise purchased from them;
 
  •  raise the prices they charge us;
 
  •  sell similar or identical products to certain of our competitors, many of whom purchase products in significantly greater volume and, in some cases, at lower prices than we do;
 
  •  enter into arrangements with competitors that could impair our ability to sell their products, including by giving our competitors exclusive licensing arrangements or exclusive access to styles, brands and products or limiting our access to such arrangements or styles, brands or products;
 
  •  initiate or expand sales of their products through their own stores or through the Internet to the retail market and therefore compete with us directly; or
 
  •  sell their products through outlet centers or discount stores, increasing the competitive pricing pressure we face.
 
Some of our vendors are small and specialized with limited resources, production capacities and operating histories. Events that adversely affect our vendors could impair our ability to obtain desired merchandise in sufficient quantities. Such events include difficulties or problems associated with our vendors’ business, finances, labor, importation of products, costs, production, insurance and reputation. For example, some of our vendors are extended credit by units of the CIT Group, or CIT, and if CIT ceases to do business or materially decreases its level of credit to our vendors, we may be required to pay for merchandise from our vendors earlier than our historical practice.
 
There can be no assurance that we will be able to acquire desired merchandise in sufficient quantities on acceptable terms or at all in the future, especially if we need significantly greater amounts of inventory in connection with the growth of our business. Any inability to acquire suitable merchandise in sufficient quantities and at acceptable prices, in particular exclusive merchandise, due to the loss of or a deterioration or change in our relationship with one or more key vendors, or events harmful to our vendors, may materially adversely affect us.
 
We are subject to risks associated with leasing substantial amounts of space, including future increases in occupancy costs.
 
We do not own any real estate. Instead, we lease all of our store locations, our corporate headquarters in Warrendale, Pennsylvania and our distribution facility in Weirton, West Virginia. We lease our distribution facility from the State of West Virginia under a lease that expires in 2011, with two five-year renewal options.


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Although some of our leases are for ten-year periods, we typically occupy our stores under operating leases with terms of five years, with additional five-year renewal options. We have been able to negotiate favorable rental rates over the last year due in part to the state of the economy and high vacancy rates within some shopping centers; however, there is no guarantee that we will be able to continue to negotiate such favorable terms, and this can cause our occupancy rates to be higher in future years or may force us to close stores in desirable locations. Some of our leases have early cancellation clauses, which permit the lease to be terminated by us or the landlord if certain sales levels are not met in specific periods or if the strip center does not meet specified occupancy standards. In addition to future minimum lease payments, some of our store leases provide for additional rental payments based on a percentage of net sales, or “percentage rent,” if sales at the respective stores exceed specified levels, as well as the payment of common area maintenance charges, real property insurance and real estate taxes. Many of our lease agreements have defined escalating rent provisions over the initial term and any extensions. As we expand our store base, our lease expense and our cash outlays for rent under the lease agreements will increase. Our substantial operating lease obligations could have significant negative consequences, including:
 
  •  requiring that a substantial portion of our available cash be applied to pay our rental obligations, thus reducing cash available for other purposes;
 
  •  increasing our vulnerability to general adverse economic and industry conditions;
 
  •  limiting our flexibility in planning for or reacting to changes in our business or in the industry in which we compete; and
 
  •  limiting our ability to obtain additional financing.
 
Any of these consequences could place us at a disadvantage with respect to our competitors. We depend on cash flow from operations to pay our lease expenses and to fulfill our other cash needs. If our business does not generate sufficient cash flow from operating activities to fund these expenses and needs, and sufficient funds are not otherwise available to us from the net proceeds we receive from this offering, we may not be able to service our lease expenses, grow our business, respond to competitive challenges or to fund our other liquidity and capital needs, which would harm our business.
 
Additional sites that we lease may be subject to long-term non-cancelable leases if we are unable to negotiate our current standard lease terms. If an existing or future store is not profitable, and we decide to close it, we may nonetheless be committed to perform our obligations under the applicable lease including, among other things, paying the base rent for the balance of the lease term. Moreover, even if a lease has an early cancellation clause, we may not satisfy the contractual requirements for early cancellation under that lease. Our inability to enter into new leases or renew existing leases on terms acceptable to us or be released from our obligations under leases for stores that we close would materially adversely affect us.
 
Our failure to find store employees that reflect our brand image and embody our culture, especially in light of our growth strategy, could adversely affect our business.
 
Our success depends in part upon our ability to attract, motivate and retain a sufficient number of store employees, including store managers, who understand and appreciate our corporate culture and customers, and are able to adequately and effectively represent our culture and establish credibility with our customers. The store employee turnover rate in the retail industry is generally high. If we are unable to hire and retain store personnel capable of consistently providing a high level of customer service, as demonstrated by their enthusiasm for our culture, understanding of our customers and knowledge of the merchandise we offer, our ability to open new stores may be impaired, the performance of our existing and new stores could be materially adversely affected and our brand image may be negatively impacted. We are also dependent upon temporary personnel to adequately staff our stores and distribution facility, with heightened dependence during busy periods such as the Easter and spring break season, back-to-school season and the winter holiday season and when multiple new stores are opening. There can be no assurance that we will receive adequate assistance from our temporary personnel, or that there will be sufficient sources of suitable temporary personnel to meet


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our demand. Any such failure to meet our staffing needs or any material increases in employee turnover rates could have a material adverse effect on our business or results of operations.
 
Our net sales and inventory levels fluctuate on a seasonal basis or due to store events or promotions, leaving our operating results particularly susceptible to changes in seasonal shopping patterns and related risks.
 
Our net sales are typically disproportionately higher in the second and fourth fiscal quarters due to increased net sales during the summer and winter holiday seasons. Net sales during these periods cannot be used as an accurate indicator of annual results. Likewise, as is the case with many retailers of apparel, accessories and gifts, we typically experience lower net sales in the first fiscal quarter relative to other quarters. Any significant decrease in net sales during the summer or winter holiday seasons would have a material adverse effect on us. In addition, in order to prepare for these seasons, we must order and keep in stock significantly more merchandise than we carry during other parts of the year. This inventory build-up may require us to expend cash faster than is generated by our operations during this period. Any unanticipated decrease in demand for our products during these peak shopping seasons could require us to sell excess inventory at a substantial markdown, which could have a material adverse effect on our business, profitability, ability to repay any indebtedness and our brand image. In addition, we may experience variability in net sales as a result of a variety of other factors, including the timing of new store openings, store events, promotions or other marketing activities, which may cause our results of operations to fluctuate on a quarterly basis and relative to corresponding periods in prior years.
 
We only have one distribution facility and have not yet implemented disaster recovery procedures, and if we encounter difficulties associated with our distribution facility or if it were to shut down for any reason, we could face shortages of inventory that would have a material adverse affect on our business operations and harm our reputation.
 
Our only distribution facility is located in Weirton, West Virginia. Our distribution facility supports our entire business. All of our merchandise is shipped to the distribution facility from our vendors, and then packaged and shipped from our distribution facility to our stores. The success of our stores depends on their timely receipt of merchandise. The efficient flow of our merchandise requires that we have adequate capacity in our distribution facility to support our current level of operations, and the anticipated increased levels that may follow from our growth plans. If we encounter difficulties associated with our distribution facility or if it were to shut down for any reason, including by fire or other natural disaster, we could face shortages of inventory, resulting in “out-of-stock” conditions in our stores, and incur significantly higher costs and longer lead times associated with distributing merchandise to our stores. This could have a material adverse effect on our business and harm our reputation. We are in the process of developing disaster recovery and business continuity plans that would allow us to be fully operational regardless of casualties or unforeseen events that may affect our corporate headquarters or distribution center. Without proper disaster recovery and business continuity plans, if we encounter difficulties with our distribution facility or other problems or disasters arise, we cannot ensure that critical systems and operations will be restored in a timely manner or at all, and this would have a material adverse effect on our business.
 
We have identified the need to upgrade our distribution facility in order to support recent and expected future growth. We are currently upgrading our distribution facility, which we expect to complete by the end of the first quarter of fiscal year 2010. We believe this upgrade will support our growth through approximately 1,300 stores with little additional capital investment. If we are unable to successfully implement this upgrade, the efficient flow of our merchandise could be disrupted, which could materially hurt our business. We may need to further increase the capacity of this facility to support our growth, which may require us to secure additional favorable real estate or may require us to obtain additional financing. Appropriate locations or financing for the purchase or lease of such additional real estate may not be available at reasonable costs or at all. Our failure to provide adequate order fulfillment and secure additional distribution capacity when necessary could impede our growth plans, and the further increase of this capacity would increase our costs.


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We rely upon independent third-party transportation providers for substantially all of our product shipments.
 
We currently rely upon independent third-party transportation providers for substantially all of our product shipments, including shipments to all of our stores. Our utilization of their delivery services for shipments, or those of any other shipping companies we may elect to use, is subject to risks, including increases in fuel prices, which would increase our shipping costs, and employee strikes and inclement weather, which may impact the shipping company’s abilities to provide delivery services that adequately meet our shipping needs. If we change shipping companies, we could face logistical difficulties that could adversely affect deliveries and we would incur costs and expend resources in connection with such change. Moreover, we may not be able to obtain terms as favorable as those received from the independent third-party transportation providers we currently use, which in turn would increase our costs. We also face shipping and distribution risks and uncertainties associated with the upgrade of our distribution facility and related systems.
 
Our ability to source our merchandise profitably or at all could be hurt if new trade restrictions are imposed or existing trade restrictions become more burdensome.
 
Trade restrictions, including increased tariffs, safeguards or quotas, on apparel and accessories could increase the cost or reduce the supply of merchandise available to us. Under the World Trade Organization, or WTO, Agreement, effective January 1, 2005, the United States and other WTO member countries removed quotas on goods from WTO members, which in certain instances affords us greater flexibility in importing textile and apparel products from WTO countries from which we source our merchandise. However, as the removal of quotas resulted in an import surge from China, the United States in May 2005 imposed safeguard quotas on seven categories of goods and apparel imported from China. Effective January 1, 2006, the United States imposed quotas on approximately twelve categories of goods and apparel from China, and may impose additional quotas in the future. These and other trade restrictions could have a significant impact on our sourcing patterns in the future. The extent of this impact, if any, and the possible effect on our purchasing patterns and costs, cannot be determined at this time. We cannot predict whether any of the countries in which our merchandise is currently manufactured or may be manufactured in the future will be subject to additional trade restrictions imposed by the United States and foreign governments, nor can we predict the likelihood, type or effect of any such restrictions. Trade restrictions, including increased tariffs or quotas, embargoes, safeguards and customs restrictions against apparel items, as well as United States or foreign labor strikes, work stoppages or boycotts, could increase the cost or reduce the supply of apparel available to us or may require us to modify our current business practices, any of which could hurt our profitability.
 
We rely significantly on information systems and any failure, inadequacy, interruption or security failure of those systems could harm our ability to effectively operate our business.
 
Our ability to effectively manage and maintain our inventory, and to ship products to our stores and our customers on a timely basis, depends significantly on our information systems, including our Island Pacific Inc., or Island Pacific, enterprise resource planning system and Epicor Software Corporation, or Epicor, including its Customer Relationship Management and store point-of-sale, or POS, system. We believe that utilizing this suite of products has allowed us to avoid the expense associated with internally developing and managing our own hardware and software systems. See “Business—Management Information Systems.” To manage the growth of our operations, personnel and real estate portfolio, we will need to continue to improve and expand our operational and financial systems, real estate management systems, transaction processing and internal controls and business processes; in doing so, we could encounter transitional issues and incur substantial additional expenses. If we are unable to maintain our current relationships with Island Pacific or Epicor, there is no assurance that we will be able to locate replacements on a timely basis or on acceptable terms. The failure of our information systems to operate effectively, problems with transitioning to upgraded or replacement systems or expanding them into new stores, or a breach in security of these systems, could adversely impact the promptness and accuracy of our merchandise distribution, transaction processing, financial accounting and reporting, the efficiency of our operations and our ability to properly forecast


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earnings and cash requirements. We could be required to make significant additional expenditures to remediate any such failure, problem or breach. Such events may have a material adverse effect on us.
 
In addition, we may now and in the future implement new systems to increase efficiencies and profitability. To manage growth of our operations and personnel, we will need to continue to improve and expand our operational and financial systems, transaction processing, and internal controls and business processes. In doing any implementation or change to existing processes, we may encounter transitional issues and incur substantial additional expenses.
 
System security risk issues could disrupt our internal operations or information technology services, and any such disruption could harm our net sales, increase our expenses, and harm our reputation and stock price.
 
Experienced computer programmers and hackers, or even internal users, may be able to penetrate our network security or that of Island Pacific or Epicor and misappropriate our confidential information or that of third parties, create system disruptions or cause shutdowns. As a result, we could incur significant expenses addressing problems created by security breaches of our network. This risk is heightened because we collect and store customer information for marketing purposes. Any compromise of customer information could subject us to customer or government litigation and harm our reputation, which could adversely affect our business and growth. Moreover, we could incur significant expenses or disruptions of our operations in connection with system failures or breaches. In addition, sophisticated hardware and operating system software and applications that we procure from third parties, including that of Island Pacific or Epicor, may contain defects in design or manufacture, including “bugs” and other problems that could unexpectedly interfere with the operation of the systems. The costs to us to eliminate or alleviate security problems, viruses and bugs, or any problems associated with the outsourced services provided by Island Pacific or Epicor, could be significant, and such efforts to address these problems could result in interruptions, delays or cessation of service that may impede our sales, distribution or other critical functions.
 
We may suffer risks if our vendors fail to follow our vendor guidelines, including the risk we could acquire merchandise without full rights to sell it and the risks that a vendor or a manufacturer may fail to use acceptable labor practices, comply with other applicable laws or face interruption with its operations.
 
We sometimes purchase merchandise from vendors who hold manufacturing and distribution rights under the terms of certain licenses or who themselves own intellectual property rights to the merchandise. In addition, we purchase merchandise that may be subject to design copyrights, design patents, or otherwise may incorporate protected intellectual property. We are not involved in the manufacture of any of the merchandise we purchase from our vendors for sale to our customers, and we do not independently investigate whether these vendors legally hold intellectual property rights to merchandise that they are manufacturing or distributing. As a result, we rely upon vendors’ representations set forth in our purchase orders and vendor agreements concerning their right to sell us the products that we purchase from them. If a third party claims to have licensing rights with respect to merchandise we purchased from a vendor, or we acquire unlicensed merchandise, we could be obligated to remove such merchandise from our stores, incur costs associated with destruction of such merchandise if the distributor or vendor is unwilling or unable to reimburse us, and be subject to liability under various civil and criminal causes of action, including actions to recover unpaid royalties and other damages and injunctions. Although our purchase orders and vendor agreement with each vendor require the vendor to indemnify us against such claims, a vendor may not have the financial resources to defend itself or us against such claims, in which case, we may have to pay the costs and expenses associated with defending such claim. Any of these results could harm our brand image and have a material adverse effect on our business and growth.
 
Many of the products sold in our stores are manufactured outside of the United States, which may increase the risk that the labor, manufacturing safety and other practices followed by the manufacturers of these products may differ from those generally accepted in the United States. Although we require each of our vendors to sign a purchase order and vendor agreement that requires adherence to accepted labor practices and compliance with labor, manufacturing safety and other laws, we do not supervise, control or audit our vendors


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or the manufacturers that produce the merchandise we sell to our customers, and we have no direct relationship and very limited contact with any of the manufacturers. We do reserve the right to conduct random testing of products and we use a third-party resource to conduct such random testing on designated categories of items to further address our concern for customer safety. However, some of our vendors are small and may not have adequate procedures in place to assure compliance with applicable labor, manufacturing safety and other laws. The violation of such labor, manufacturing safety or other laws by any of our vendors or these manufacturers, or the divergence of the labor practices followed by any of our vendors or these manufacturers from those generally accepted in the United States, could interrupt, or otherwise disrupt, the shipment of finished products to us or damage our brand image and/or subject us to boycotts by our customers or activist groups.
 
In fiscal year 2008, substantially all of our merchandise was sourced from foreign factories, many of which were located in China and India. Any event causing a sudden disruption of manufacturing or imports from Asia, Central America or elsewhere, including the imposition of additional import restrictions, could materially harm our operations. We have no long-term merchandise supply contracts, and many of our imports are subject to existing or potential duties, tariffs or quotas that may limit the quantity of certain types of goods that may be imported into the United States from countries in Asia, Central America or elsewhere. We compete with other companies for production facilities and import quota capacity.
 
Our vendors’ sourcing operations may also be hurt by political and financial instability, strikes, health concerns regarding infectious diseases in countries in which our merchandise is produced, adverse weather conditions or natural disasters that may occur in Asia, Central America or elsewhere or acts of war or terrorism in the United States or worldwide, to the extent these acts affect the production, shipment or receipt of merchandise. Our future operations and performance will be subject to these factors, which are beyond our control, and these factors could materially hurt our business, financial condition and results of operations or may require us to modify our current business practices or incur increased costs.
 
There are claims made against us from time to time that can result in litigation or regulatory proceedings which could distract management from our business activities and result in significant liability or damage to our brand image.
 
As a growing company with expanding operations, we increasingly face the risk of litigation and other claims against us. Litigation and other claims may arise in the ordinary course of our business and include employee claims, commercial disputes, intellectual property issues, product-oriented allegations and slip and fall claims. Often these cases raise complex factual and legal issues, which are subject to risks and uncertainties and which could require significant management time. Litigation and other claims against us could result in unexpected expenses and liability, as well as materially adversely affect our operations and our reputation.
 
We may be subject to liability if we infringe upon the trademarks or other intellectual property rights of third parties.
 
We may be subject to liability if we infringe upon the trademarks or other intellectual property rights of third parties. If we were to be found liable for any such infringement, we could be required to pay substantial damages and could be subject to injunctions preventing further infringement. Such infringement claims could subject us to boycotts by our customers or otherwise harm our brand image. In addition, any payments we are required to make and any injunctions we are required to comply with as a result of such infringement actions could adversely affect our financial results.
 
Changes in laws, including employment laws and laws related to our merchandise, could make conducting our business more expensive or otherwise change the way we do business.
 
We are subject to numerous regulations, including labor and employment, customs, truth-in-advertising, consumer protection and zoning and occupancy laws and ordinances that regulate retailers generally and/or govern the importation, promotion and sale of merchandise and the operation of stores and warehouse


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facilities. If these regulations were to change or were violated by our management, employees, vendors, buying agents or trading companies, the costs of certain goods could increase, or we could experience delays in shipments of our goods, be subject to fines or penalties, or suffer reputational harm, which could reduce demand for our merchandise and hurt our business and results of operations.
 
In addition to increased regulatory compliance requirements, changes in laws could make ordinary conduct of our business more expensive or require us to change the way we do business. For example, changes in federal and state minimum wage laws could raise the wage requirements for certain of our employees, which would likely cause us to reexamine our entire wage structure for stores. Other laws related to employee benefits and treatment of employees, including laws related to limitations on employee hours, supervisory status, leaves of absence, mandated health benefits or overtime pay, could also negatively impact us, such as by increasing compensation and benefits costs for overtime and medical expenses. Moreover, changes in product safety or other consumer protection laws could lead to increased costs to us for certain merchandise, or additional labor costs associated with readying merchandise for sale. For example, in August 2008, the Consumer Product Safety Improvement Act of 2008, or CPSIA, was signed into law. The CPSIA imposes new requirements for the textile and apparel industries. These new requirements relate to all products marketed to children 12 years of age and under. Among other requirements, the Consumer Product Safety Commission requires certification and testing of lead paint levels as applied to certain products, along with testing of the lead content of the product as a whole. We have engaged an accredited third party testing service to ensure our vendors’ compliance with consumer safety laws and to meet further product safety goals. It is often difficult for us to plan and prepare for potential changes to applicable laws and future actions or payments related to such changes could be material to us.
 
We may incur indebtedness in the future and that indebtedness could adversely affect our financial health and harm our ability to react to changes to our business. Any future indebtedness may contain covenants that limit our business activities.
 
We may incur indebtedness in the future. Any increase in the amount of our indebtedness could require us to divert funds identified for other purposes for debt service and impair our liquidity position. If we cannot generate sufficient cash flow from operations to service our debt, we may need to refinance our debt, dispose of assets or issue equity to obtain necessary funds. We do not know whether we will be able to take any of such actions on a timely basis, on terms satisfactory to us or at all.
 
Our level of indebtedness has important consequences to you and your investment in our common stock. For example, our level of indebtedness may:
 
  •  require us to use a substantial portion of our cash flow from operations to pay interest and principal on our debt, which would reduce the funds available to us for working capital, capital expenditures and other general corporate purposes;
 
  •  limit our ability to pay future dividends;
 
  •  limit our ability to obtain additional financing for working capital, capital expenditures, expansion plans and other investments, which may limit our ability to implement our business strategy;
 
  •  result in higher interest expense if interest rates increase on any floating rate borrowings;
 
  •  heighten our vulnerability to downturns in our business, the industry or in the general economy and limit our flexibility in planning for or reacting to changes in our business and the retail industry; or
 
  •  prevent us from taking advantage of business opportunities as they arise or successfully carrying out our plans to expand our store base and product offerings.
 
We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us in amounts sufficient to enable us to make payments on our indebtedness or to fund our operations.


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Any indebtedness we incur may contain covenants that restrict our ability to incur additional debt, pay dividends, make acquisitions or investments or do certain other things that may impact the value of our common stock.
 
The terms of our senior secured credit facility may restrict our current and future operations, which would adversely affect our ability to respond to changes in our business and to manage our operations.
 
Our senior secured credit facility contains, and any future indebtedness of ours would likely contain, a number of restrictive covenants that impose significant operating and financial restrictions on us, including restrictions on our ability to, among other things:
 
  •  place liens on our or our direct or indirect subsidiaries’ assets;
 
  •  make investments other than permitted investments;
 
  •  incur additional indebtedness, subject to certain exceptions;
 
  •  prepay or redeem certain indebtedness;
 
  •  merge, consolidate and dissolve;
 
  •  sell assets;
 
  •  engage in transactions with affiliates;
 
  •  change the nature of our business;
 
  •  change our or our direct or indirect subsidiaries’ fiscal year or organizational documents; and
 
  •  make restricted payments, including certain equity issuances and payment of dividends in a form other than in common stock.
 
A failure by us to comply with the covenants or financial ratios contained in our senior secured credit facility could result in an event of default under our credit facility, which could adversely affect our ability to respond to changes in our business and manage our operations. A change in control of our company is also an event of default under our senior secured credit facility. Under our senior secured credit facility, a change in control of our company will occur if, among other things, any person or entity other than the funds advised by Apax Partners or us or our subsidiaries acquires, directly or indirectly, more than 35% of the outstanding equity interests of us or a greater percentage of the equity interest than is beneficially owned by the funds advised by Apax Partners. Upon the occurrence of an event of default under our senior secured credit facility, the lenders could elect to declare all amounts outstanding to be due and payable, require us to apply all of our available cash to repay these amounts and exercise other remedies as set forth in the senior secured credit facility. If the indebtedness under our senior secured credit facility were to be accelerated, there can be no assurance that our assets would be sufficient to repay this indebtedness in full. We intend to obtain an amendment of certain provisions of our senior secured credit facility in connection with this offering. See “Description of Certain Indebtedness — Senior Secured Credit Facility.”
 
We may be unable to protect our trademarks or other intellectual property rights.
 
We are not aware of any claims of infringement upon or challenges to our right to use any of our brand names or trademarks in the United States. Nevertheless, there can be no assurance that the actions we have taken to establish and protect our trademarks will be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products as a violation of the trademarks or proprietary rights of others. Also, others may assert rights in, or ownership of, our trademarks and other proprietary rights or claim that we are infringing on their proprietary rights, and we may not be able to successfully resolve these types of conflicts to our satisfaction. In addition, we do not register our marks internationally, and the laws of certain foreign countries may not protect proprietary rights to the same extent as do the laws of the United States.


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Because we have not registered our trademarks in any foreign countries, international protection of our brand image and the use of these marks could be limited. Other entities may have rights to trademarks that contain portions of our marks or may have registered similar or competing marks for apparel and accessories in foreign countries in which our vendors source our merchandise. There may also be other prior registrations in other foreign countries of which we are not aware. Accordingly, it may be possible for others to enjoin the manufacture, sale or exportation of our branded goods to the United States. If we were unable to reach a licensing arrangement with these parties, our vendors may be unable to manufacture our products in those countries. Our inability to register our trademarks or purchase or license the right to use our trademarks or logos in these jurisdictions could limit our ability to obtain supplies from less costly markets or penetrate new markets should our business plan change to include selling our merchandise in those jurisdictions outside the United States.
 
We may be subject to unionization, work stoppages, slowdowns or increased labor costs, especially if the Employee Free Choice Act is adopted.
 
Currently, none of our employees is represented by a union. However, our employees have the right at any time under the National Labor Relations Act to form or affiliate with a union. If some or all of our workforce were to become unionized and the terms of the collective bargaining agreement were significantly different from our current compensation arrangements, it could increase our costs and adversely impact our profitability. The Employee Free Choice Act of 2007: H.R. 800, or EFCA, was passed in the United States House of Representatives last year and the same legislation has been introduced again in 2009 as H.R. 1409 and S. 560. President Obama and leaders of Congress have made public statements in support of this bill. Accordingly, this bill or a variation of it could be enacted in the future and the enactment of this bill could have an adverse impact on our business, by making it easier for workers to obtain union representation and increasing the penalties employers may incur if they engage in labor practices in violation of the National Labor Relations Act.
 
Maintaining and improving our financial controls and the requirements of being a public company may strain our resources, divert management’s attention and affect our ability to attract and retain qualified board members.
 
As a public company, we will be subject to the reporting requirements of the Securities Exchange Act of 1934, or the Exchange Act, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and The NASDAQ Stock Market rules. The requirements of these rules and regulations will significantly increase our legal and financial compliance costs, including costs associated with the hiring of additional personnel, make some activities more difficult, time-consuming or costly, and may also place undue strain on our personnel, systems and resources. The Exchange Act will require, among other things, that we file annual, quarterly and current reports with respect to our business and financial condition.
 
The Sarbanes-Oxley Act will require, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. Ensuring that we have adequate internal financial and accounting controls and procedures in place is a costly and time-consuming effort that needs to be re-evaluated frequently. We have not begun documenting or testing our internal control procedures in order to comply with the requirements of Section 404 of the Sarbanes-Oxley Act, or Section 404. Section 404, which requires annual management assessments of the effectiveness of our internal control over financial reporting and a report by our independent registered public accounting firm auditing our effectiveness of internal control over financial reporting beginning with fiscal year 2010. Both we and our independent registered public accounting firm will be testing our internal controls in connection with the Section 404 requirements and could, as part of that documentation and testing, identify material weaknesses, significant deficiencies or other areas for further attention or improvement. Implementing any appropriate changes to our internal controls may require specific compliance training for our directors, officers and employees, require the hiring of additional finance, accounting and other personnel, entail substantial costs to modify our existing accounting systems, and take a significant period of time to complete. Such changes may not, however, be effective in maintaining the adequacy of our internal controls, and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. Moreover, effective internal controls are necessary for us to produce reliable financial reports and


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are important to help prevent fraud. As a result, our failure to satisfy the requirements of Section 404 on a timely basis could result in the loss of investor confidence in the reliability of our financial statements, which in turn could cause the market value of our common stock to decline.
 
We expect that various rules and regulations applicable to public companies will make it more difficult and more expensive for us to maintain directors’ and officers’ liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to maintain coverage. If we are unable to maintain adequate directors’ and officers’ insurance, our ability to recruit and retain qualified officers and directors, especially those directors who may be deemed independent for purposes of The NASDAQ Stock Market rules, will be significantly curtailed.
 
Risks Related to this Offering and Ownership of Our Common Stock
 
Concentration of ownership among our existing executive officers, directors and principal stockholders may prevent new investors from influencing significant corporate decisions.
 
Upon consummation of this offering our executive officers, directors and principal stockholders will own, in the aggregate, approximately 71.1% of our outstanding common stock and will own options that will enable them to own, in the aggregate, approximately 71.8% of our outstanding common stock. As a result, these stockholders will be able to exercise control over all matters requiring stockholder approval, including the election of directors, amendment of our amended and restated certificate of incorporation and approval of significant corporate transactions and will have significant control over our management and policies. We currently expect that, following this offering, two of the five members of our board of directors will be principals of Apax Partners. Funds advised by Apax Partners can take actions that have the effect of delaying or preventing a change in control of us or discouraging others from making tender offers for our shares, which could prevent stockholders from receiving a premium for their shares. These actions may be taken even if other stockholders oppose them. The concentration of voting power among funds advised by Apax Partners may have an adverse effect on the price of our common stock. The interests of these stockholders may not be consistent with your interests as a stockholder. After the lock-up period expires, funds advised by Apax Partners will be able to transfer control of us to a third-party by transferring their common stock, which would not require the approval of our board of directors or our other stockholders.
 
In addition, our amended and restated certificate of incorporation will provide that the provisions of Section 203 of the Delaware General Corporation Law, or the DGCL, that relate to business combinations with interested stockholders will apply to us. Section 203 of the DGCL prohibits a publicly held Delaware corporation from engaging in a business combination transaction with an interested stockholder for a period of three years after the interested stockholder became such unless the transaction fits within an applicable exemption, such as board approval of the business combination or the transaction which resulted in such stockholder becoming an interested stockholder. The provisions of Section 203 of the DGCL may delay, prevent or deter a merger, acquisition, tender offer or other transaction that might otherwise result in our stockholders receiving a premium over the market price for their common stock.
 
Our amended and restated certificate of incorporation will provide that the doctrine of corporate opportunity will not apply against Apax Partners, funds advised by Apax Partners, or any of our directors who are employees of or affiliated with Apax Partners or funds advised by Apax Partners, in a manner that would prohibit them from investing or participating in competing businesses. To the extent they invest in such other businesses, Apax Partners or funds advised by Apax Partners may have differing interests than our other stockholders.
 
We will be a controlled company within the meaning of The NASDAQ Stock Market rules, and, as a result, we will rely on exemptions from certain corporate governance requirements that provide protection to stockholders of other companies.
 
Upon completion of this offering, funds advised by Apax Partners will own more than 50% of the total voting power of our common stock and we will be a controlled company under The NASDAQ Stock Market corporate governance listing standards. As a controlled company, certain exemptions under The NASDAQ


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Stock Market listing standards will exempt us from the obligation to comply with certain of the NASDAQ Stock Market corporate governance requirements, including the requirements:
 
  •  that a majority of our board of directors consist of independent directors, as defined under the rules of The NASDAQ Stock Market;
 
  •  that we have a corporate governance and nominating committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities; and
 
  •  that we have a compensation committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities.
 
Accordingly, for so long as we are a controlled company, holders of our common stock will not have the same protections afforded to stockholders of companies that are subject to all of The NASDAQ Stock Market corporate governance requirements.
 
There may not be a viable public market for our common stock.
 
Prior to this offering, there has been no public market for our common stock. The initial public offering price for our common stock will be determined through negotiations between us and the representatives of the underwriters and may not be indicative of the market price of our common stock after this offering. If you purchase shares of our common stock, you may not be able to resell those shares at or above the initial public offering price. We cannot predict the extent to which investor interest in our company will lead to the development of an active trading market on The NASDAQ Global Select Market or otherwise or how liquid that market might become. An active public market for our common stock may not develop or be sustained after the offering. If an active public market does not develop or is not sustained, it may be difficult for you to sell your shares of common stock at a price that is attractive to you, or at all.
 
Our stock price may be volatile or may decline regardless of our operating performance, and you may not be able to resell your shares at or above the initial public offering price.
 
After this offering, the market price for our common stock is likely to be volatile, in part because our shares have not been traded publicly. In addition, the market price of our common stock may fluctuate significantly in response to a number of factors, most of which we cannot control, including:
 
  •  fashion trends and changes in consumer preferences;
 
  •  market conditions or trends in our industry or the economy as a whole and, in particular, in the retail sales environment;
 
  •  the timing of new store openings and the relative proportion of our new stores to existing stores;
 
  •  the performance and successful integration of any new stores that we open;
 
  •  changes in our merchandise mix;
 
  •  timing of promotional events;
 
  •  changes in key personnel;
 
  •  entry into new markets;
 
  •  our levels of comparable store sales;
 
  •  announcements by us or our competitors of new product offerings or significant acquisitions;
 
  •  actions by competitors or other strip center, regional mall and outlet center tenants;
 
  •  weather conditions, particularly during the holiday shopping period;
 
  •  the level of pre-opening expenses associated with our new stores;
 
  •  the level of expenses associated with our store conversions;


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  •  inventory shrinkage beyond our historical average rates;
 
  •  changes in operating performance and stock market valuations of other retail companies;
 
  •  the public’s response to press releases or other public announcements by us or third parties, including our filings with the Securities and Exchange Commission, or SEC, and announcements relating to litigation;
 
  •  the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections;
 
  •  changes in financial estimates by any securities analysts who follow our common stock, our failure to meet these estimates or failure of those analysts to initiate or maintain coverage of our common stock;
 
  •  ratings downgrades by any securities analysts who follow our common stock;
 
  •  the development and sustainability of an active trading market for our common stock;
 
  •  future sales of our common stock by our officers, directors and significant stockholders;
 
  •  other events or factors, including those resulting from war, acts of terrorism, natural disasters or responses to these events; and
 
  •  changes in accounting principles.
 
In addition, the stock markets, and in particular The NASDAQ Global Select Market, have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many retail companies. In the past, stockholders have instituted securities class action litigation following periods of market volatility. If we were involved in securities litigation, we could incur substantial costs and our resources and the attention of management could be diverted from our business.
 
Future sales of our common stock, or the perception in the public markets that these sales may occur, may depress our stock price.
 
Sales of substantial amounts of our common stock in the public market after this offering, or the perception that these sales could occur, could adversely affect the price of our common stock and could impair our ability to raise capital through the sale of additional shares. Upon completion of this offering, we will have 24,160,662 shares of common stock outstanding. The shares of common stock offered in this offering will be freely tradable without restriction under the Securities Act of 1933, as amended, or the Securities Act, except for any shares of our common stock that may be held or acquired by our directors, executive officers and other affiliates, as that term is defined in the Securities Act, which will be restricted securities under the Securities Act. Restricted securities may not be sold in the public market unless the sale is registered under the Securities Act or an exemption from registration is available.
 
We, each of our officers, directors and the selling stockholders have agreed, subject to certain exceptions, with the underwriters not to dispose of or hedge any of the shares of common stock or securities convertible into or exchangeable for shares of common stock during the period from the date of this prospectus continuing through the date 180 days after the date of this prospectus, except, in our case, for the issuance of common stock upon exercise of options under existing option plans. Merrill Lynch, Pierce, Fenner & Smith Incorporated and Goldman, Sachs & Co. may, in their sole discretion, release any of these shares from these restrictions at any time without notice. See “Underwriting.”
 
All of our shares of common stock outstanding as of the date of this prospectus may be sold in the public market by existing stockholders 180 days after the date of this prospectus, subject to applicable volume and other limitations imposed under federal securities laws. See “Shares Eligible for Future Sale” for a more detailed description of the restrictions on selling shares of our common stock after this offering.
 
In the future, we may also issue our securities in connection with investments or acquisitions. The amount of shares of our common stock issued in connection with an investment or acquisition could constitute a material portion of our then-outstanding shares of our common stock.


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Anti-takeover provisions in our charter documents and Delaware law might discourage or delay acquisition attempts for us that you might consider favorable.
 
Our amended and restated certificate of incorporation and amended and restated bylaws will contain provisions that may make the acquisition of our company more difficult without the approval of our board of directors. These provisions:
 
  •  establish a classified board of directors so that not all members of our board of directors are elected at one time;
 
  •  authorize the issuance of undesignated preferred stock, the terms of which may be established and the shares of which may be issued without stockholder approval, and which may include super voting, special approval, dividend, or other rights or preferences superior to the rights of the holders of common stock;
 
  •  prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders;
 
  •  provide that the board of directors is expressly authorized to make, alter, or repeal our amended and restated bylaws; and
 
  •  establish advance notice requirements for nominations for elections to our board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings.
 
These anti-takeover provisions and other provisions under Delaware law could discourage, delay or prevent a transaction involving a change in control of our company, even if doing so would benefit our stockholders. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing and to cause us to take other corporate actions you desire.
 
If you purchase shares of common stock sold in this offering, you will incur immediate and substantial dilution.
 
If you purchase shares of common stock in this offering, you will incur immediate and substantial dilution in the amount of $14.97 per share because the initial public offering price of $17.00 is substantially higher than the pro forma net tangible book value per share of our outstanding common stock. This dilution is due in large part to the fact that our earlier investors paid substantially less than the initial public offering price when they purchased their shares. In addition, you may also experience additional dilution upon future equity issuances or the exercise of stock options to purchase common stock granted to our employees, consultants and directors under our stock option and equity incentive plans. See “Dilution.”
 
If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.
 
The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. We do not currently have and may never obtain research coverage by securities and industry analysts. If no securities or industry analysts commence coverage of our company, the trading price for our common stock would be negatively impacted. If we obtain securities or industry analyst coverage and if one or more of the analysts who covers us downgrades our common stock or publishes inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, demand for our common stock could decrease, which could cause our stock price and trading volume to decline.
 
We do not expect to pay any cash dividends for the foreseeable future.
 
The continued operation and expansion of our business will require substantial funding. Accordingly, we do not anticipate that we will pay any cash dividends on shares of our common stock for the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our board of directors and


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will depend upon results of operations, financial condition, contractual restrictions, including our senior secured credit facility and other indebtedness we may incur, restrictions imposed by applicable law and other factors our board of directors deems relevant. Accordingly, if you purchase shares in this offering, realization of a gain on your investment will depend on the appreciation of the price of our common stock, which may never occur. Investors seeking cash dividends in the foreseeable future should not purchase our common stock.


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FORWARD-LOOKING STATEMENTS
 
This prospectus contains forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical fact included in this prospectus are forward-looking statements. Forward-looking statements give our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe,” “may,” “will,” “should,” “can have,” “likely” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. For example, all statements we make relating to our estimated and projected earnings, revenues, costs, expenditures, cash flows, growth rates and financial results, our plans and objectives for future operations, growth or initiatives, strategies, or the expected outcome or impact of pending or threatened litigation are forward-looking statements. All forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we expected, including:
 
  •  failure to successfully execute our growth strategy, including delays in store growth and store conversions, difficulties executing sales and operating profit margin initiatives and inventory shrinkage prevention;
 
  •  the failure of our new stores or the conversion of our existing stores to achieve sales and operating levels consistent with our expectations;
 
  •  risks and challenges in connection with sourcing merchandise from domestic and foreign vendors;
 
  •  our level of success in gaining and maintaining broad market acceptance of our exclusive brands;
 
  •  our failure to protect our brand image;
 
  •  our debt levels and restrictions in our senior secured credit facility and in agreements for other indebtedness we may incur;
 
  •  economic conditions, including their effect on the financial and capital markets, our vendors and business partners, employment levels, consumer demand, spending patterns, inflation and the cost of goods;
 
  •  our loss of key personnel or our inability to hire additional personnel;
 
  •  seasonality of our business;
 
  •  increases in costs of fuel, or other energy, transportation or utilities costs and in the costs of labor and employment;
 
  •  the impact of governmental laws and regulations and the outcomes of legal proceedings;
 
  •  disruptions in our supply chain and distribution facility;
 
  •  damage or interruption to our information systems;
 
  •  changes in the competitive environment in our industry and the markets in which we operate;
 
  •  natural disasters, unusually adverse weather conditions, pandemic outbreaks, boycotts and geo-political events;
 
  •  the incurrence of material uninsured losses or excessive insurance costs; and
 
  •  our failure to maintain effective internal controls.
 
We derive many of our forward-looking statements from our operating budgets and forecasts, which are based upon many detailed assumptions. While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors, and, it is impossible for us to anticipate all factors that could affect our actual results. Important factors that could cause actual results to differ materially from


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our expectations, or cautionary statements, are disclosed under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this prospectus. All written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by the cautionary statements as well as other cautionary statements that are made from time to time in our other SEC filings and public communications. You should evaluate all forward-looking statements made in this prospectus in the context of these risks and uncertainties.
 
We caution you that the important factors referenced above may not contain all of the factors that are important to you. In addition, we cannot assure you that we will realize the results or developments we expect or anticipate or, even if substantially realized, that they will result in the consequences we anticipate or affect us or our operations in the way we expect. The forward-looking statements included in this prospectus are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law.


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USE OF PROCEEDS
 
We estimate that the net proceeds to us from the sale of the shares of common stock offered by us will be approximately $22.1 million based upon an assumed initial public offering price of $17.00 per share, the midpoint of the range set forth on the cover of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. We will not receive any proceeds from the sale of shares of our common stock by the selling stockholders, including any shares sold by certain of the selling stockholders in connection with the exercise of the underwriters’ option to purchase additional shares.
 
A $1.00 increase or decrease in the assumed initial public offering price of $17.00 per share would increase or decrease the net proceeds we receive from this offering by approximately $1.5 million, assuming the number of shares offered by us, as set forth on the cover of this prospectus, remains the same and after deducting the estimated underwriter discounts and commissions and estimated offering expenses payable by us.
 
We currently intend to use the net proceeds we receive from this offering for the repayment of approximately $22.1 million of our outstanding indebtedness. We currently intend to use the remaining net proceeds, if any, for working capital and other general corporate purposes. As of August 1, 2009 and November 6, 2009, we had $29.2 million and $29.0 million, respectively, of borrowings outstanding under our senior secured credit facility with Bank of America, N.A., an affiliate of Merrill Lynch, Pierce, Fenner & Smith Incorporated, an underwriter in this offering. Immediately prior to the completion of this offering, we anticipate the outstanding borrowings under our senior secured credit facility will be approximately $30.0 million. In April 2008, we used borrowings under our senior secured credit facility to discharge all of our long-term debt, accrued monitoring fees payable to Apax Partners and a commitment fee payable to Bank of America, N.A. Our revolving credit facility has a maturity date of April 10, 2013 and is expandable at our option in increments of $5.0 million up to a limit of $85.0 million under certain defined conditions. Availability under our senior secured credit facility is collateralized by a first priority interest in all of our assets. The revolving credit facility accrues interest at the Bank of America base rate, defined at our option as the prime rate or the Eurodollar rate plus applicable margin, which ranges from 1.25% to 2.00% set quarterly dependent upon average net availability under the senior secured credit facility during the previous quarter. The weighted-average interest rate under the revolving credit facility was 1.32% for the twenty-six weeks ended August 1, 2009. We intend to obtain an amendment of certain provisions of our senior secured credit facility in connection with this offering. See “Description of Certain Indebtedness — Senior Secured Credit Facility.”
 
Pending use of the net proceeds from this offering described above, we intend to invest the net proceeds in short- and intermediate-term interest-bearing obligations, investment-grade instruments, certificates of deposit or direct or guaranteed obligations of the United States government.
 
By establishing a public market for our common stock, this offering is also intended to facilitate our future access to public markets.


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DIVIDEND POLICY
 
We have never declared or paid cash dividends on our common stock. We do not expect to pay dividends on our common stock for the foreseeable future. Instead, we anticipate that all of our earnings in the foreseeable future will be used in the operation and growth of our business. Any future determination to pay dividends will be at the discretion of our board of directors, subject to compliance with certain contractual restrictions, including under our senior secured credit facility and agreements for other indebtedness we may incur, which restricts or limits our ability to pay dividends, and will depend upon, among other factors, our results of operations, financial condition, capital requirements, restrictions contained in current and future financing instruments and other factors that our board of directors deems relevant. See “Description of Certain Indebtedness.”


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CAPITALIZATION
 
The following table sets forth our cash and cash equivalents and our capitalization as of August 1, 2009 on:
 
  •  an actual basis; and
 
  •  on an as adjusted basis to give effect to the following:
 
  •  the exercise by employees of options to purchase an aggregate of 419,620 shares of common stock between August 1, 2009 and October 27, 2009;
 
  •  the sale of 1,650,000 shares of our common stock in this offering by us at an assumed initial public offering price of $17.00 per share, the midpoint of the price range set forth on the cover of this prospectus, after deducting underwriting discounts and commissions and estimated offering expenses payable by us; and
 
  •  the application of the net proceeds from this offering to us as described under “Use of Proceeds.”
 
You should read the following table in conjunction with the sections titled “Use of Proceeds,” “Selected Consolidated Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and related notes included elsewhere in this prospectus.
 
                 
    As of August 1, 2009  
   
Actual
    As Adjusted(1)  
    (unaudited)
 
    (in thousands)  
 
Cash and cash equivalents
  $ 8,668     $ 8,668  
                 
Long-term debt(2):
  $ 29,234       7,148  
Stockholders’ equity:
               
Common stock, $0.004 par value per share, 50,000,000 authorized; 22,091,042 shares issued and outstanding, actual; $0.001 par value per share, 200,000,000 authorized; 24,160,662 shares issued and outstanding, on a pro forma as adjusted basis
    88       24  
Additional paid-in capital
    37       22,188  
Retained earnings
    26,805       26,805  
                 
Total stockholders’ equity
    26,930       49,017  
                 
Total capitalization
  $ 56,164       56,164  
                 
 
 
(1) A $1.00 increase or decrease in the assumed initial public offering price of $17.00 per share, the midpoint of the range set forth on the cover of this prospectus, would increase or decrease the amount of additional paid-in capital, total stockholders’ equity and total capitalization by approximately $1.5 million, assuming the number of shares offered by us, as set forth on the cover of this prospectus, remains the same and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.
 
(2) As of August 1, 2009 and November 6, 2009, we had $30.8 million and $31.0 million, respectively, of availability under the revolving portion of our senior secured credit facility, excluding the accordion option.
 
The outstanding share information set forth above is as of August 1, 2009, and excludes:
 
  •  1,582,520 shares of common stock issuable upon exercise of stock options outstanding as of August 1, 2009 at a weighted average exercise price of $4.88 per share on an actual basis, 1,205,380 shares of common stock issuable upon exercise of stock options outstanding as of October 27, 2009 at a weighted average exercise price of $6.82 per share on an as adjusted basis, of which 288,300 will vest upon completion of this offering, and shares of common stock issuable upon exercise of stock options by management in connection with this offering;
 
  •  an aggregate of 3,626,000 shares of common stock reserved for issuance under our equity compensation plan, which we plan to adopt in connection with this offering; and
 
  •  assumes no exercise by the underwriters of their option to purchase up to an additional 1,014,815 shares from certain of the selling stockholders to cover their option to purchase additional shares.


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DILUTION
 
If you invest in our common stock, your ownership interest will be diluted to the extent of the difference between the initial public offering price per share of our common stock in this offering and the pro forma net tangible book value per share of common stock upon completion of this offering.
 
Historical net tangible book value per share represents the amount of our total tangible assets less total liabilities, divided by the number of shares of common stock outstanding. The historical net tangible book value of our common stock as of August 1, 2009 was approximately $26.9 million, or approximately $1.22 per share of common stock, based upon the number of shares of common stock outstanding as of August 1, 2009.
 
Investors participating in this offering will incur immediate, substantial dilution. After giving effect to (1) the sale of 1,650,000 shares of our common stock by us at an assumed initial public offering price of $17.00 per share, the midpoint of the price range set forth on the cover of this prospectus, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, (2) the exercise by employees of options to purchase an aggregate of 419,620 shares of common stock between August 1, 2009 and October 27, 2009, but not shares of common stock issuable upon exercise of stock options by management in connection with this offering, and (3) the application of the net proceeds to us from this offering as described in “Use of Proceeds,” our pro forma net tangible book value as of August 1, 2009 would have been approximately $49.0 million, or approximately $2.03 per share of common stock. This represents an immediate increase in pro forma net tangible book value of $0.81 per share to existing common stockholders, and an immediate dilution of $14.97 per share to investors participating in this offering. If the initial public offering price is higher or lower, the dilution to new stockholders will be greater or less.
 
The following table illustrates this dilution on a per share basis:
 
                 
Assumed initial public offering price per share of common stock
                   $ 17.00  
Historical net tangible book value per share as of August 1, 2009
  $ 1.22          
Increase per share attributable to this offering
    0.81          
                 
Pro forma net tangible book value per share after this offering
            2.03  
                 
Dilution in pro forma net tangible book value per share to new investors(1)
          $ 14.97  
                 
 
 
(1) Dilution is determined by subtracting pro forma net tangible book value per share after giving effect to the offering from the initial public offering price paid by a new investor.
 
Each $1.00 increase (decrease) in the assumed initial public offering price of $17.00 per share would increase (decrease) our pro forma net tangible book value by approximately $1.5 million, or $0.06 per share, and the dilution in net tangible book value per share to investors in this offering by $15.91 per share, assuming that the number of shares offered by us, as set forth on the cover of this prospectus, remains the same. This pro forma information is illustrative only, and following the completion of this offering, will be adjusted based on the actual initial public offering price and other terms of this offering determined at pricing.
 
The following table summarizes as of August 1, 2009 the differences between our existing stockholders and new investors with respect to the number of shares of our common stock sold in this offering, the total consideration paid and the average price per share paid. The calculations with respect to shares purchased by new investors in this offering reflect an assumed initial public offering price of $17.00 per share, the midpoint of the range set forth on the cover of this prospectus, before deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us:
 
                                         
    Shares Purchased     Total Consideration     Average Price
 
    Number     Percentage     Amount     Percentage     Per Share  
 
Existing stockholders
    22,091,042       93.1     $ 126,000       0.4     $ 0.01  
New investors
    1,650,000       6.9       28,050,000       99.6       17.00  
                                         
Total
    23,741,042       100 %   $ 28,176,000       100 %     1.19  
                                         


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A $1.00 increase (decrease) in the assumed initial public offering price of $17.00 per share, the midpoint of the price range set forth on the cover of this prospectus, would increase (decrease) the total consideration paid by investors participating in this offering by $6.8 million, or increase (decrease) the percent of total consideration paid by investors participating in this offering by 5.9%, assuming that the number of shares offered by us and the selling stockholders, as set forth on the cover of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.
 
Except as otherwise indicated, the discussion and tables above assume no exercise of the underwriters’ option to purchase additional shares, no exercise of any outstanding options and no sale of common stock by the selling stockholders. The sale of 5,115,437 shares of common stock to be sold by the selling stockholders in this offering will reduce the number of shares held by existing stockholders to 16,975,605, or 71.5% of the total shares outstanding, and will increase the number of shares held by investors participating in this offering to 6,765,437, or 28.5% of the total shares outstanding. In addition, if the underwriters’ option to purchase additional shares is exercised in full, the number of shares of common stock held by existing stockholders will be further reduced to 67.2% of the total number of shares of common stock to be outstanding upon the closing of this offering, and the number of shares of common stock held by investors participating in this offering will be further increased to 7,780,252 shares or 32.8% of the total number of shares of common stock to be outstanding upon the closing of this offering.
 
Except where specifically indicated, the tables and calculations above are based on 22,091,042 shares of common stock issued and outstanding as of August 1, 2009, and exclude:
 
  •  1,582,520 shares of common stock issuable upon exercise of stock options outstanding as of August 1, 2009 at a weighted average exercise price of $4.88 per share, on an actual basis, 1,205,380 shares of common stock issuable upon exercise of stock options outstanding as of October 27, 2009 at a weighted average exercise price of $6.82 per share on an adjusted basis, of which 288,300 will vest upon completion of this offering, and shares of common stock issuable upon exercise of stock options by management in connection with this offering;
 
  •  an aggregate of 3,626,000 shares of common stock reserved for issuance under our equity compensation plan, which we plan to adopt in connection with this offering; and
 
  •  the exercise by employees of options to purchase an aggregate of 419,620 shares of common stock between August 1, 2009 and October 27, 2009.
 
To the extent that any outstanding options are exercised, new investors will experience further dilution.


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SELECTED CONSOLIDATED FINANCIAL DATA
 
The following tables set forth selected consolidated financial and other data for the periods and at the dates indicated. The selected income statement data for the fiscal years ended January 29, 2005, January 28, 2006, February 3, 2007, February 2, 2008 and January 31, 2009 and selected consolidated balance sheet data as of January 29, 2005, January 28, 2006, February 3, 2007, February 2, 2008 and January 31, 2009 are derived from our audited consolidated financial statements. Our audited statements of income for the fiscal years ended February 3, 2007, February 2, 2008 and January 31, 2009 and our audited consolidated balance sheets as of February 2, 2008 and January 31, 2009 are included elsewhere in this prospectus. Our audited consolidated statements of income for the fiscal years ended January 29, 2005 and January 28, 2006 and our audited consolidated balance sheets as of January 29, 2005, January 28, 2006 and February 3, 2007 have not been included in this prospectus. The selected income statement data for the twenty-six weeks ended August 2, 2008 and the twenty-six weeks ended August 1, 2009 and the selected balance sheet data as of August 2, 2008 and August 1, 2009 are derived from our unaudited condensed consolidated financial statements included elsewhere in this prospectus. The historical results presented below are not necessarily indicative of the results to be expected for any future period. You should read this selected consolidated financial data in conjunction with the consolidated financial statements and related notes and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this prospectus. The historical results set forth below are not necessarily indicative of results of operations to be expected in any future period.
 
                                                         
    Fiscal Year Ended     Twenty-Six Weeks Ended  
    January 29,
    January 28,
    February 3,
    February 2,
    January 31,
    August 2,
    August 1,
 
    2005     2006     2007     2008     2009     2008     2009  
                                  (unaudited)  
    (in thousands, except per share and operating data)  
 
Statement of Income Data:
                                                       
Net sales
  $ 146,918     $ 192,818     $ 225,559     $ 296,887     $ 391,414     $ 174,837     $ 233,104  
Cost of goods sold(1)
    100,216       129,214       150,163       195,034       257,853       114,904       150,194  
                                                         
Gross profit
    46,702       63,604       75,396       101,853       133,561       59,933       82,910  
Selling, general and administrative expense
    38,136       48,703       57,575       76,039       99,886       45,280       61,082  
Depreciation and amortization expense
    2,782       3,945       5,926       8,241       11,532       5,274       7,774  
                                                         
Income from operations
    5,784       10,956       11,895       17,573       22,143       9,379       14,054  
Interest expense, net
    1,685       1,959       2,645       2,520       1,477       904       297  
Provision for income taxes
    190       1,638       1,452       5,920       8,027       3,322       5,440  
                                                         
Net income
  $ 3,909     $ 7,359     $ 7,798     $ 9,133     $ 12,639     $ 5,153     $ 8,317  
                                                         
Net income per common share:
                                                       
Basic
  $ 0.20     $ 0.38     $ 0.39     $ 0.42     $ 0.58     $ 0.24     $ 0.38  
Diluted
  $ 0.17     $ 0.33     $ 0.36     $ 0.40     $ 0.55     $ 0.23     $ 0.36  
Weighted average shares outstanding:
                                                       
Basic
    19,217       19,217       19,782       21,705       21,914       21,880       22,090  
Diluted
    21,978       22,184       21,888       22,842       22,814       22,845       23,004  
 


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    Fiscal Year Ended     Twenty-Six Weeks Ended  
    January 29,
    January 28,
    February 3,
    February 2,
    January 31,
    August 2,
    August 1,
 
    2005     2006     2007     2008     2009     2008     2009  
 
Operating Data (unaudited):
                                                       
Sales per gross square foot
  $ 217     $ 245     $ 234     $ 236     $ 235     $ 238     $ 233  
Comparable store sales change(2)
    10.8 %     10.9 %     (4.7 )%     7.8 %     3.7 %     (2.0 )%     4.1 %
Number of stores open at end of period
    193       229       278       352       449       403       505  
Total gross square feet at end of period (in thousands)
    750       896       1,095       1,448       1,949       1,729       2,229  
Store conversions during period
    10       6       18       20       21       11       18  
Capital expenditures (in thousands)
  $   7,174     $  12,098     $ 16,586     $  20,265     $  26,464     $   9,526     $  16,656  
 
                                                         
    As of     As of  
    January 29,
    January 28,
    February 3,
    February 2,
    January 31,
    August 2,
    August 1,
 
    2005     2006     2007     2008     2009     2008     2009  
                                  (unaudited)  
    (in thousands)  
 
Balance Sheet Data:
                                                       
Cash and cash equivalents
    3,977       4,075       2,525       3,343       4,611       7,385       8,668  
Working capital
    3,231       37       (622 )     3,946       798       7,171       14,830  
Total assets
    38,227       52,716       79,092       102,285       141,200       138,767       184,275  
Total long-term debt
    30,930       25,279       23,317       27,968       19,476       27,567       29,234  
Stockholders’ (deficit) equity
    (18,535 )     (11,174 )     (3,537 )     5,753       18,393       10,956       26,930  
Cash Flow Data:
                                                       
Net cash provided by operating activities
  $ 11,283     $ 16,195     $ 17,480     $ 21,512     $ 36,859     $ 13,969     $ 10,955  
 
 
(1) Includes certain buying, freight, distribution facility and store occupancy expenses.
 
(2) Comparable store sales in fiscal years 2006 and 2007 are adjusted for the 53rd week in fiscal year 2006.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
You should read the following discussion together with “Selected Consolidated Financial Data,” and the historical financial statements and related notes included elsewhere in this prospectus. The statements in this discussion regarding industry outlook, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements in this discussion are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in “Risk Factors” and “Forward-Looking Statements.” Our actual results may differ materially from those contained in or implied by any forward-looking statements.
 
We operate on a fiscal calendar widely used by the retail industry that results in a given fiscal year consisting of a 52- or 53-week period ending on the Saturday closest to January 31 of the following year. For example, references to “fiscal year 2008” refer to the fiscal year ended January 31, 2009. Our fiscal year 2006 consisted of a 53-week period and ended on February 3, 2007.
 
Overview
 
rue21 is a fast growing specialty apparel retailer offering the newest fashion trends for girls and guys at value prices. We were originally founded in 1976 as a value-focused specialty apparel retailer. In 1998, we were acquired by certain funds now advised by Apax Partners, through SKM Equity Fund II, L.P. and SKM Investment Fund II. In 2001, our current President and Chief Executive Officer, Bob Fisch, joined us. Upon his hiring, Bob Fisch began repositioning our company by aligning our stores under one brand name, strengthening our management team, honing our fashion value merchandise approach and refocusing our store growth strategy. As part of our turnaround, we sought bankruptcy protection in February 2002 and emerged within fifteen months as a stronger company with a rationalized store base of 168 stores. We have been growing consistently since that time. In late 2006, we introduced our larger rue21 etc! store layout, which averages approximately 4,700 square feet and features a separate store-in-store for our rue21 etc! girls jewelry and accessories category. As of October 3, 2009, we operated 527 stores in 43 states, 302 of which featured the larger rue21 etc! store layout.
 
Our strong growth and operating results reflect the initiatives taken by our management team, as well as the increasing acceptance of our brand and merchandise. Our net sales increased from $146.9 million in fiscal year 2004 to $391.4 million in fiscal year 2008, a compound annual growth rate of 27.8%. Over the same period, we grew income from operations from $5.8 million to $22.1 million, a compound annual growth rate of 39.9%. Since the beginning of fiscal year 2004, we have increased our store base from 175 stores to 527 stores as of October 3, 2009. Our total square footage growth has outpaced our total store growth over this same period, reflecting the increasing size of our average store.
 
We expect to continue our strong growth in the future. We believe there is a significant opportunity to grow our store base to more than 1,000 stores within five years. We plan to open 88 stores in fiscal year 2009, including 78 new stores opened as of October 3, 2009, and 100 stores in fiscal year 2010. We also plan to continue to convert our existing stores into the larger rue21 etc! layout, which allows us to offer an increased proportion of higher margin categories, such as accessories, intimate apparel, footwear and fragrances. We converted 21 stores to the rue21 etc! layout in fiscal year 2008 and plan to convert 26 stores in fiscal year 2009, including 24 stores converted as of October 3, 2009. We expect to continue to drive our comparable store sales by increasing the penetration of our newer product categories, increasing our brand awareness, continuing to provide our distinctive in-store experience and converting stores to the rue21 etc! layout.
 
Our growth in total square footage is supported by our store economics, which we believe to be very attractive. As a result of our low store build-out costs, favorable lease terms and low-cost operating model, our stores generate strong returns on investment. We focus our real estate strategy on strip centers, regional malls and outlet centers, primarily in small- and middle-market communities, which we believe are underserved by traditional junior and young men’s specialty apparel retailers. Our typical new store investment is approximately $160,000, which includes build-out costs, net of landlord tenant allowances and initial inventory, net of payables. New stores generate on average between $900,000 and $1.1 million in net sales per store in the first twelve


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months and pay back our investment in less than one year. However, new stores opened in the future may not generate similar net sales in the first twelve months or pay back our investment in a similar time period.
 
We have recently invested significant capital to build the infrastructure necessary to support our future growth. This investment includes an upgrade of our distribution facility and related systems, which we expect to complete by the end of the first quarter of fiscal year 2010. Upon completion, our distribution facility will be able to support approximately 1,300 stores. Additionally, we continue to invest in our systems infrastructure, including implementation of the latest store merchandising, distribution, financial and real estate applications. Furthermore, in fiscal year 2008, we invested in an expansion of our corporate headquarters, which increased the square footage by 50%.
 
We believe our business strategy will continue to offer significant opportunity, but it also presents risks and challenges. These risks and challenges include that we may not be able to effectively identify and respond to changing fashion trends and customer preferences, that we may not be able to find desirable locations in strip centers and regional malls or that we may not be able to effectively manage our operations which have grown rapidly, or our future growth. We seek to ensure that addressing these risks does not divert our management’s attention from continuing to build on the strengths that we believe have driven the growth of our business. We believe our focus on maintaining the desirability of our products to our customers, maintaining and scaling our supply chain resources and improving our in-store shopping experience and our customer service will contribute to our ongoing success.
 
How We Assess the Performance of Our Business
 
In assessing the performance of our business, we consider a variety of performance and financial measures. The key measures for determining how our business is performing are net sales, comparable store and non-comparable store sales, gross profit margin and selling, general and administrative expense.
 
Net Sales
 
Net sales constitute gross sales net of any returns and merchandise discounts. Net sales consist of sales from comparable stores and non-comparable stores.
 
Comparable Store Sales
 
A store is included in comparable store sales on the first day of the sixteenth month as new stores generally open with above run-rate sales volumes, which usually extend for a period of at least three months, and comparability is achieved twelve months after the initial three-month period after store opening. Comparable store sales include existing stores that have been converted to our rue21 etc! layout. When a store that is included in comparable store sales is in process of being converted to our rue21 etc! layout, net sales from that store remain in comparable store sales. There may be variations in the way in which some of our competitors and other apparel retailers calculate comparable or “same store” sales. As a result, data in this prospectus regarding our comparable store sales may not be comparable to similar data made available by other retailers. Non-comparable store sales include sales not included in comparable store sales and sales from closed stores.
 
Measuring the change in year-over-year comparable store sales allows us to evaluate how our store base is performing. Various factors affect comparable store sales, including:
 
  •  consumer preferences, buying trends and overall economic trends;
 
  •  our ability to identify and respond effectively to fashion trends and customer preferences;
 
  •  competition;
 
  •  changes in our merchandise mix;
 
  •  pricing;
 
  •  the timing of our releases of new merchandise and promotional events;
 
  •  the level of customer service that we provide in our stores;


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  •  our ability to source and distribute products efficiently; and
 
  •  the number of stores we open, close and convert in any period.
 
As we continue to pursue our store growth strategy, we expect that a significant percentage of our net sales increase will continue to come from non-comparable store sales. Opening new stores is an important part of our growth strategy. Accordingly, comparable store sales is only one element we use to assess the success of our growth strategy.
 
The retail apparel industry is cyclical, and consequently our net sales are affected by general economic conditions. Purchases of apparel and accessories are sensitive to a number of factors that influence the levels of consumer spending, including economic conditions and the level of disposable consumer income, consumer debt, interest rates and consumer confidence.
 
Our business is seasonal and as a result, our net sales fluctuate from quarter to quarter. Net sales are usually higher in the second and fourth fiscal quarters, and particularly in the months of August and December, as customers make back-to-school and holiday purchases.
 
Gross Profit
 
Gross profit is equal to our net sales minus our cost of goods sold. Gross margin measures gross profit as a percentage of our net sales. Cost of goods sold includes the direct cost of purchased merchandise, distribution center costs, all freight costs incurred to get merchandise to our stores, store occupancy costs and buying costs. The components of our cost of goods sold may not be comparable to those of other retailers.
 
Our cost of goods sold is substantially higher in higher volume quarters because cost of goods sold generally increases as net sales increase. Changes in the mix of our products, such as changes in the proportion of accessories, may also impact our overall cost of goods sold. We review our inventory levels on an ongoing basis in order to identify slow-moving merchandise, and generally use markdowns to clear that merchandise. The timing and level of markdowns are not seasonal in nature but are driven by customer acceptance of our merchandise. If we misjudge the market for our products, we may be faced with significant excess inventories for some products and be required to mark down those products in order to sell them. Significant markdowns have reduced our gross profit in some prior periods and may have a material adverse impact on our earnings for future periods depending on the amount of the markdowns and the amount of merchandise affected.
 
Selling, General and Administrative Expense
 
Selling, general and administrative expense includes administration, share-based compensation and store expenses but excludes store occupancy costs and freight to stores. These expenses do not generally vary proportionally with net sales. As a result, selling, general and administrative expense as a percentage of net sales is usually higher in lower volume quarters and lower in higher volume quarters. The components of our selling, general and administrative expense may not be comparable to those of other retailers. We expect that our selling, general and administrative expense will increase in future periods due to our continuing store growth and in part to additional legal, accounting, insurance and other expenses we expect to incur as a result of being a public company. Among other things, we expect that compliance with the Sarbanes-Oxley Act and related rules and regulations will result in significant legal and accounting costs.
 
Share-based compensation expense related to stock options was $34,000, $34,000 and $0 for fiscal years 2006, 2007 and 2008, respectively. We granted options to purchase an aggregate of 397,000 shares and 126,500 shares of common stock in fiscal years 2007 and 2008, respectively. These and any future stock option grants will increase our share-based compensation expense in fiscal year 2009 and in future fiscal years compared to fiscal year 2008. See “—Critical Accounting Policies”.


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Results of Operations
 
The following tables summarize key components of our results of operations for the periods indicated, both in dollars and as a percentage of net sales:
 
                                         
    Fiscal Year Ended     Twenty-Six Weeks Ended  
    February 3,
    February 2,
    January 31,
    August 2,
    August 1,
 
    2007     2008     2009     2008     2009  
                      (unaudited)  
    (in thousands, except operating data)  
 
Net sales
  $ 225,559     $ 296,887     $ 391,414     $ 174,837     $ 233,104  
Cost of goods sold(l)
    150,163       195,034       257,853       114,904       150,194  
                                         
Gross profit
    75,396       101,853       133,561       59,933       82,910  
Selling, general and administrative expense
    57,575       76,039       99,886       45,280       61,082  
Depreciation and amortization expense
    5,926       8,241       11,532       5,274       7,774  
                                         
Income from operations
    11,895       17,573       22,143       9,379       14,054  
Interest expense, net
    2,645       2,520       1,477       904       297  
                                         
Income before income taxes
    9,250       15,053       20,666       8,475       13,757  
Provision for income taxes
    1,452       5,920       8,027       3,322       5,440  
                                         
Net income
  $ 7,798     $ 9,133     $ 12,639     $ 5,153     $ 8,317  
                                         
Operating data (unaudited):
                                       
Number of stores open at end of period
    278       352       449       403       505  
Total gross square feet at end of the period (in thousands)
    1,095       1,448       1,949       1,729       2,229  
Sales per gross square foot
  $ 234     $ 236     $ 235     $ 238     $ 233  
Comparable store sales change(2)
    (4.7 )%     7.8 %     3.7 %     (2.0 )%     4.1 %
 
 
(1) Includes certain buying, freight, distribution facility and store occupancy expenses.
 
(2) Comparable store sales in fiscal years 2006 and 2007 are adjusted for the 53rd week in fiscal year 2006.
 
                                         
    Fiscal Year Ended     Twenty-Six Weeks Ended  
    February 3,
    February 2,
    January 31,
    August 2,
    August 1,
 
    2007     2008     2009     2008     2009  
 
Net sales
    100.0 %     100.0 %     100.0 %     100.0 %     100.0 %
Cost of goods sold(l)
    66.6       65.7       65.9       65.7       64.4  
                                         
Gross profit
    33.4       34.3       34.1       34.3       35.6  
Selling, general and administrative expense
    25.5       25.6       25.5       25.9       26.2  
Depreciation and amortization expense
    2.6       2.8       2.9       3.0       3.3  
                                         
Income from operations
    5.3       5.9       5.7       5.4       6.0  
Interest expense, net
    1.2       0.8       0.4       0.5       0.1  
                                         
Income before income taxes
    4.1       5.1       5.3       4.9       5.9  
Provision for income taxes
    0.6       2.0       2.1       1.9       2.3  
                                         
Net income
    3.5 %     3.1 %     3.2 %     3.0 %     3.6 %
                                         
 
 
(1) Includes certain buying, freight, distribution facility and store occupancy expenses.


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The approximate percentage of our net sales derived from our product categories, based on our internal merchandising system, is as follows:
 
                                         
    Fiscal Year Ended     Twenty-Six Weeks Ended  
    February 3,
    February 2,
    January 31,
    August 2,
    August 1,
 
    2007     2008     2009     2008     2009  
                      (unaudited)  
 
Merchandise categories:
                                       
Girls apparel
    60.9 %     61.6 %     58.3 %     60.1 %     58.0 %
Girls accessories
    21.4 %     21.9 %     23.5 %     22.8 %     24.6 %
Guys apparel and accessories
    17.7 %     16.5 %     18.2 %     17.1 %     17.4 %
                                         
Total
    100.0 %     100.0 %     100.0 %     100.0 %     100.0 %
 
The increase in girls accessories net sales as a percentage of total net sales is due to management efforts to expand the number of items in the girls accessories category.
 
The following table summarizes the number of stores open at the beginning of the period and at the end of the period.
 
                                         
    Fiscal Year Ended     Twenty-Six Weeks Ended  
    February 3,
    February 2,
    January 31,
    August 2,
    August 1,
 
    2007     2008     2009     2008     2009  
 
Number of stores open at beginning of period
    229       278       352       352       449  
New stores
    56       74       99       51       56  
Store closings
    (7 )           (2 )            
                                         
Number of stores open at end of period
    278       352       449       403       505  
                                         
Store conversions during period
    18       20       21       11       18  
 
Twenty-Six Weeks Ended August 1, 2009 Compared to Twenty-Six Weeks Ended August 2, 2008
 
Net Sales
 
Net sales increased 33.3%, or $58.3 million, to $233.1 million for the twenty-six weeks ended August 1, 2009 from $174.8 million for the twenty-six weeks ended August 2, 2008. The increase in net sales was due to an increase of approximately 35% in the number of transactions, primarily driven by new store openings, partially offset by a decrease of approximately 1% in the average dollar value of transactions per store.
 
Comparable store sales increased 4.1% for the twenty-six weeks ended August 1, 2009 compared to a decrease of 2.0% for the twenty-six weeks ended August 2, 2008. Comparable store sales increased by $38.2 million and non-comparable store sales increased by $20.1 million. There were 362 comparable stores and 143 non-comparable stores open at August 1, 2009 compared to 286 and 117, respectively, at August 2, 2008.
 
The increase in the girls accessories category as a percentage of net sales and the approximate corresponding decrease in the girls apparel category as a percentage of net sales was reflective of varying category sales growth rates. The girls accessories category grew by approximately 44% and the girls apparel category grew by approximately 29%. The guys apparel and accessories category sales as a percentage of net sales change was minimal as category growth was closer to total net sales growth. The increase in girls accessories as a percentage of total net sales was due to management efforts to expand the number of items in the girls accessories category.
 
Gross Profit
 
Gross profit increased 38.3%, or $23.0 million, in the twenty-six weeks ended August 1, 2009 to $82.9 million from $59.9 million in the twenty-six weeks ended August 2, 2008. Gross margin increased


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130 basis points to 35.6% for the twenty-six weeks ended August 1, 2009 from 34.3% for the twenty-six weeks ended August 2, 2008. This increase was primarily attributable to a 110 basis point increase in merchandise margin, due primarily to lower merchandise costs. The remainder of the gross margin increase was due to a 20 basis point decrease in store occupancy, distribution and buying costs as these costs increased at a lower rate than net sales.
 
Selling, General and Administrative Expense
 
Selling, general and administrative expense increased 34.9%, or $15.8 million, to $61.1 million in the twenty-six weeks ended August 1, 2009 from $45.3 million for the twenty-six weeks ended August 2, 2008. As a percentage of net sales, selling, general and administrative expense increased to 26.2% in the twenty-six weeks ended August 1, 2009 from 25.9% in the twenty-six weeks ended August 2, 2008.
 
Store operating expenses increased by $12.2 million primarily resulting from the operation of 505 stores as of August 1, 2009 compared to the operation of 403 stores as of August 2, 2008. As a percentage of net sales, store operating expenses increased to 19.4% for the twenty-six weeks ended August 1, 2009 from 18.8% for the twenty-six weeks ended August 2, 2008, due primarily to increased store salaries as a percentage of net sales.
 
Due in part to insurance settlement proceeds received of $223,000, administrative and general expenses decreased as a percentage of net sales to 6.8% for the twenty-six weeks ended August 1, 2009 from 7.1% for the twenty-six weeks ended August 2, 2008 as these costs increased at a lower rate than net sales.
 
Depreciation and Amortization Expense
 
Depreciation and amortization expense increased as a percentage of net sales to 3.3% for the twenty-six weeks ended August 1, 2009 from 3.0% for the twenty-six weeks ended August 2, 2008, or $2.5 million. The increase was due to growth in capital expenditures to $16.7 million for the twenty-six weeks ended August 1, 2009 from $9.5 million for the twenty-six weeks ended August 2, 2008. This increase follows annual increases in capital expenditures of $3.7 million in fiscal year 2007 and $6.2 million in fiscal year 2008.
 
Interest Expense, Net
 
Interest expense, net decreased by $607,000 to $297,000 for the twenty-six weeks ended August 1, 2009 due primarily to reduced weighted average borrowings and a reduced average interest rate under our senior secured credit facility.
 
Provision for Income Taxes
 
The increase in provision for income taxes of $2.1 million in the twenty-six weeks ended August 1, 2009 from the twenty-six weeks ended August 2, 2008 was due primarily to the $5.3 million increase in pre-tax income. The effective tax rates were 39.5% and 39.2% for the twenty-six weeks ended August 1, 2009 and the twenty-six weeks ended August 2, 2008, respectively.
 
Net Income
 
Net income increased 61.4%, or $3.2 million, to $8.3 million for the twenty-six weeks ended August 1, 2009 from $5.2 million for the twenty-six weeks ended August 2, 2008. This increase was due primarily to the $23.0 million increase in gross profit and lower interest expense, partially offset by increases in selling, general and administrative expense of $15.8 million, higher depreciation and amortization expense of $2.5 million and higher provision for income taxes of $2.1 million.


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Fiscal Year 2008 Compared to Fiscal Year 2007
 
Net Sales
 
Net sales increased 31.8%, or $94.5 million, to $391.4 million in fiscal year 2008 from $296.9 million in fiscal year 2007. The increase in net sales was due to an increase of approximately 23% in the number of transactions, driven by new store openings and an increase of approximately 2% in the average dollar value of transactions per store.
 
Comparable store sales increased 3.7% for fiscal year 2008 compared to an increase of 7.8% for fiscal year 2007. Comparable store sales increased by $66.7 million and non-comparable store sales increased by $27.8 million. There were 330 comparable stores and 119 non-comparable stores open at January 31, 2009 compared to 260 and 92, respectively, at February 2, 2008.
 
The increase in the girls accessories and guys apparel and accessories categories as a percentage of net sales and the approximate corresponding decrease in the girls apparel category as a percentage of net sales was reflective of varying category sales growth rates. The girls accessories and guys apparel and accessories categories grew by approximately 42% and 45%, respectively. Girls apparel category growth was approximately 25%. The increase in girls accessories as a percentage of net sales was due to management efforts to expand the number of items in the girls accessories category.
 
Gross Profit
 
Gross profit increased 31.1%, or $31.7 million, in fiscal year 2008 to $133.6 million from $101.9 million in fiscal year 2007. Gross margin decreased 20 basis points to 34.1% for fiscal year 2008 from 34.3% for fiscal year 2007. This decrease was primarily attributable to a 30 basis point decrease in merchandise margin, due primarily to increased markdowns. Gross margin was positively impacted by a 10 basis point increase in store occupancy, distribution and buying costs, as these costs increased at a rate lower than net sales.
 
Selling, General and Administrative Expense
 
Selling, general and administrative expense increased 31.4%, or $23.8 million to $99.9 million in fiscal year 2008 from $76.0 million in fiscal year 2007. As a percentage of net sales, selling, general and administrative expense remained constant at 25.5% and 25.6% in fiscal year 2008 and fiscal year 2007, respectively.
 
Store operating expenses increased by $18.6 million primarily resulting from the operation of 449 stores as of January 31, 2009 compared to the operation of 352 stores as of February 2, 2008. As a percentage of net sales, store operating expenses increased to 18.6% in fiscal year 2008 from 18.3% in fiscal year 2007, due primarily to increased store salaries as a percentage of net sales.
 
Administrative and general expenses decreased as a percentage of net sales to 6.9% in fiscal year 2008 from 7.4% in fiscal year 2007 as these costs increased at a lower rate than net sales. Offsetting the decrease in administrative expense margin was a $434,000 asset write-off related to store conversions.
 
Depreciation and Amortization Expense
 
Depreciation and amortization expense increased as a percentage of net sales to 2.9% in fiscal year 2008 from 2.8% in fiscal year 2007, or $3.3 million. The increase was due to growth in capital expenditures of $6.2 million and $3.7 in fiscal year 2008 and fiscal year 2007, respectively.
 
Interest Expense, Net
 
Interest expense, net decreased by $1.0 million to $1.5 million in fiscal year 2008 due to both reduced weighted average borrowings and a reduced average interest rate under our senior secured credit facility.


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Provision for Income Taxes
 
The increase in provision for income taxes of $2.1 million in fiscal year 2008 from fiscal year 2007 was due primarily to a $5.6 million increase in pre-tax income. The effective tax rate declined to 38.8% in fiscal year 2008 from 39.3% in fiscal year 2007.
 
Net Income
 
Net income increased 38.4%, or $3.5 million, to $12.6 million in fiscal year 2008 from $9.1 million in fiscal year 2007. This increase was due primarily to a $31.7 million increase in gross profit and lower interest expense, partially offset by increases in selling, general and administrative expense of $23.8 million, higher depreciation and amortization expense of $3.3 million and a higher provision for income taxes of $2.1 million.
 
Fiscal Year 2007 Compared to Fiscal Year 2006
 
Net Sales
 
Net sales increased 31.6%, or $71.3 million, to $296.9 million in fiscal year 2007 from $225.6 million in fiscal year 2006. The increase in net sales was due primarily to the increase of approximately 19% in the number of transactions coupled with an increase of approximately 6% in the average dollar value of transactions per store.
 
Comparable store sales increased 7.8% for fiscal year 2007 compared to a decrease of 4.7% for fiscal year 2006. Comparable store sales increased by $46.4 million and non-comparable stores increased by $24.9 million. There were 260 comparable stores and 92 non-comparable stores open at February 2, 2008 compared to 208 and 69, respectively, at February 3, 2007.
 
The increases in the girls apparel and girls accessories categories as a percentage of net sales and the approximate corresponding decrease in the guys apparel and accessories category as a percentage of net sales was reflective of varying category sales growth rates. The girls apparel and girls accessories categories grew by approximately 35% and 37%, respectively. The guys apparel and accessories category growth was approximately 25%. The increase in girls accessories as a percentage of net sales was due to management efforts to expand the number of items in the girls accessories category.
 
Gross Profit
 
Gross profit increased 35.1%, or $26.5 million, in fiscal year 2007 to $101.9 million from $75.4 million in fiscal year 2006. Gross margin increased 90 basis points to 34.3% for fiscal year 2007 from 33.4% for fiscal year 2006. This increase was primarily attributable to a 50 basis point increase in merchandise margin, due primarily to lower merchandise costs. In addition, store occupancy, distribution and buying costs decreased 40 basis points as these costs increased at a lower rate than net sales.
 
Selling, General and Administrative Expense
 
Selling, general and administrative expense increased 32.1%, or $18.5 million, to $76.0 million in fiscal year 2007 from $57.6 million in fiscal year 2006. As a percentage of net sales, selling, general and administrative expense remained constant at 25.6% and 25.5% in fiscal year 2007 and fiscal year 2006, respectively.
 
Store operating expenses increased by $11.9 million primarily resulting from the operation of 352 stores as of February 2, 2008 compared to the operation of 278 stores as of February 3, 2007. However, these costs declined from 18.8% of net sales in fiscal year 2006 to 18.3% of net sales in fiscal year 2007.
 
Administrative and general expenses increased as a percentage of net sales to 7.4% in fiscal year 2007 from 6.8% in fiscal year 2006 as these costs increased at a rate greater than net sales, due primarily to increased administrative salaries.


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Depreciation and Amortization Expense
 
Depreciation and amortization expense increased as a percentage of net sales to 2.8% in fiscal year 2007 from 2.6% in fiscal year 2006, or $2.3 million. This increase was due to growth in capital expenditures of $3.7 million in fiscal year 2007.
 
Interest Expense, Net
 
Interest expense, net decreased by $125,000 to $2.5 million in fiscal year 2007 from $2.6 million in fiscal year 2006 due to relatively constant levels of weighted average borrowings and average interest rate under our senior secured credit facility.
 
Provision for Income Taxes
 
The increase in provision for income taxes of $4.5 million in fiscal year 2007 from fiscal year 2006 was due primarily to the increase in the effective tax rate and to a lesser extent pre-tax income being $5.8 million higher. The effective tax rates were 39.3% and 15.7% for fiscal year 2007 and fiscal year 2006, respectively. The fiscal year 2006 effective tax rate was significantly less than the fiscal year 2007 effective tax rate as a result of the reversal of income tax reserves due to settlement of a 2004 Internal Revenue Service audit as well as the reversal of the valuation allowance as we determined as of February 3, 2007 that it was more likely than not that the deferred tax assets would be fully realized.
 
Net Income
 
Net income increased 17.1%, or $1.3 million, to $9.1 million in fiscal year 2007 from $7.8 million in fiscal year 2006. This increase was due primarily to a $26.5 million increase in gross profit, partially offset by increases in selling, general and administrative expense of $18.5 million, higher depreciation and amortization expense of $2.3 million and a higher provision for income taxes of $4.5 million.
 
Quarterly Results and Seasonality
 
The following table sets forth our historical unaudited quarterly consolidated statements of income data for each of the ten fiscal quarters ended August 1, 2009 and expressed as a percentage of our net sales. This unaudited quarterly information has been prepared on the same basis as our annual audited financial statements appearing elsewhere in this prospectus, and includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary to present fairly the financial information for the fiscal quarters presented.
 
The quarterly data should be read in conjunction with our audited and unaudited consolidated financial statements and the related notes appearing elsewhere in this prospectus.


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Quarterly Results of Operations
 
                                                                                 
    Fiscal Year 2007     Fiscal Year 2008     Fiscal Year 2009  
    First
    Second
    Third
    Fourth
    First
    Second
    Third
    Fourth
    First
    Second
 
    Quarter     Quarter     Quarter     Quarter     Quarter     Quarter     Quarter     Quarter     Quarter     Quarter  
    (unaudited)  
    (in thousands, except percentages)  
 
Net sales
  $ 63,745     $ 77,282     $ 72,929     $ 82,931     $ 76,779     $ 98,058     $ 97,464     $ 119,113     $ 107,998     $ 125,106  
Gross profit
    21,097       26,902       25,558       28,296       25,218       34,714       35,149       38,480       37,918       44,992  
Income from operations
    1,537       6,113       3,633       6,290       1,873       7,505       5,107       7,658       5,116       8,938  
Net income
    535       3,288       1,855       3,455       836       4,315       2,890       4,598       2,989       5,328  
                                                                                 
Year-Over-Year-Increase
                                                                               
Net sales
    40.1 %     42.0 %     27.9 %     20.9 %     20.4 %     26.9 %     33.6 %     43.6 %     40.7 %     27.6 %
Gross profit
    46.1       45.3       31.8       22.8       19.5       29.0       37.5       36.0       50.4       29.6  
                                                                                 
Percent of Annual Results
                                                                               
Net sales
    21.5 %     26.0 %     24.6 %     27.9 %     19.6 %     25.1 %     24.9 %     30.4 %                
Gross profit
    20.7       26.4       25.1       27.8       18.9       26.0       26.3       28.8                  
Income from operations
    8.7       34.8       20.7       35.8       8.4       33.9       23.1       34.6                  
Net Income
    5.9       36.0       20.3       37.8       6.6       34.1       22.9       36.4                  
                                                                                 
Operating Data
                                                                               
Comparable store sales change(1)
    12.7 %     8.9 %     9.8 %     1.8 %     (5.2 )%     0.7 %     6.6 %     11.2 %     8.3 %     0.6 %
 
 
(1) Comparable store sales in fiscal year 2007 is adjusted for the 53rd week in fiscal year 2006.
 
Liquidity and Capital Resources
 
Our primary sources of liquidity are cash flows from operations and borrowings under our senior secured credit facility. Our primary cash needs are for capital expenditures in connection with opening new stores and converting existing stores, and the additional working capital required for the related increase in merchandise inventories. Cash is also required for investment in information technology and distribution facility enhancements and funding normal working capital requirements. The most significant components of our working capital are cash and cash equivalents, merchandise inventories, accounts payable and other current liabilities. Our working capital position benefits from the fact that we generally collect cash from sales to customers the same day or, in the case of credit or debit card transactions, within several days of the related sale, and we typically have up to 75 days to pay our vendors.
 
Cash Flow
 
A summary of operating, investing and financing activities are shown in the following table:
 
                                         
    Fiscal Year Ended     Twenty-Six Weeks Ended  
    February 3,
    February 2,
    January 31,
    August 2,
    August 1,
 
    2007     2008     2009     2008     2009  
                      (unaudited)  
    (in thousands)  
 
Provided by operating activities
  $ 17,480     $ 21,512     $ 36,859     $ 13,969     $ 10,955  
Used for investing activities
    (16,586 )     (20,265 )     (26,464 )     (9,526 )     (16,656 )
Provided (used) for financing activities
    (2,444 )     (429 )     (9,127 )     (401 )     9,758  
                                         
Increase (decrease) in cash and cash equivalents
  $ (1,550 )   $ 818     $ 1,268     $ 4,042     $ 4,057  
                                         


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Operating Activities
 
Operating activities consist primarily of net income adjusted for non-cash items, including depreciation and amortization, deferred taxes, the effect of working capital changes and tenant allowances received from landlords.
 
                                         
    Fiscal Year Ended     Twenty-Six Weeks Ended  
    February 3,
    February 2,
    January 31,
    August 2,
    August 1,
 
    2007     2008     2009     2008     2009  
                      (unaudited)  
    (in thousands)  
 
Net income
  $ 7,798     $ 9,133     $ 12,639     $ 5,153     $ 8,317  
Adjustments to reconcile net income to net cash provided by operating activities:
                                       
Depreciation and amortization
    5,926       8,241       11,532       5,274       7,774  
Deferred taxes
    (2,573 )     (522 )     1,900       (369 )     (419 )
Changes in working capital(1)
    1,823       1,639       5,144       999       (9,636 )
Other
    4,506       3,021       5,644       2,912       4,919  
                                         
Net cash provided by operating activities
  $ 17,480     $ 21,512     $ 36,859     $ 13,969     $ 10,955  
                                         
                                       
(1) Includes the following change in merchandise inventory:
                               
Merchandise inventory, net
  $ (11,184 )   $ (8,977 )   $ (19,685 )   $ (24,561 )   $ (26,149 )
 
Net cash provided by operating activities was $14.0 million and $11.0 million for the twenty-six weeks ended August 2, 2008 and August 1, 2009, respectively. The $3.0 million decline in the twenty-six weeks ended August 1, 2009 when compared to August 2, 2008 was due to a $10.6 million increase in the changes in working capital partially offset by Other, which includes tenant allowances received, additionally offset by increased net income and depreciation and amortization. The increase in the changes in working capital was due to accounts payable increasing at a faster rate than inventory in fiscal year 2008, attributable in part to better terms received from our vendors. In the twenty-six weeks ended August 1, 2009, the rate of accounts payable increase was more consistent with the rate of inventory increase.
 
Merchandise inventory increased $26.1 million in the twenty-six weeks ended August 1, 2009 compared to an increase of $24.6 million in the twenty-six weeks ended August 2, 2008. Merchandise inventory was planned to, and did, increase during the twenty-six week period in preparation for the back-to-school selling season, which typically peaks in the beginning of the third fiscal quarter. Increases to merchandise inventory also related to new store openings, both those previously opened and those planned for the subsequent quarter. We estimate inventory levels and capital requirements based on historical store sales performance, as well as planned merchandise assortments. To the extent that inventory levels substantially increase, we may rely upon various promotional events or pricing strategies to sell through the inventory levels. Management believes that at August 1, 2009 merchandise inventory is at an appropriate level, from both a business and capital structure perspective, and properly planned for the prospective selling season. While management is particularly cautious in the current economic environment, we do not believe it will have a negative effect on our present business strategy.
 
The $15.3 million improvement in net cash provided by operating activities in fiscal year 2008 compared to fiscal year 2007 is due to the growth in net income of $3.5 million, the increase in depreciation and amortization expense of $3.3 million, an increase in changes in working capital of $3.5 million, and an increase in the changes in Other, primarily tenant allowances received from landlords due to additional new store openings. The increase in the changes in working capital was primarily related to an increase in trade payables as we sought and secured longer payment terms from our vendors which were partially offset by an increase in merchandise inventory.
 
Merchandise inventory increased $19.7 million in fiscal year 2008 compared to an increase of $9.0 million in fiscal year 2007. Increases to merchandise inventory were due to actual and anticipated sales increases


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related to comparable store sales and non-comparable store count increases as well as new store openings planned for the subsequent quarter.
 
The $4.0 million improvement in net cash provided by operating activities in fiscal year 2007 compared to fiscal year 2006 was due to the growth in net income of $1.3 million, the increase in depreciation and amortization expense of $2.3 million and the decrease in deferred taxes assets of $2.0 million. The increases were partially offset by a decrease in Other of $1.5 million and a decrease in the changes in working capital of $184,000.
 
Merchandise inventory increased $9.0 million in fiscal year 2007 compared to an increase of $11.2 million in fiscal year 2006. Increases to merchandise inventory were due to actual and anticipated sales increases related to comparable store sales and non-comparable store count increases as well as new store openings planned for the subsequent quarter.
 
Investing Activities
 
Investing activities consist entirely of capital expenditures for new and converted stores, as well as investment in information technology and our distribution facility enhancements.
 
                                         
    Fiscal Year Ended     Twenty-Six Weeks Ended  
    February 3,
    February 2,
    January 31,
    August 2,
    August 1,
 
    2007     2008     2009     2008     2009  
                      (unaudited)  
    (in thousands)  
 
Capital expenditures, net of tenant allowances
  $ (11,331 )   $ (14,304 )   $ (17,555 )   $ (5,725 )   $ (11,576 )
Tenant allowances
    (5,255 )     (5,961 )     (8,909 )     (3,801 )     (5,080 )
                                         
Capital expenditures
  $ (16,586 )   $ (20,265 )   $ (26,464 )   $ (9,526 )   $ (16,656 )
                                         
 
For the twenty-six weeks ended August 1, 2009, capital expenditures, net of tenant allowances were $11.6 million. Capital expenditures, net of tenant allowances, for the opening of 51 new stores and 11 store conversions were $4.5 million in the twenty-six weeks ended August 2, 2008 and $7.3 million for 56 new stores and 18 conversions in the twenty-six weeks ended August 1, 2009. The remaining capital expenditures in each period were primarily for investment in information technology and distribution facility enhancements.
 
Capital expenditures, net of tenant allowances, for the opening of new stores and conversions were $5.7 million, $7.8 million and $10.9 million in fiscal years 2006, 2007 and 2008, respectively. The remaining capital expenditures in each period were primarily for investment in the headquarters facility expansion, information technology and distribution facility enhancements.
 
Management anticipates that capital expenditures, net of tenant allowances in fiscal year 2009 will be approximately $27.8 million, including $13.6 million for 88 new stores and 26 store conversions and $9.5 million for investment in information technology and distribution facility enhancements. Management anticipates that capital expenditures net of tenant allowances in fiscal year 2010 will be approximately $32.0 million.


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Financing Activities
 
Financing activities consist principally of borrowings and payments on our outstanding credit facilities.
 
                                         
    Fiscal Year Ended     Twenty-Six Weeks Ended  
    February 3,
    February 2,
    January 31,
    August 2,
    August 1,
 
    2007     2008     2009     2008     2009  
                      (unaudited)  
    (in thousands)  
 
Net borrowings under revolver
  $ 3,257     $ 1,573     $ 14,645     $ 22,751     $ 9,758  
Payments on long-term debt
    (5,716 )     (2,002 )     (23,326 )     (23,152 )      
Proceeds from stock options exercised
    15             1              
Debt financing costs
                (447 )            
                                         
Net cash (used) provided for financing activities
  $ (2,444 )   $ (429 )   $ (9,127 )   $ (401 )   $ 9,758  
                                         
 
Net cash of $9.8 million was provided by financing activities in the twenty-six weeks ended August 1, 2009 to fund higher capital expenditures.
 
$23.3 million of the proceeds from our senior secured credit facility in fiscal year 2008 were used to repay the senior secured credit facility established on May 15, 2003, or the Senior Revolver, and all term note loan facility financing arrangements with BNP Paribas, or the Term Notes. The outstanding borrowings under our senior secured credit facility were then reduced to $19.5 million by the end of fiscal year 2008, resulting in the $9.1 million use of cash.
 
The $2.4 million use of cash in fiscal year 2006 resulted primarily from the scheduled payments for the Term Notes of $5.7 million.
 
Senior Secured Credit Facility
 
Effective April 10, 2008, we established a five-year $60.0 million senior secured credit facility with Bank of America, N.A., or the senior secured credit facility. The accordion feature allows us to increase the limit of the senior secured credit facility in increments of $5.0 million up to $85.0 million under certain defined conditions. Availability under our senior secured credit facility is collateralized by a first priority interest in all of our assets.
 
Our senior secured credit facility accrues interest at the Bank of America base rate, defined at our option as the prime rate or the Eurodollar rate plus applicable margin, which ranges from 1.25% to 2.0% set quarterly dependent upon average net availability under our senior secured credit facility during the previous quarter. The weighted-average interest rate under our senior secured credit facility for the year ended January 31, 2009 and for the twenty-six weeks ended August 1, 2009 was 3.22% and 1.32%, respectively. We had $40.5 million and $30.8 million availability under our senior secured credit facility on January 31, 2009 and August 1, 2009, respectively, excluding the accordion option.
 
Our senior secured credit facility includes a fixed charge covenant applicable only if net availability falls below thresholds of 15% in calendar year 2009 and 10% thereafter. We are in compliance with all covenants under our senior secured credit facility as of August 1, 2009. We intend to obtain an amendment of certain provisions of our senior secured credit facility in connection with this offering. See “Description of Certain Indebtedness — Senior Secured Credit Facility.”
 
We believe that our cash position, net cash provided by operating activities and availability under our senior secured credit facility will be adequate to finance working capital needs and planned capital expenditures for at least the next twelve months.
 
Off Balance Sheet Arrangements
 
We are not a party to any off balance sheet arrangements.


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Contractual Obligations
 
The following table summarizes our contractual obligations as of August 1, 2009 and the effect such obligations are expected to have on our liquidity and cash flows in future periods.
 
                                         
    Payments Due by Period  
          Less than
                More than
 
    Total     1 year     1 - 3 years     3 - 5 years     5 years  
    (in thousands)  
 
Long-term debt obligations
  $ 29,234                 $ 29,234        
Operating lease obligations(1)
    196,480       37,250       90,407       19,645       49,178  
Merchandise inventory purchase commitments
    59,844       59,844                    
Contract for upgrade of distribution facility
    4,187       4,187                    
                                         
    $ 289,745     $ 101,281     $ 90,407     $ 48,879     $ 49,178  
                                         
 
 
(1) Excludes common area maintenance charges, real estate taxes and certain other expenses which amounted to approximately 22% of minimum lease obligations in fiscal year 2008. We expect this percentage to be relatively consistent for the next three years.
 
Impact of Inflation
 
Our results of operations and financial condition are presented based on historical cost. While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we believe the effects of inflation, if any, on our results of operations and financial condition have been immaterial.
 
Recent Accounting Pronouncements
 
In May 2009, the FASB issued Statement of Financial Accounting Standards (“SFAS”) 165, “Subsequent Events” (“SFAS 165”), which establishes guidance regarding the Company’s accounting for and disclosure of subsequent events. SFAS 165 requires management to evaluate, as of each reporting period: events or transactions that occur after the balance sheet date through the date that the financial statements are issued or are available to be issued. The Company adopted SFAS 165 as of August 1, 2009 and the adoption did not have a material impact on the Company’s Consolidated Financial Statements.
 
In July 2009, the FASB issued SFAS 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162 (“SFAS 168”). SFAS 168 establishes the FASB Accounting Standard Codification as the single source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. The Company will adopt SFAS 168 beginning in the third quarter of fiscal year 2009. The Company does not expect the adoption of SFAS 168 to have a material impact on its Consolidated Financial Statements.
 
Effective February 1, 2009, we adopted SFAS No. 157, “Fair Value Measurements”, or SFAS No. 157, for non-financial assets and non-financial liabilities, and it did not have a material impact on our consolidated financial statements. In October 2008, the FASB issued Staff Position No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active”, or FSP FAS 157-3, which clarified the application of SFAS No. 157 in cases where a market is not active. We have considered the guidance provided by FSP FAS 157-3 in our determination of fair values as of January 31, 2009, and the impact was not material.
 
In December 2007, the SEC issued Staff Accounting Bulletin, or SAB, 110, “Share-Based Payments”, or SAB 110. SAB 110 allows for continued use of the simplified method for estimating the expected term of “plain vanilla” share option grants under specified conditions. The expected term used to value a share option grant under the simplified method is the midpoint between the vesting date and the contractual term of the share option. SAB 110 eliminates the December 31, 2007 sunset provision previously specified in SAB No. 107, “Share-Based Payments”, or SAB 107. SAB 110 is effective for share option grants made on or after January 1, 2008. We have utilized the simplified method for estimating the expected term of its stock option


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grants under SAB 107 and SAB 110 and will continue to utilize this simplified method until we have sufficient historical exercise data to provide a reasonable basis to estimate the expected term.
 
Critical Accounting Policies
 
Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires estimates and judgments that affect the reported amounts of our assets, liabilities, net sales and expenses. Management bases estimates on historical experience and other assumptions it believes to be reasonable given the circumstances and evaluates these estimates on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.
 
We believe that the following critical accounting policies involve a higher degree of judgment and complexity. See Note 1 to our consolidated financial statements for the fiscal year ended January 31, 2009 for a complete discussion of our significant accounting policies. The following reflect the significant estimates and judgments used in the preparation of our consolidated financial statements.
 
Revenue Recognition
 
Revenue is recognized upon purchase of merchandise by customers. Allowances for sales returns are recorded as a reduction of sales in the periods in which the sales are recognized. Deferred revenue is established upon the purchase of gift cards by customers, and revenue is recognized upon redemption of gift cards for merchandise.
 
Inventory Valuation
 
We value merchandise inventory at the lower of cost (first-in, first-out basis) or market using the retail inventory method. We record merchandise receipts at the time they are delivered to our consolidator, as we do not directly import any merchandise. This is the point at which title and risk of loss transfer to us.
 
We review our inventory levels to identify slow-moving merchandise and generally use markdowns to clear slow-moving merchandise. We record a markdown reserve based on estimated future markdowns related to current inventory to clear slow-moving inventory. Each period we evaluate the selling trends experienced and the related promotional events or pricing strategies in place to sell through the current inventory levels. Markdowns may occur when inventory exceeds customer demand for reasons of style, seasonal adaptation, changes in customer preference, lack of consumer acceptance of fashion items, competition, or if it is determined that the inventory in stock will not sell at its currently ticketed price. Such markdowns may have an adverse impact on earnings, depending on the extent and amount of inventory affected. The anticipated deployment of new seasonal merchandise is reflected within the estimated future markdowns reserve used in valuing current inventory, as such new inventory in certain circumstances will displace merchandise units currently on-hand. The markdown reserve is recorded as an increase to cost of goods sold in the accompanying consolidated statements of income.
 
We also estimate a shrinkage reserve for the period of time between the last physical count and the balance sheet date. The estimate for shrinkage reserve can be affected by changes in merchandise mix and changes in actual shrinkage trends.
 
Asset Impairment
 
We are exposed to potential impairment if the book value of our assets exceeds their expected future cash flows. The major components of our long-lived assets are store fixtures, equipment and leasehold improvements. We have recognized impairment charges related to store conversions and may recognize impairment charges in the future. The impairment of unamortized costs is measured at the store level and the unamortized cost is reduced to fair value if it is determined that the sum of expected discounted future net cash flows is less than net book value.


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Income Taxes
 
Effective February 4, 2007, we adopted FASB Interpretation Number, or FIN, 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109”, or FIN 48. FIN 48 prescribes a comprehensive model for recognizing, measuring, presenting and disclosing in the financial statements tax positions taken or expected to be taken on a tax return, including a decision whether to file or not to file in a particular jurisdiction. Under FIN 48, a tax benefit from an uncertain position may be recognized only if it is “more likely than not” that the position is sustainable based on its technical merits. See Note 9 to our consolidated financial statements for further discussion of the adoption of FIN 48.
 
We calculate income taxes in accordance with SFAS No. 109 “Accounting For Income Taxes”, or SFAS No. 109, which requires the use of the asset and liability method. Under this method, deferred tax assets and liabilities are recognized based on the difference between our consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases as computed pursuant to FIN 48. Deferred tax assets and liabilities are measured using the tax rates, based on certain judgments regarding enacted tax laws and published guidance, in effect in the years when those temporary differences are expected to reverse. A valuation allowance is established against the deferred tax assets when it is more likely than not that some portion or all of the deferred taxes may not be realized. Changes in the level and composition of earnings, tax laws or the deferred tax valuation allowance, as well as the results of tax audits may materially impact our effective tax rate.
 
The calculation of the deferred tax assets and liabilities, as well as the decision to recognize a tax benefit from an uncertain position and to establish a valuation allowance require management to make estimates and assumptions. We believe that our assumptions and estimates are reasonable, although actual results may have a positive or negative material impact on the balances of deferred tax assets and liabilities, valuation allowances, or net income.
 
Share-Based Compensation
 
We estimate the grant date fair value of stock option awards under the provisions of SFAS No. 123(R) “Share-Based Payments,” or SFAS No. 123(R), using the Black-Scholes option pricing model. For fiscal year 2008, the twenty-six weeks ended August 2, 2008 and the twenty-six weeks ended August 1, 2009, the fair value of stock options was estimated at the grant date using the following assumptions:
 
                     
        Twenty-Six Weeks Ended        
    Fiscal Year
  August 2,
  August 1,
       
    2008   2008   2009        
        (unaudited)        
 
Expected volatility
  55%   55%   60%        
Risk-free interest rate
  4.7%   4.7%   2.6%        
Weighted average expected term
  6.3 years   6.3 years   6.3 years        
Expected dividend yield
             
 
The expected option life reflects the application of the simplified method set out in SAB 107. The simplified method defines the life as the average of the contractual term of the options and the weighted-average vesting period for all option tranches. The risk-free interest rate is based on 5-year U.S. Treasury instruments whose maturities are similar to those of the expected term of the award being valued. The expected volatility reflects the application of SAB 110’s interpretive guidance and, accordingly, incorporates historical volatility of similar entities whose share prices are publicly available. The expected dividend yield was based on our expectation of not paying dividends on our common stock for the foreseeable future. The weighted-average grant date fair value per share of stock options granted to employees during fiscal year 2008, the twenty-six weeks ended August 2, 2008 and the twenty-six weeks ended August 1, 2009 was $0.43, $0.40 and $6.19, respectively.
 
We have granted to our employees and non employees options to purchase our common stock at exercise prices greater than or equal to the fair value of the underlying stock at the time of each grant based upon the most recent valuation.


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The following table sets forth all stock option grants since the beginning of fiscal year 2006:
 
                                     
                Common
           
                Stock Fair
           
    Number of
    Exercise
    Value per
    Effective
     
    Options
    Price per
    Share at
    Valuation
  Vesting Period
 
Grant Date
  Granted     Share     Grant Date    
Date
  (Years)  
 
August 1, 2006
    120,000     $ 0.006     $ 0.005     August 1, 2006     5  
August 1, 2006
    344,500     $ 0.005     $ 0.005     August 1, 2006     5  
January 27, 2007
    80,000     $ 0.310     $ 0.310     January 27, 2007     5  
May 8, 2007
    12,500     $ 0.310     $ 0.310     January 27, 2007     5  
June 11, 2007
    5,000     $ 0.310     $ 0.310     January 27, 2007     5  
August 1, 2007
    5,000     $ 1.79     $ 1.79     August 4, 2007     5  
January 4, 2008
    374,500     $ 8.00     $ 1.79     August 4, 2007     3.5  
February 4, 2008
    4,000     $ 8.00     $ 1.79     August 4, 2007     4  
June 16, 2008
    115,000     $ 8.00     $ 1.79     August 4, 2007     4  
October 1, 2008
    7,500     $ 8.00     $ 2.80     August 2, 2008     4  
February 2, 2009
    36,000     $ 8.00     $ 2.80     August 2, 2008     4  
March 10, 2009
    7,500     $ 8.00     $ 2.80     August 2, 2008     4  
July 24, 2009
    326,500     $ 11.80     $ 11.80     August 1, 2009     4  
August 21, 2009
    42,480     $ 11.80     $ 11.80     August 1, 2009     4  
 
Given the absence of an active market we perform a valuation of our common stock at least annually. We set the exercise price of all stock options granted at or above the result of the most recent valuation. The valuation is dependent upon objective and subjective factors, including:
 
  •  impact from, and stage or recovery from, our 2001 bankruptcy;
 
  •  negative equity from the time of our 2003 emergence from bankruptcy until July 2007;
 
  •  the February 2006 buyback of debt and approximately 5% of our equity at a price of 96% of the face value of the debt;
 
  •  stage of development and growth of our net sales, both enterprise and same store, and number of stores;
 
  •  budgets and forecasts of our financial performance, including our historical success in meeting those budgets;
 
  •  comparative benchmarking of our financial results with those of our industry peer group;
 
  •  the continued expansion of the depth and quality of management team;
 
  •  material events that could result in increased valuation of our common stock;
 
  •  material risks affecting our business; and
 
  •  the lack of marketability of our common stock.
 
Our common stock valuations utilized methodologies consistent with the recommendations of the American Institute of Certified Public Accountants, or AICPA, Audit and Accounting Practice Aid Series, Valuation of Privately-Held Company Equity Securities Issued as Compensation. In light of advancements in our stage of development and growth, we determined it was appropriate for the cash flow estimates used to value our common stock be based on the relative likelihood of occurrence that we would follow one of four possible future scenarios:
 
  •  continue to operate as a private company;
 
  •  complete a strategic merger or sale;


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  •  complete an initial public offering; or
 
  •  liquidate our assets upon failure and dissolve.
 
The estimated fair value of our common stock under each scenario was in turn affected by the use of certain assumptions and valuation methodologies. We assessed the relative likelihood and occurrence of the future scenarios as of the dates options were granted.
 
For the options granted subsequent to August 1, 2006, we determined that the undertaking of an initial public offering was the most likely event, the likelihood of a strategic merger or sale being a less likely event, the likelihood of continuing to operate as a private company even less likely and the likelihood of liquidating our assets upon failure and dissolution having no likelihood. For all options granted subsequent to August 1, 2007, we assessed the relative likelihood of a strategic merger or sale, or of continuing to operate as a private company as being a less likely event, and the likelihood of liquidating our assets upon failure and dissolution as having no likelihood.
 
The first step in the valuation process involved estimating the enterprise value of our firm. Based on our stage of development, our operating history and the reliability with which we can forecast future performance at the dates options were granted. We used a market approach and an income approach, as detailed in the AICPA guidelines.
 
In the market approach, we developed a list of comparable companies and valuation multiples based on those comparable companies’ historical and pro forma financial statements and stock prices, including multiples and ratios such as revenue, earnings before interest and taxes, or EBIT, earnings before interest, taxes, depreciation and amortization, or EBITDA, net income and/or tangible book value. We then applied these multiples to our financial performance to determine our estimated enterprise value. A second technique considered under the market approach involved developing a list of comparable merger and acquisition transactions and applying the observed exit multiples to our financial performance to determine our enterprise value.
 
The comparable companies considered in the market valuation multiples have historically included retail apparel and accessory companies that focus on teen and young adults, with lower price points, comparable distribution methods and other characteristics that make those companies alternative investment opportunities. Based on the significant historical growth we have experienced and the forecasted growth we are expecting, the list of comparable companies considered in our valuation as of August 1, 2009 was expanded to include other high growth apparel retailers with higher price points, and some with different distribution and supply chain systems that focus on a broader demographic group, because we now consider ourselves a reasonable investment alternative to those companies.
 
Similarly, the degree of growth that we have achieved and are forecasting to achieve impacts the decision regarding whether to rely on comparable historical or forecasted earnings multiples. For our August 2, 2008 and earlier valuations, based on our operating history, proximity to having emerged from bankruptcy in 2003, and our stage of growth, only historical earnings multiples were used in our valuations. Based on a consideration of the following factors, both historical and forecasted EBITDA multiples were used to value our common stock as of August 1, 2009:
 
  •  our discernible, demonstrated history of successfully meeting or exceeding the results we forecast;
 
  •  the importance that investors’ are placing on forecasted future earnings;
 
  •  our belief that we were closer to an initial public offering as of the date options were granted on July 24, 2009; and
 
  •  the expectation that a significant portion of the shares issued in our initial public offering would be purchased by institutional investors, that are expected to place weight on forecasted multiples of earnings.


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The inclusion of a broader range of high growth apparel retailers in our peer group of comparable companies, and the recent relevance of using forecasted earnings multiples to value us, are key factors that have resulted in a significant increase in our value from August 2008 to August 2009.
 
In the income approach, we performed discounted cash flow analyses. For options granted subsequent to August 1, 2006, valuations of our total equity were performed by first estimating the value of total invested capital based on debt free cash flow, discounted to present value using estimates of a weighted average cost of capital estimate reflective of the degree of risk associated with our forecasted financial information. The value of total invested capital was then reduced by the market value of debt to estimate the value of our equity.
 
For options granted subsequent to August 1, 2007, the total equity was valued based on the cash flows that would be available to equity owners after anticipated borrowing and debt service was considered. This method was considered appropriate because our capital structure was expected to fluctuate from year to year.
 
Consistent with Concept Statement 7, “CON 7: Using Cash Flow Information and Present Value in Accounting Measurements,” issued by the FASB, we utilized the expected cash flow approach to estimate our future cash flows using forecasts of net sales and expenses, inclusive of anticipated borrowing and debt service activity as appropriate. The probability-weighted expected cash flows were estimated based on assessments of the probabilities of various cash flow scenarios that focused on the amounts and timing that cash flows were expected to be received.
 
The probability-weighted expected cash flows were estimated and then discounted to a present value at rates of return that reflected the degree of risk associated with our enterprise, including but not limited to, our improving demonstrated success in achieving or surpassing forecasted financial results, risks related to our target customers, competition, and ability to timely anticipate, identify and respond to changing fashion trends, customer preferences, depth of management, and both liquidity and leverage risks associated with the availability of capital for future expansion. The following estimated discount rates used on our valuations were based on the preceding market participant considerations:
 
         
    Equity Rate
 
Valuation Date
  of Return  
 
August 1, 2006
    25.1 %
August 4, 2007
    27.8 %
August 2, 2008
    26.0 %
August 1, 2009
    18.1 %
 
The downward trend in the estimated rates of return used in our August 2009 valuation reflects our success in exceeding the results we forecasted, our ability to obtain and repay the debt necessary to achieve significant growth, our continued improvement in the quality and depth of our management team, and other meaningful reductions in the risks associated with investing in us. These demonstrated improvements have resulted in a significant increase in our value over the past year.
 
The second step in the valuation process involved applying discounts to reflect the impairment to value resulting from the lack of marketability inherent in the ownership of our common stock, where we believed it was appropriate to do so. The level of discounts were impacted by numerous factors, including historical and forecasted profitability, growth expectations, restrictions on the transferability of the shares and the estimated term before those restrictions would lapse, and the estimated holding period of the stock, which is impacted by the time period(s) from the measurement date to when an initial public offering might take place:
 
         
    Discount for Lack
 
Valuation Date
  of Marketability  
 
August 1, 2006
    10 %
August 4, 2007
    15 %
August 2, 2008
    15 %
August 1, 2009
    10 %


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Based on such valuations and other information considered by our board of directors, we determined the fair value per share of our common stock. We then recorded share-based compensation for stock option grants based on the Black-Scholes option pricing model and the adjusted fair values of our common stock.
 
There are significant judgments and estimates inherent in the determination of the fair values. These judgments and estimates include determinations of the appropriate valuation methods and, when utilizing a market-based approach, the selection and weighting of appropriate market comparables and valuation multiples. For these and other reasons, the assessed fair values used to compute share-based compensation expense for financial reporting purposes may not reflect the fair values that would result from the application of other valuation methods, including accepted valuation methods, assumptions and inputs for tax purposes.
 
We recorded share-based compensation expense for fiscal years ended February 3, 2007, February 2, 2008, January 31, 2009, the twenty-six weeks ended August 2, 2008 and the twenty-six weeks ended August 1, 2009 of $34,000, $34,000, $0, $0 and $24,000, respectively.
 
The total intrinsic value of outstanding options as of February 3, 2007, February 2, 2008, January 31, 2009 and August 1, 2009 was $16,000, $360,000, $2.1 million and $10.9 million, respectively. Based on the assumed initial public offering price of $17.00 per share, the midpoint of the price range set forth on the cover page of this prospectus, the total intrinsic value of outstanding options as of January 31, 2009 was $17.1 million and as of August 1, 2009 was $19.4 million. As of January 31, 2009 and August 1, 2009, total unrecognized compensation expense related to non-vested stock options was approximately $153,000 and $2.4 million, respectively. This expense is expected to be recognized over a weighted-average period of 2.8 years and 3.8 years, respectively.
 
Quantitative and Qualitative Disclosures about Market Risk
 
Our principal market risk relates to interest rate sensitivity, which is the risk that future changes in interest rates will reduce our net income or net assets. Our senior secured credit facility accrues interest at the Bank of America base rate, defined at our option as the prime rate or the Eurodollar rate plus applicable margin, which ranges from 1.25% to 2.00% set quarterly dependent upon average net availability under our senior secured credit facility during the previous quarter. At August 1, 2009 the weighted-average interest rate on our borrowings was 1.32%. Based upon a sensitivity analysis at August 1, 2009, assuming average outstanding borrowings during fiscal year 2009 of $21.0 million, a 50 basis point increase in interest rates would result in an increase in interest expense of $105,000.


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BUSINESS
 
Our Company
 
rue21 is a fast growing specialty apparel retailer offering the newest fashion trends to girls and guys at value prices. We operate over 500 stores in 43 states. Our merchandise is designed to appeal to 11 to 17 year olds who aspire to be “21” and adults who want to look and feel “21”. We react quickly to market trends and our daily shipments ensure there is always new merchandise for our customers to discover. In addition, we offer our own brands, such as rue21 etc!, Carbon, tarea and rueKicks, to create merchandise excitement and differentiation in our stores. The energy in our stores and our focus on customer service, combined with our great value products, keep our customers returning to us. Through viral marketing and our interactive website, we continue to build a rueCommunity with a loyal customer base that will drive our growth into the future. The company and customer culture we have created invokes only one simple thought in the minds of most... Do you rue? I do!
 
We pursue a three-pronged strategy that focuses on diversification and growth. The key elements of our strategy are:
 
  •  Diversified Product — girls, guys, rue21 etc!  We offer a broad range of girls and guys apparel, accessories, footwear, jewelry and fragrances. Over the last few years, we have expanded and developed a number of product categories to complement our extensive apparel offerings, including rue21 etc!, our girls jewelry and accessories category; tarea by rue21, our intimate apparel category; Carbon, our guys apparel and accessories category; rueKicks, one of our footwear lines and a full line of fragrances for both girls and guys. While our girls apparel category currently represents the majority of our net sales, we believe the expansion of our guys apparel and accessories category presents a significant opportunity for us.
 
  •  Flexible Real Estate — strip centers, regional malls, outlet centers.  As of October 3, 2009 approximately 51% of our stores were located in strip centers, 27% in regional malls and 22% in outlet centers. Our stores are located primarily in small- and middle-market communities that we believe have been underserved by traditional specialty apparel retailers. As a result, we are often the only junior and young men’s specialty apparel retailer in such communities and face limited direct competition. In these markets, our limited competition comes from large value retailers and department stores.
 
  •  Balanced Growth — new stores, store conversions, comparable store sales.  We drive sales growth through opening new stores, converting existing stores into our new, larger rue21 etc! layout, and increasing our comparable store sales. In fiscal year 2009, we plan to open 88 new stores, including 78 new stores opened as of October 3, 2009. We also plan to convert 26 stores, including 24 stores converted as of October 3, 2009, to a larger layout that includes a separate rue21 etc! store-in-store. We believe our merchandising initiatives and new category introductions will further enhance our comparable store sales growth.
 
In 2001, our President and Chief Executive Officer, Bob Fisch, joined our company and began repositioning our business by aligning our stores under one brand name, structuring our management team, honing our fashion value merchandise and refocusing our store growth strategy. At that time, we had over $60.0 million in liabilities, including $38.0 million in senior debt, coupled with a shareholder deficit of $18.5 million and a net loss for the preceding twelve months of $13.0 million. As part of our turnaround, we sought bankruptcy protection in February 2002 due to the poor financial condition of our business. We used bankruptcy protection to reorganize our operations and restructure our debt and emerged within fifteen months as a stronger company with a rationalized store base of 168 stores. Since emerging from bankruptcy, we have experienced rapid and consistent growth in net sales and net income.
 
We have continued to deliver strong results in recent quarters despite the difficult economic environment. Our comparable store sales increases were 4.1% in the twenty-six weeks ended August 1, 2009 and 3.7% in fiscal year 2008. In the twenty-six weeks ended August 1, 2009, our net sales were $233.1 million, which represents a 33.3% increase over the twenty-six weeks ended August 2, 2008. Our net income was $8.3 million in the twenty-six weeks ended August 1, 2009, which represents a 61.4% increase over the twenty-six weeks


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ended August 2, 2008. We believe our compelling value proposition and trend-right merchandise have contributed to our strong operating results.
 
Our Competitive Strengths
 
We attribute our success as a specialty apparel retailer to the following competitive strengths:
 
  •  Compelling “fashion meets value” proposition.  We offer the newest fashion to girls and guys at prices lower than many other similar apparel retailers. Our broad product assortment, ranging from apparel to accessories to footwear, enables our customers to create a complete look. In addition, we provide our customers with a distinctive shopping experience in a fun-to-shop environment, further enhancing our branded value proposition.
 
  •  Flexible, fast-fashion business model.  Our merchandising model allows us to quickly identify and respond to trends and bring proven concepts and styles to our stores. Our sourcing model is designed to achieve lower cost, faster turnaround and lower inventory levels. Our vendor network consists of domestic importers and domestic suppliers. Our collaborative relationship with our vendors allows us to test small quantities of new products in select stores before broadly distributing them to our stores which, in turn, reduces markdown risk. By carrying the newest styles and regularly updating our floor sets, we provide our customers with a reason to frequently shop our stores.
 
  •  Presence in locations with limited direct competition.  We focus on small- and middle-market communities, which we define as communities with populations between 25,000 and 200,000 people, where household incomes do not typically support higher-priced retailers. As a result, we often are the only junior and young men’s specialty apparel retailer in a shopping center and face limited direct competition in these communities. We have a prominent, central location in many of our strip centers and regional malls to further drive traffic to our stores. We believe we are a highly attractive tenant and, as such, we are able to negotiate competitive and favorable lease terms and low construction costs.
 
  •  Attractive new store economics.  We operate a proven and efficient store model that delivers strong cash flow. Not only do our stores provide a distinctive shopping experience and compelling merchandise assortment, but with low store build-out costs, competitive lease terms and a low-cost operating model, our stores also generate a strong return on store investment. All of our new stores feature our rue21 etc! store-in-store layout, showcasing an expanded accessories offering. Our new stores average approximately 4,700 square feet, which is larger than our historical store layout, and pay back our investment in less than one year.
 
  •  Distinct company and customer culture.  We have a strong core culture that emanates from our employees, many of whom are high school and college students who live in the community and are rue21 customers. Through our viral marketing efforts and the support of our online rueCommunity, we bring the rue21 culture to our customer base. We believe our culture enables us to connect to our employees and customers, differentiate our in-store shopping experience and ultimately strengthen our brand image and drive customer loyalty.
 
  •  Strong and experienced management team.  Our senior management team has extensive experience across a broad range of disciplines in the specialty retail industry, including merchandising, real estate, supply chain and finance. Bob Fisch, our President and Chief Executive Officer, has more than 30 years of experience in the apparel industry. Since being named President and Chief Executive Officer, he has helped turn around our company and has overseen consistent growth in net sales and income from operations. Upon completion of this offering, our executive officers will own 8.5% of our common stock and will have options that will enable them to own, in the aggregate, up to 11.3% of our common stock.
 
Our Growth Strategy
 
We believe we are positioned to take advantage of significant opportunities to increase net sales and net income. We have recently invested significant capital to build the infrastructure necessary to support our


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growth. This investment includes an upgrade of our distribution facility and related systems, which we expect to complete by the end of the first quarter of fiscal year 2010. Upon completion, the distribution facility will be able to support approximately 1,300 stores. Key elements of our growth strategy include:
 
  •  Increase Square Footage.  We intend to drive our square footage growth by opening new stores and converting existing stores to our larger rue21 etc! layout.
 
Open new stores.  We believe there is a significant opportunity to expand our store base from 527 locations as of October 3, 2009 to over 1,000 stores within the next five years. We expect to open 88 stores in fiscal year 2009, including 78 new stores opened as of October 3, 2009, and 100 stores in fiscal year 2010. Most of our new stores will be opened in strip centers and regional malls in small- and middle-market communities. We will focus our store expansion in the south, southwest and western United States.
 
Convert existing stores to rue21 etc! layout.  We plan to continue to convert our existing stores into our larger rue21 etc! layout, which averages approximately 4,700 square feet. This store layout allows us to offer an increased proportion of higher margin categories, such as accessories, intimate apparel, footwear and fragrances. As of October 3, 2009, more than 50% of our store base was in the rue21 etc! layout. We converted 21 stores to the rue21 etc! layout in fiscal year 2008 and plan to convert 26 stores in fiscal year 2009, including 24 stores converted as of October 3, 2009. These conversions result in increased store profitability and generate return on investment in excess of 30% over a twelve-month period.
 
  •  Drive Comparable Store Sales.  We seek to maximize our comparable store sales by increasing the penetration of our diversified product categories, increasing our rue21 brand awareness, continuing to provide our distinctive store experience and converting existing stores to our larger rue21 etc! layout. We believe that our fashionable merchandise selections and affordable prices create more shopping excitement for our customers, increase our brand loyalty and drive sales. We believe significant opportunities exist to grow our guys apparel and accessories category, as there is limited specialty competition in guys at value prices, and our highly attractive footwear category, both of which have been recent drivers of comparable store sales. We also believe that our ability to quickly and consistently introduce the newest fashions into our stores keeps our shopping experience fresh and exciting and drives repeat customer visits.
 
  •  Improve profit margins.  We believe we have the opportunity to drive margin expansion through scale efficiencies, continued cost discipline and changes in merchandise mix. We believe our strong expected store growth will permit us to take advantage of economies of scale in sourcing and to leverage our existing infrastructure, corporate overhead and fixed costs. We are focused on reducing costs throughout our organization and believe further cost reduction opportunities exist in inventory and supply chain management. We believe the expansion of our higher margin categories, such as accessories and footwear, will increase our overall margins over time.
 
Our Market
 
According to The NPD Group Inc., a nationally recognized firm that specializes in apparel market research based upon consumer panel tracking data, retail sales of domestic apparel totaled $199.4 billion in the United States in 2008. The specialty retail distribution channel represented 30.8% of the total market, or $61.5 billion in retail sales, in 2008. Teen specialty apparel retail sales totaled $12.9 billion in 2008. The value apparel market, as defined by us, totaled $100.7 billion in 2008.
 
Our customers, who include both 11 to 17 year olds who aspire to be “21” and adults who want to look and feel “21,” live in small- or middle-market communities, which we define as communities with populations between 25,000 and 200,000 people. Based upon Nielsen Claritas SiteReports, an online source for United States demographics, our customers typically live in households with a median annual income of less than $50,000. We believe we appeal to our customers by providing the newest fashions at value prices and locating our stores in strip centers and regional malls in their communities.


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Our Stores
 
As of October 3, 2009, we operated 527 stores in 504 cities in 43 states throughout the United States. Our stores are located in strip centers, regional malls and outlet centers in small- and middle-market communities. Our stores averaged net sales of approximately $946,000 and net sales per gross square foot of $235 for fiscal year 2008.
 
The table below indicates certain historical information regarding our stores by type of shopping center as of the fiscal year end for each of the years indicated below and as of October 3, 2009:
 
                                                 
                                  October 3,
 
    2004     2005     2006     2007     2008     2009  
 
Strip centers
    13       47       93       148       215       270  
Regional malls
    66       72       74       90       118       143  
Outlet centers
    114       110       111       114       116       114  
                                                 
Total stores
    193       229       278       352       449       527  
                                                 
Total gross square feet at end of period (in thousands)
    750       896       1,095       1,448       1,949       2,229  
Average gross square feet per store
    3,884       3,906       3,937       4,113       4,341       4,413  
 
The gross square footage of new stores opened in fiscal years 2008 and 2009 averaged approximately 4,700 square feet, which is larger than our historical store base and features a separate store-in-store for our rue21 etc! girls jewelry and accessories category. We have an ongoing strategy to convert our existing store base into the larger rue21 etc! layout which frequently involves relocating our stores. As a result, we have worked with our landlords to either convert or relocate our existing stores to attractively priced new locations, either in the same shopping center or in shopping centers in close proximity to the existing store, that would allow us to prominently showcase all of our product lines in a compelling store layout. In fiscal year 2008, we converted 21 stores to our rue21 etc! layout.
 
Store Locations
 
The following store list shows the number of stores operated in each state as of October 3, 2009:
 
         
    Total
 
    Number of
 
State
  Stores  
 
Alabama
    27  
Arizona
    13  
Arkansas
    8  
California
    16  
Colorado
    7  
Connecticut
    1  
Delaware
    1  
Florida
    20  
Georgia
    37  
Illinois
    16  
Indiana
    14  
Iowa
    7  
Kansas
    4  
Kentucky
    8  
Louisiana
    21  
Maine
    1  
Maryland
    6  
Massachusetts
    3  
Michigan
    14  
Minnesota
    4  
Mississippi
    17  
Missouri
    14  
Nebraska
    2  
Nevada
    4  
New Hampshire
    2  
New Jersey
    2  
New Mexico
    7  
New York
    13  
North Carolina
    33  
Ohio
    14  
Oklahoma
    14  
Oregon
    4  
Pennsylvania
    24  
South Carolina
    17  
Tennessee
    23  
Texas
    68  
Utah
    9  
Vermont
    1  
Virginia
    11  
Washington
    4  
West Virginia
    7  
Wisconsin
    8  
Wyoming
    1  
         
Total
    527  
         
 


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Distinctive Store Experience
 
Our stores are designed by our in-house team in partnership with architectural consultants with the goal of creating an exciting and inviting atmosphere for girls and guys to shop and socialize. Our stores feature colorful displays showcasing the latest styles and trends, themed dressing rooms and top-40 music. Girls and guys apparel is located in separate areas with trend walls displaying the newest fashions. In our larger rue21 etc! layout stores, we feature our rue21 etc! accessories in the center of our stores, along with denim and fragrance bars and rueKicks displays. We believe that the fun and playful atmosphere in our stores contributes to the overall shopping experience.
 
Each of our stores is typically led by a manager, a full-time assistant manager and two part-time assistant managers. In addition, each store has eight to ten part-time sales associates, depending on store volume, many of whom are young members of the community who represent the rue21 demographic and carry the rueCulture not only inside the store, but also in their schools and communities.
 
Store Growth and Store Conversions
 
Our in-house real estate team works along with our brokerage network to negotiate the leases, lease renewals, and construction costs of every site. We lease all of our stores and determine store locations based on several factors, including geographic location, demographic information and proximity to other value retailers including Walmart, Target and Kohl’s. Additionally, we analyze factors such as performance of a particular shopping center, the quality and nature of existing shopping center tenants and the configuration of the space and the lease terms being offered. We have prominent positioning in many of our strip center and regional mall locations as well as a highly visible façade.
 
In fiscal year 2008, we opened 99 new stores. We plan to open a total of 88 stores in fiscal year 2009, including 78 new stores opened as of October 3, 2009, and 100 stores in fiscal year 2010. We expect our store base to grow from 527 stores today to more than 1,000 stores within the next five years. Our new store operating model assumes an average store size of 4,700 square feet that has historically achieved sales per store of $900,000 to $1.1 million in the first twelve months. Our average net investment to open a new store is approximately $160,000, which includes $120,000 of average build-out costs, net of landlord contributions, and $40,000 of initial inventory, net of payables. This operating model results in an average pretax cash return on investment in excess of 100%. As a result, our stores pay back our investment in less than one year.
 
Our new store strategy is primarily focused on expanding our strip center presence, particularly in single anchor centers. We also see an opportunity to increase our footprint within regional malls, particularly in the small- and middle-markets communities, and to a more limited extent in outlet centers.
 
Converting existing stores to our larger rue21 etc! layout remains central to our growth strategy. As of October 3, 2009, 302 of our 527 stores were in the rue21 etc! layout. We have plans to continue to convert additional stores within the next five years to the larger rue 21 etc! layout as opportunities to do so become available. We have plans to convert 26 stores to the rue21 etc! layout in fiscal year 2009, including 24 stores converted as of October 3, 2009, and plan to convert approximately 30 stores in fiscal year 2010.
 
The table below highlights certain information regarding our new stores opened and existing stores converted to the rue21 etc! layout as of the fiscal year end for each of the years indicated below and as of October 3, 2009:
 
                                                 
                                  October 3,
 
    2004     2005     2006     2007     2008     2009  
 
Stores at beginning of period
    175       193       229       278       352       449  
Stores opened during period(1)
    21       42       56       74       99       78  
Stores closed during period
    3       6       7             2        
                                                 
Stores at end of period
    193       229       278       352       449       527  
Store conversions during period
    10       6       18       20       21       24  
 
 
(1) Stores opened during period does not include existing stores that have been converted.


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rueCulture and rueCommunity
 
A key component to our ongoing success has been our ability to preserve and continue to build our deep-rooted corporate and customer culture. The passion and commitment fostered by rueCulture enables us to connect with our employees and customers, to differentiate our customers’ shopping experience and to ultimately drive our growth and profitability.
 
Customer Connection
 
We create a fun and exciting fashion destination for our customers both in the store, through our themed dressing rooms and our top-40 music selection, and on the internet via our website, the rueCommunity blog and other social networking sites such as Facebook, MySpace, Twitter and YouTube. We consult a panel of teen advisors who regularly provide us with feedback on products and trends. By carrying the newest styles and regularly updating floor sets, we encourage our customers to shop our stores frequently. Our store associates share the rue21 excitement and deliver a memorable, high energy in-store experience to our customers. Our stores have become a community destination of choice where customers can meet and socialize with friends.
 
Associate Development
 
rueCulture emphasizes exceptional people, and we believe that the passion and commitment of our managers, assistant managers and sales associates are key to our past and future success. We are intensely focused on fostering the talents of our employees, and are committed to providing sales associates and managers with career advancement opportunities. We endeavor to promote a large portion of store managers and district managers from within our company. We emphasize clear communication throughout the company, and routinely hold store manager conference calls and store level, district, and regional management meetings to keep our employees focused, informed and involved. In addition, we provide continuing education and training through our Management Advancement Development training program and our “rueniversity” assistant manager training program, which promote building effective management skills and reinforce the rueCulture.
 
Our Products and Brands
 
We offer a complete assortment of fashion apparel and accessories for girls and guys, including graphic t-shirts, denim, dresses, shirts, hoodies, belts, jewelry, handbags, footwear, intimate apparel and other accessories. We seek to identify the most current fashion trends in the market and utilize our product and sourcing teams to quickly introduce these fashions to our stores. Our strategy is to price our fashion merchandise lower than most other similar apparel retailers, with most of our products priced below $35. The prices for each of our products typically range from $7.99 to $39.99 for our girls and guys apparel, $1.99 to $19.99 for our accessories, $14.99 to $29.99 for our footwear and $9.99 for our fragrances.
 
The table below indicates our product mix as a percentage of our net sales derived from our product categories, based on our internal merchandising system, as of the fiscal year end for each of the years indicated below and as of August 1, 2009.
 
                                 
                      August 1,
 
    2006     2007     2008     2009  
 
Girls apparel
    60.9 %     61.6 %     58.3 %     58.0 %
Girls accessories
    21.4       21.9       23.5       24.6  
Guys apparel and accessories
  17.7     16.5     18.2     17.4  
                                 
Total
    100 %     100 %     100 %     100 %
                                 
 
We believe that we have an opportunity to increase sales in our guys apparel and accessories category because there are few value retailers who offer similarly priced fashion apparel for young men. Currently, we offer more girls apparel and girls accessories than guys apparel and accessories. Our product mix may change based on the growth rate of each product category, although an increase in net sales in one of our product


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categories may not necessarily decrease net sales in our other product categories. Our diversified product assortment allows us to benefit from increased sales in all categories.
 
All our brands are sold exclusively through our own stores. An overview of our key brands is as follows:
 
         
Brand
 
Year Introduced
 
Category
 
  1999   Girls apparel, including graphic t-shirts, fashion tops, dresses, denim and outerwear
         
  2006   Girls accessories, including jewelry, handbags, wallets, belts, sunglasses and scarves
         
  2005   Guys apparel and accessories, including graphic t-shirts, denim, shirts, outerwear and accessories
         
  2007   Girls intimate apparel, including lingerie sets, bras, underwear, sleepwear and loungewear
         
  2009   Girls and guys footwear
         
  2004 - 2009   Girls fragrances and guys colognes
 
Merchandising and Sourcing
 
Our flexible, fast fashion model allows us to quickly identify and respond to trends and bring the newest, tested concepts and styles to our stores. We strive to offer a compelling product selection for our customers by regularly editing our merchandise assortment to reflect key fashion trends and by shipping daily deliveries of new merchandise to our stores.
 
Merchandising
 
We maintain a separate merchandising team for each of the three principal categories of our business — girls apparel, girls accessories and guys apparel and accessories. Our merchandise directors, with the support of our product development and visual teams, coordinate color and trends across the product categories to ensure brand consistency. We utilize fashion and color services, trade shows, vendors, retail shopping and social networking to identify the merchandise that meets the demands of our customers. Our merchandising team schedules weekly trend meetings to review the information gathered and determine the trends to incorporate into our product offerings. We order our product assortments after careful review and consideration of the volumes required by each of our stores. We frequently test our new products in a limited number of our stores before broadly distributing to the rest of our stores.
 
Sourcing
 
We do not own or operate any manufacturing facilities. We purchase all of our merchandise from a network of third-party vendors. Our vendor network currently consists of approximately 330 domestic importers and domestic suppliers. During the last twelve months, we sourced approximately 70% of our merchandise from our top thirty vendors, with no single vendor accounting for more than 8% of our merchandise. We believe our lack of dependence on any one vendor enhances our flexibility and minimizes product risk. In addition, we believe our long-term relationships with many of our vendors enable us to benefit from quick deliveries as well as very competitive pricing.
 
A majority of our products are manufactured in China and India at lead times of less than 90 days. Our vendors are responsible for importing products. We do not directly import any of our products. A small portion


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of our merchandise is manufactured domestically, with lead times as short as seven days to eight weeks. This maximizes our speed to market on key fashion items.
 
Although we typically transact business on an order-by-order basis, all of our vendors are required to sign our vendor agreement that incorporates a comprehensive vendor compliance manual. The vendor compliance manual details our packing, shipping and production requirements, as well as our legal requirements, professional and ethical standards and payment terms. Each purchase order also incorporates and references these requirements, standards and terms. The purchase orders, vendor agreement and vendor compliance manual all are designed to ensure that our vendors operate in compliance with all applicable rules and regulations, including labor, customs and consumer protection laws. We do not control or audit the vendors that produce the merchandise we sell. We do reserve the right to conduct random testing of products and use a third party resource to conduct such random testing on designated categories of items to further address our concern for customer safety.
 
Our national freight consolidator ships to our distribution facility from both the west coast and east coast and ships to our distribution facility in Weirton, West Virginia.
 
Marketing and Advertising
 
We believe that girls and guys rely heavily on the opinions of their peers, often expressed through social media, websites and blogs, to determine whether a retailer is relevant to them. As a result, we do not depend on conventional advertising, but instead employ a viral approach to marketing that is designed to capture the interest of our customers and drive them into our stores. For example, product knowledge, trend statements and fashion blogs are posted daily through Facebook, MySpace, Twitter and YouTube. Our rue21.com website reinforces our brand image and allows us to reach our customers in a fun and interactive environment. Website promotions and contests are an added incentive to motivate teens to share their voice. In addition, email campaigning is used to send “e-blasts” on a regular basis to customers who have provided their email addresses to us though our website or in-store collection processes. The “e-blasts” highlight key trends, new products and promotional events to drive our customer back to our stores.
 
In addition to using our website and social networking to promote our brand image, we employ a community-based marketing approach to building brand awareness and customer loyalty. We often initiate marketing efforts in concert with the local shopping center management in advance of opening our stores. At a store level, we reinforce our brands through in-store signage, events, and product labeling.
 
Our coupon programs encourage repeat business from our customers. We have built an extensive coupon program, which is strategically planned during select time periods during the year to maximize sales, traffic and customer loyalty. During an event, coupons are distributed in stores to our customers to generate repeat traffic as well as provide us with information as to customer spending, shopping patterns and habits.
 
Hiring the right people is a brand building tool in and of itself. We seek to hire a diverse, energetic, enthusiastic, trendy, passionate and knowledgeable group of individuals to be a part of our team. We promote individuality by welcoming diversity, keeping an open mind, and valuing different points of view.
 
Distribution
 
We distribute all of our merchandise from an 189,600 square foot distribution and office facility located in Weirton, West Virginia. Substantially all merchandise arrives at our distribution facility pre-ticketed by our vendors, which allows for a quick turn around time and reduced internal labor. In general, the merchandise is received, sorted by stock keeping unit, or SKU, based upon class, vendor and style, and packed in to shipments for each store based on a predetermined allocation plan. The distribution facility then uses an automated sorting system for separating shipments by store. Merchandise is shipped to our stores daily via a third-party delivery service to ensure a steady flow of new products to our stores. We are in the process of upgrading our distribution facility and related systems, which we expect to complete the end of the first quarter of fiscal year 2010. Upon completion, the distribution facility will be able to support approximately 1,300 stores.


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Management Information Systems
 
Our management information systems provide a full range of business process support and information to our store, merchandising, financial and real estate business teams. We believe the combination of our business processes and systems provide us with improved operational efficiencies, scalability, increased management control and timely reporting that allow us to identify and respond to trends in our business. These applications operate on vendor supported NCR registers, IBM and Dell servers, and operate on Epicor/CRS software for store point of sale and loss prevention, Island Pacific software for merchandising, allocation, inventory and warehouse management, and Lawson software for accounting and financial reporting.
 
Using a high-speed, broadband network, which we anticipate will be operational in all of our stores by the end of fiscal year 2009, we will have the ability to communicate to our stores continuously, change POS promotional pricing daily and update each store’s SKU level inventory that is updated daily in our inventory management system.
 
Competition
 
We believe rue21 is specialized in its ability to operate successfully in many different types of markets, including small or middle markets where there is limited direct competition. Small markets, which we define as communities with populations of less than 50,000 people, provide us with the ability to have a prominent location within the community. Typically, no other junior and young men’s specialty apparel retailer operates in these markets and our principal competitors are large value retailers. Even in middle markets, which we define as communities with populations between 50,000 and 200,000 people, we typically face limited direct competition from other junior and young men’s specialty apparel retailers. Although large value retailers, including Walmart, Target and Kohl’s, sell merchandise at comparable price points, our store format and in-store shopping experience is distinctive, with an exciting and inviting atmosphere offering trend-right fashions and our exclusive brands. Large value retailers may only have a small part of their store and total product selection dedicated to apparel and accessories. Department stores, including Dillard’s and JC Penney, or other junior retailers may be located in regional malls or outlet centers in small to middle markets; however we believe that we have been successful competing in these markets against all types of competition based on our product assortment, exclusive brands, ability to respond to changing trends, and our distinctive combination of fashion and value. Although we feel we have many competitive strengths, we recognize that we face some competitive challenges in small to middle markets, including the fact that large value retailers, department stores and some junior retail stores have substantially greater name recognition, as well as financial, marketing, and other resources, and devote greater resources to the marketing and sale of their products than we do. We believe that we benefit from the traffic that large value retailers generate in a shopping center, and often seek to place ourselves in close proximity to large value retailers.
 
The junior and young men’s specialty apparel landscape is highly competitive in large markets, which we define as communities with populations in excess of 200,000 people. We believe we are able to operate successfully in these markets given our distinctive combination of fashion and value. In large markets, we tend to position ourselves adjacent to other value retailers in strip centers or outlet centers. This provides the possibility of significant customer traffic and increased potential for sales, as most junior and young men’s specialty apparel retailers, including Aéropostale, American Eagle Outfitters, Charlotte Russe, Forever 21, the Gap, J. Crew, Metropark, Old Navy and Wet Seal, choose to position themselves in the more dominant regional malls. We recognize that some of the specialty apparel retailers with whom we compete also successfully offer a personalized shopping experience that could appeal to our target customers and that existing and new competitors may seek to emulate facets of our business strategy and in-store experience. Further, we may face new competitors and increased competition from existing competitors as we expand into new markets and increase our presence in existing markets. Competitive forces and pressures may intensify as our presence in the retail marketplace grows.


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Intellectual Property
 
We have registered numerous trademarks, trade names and logos with the United States Patent and Trademark Office, including rue21 and rue21 etc!, Carbon, Carbon Black, the CJ logo design, and tarea by rue21. We also own trademark registrations for the names of our fragrances, including rue by rue21, revert eco, CJ Black, sparkle rue21 and Pink Ice rue21. In addition we own domain names, including www.rue21.com, for our primary trademarks and own unregistered copyright rights in our website content. We also rely on a variety of intellectual property rights that we license from third parties. We expect to continually grow our merchandise assortment and strengthen our brands, and we will continue to file new applications as appropriate to protect our intellectual property rights.
 
Regulation and Legislation
 
We are subject to labor and employment laws, laws governing advertising and promotions, privacy laws, safety regulations and other laws, including consumer protection regulations that regulate retailers and or govern the promotion and sale of merchandise and the operation of stores and warehouse facilities. We monitor changes in these laws and believe that we are in material compliance with applicable laws.
 
Insurance
 
We use a combination of insurance and self-insurance for a number of risk management activities including workers’ compensation, general liability, automobile liability, and employee-related health care benefits, a portion of which is paid by the employees. We believe that we have adequately reserved for our self-insurance liability. We evaluate our insurance requirements on an ongoing basis to ensure we maintain adequate levels of coverage.
 
Employees
 
As of October 3, 2009, we had 5,833 employees of which 4,205 were part-time employees. Of this total number, 199 employees were based at our corporate headquarters, 135 employees were employed at our distribution facility, 73 managers were employed in the field, 1,952 managers and assistant managers and 3,474 sales associates were located in our stores. None of our employees is represented by a union and we have had no labor-related work stoppages. Our rueCulture emphasizes teamwork and the belief that everyone can make a difference. The value we place on our employees is one of the keys to our success, and as a result we believe our relationship with our employees is strong.
 
Seasonality
 
Our business is seasonal and, historically, we have realized a higher portion of our net sales, net income and operating cash flows in the second and fourth fiscal quarters, attributable to the impact of the summer selling season and the holiday selling season. As a result, our working capital requirements fluctuate during the year, increasing in mid-summer in anticipation of the fourth fiscal quarter. 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.
 
Legal Proceedings
 
We are subject to various legal proceedings and claims which arise in the ordinary course of our business. Although the outcome of these and other claims cannot be predicted with certainty, management does not believe that the ultimate resolution of these matters will have a material adverse effect on our financial condition or on our operations.
 
Properties
 
We do not own any real property. Our principal executive office is located in Warrendale, Pennsylvania and is leased under a lease agreement expiring in 2017, with an option to renew for an additional five-year term. The 53,035 square foot space includes two state-of-the-art simulated stores that provide a forum for planning, visual and marketing concepts prior to their execution in our stores. We also lease office space in New York City at 1071 Sixth Avenue under a lease agreement that expires at the end of 2013.


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Our 189,600 square foot distribution facility is located in Weirton, West Virginia. Our distribution facility is leased under a lease agreement expiring in 2011, with options to renew for two additional five-year terms. We are currently upgrading our distribution facility and related systems, which we expect to complete by the end of the first quarter of fiscal year 2010. Upon completion, the distribution facility will be able to support approximately 1,300 stores.
 
As of October 3, 2009, we operated 527 stores in 504 cities in 43 states. All of our stores are leased from third parties and the leases typically have terms of five years with options to renew for additional five-year periods thereafter. Some of our leases have early cancellation clauses, which permit the lease to be terminated by us or the landlord if certain sales levels are not met in specific periods or if a shopping center does not meet specified occupancy standards. In addition to future minimum lease payments, some of our store leases provide for additional rental payments based on a percentage of net sales if sales at the respective stores exceed specified levels, as well as the payment of common area maintenance charges, real property insurance and real estate taxes. Many of our lease agreements have defined escalating rent provisions over the initial term and any extensions.
 
We believe that our facilities are generally adequate for current and anticipated future use, although we may from time to time lease new facilities or vacate existing facilities as our operations require.


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MANAGEMENT
 
Directors and Executive Officers
 
Set forth below are the name, age, position and a description of the business experience of each of our executive officers, directors and other key employees as of November 10, 2009.
 
             
Name
 
Age
 
Position
 
Robert N. Fisch
    59     President, Chief Executive Officer and Chairman
Kim A. Reynolds
    52     Senior Vice President and General Merchandise Manager
Keith A. McDonough
    50     Senior Vice President and Chief Financial Officer
John P. Bugnar
    60     Senior Vice President and Director of Stores
Michael A. Holland
    45     Senior Vice President of Information Technology
Mark K.J. Chrystal
    36     Senior Vice President of Planning and Allocation
Robert R. Thomson
    50     Senior Vice President of Real Estate
Mark F. Darrel
    52     Director
John F. Megrue Jr. 
    51     Director
Alex S. Pellegrini
    34     Director
Douglas E. Coltharp
    48     Director Nominee
 
Executive Officers
 
Robert N. Fisch has served as our President and Chief Executive Officer and Chairman of our board of directors since June 2001. From February 1987 to December 1999, he served as president of Casual Corner Group, Inc. Since June 2004, Mr. Fisch has served as director at The Children’s Place Retail Stores, Inc. and currently serves on its audit committee and compensation committee.
 
Kim A. Reynolds has served as our Senior Vice President and General Merchandise Manager since July 2001. From March 1987 to November 1999, she served as general merchandising manager of Casual Corner Group, Inc.
 
Keith A. McDonough has served as our Chief Financial Officer since May 2003. From February 1990 to March 2001, Mr. McDonough served as senior vice president of finance and chief operating officer at Iron Age Corp. From March 2001 to December 2002, he served as chief operating officer at Iron Age Corp.
 
John P. Bugnar has served as our Senior Vice President and Director of Stores since September 2001. From December 1997 to September 2001, he served as vice president at Jones Apparel Group, Inc./Jones Retail Corporation.
 
Michael A. Holland has served as our Senior Vice President of Information Technology since April 2004. From January 1995 to March 2004, he served as senior director of information technology at the Timberland Company.
 
Mark K.J. Chrystal has served as our Senior Vice President of Planning and Allocation since June 2008. From April 2007 to June 2008, Mr. Chrystal served as vice president of allocation, replenishment and planning for American Eagle Outfitters. From September 2004 to April 2007, he served as vice president of planning and allocation at The Disney Store, Inc.
 
Robert R. Thomson has served as our Senior Vice President of Real Estate since January 2007. From June 2000 to January 2007, Mr. Thomson served as vice president of real estate and construction at Brookstone Corporation. From April 1995 to June 2000, he served as the director of real estate at The Stride Rite Corporation.
 
Our executive officers are appointed by our board of directors and serve until their successors have been duly elected and qualified or their earlier resignation or removal. There are no family relationships among any of our directors or executive officers.


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Directors
 
Mark F. Darrel has served as a member of our board of directors since June 2008. Since February 2009, Mr. Darrel has been the Head of Private Equity Portfolio Management at BNP Paribas. Since February 2004, Mr. Darrel has served as a director of the Structured Finance Group of BNP Paribas, the parent company of one of our significant stockholders. Mr. Darrel has advised us that he will resign as a member of our board of directors shortly after completion of this offering.
 
John F. Megrue Jr. has served as a member of our board of directors since July 1998. Since November 2006, Mr. Megrue has served as chief executive officer of Apax Partners in the United States. From April 2005 to November 2006, he served as co-chief executive officer of Apax Partners, L.P. From May 1992 to April 2005, he served as a partner of Saunders Karp & Megrue, LLC. Mr. Megrue also serves as a member of the board of directors of Bob’s Discount Furniture, L.L.C., Tommy Hilfiger Corporation and MagnaCare Holdings, Inc. and has previously served as a member of the board of directors of Dollar Tree, Inc., The Children’s Place Retail Stores, Inc. and Hibbett Sports, Inc.
 
Alex Pellegrini has served as a member of our board of director since September 2009. Since January 2009, Mr. Pellegrini has served as a partner of Apax Partners, L.P. From April 2005 to December 2008, he served as a principal at Apax Partners, L.P. From August 2000 to April 2005, he served as an investment professional of Saunders Karp & Megrue, LLC. Mr. Pellegrini also serves as a member of the board of directors of MagnaCare Holdings, Inc. and Spectrum Laboratory Holdings.
 
Douglas E. Coltharp has been nominated, and has agreed to serve, as a member of our board of directors upon completion of this offering. Since May 2007, Mr. Coltharp has served as a partner at Arlington Capital Advisors, LLC and Arlington Investment Partners. From November 1996 to May 2007, Mr. Coltharp served as executive vice president and chief financial officer of Saks Incorporated and its predecessor organization. Mr. Coltharp also serves as a member of the board of directors of Under Armour, Inc. and Ares Capital Corporation.
 
Corporate Governance
 
Controlled Company
 
We intend to avail ourselves of the controlled company exemption under the corporate governance rules of The NASDAQ Stock Market. Although we will have a majority of independent directors on our board of directors, we will not have a compensation committee and a nominating and corporate governance committee composed entirely of independent directors as defined under the rules of The NASDAQ Stock Market. The controlled company exemption does not modify the independence requirements for the audit committee, and we intend to comply with the requirements of Sarbanes-Oxley and The NASDAQ Stock Market, which require that our audit committee be composed of at least three members, one of whom will be independent upon the listing of our common stock on The NASDAQ Global Select Market, a majority of whom will be independent within 90 days of the date of this prospectus, and each of whom will be independent within one year of the date of this prospectus.
 
Board Composition
 
Our business and affairs will be managed under the direction of our board of directors. Our amended and restated bylaws will provide that our board of directors will be fixed from time to time by resolution adopted by the affirmative vote of a majority of the total directors then in office. Within 90 days of the completion of this offering, our board of directors will be comprised of five directors. Currently, all of our directors are either employed by us or affiliated with Apax Partners or BNP Paribas North America, Inc. Within 90 days of the completion of this offering, we expect that at least two additional members of our board of directors will be independent under the corporate governance rules of The NASDAQ Stock Market. Our board of directors has determined that Messrs. Megrue, Pellegrini and Darrel are independent as defined under the corporate governance rules of The NASDAQ Stock Market. In making that determination, our board of directors affirmatively determined that, in the opinion of our board of directors, neither Messrs. Megrue, Pellegrini, who are affiliated with Apax Partners, our controlling stockholder, or Mr. Darrel, who is affiliated with BNP


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Paribas North America, Inc., a significant stockholder, have any relationship which would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. The directors will have discretion to increase or decrease the size of the board of directors.
 
Our board of directors will be divided into three classes, with each director serving a three-year term and one class being elected at each year’s annual meeting of stockholders. Mr. Darrel and Mr. Fisch will serve as Class I directors with an initial term expiring in 2010. Mr. Darrel has advised us that he will resign as a member of our board of directors shortly after completion of this offering. If Mr. Darrel resigns, our board of directors may keep his directorship vacant, fill the vacancy by vote of a majority of the remaining members of our board of directors at any meeting of our board of directors or apportion our existing board of directors among each class to make all classes as nearly equal in number as practicable. Mr. Pellegrini and Mr. Coltharp will serve as Class II directors, with an initial term expiring in 2011. Mr. Megrue will serve as a Class III director with an initial term expiring in 2012.
 
Board Committees
 
Our board of directors plans to establish the following committees: an audit committee, a compensation committee and a corporate governance and nominating committee. The composition and responsibilities of each committee are described below. Members will serve on these committees until their resignation or until otherwise determined by our board of directors.
 
Audit Committee
 
We do not currently have an audit committee; however, we plan to establish an audit committee prior to completion of this offering. Upon completion of this offering, our audit committee will consist of Messrs. Coltharp, Megrue, and Pellegrini, with Mr. Coltharp serving as chair of the audit committee. Our audit committee will have responsibility for, among other things:
 
  •  selecting and hiring our independent registered public accounting firm, and approving the audit and non-audit services to be performed by our independent registered public accounting firm;
 
  •  evaluating the qualifications, performance and independence of our independent;
 
  •  monitoring the integrity of our financial statements and our compliance with legal and regulatory requirements as they relate to financial statements or accounting matters;
 
  •  reviewing the adequacy and effectiveness of our internal control policies and procedures;
 
  •  discussing the scope and results of the audit with the independent registered public accounting firm and reviewing with management and the independent registered public accounting firm our interim and year-end operating results; and
 
  •  preparing the audit committee report required by the SEC to be included in our annual proxy statement.
 
The SEC and NASDAQ Stock Market rules require us to have one independent audit committee member upon the listing of our common stock on The NASDAQ Global Select Market, a majority of independent directors within 90 days of the date of such listing and all independent audit committee members within one year of the date of such listing. Our board of directors has affirmatively determined that Mr. Coltharp meets the definition of “independent directors” for purposes of serving on an audit committee under applicable SEC and The NASDAQ Stock Market rules, and we intend to comply with these independence requirements within the time periods specified. Our board of directors has also determined that each of Messrs. Megrue and Pellegrini does not meet the criteria for independence set forth in Rule 10A-3 of the Exchange Act because they are deemed an affiliated person of the company based upon their association with Apax Partners, our controlling stockholder. However, Messrs. Megrue and Pellegrini are deemed to be independent under the general corporate governance rules of The NASDAQ Stock Market. In addition, Mr. Coltharp qualifies as our “audit committee financial expert.”
 
Our board of directors will adopt a written charter for our audit committee, which will be available on our corporate website at www.rue21.com upon completion of this offering.


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Compensation Committee
 
Upon completion of this offering, our compensation committee will consist of Messrs. Megrue, Fisch and Pellegrini. Mr. Megrue will be the chairperson of our compensation committee. The compensation committee will be responsible for, among other things:
 
  •  reviewing and approving compensation of our executive officers including annual base salary, annual incentive bonuses, specific goals, equity compensation, employment agreements, severance and change in control arrangements, and any other benefits, compensation or arrangements;
 
  •  reviewing succession planning for our executive officers;
 
  •  reviewing and recommending compensation goals, bonus and stock compensation criteria for our employees;
 
  •  determining the compensation of our directors;
 
  •  reviewing and discussing annually with management our “Compensation Discussion and Analysis” disclosure required by SEC rules;
 
  •  preparing the compensation committee report required by the SEC to be included in our annual proxy statement; and
 
  •  administrating, reviewing and making recommendations with respect to our equity compensation plans.
 
We expect to have one independent compensation committee member upon the listing of our common stock on The NASDAQ Global Select Market and a majority of independent directors within 90 days of such listing. However, as a controlled company, we will rely upon the exemption from the requirement that we have a compensation committee that is composed entirely of independent directors within one year from the date of such listing. Our board of directors has affirmatively determined that Messrs. Megrue and Pellegrini meet the definition of “independent directors” for purposes of serving on a compensation committee under applicable SEC and The NASDAQ Stock Market rules.
 
Our board of directors will adopt a written charter for our compensation committee, which will be available on our corporate website at www.rue21.com upon completion of this offering.
 
Corporate Governance and Nominating Committee
 
Upon completion of this offering, our corporate governance and nominating committee will consist of Messrs. Coltharp, Pellegrini and Fisch and Mr. Coltharp will be the chairperson of this committee.
 
The corporate governance and nominating committee will be responsible for, among other things:
 
  •  assisting our board of directors in identifying prospective director nominees and recommending nominees for each annual meeting of stockholders to the board of directors;
 
  •  reviewing developments in corporate governance practices and developing and recommending governance principles applicable to our board of directors;
 
  •  overseeing the evaluation of our board of directors and management; and
 
  •  recommending members for each board committee of our board of directors.
 
We expect to have one independent corporate governance and nominating committee member upon the listing of our common stock on The NASDAQ Global Select Market and a majority of independent directors within 90 days of such listing. However, as a controlled company, we will rely upon the exemption from the requirement that we have a corporate governance and nominating committee that is composed entirely of independent directors within one year from the date of such listing. Our board of directors has affirmatively determined that Messrs. Coltharp and Pellegrini meet the definition of “independent directors” for purposes of serving on a corporate governance and nominating committee under applicable SEC and The NASDAQ Stock Market rules, and we intend to comply with these independence requirements within the time periods specified.


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Our board of directors will adopt a written charter for our corporate governance and nominating committee, which will be available on our corporate website at www.rue21.com upon completion of this offering.
 
Compensation Committee Interlocks and Insider Participation
 
None of our executive officers currently serves, or in the past year has served, as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving on our board of directors or compensation committee.
 
Code of Business Conduct and Ethics
 
We will adopt a code of business conduct and ethics applicable to our principal executive, financial and accounting officers and all persons performing similar functions. A copy of that code will be available on our corporate website at www.rue21.com upon completion of this offering. We expect that any amendments to such code, or any waivers of its requirements, will be disclosed on our website.
 
Director Compensation
 
Prior to this offering, members of our board of directors did not receive compensation for their services as directors, except for the reimbursement of reasonable and documented costs and expenses incurred by directors in connection with attending any meetings of the board of directors or any committee thereof. Apax Partners L.P., of which Mr. Megrue is chief executive officer and Mr. Pellegrini is a partner, has received fees from us pursuant to a letter agreement for financial advisory services performed by Apax Partners. See “Certain Relationships and Related Party Transactions — Agreement with Apax Partners.”
 
We did not pay any compensation to members of our board of directors during 2008 because all of our directors were either employees of our company or affiliated with Apax Partners, our largest stockholder, or BNP Paribas North America, Inc., a principal stockholder.
 
Upon completion of this offering, our executive officers who are members of our board of directors and the directors who continue to provide services to, or are affiliated with, Apax Partners or funds advised by Apax Partners or BNP Paribas North America, Inc. will not receive compensation from us for their service on our board of directors. Accordingly, Messrs. Fisch, Darrel, Megrue and Pellegrini will not receive compensation from us for their service on our board of directors. Only those directors who are considered independent directors under the corporate governance rules of The NASDAQ Stock Market and are not affiliated with Apax Partners or funds advised by Apax Partners or BNP Paribas North America, Inc. are eligible to receive compensation from us for their service on our board of directors. Mr. Coltharp and all other non-employee directors not affiliated with Apax Partners or funds affiliated with Apax Partners or BNP Paribas North America, Inc. will be paid quarterly in arrears:
 
  •  a base annual retainer of $50,000 in cash;
 
  •  an additional annual retainer of $20,000 in cash to the chair of the audit committee; and
 
  •  an additional annual retainer of $10,000 in cash to each of the chairs of the compensation committee and the corporate governance and nominating committee.
 
In addition, upon initial election to our board of directors, each non-employee director not affiliated with Apax Partners, funds advised by Apax Partners or BNP Paribas North America, Inc. will receive an option grant of 12,500 shares of our common stock. For each year of continued service thereafter, each non-employee director not affiliated with Apax Partners, funds advised by Apax Partners or BNP Paribas North America, Inc. will receive an annual option grant of 5,000 shares. Each grant will be subject to the same terms as those of our employees as described in the 2009 Omnibus Incentive Plan narrative. See “Executive Compensation — 2009 Omnibus Incentive Plan.” We will also reimburse directors for reasonable expenses incurred to attend meetings of our board of directors or committees.


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EXECUTIVE COMPENSATION
 
Compensation Discussion and Analysis
 
The purpose of this compensation discussion and analysis section is to provide information about the material elements of compensation that are paid, awarded to, or earned by, our “named executive officers,” who consist of our principal executive officer, principal financial officer, and the three other most highly compensated executive officers. For fiscal year 2008, our named executive officers, were:
 
  •  Robert N. Fisch, President and Chief Executive Officer;
 
  •  Kim A. Reynolds, Senior Vice President and General Merchandise Manager;
 
  •  Keith A. McDonough, Senior Vice President and Chief Financial Officer;
 
  •  John P. Bugnar, Senior Vice President and Director of Stores; and
 
  •  Michael A. Holland, Senior Vice President of Information Technology.
 
Historical Compensation Decisions
 
Our compensation approach is necessarily tied to our stage of development. Prior to this offering, we were a privately-held company with a relatively small number of stockholders, including our principal investors, funds advised by Apax Partners and BNP Paribas North America, Inc. As a result, we have not been subject to any stock exchange listing or SEC rules requiring a majority of our board of directors to be independent or relating to the formation and functioning of board committees, including audit, compensation and nominating committees. Most, if not all, of our prior compensation policies and determinations, including those made for fiscal year 2008, have been the product of informal discussions between our President and Chief Executive Officer and our board of directors.
 
Compensation Philosophy and Objectives
 
Upon completion of this offering, our compensation committee will review and approve the compensation of our named executive officers and oversee and administer our executive compensation programs and initiatives. As we gain experience as a public company, we expect that the specific direction, emphasis and components of our executive compensation program will continue to evolve. For example, over time we may reduce our reliance upon determinations made by our President and Chief Executive Officer and/or board of directors in favor of a more empirically-based approach that involves benchmarking against peer companies. Accordingly, the compensation paid to our named executive officers for fiscal year 2008 is not necessarily indicative of how we will compensate our named executive officers following this offering.
 
We have strived to create an executive compensation program that balances short-term versus long-term payments and awards, cash payments versus equity awards and fixed versus contingent payments and awards in ways that we believe are most appropriate to motivate our executive officers. Our executive compensation program is designed to:
 
  •  attract and retain talented and experienced executives in our industry;
 
  •  reward executives whose knowledge, skills and performance are critical to our success;
 
  •  align the interests of our executive officers and stockholders by motivating executive officers to increase stockholder value and rewarding executive officers when stockholder value increases;
 
  •  ensure fairness among the executive management team by recognizing the contributions each executive officer makes to our success;
 
  •  foster a shared commitment among executives by aligning their individual goals with the goals of the executive management team and our company; and
 
  •  compensate our executives in a manner that incentivizes them to manage our business to meet our long-range objectives.


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The compensation committee will meet outside the presence of all of our executive officers, including our named executive officers, to consider appropriate compensation for our President and Chief Executive Officer. For all other named executive officers, the compensation committee will meet outside the presence of all executive officers except our President and Chief Executive Officer. Going forward, our President and Chief Executive Officer will review annually each other named executive officer’s performance with the compensation committee and recommend appropriate base salary, cash performance awards and grants of long-term equity incentive awards for all other executive officers. Based upon the recommendations from our President and Chief Executive Officer and in consideration of the objectives described above and the principles described below, the compensation committee will approve the annual compensation packages of our executive officers other than our President and Chief Executive Officer. The compensation committee also will annually analyze our President and Chief Executive Officer’s performance and determine his base salary, cash performance awards and grants of long-term equity incentive awards based on its assessment of his performance with input from any consultants engaged by the compensation committee.
 
Compensation amounts historically have been highly individualized, resulted from arm’s length negotiations and have been based on a variety of informal factors including, in addition to the factors listed above, our financial condition and available resources, our need for that particular position to be filled and the compensation levels of our other executive officers, each as of the time of the applicable compensation decision. In addition, we informally considered the competitive market for corresponding positions within comparable geographic areas and companies of similar size and stage of development operating in the retail apparel industry. This informal consideration was based on the general knowledge possessed by our President and Chief Executive Officer regarding the compensation given to some of the executive officers of other companies in our industry through informal discussions with recruiting firms, research and informal benchmarking against their personal knowledge of the competitive market. As a result, our President and Chief Executive Officer historically has typically applied his discretion to make compensation decisions and did not formally benchmark executive compensation against a particular set of comparable companies or use a formula to set the compensation for our executives in relation to survey data. Our President and Chief Executive Officer, in consultation with members of our board of directors, made compensation decisions for our executive officers and after thorough discussion of various factors, including any informal knowledge or data he may have had, set the compensation for each executive officer on an individual basis. We anticipate that our compensation committee will more formally benchmark executive compensation against a peer group of comparable companies in the future. We also anticipate that our compensation committee may make adjustments in executive compensation levels in the future as a result of this more formal benchmarking process.
 
In April 2008, management engaged Ernst & Young LLP to advise management with their efforts to construct, from publicly available data, a peer group of companies to be used for compensation purposes in preparation for an initial public offering, provide market compensation data on the peer group companies, supplemented by survey data, as appropriate, and general market trends and developments. Management intends to use the information provided by Ernst & Young LLP and other resources and tools to develop recommendations to be presented and approved by our board of directors. Ernst & Young LLP has not recommended specific compensation amounts or the form of payment for any of our named executive officers. Management’s review and analysis of its executive compensation program is ongoing and has not been completed. Ernst & Young LLP is also our independent registered public accounting firm.
 
Elements of Compensation
 
Our current executive compensation program, which was set by our President and Chief Executive Officer in consultation with our board of directors prior to the establishment of our compensation committee, consists of the following components:
 
  •  base salary;
 
  •  annual cash incentive awards linked to corporate and business segment performance;
 
  •  periodic grants of long-term equity-based compensation, such as restricted stock or options;


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  •  other executive benefits and perquisites; and
 
  •  employment agreements, which contain termination and change in control benefits.
 
Executive compensation includes both fixed components (base salary, benefits and executive perquisites) and variable components (annual bonus/incentive, stock option and/or restricted stock unit grants) with the heaviest weight generally placed on the variable components. Each component is linked to one or more of the strategic objectives listed above. The fixed components of compensation are designed to be competitive in order to induce talented executives to join our company. Revisions to the fixed components of compensation occur infrequently aside from our annual salary review, which generally results in salary increases that range from 4% to 7%. Salary increases are, in part, designed to reward executives for their management activities during the year and to maintain their level of income with respect to cost of living increases.
 
The variable components are tied specifically to the achievement of our annual financial objectives and are designed so that above average performance is rewarded with above average rewards. Bonus levels, as a percentage of base salary, are set once the executive is hired and generally relate to his or her scope of responsibility, with revisions typically occurring upon promotions or substantial increases to the executive’s scope of responsibility. Although bonus levels, as a percentage of base salary, generally do not change, the opportunity to accelerate bonus payments to twice the target amount for any one year does exist for an executive based upon our overall financial performance. Our bonus policy is designed to align each executive’s annual goals for their respective area of responsibility with the financial goals of the entire business as set by our board of directors. The other material element to variable compensation is stock option awards. Our Amended and Restated 2003 Ownership Incentive Plan was adopted by our board of directors to award grants, usually on an annual basis, to executive officers, general management and select associates. The grants awarded over the last six years have had no public market and no certain opportunity for liquidity, making them inherently long-term compensation. The awards have been used to motivate executives and employees to individually and collectively build long-term shareholder value that might in the future create a liquid market opportunity.
 
Base Salary
 
The primary component of compensation of our executive officers has historically been base salary. The base salary established for each of our executive officers is intended to reflect each individual’s professional responsibilities, the skills and experience required for the job, their individual performance, business performance, labor market conditions and competitive market salary levels. Base salary is also designed to provide our executive officers with steady cash flow during the course of the fiscal year that is not contingent on short-term variations in our corporate performance. Our President and Chief Executive Officer and/or board of directors determine market level compensation for base salaries based on our executives’ experience in the industry with reference to the base salaries of similarly situated executives in other companies of similar size and stage of development operating in the retail apparel industry. This determination is informal and based primarily on the general knowledge of our President and Chief Executive Officer of the compensation practices within our industry.
 
Mr. Fisch’s employment agreement sets forth his annual salary. Effective February 1, 2008, his base salary was increased to $735,000 and, effective February 1, 2009, his base salary was increased to $800,000.
 
Base salaries are reviewed during the fiscal year by our President and Chief Executive Officer, and salary increases typically take effect in June of each year, unless business circumstances require otherwise. In past years, our President and Chief Executive Officer and/or board of directors reviewed the performance of all executive officers, and based on this review and any relevant informal competitive market data made available to him or them during the preceding year, through informal discussions with recruiting firms, research and informal benchmarking against our President and Chief Executive Officer and/or directors’ personal knowledge of the competitive market, set the salary level for each executive officer for the coming year. Upon completion of this offering, the compensation committee will take a more significant role in this annual review and decision-making process.


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As part of our annual review process, in June 2008, our President and Chief Executive Officer approved annual merit salary increases for each of our named executive officers, except for himself. These merit increases for our named executive officers for fiscal year 2008 ranged from 4% to 7% and took into account accomplishments of each individual; for example, Mr. McDonough’s contributions to expense control and supply chain efficiencies, Ms. Reynold’s contributions to merchandise mix and increasing gross margins; Mr. Holland’s success in significant technology implementations; Mr. Bugnar’s management of the operational aspects of our store growth and developing our management training programs. Ms. Reynolds’s salary increased from $308,000 to $330,000; Mr. McDonough’s salary increased from $212,000 to $227,000; Mr. Bugnar’s salary increased from $243,000 to $253,000; and Mr. Holland’s salary increased from $210,000 to $222,500.
 
Bonus
 
Our President and Chief Executive Officer and/or board of directors have authority to award annual cash bonuses to our executive officers. The annual cash bonuses are intended to offer incentive compensation by rewarding the achievement of corporate objectives linked to seasonal financial results of the Company.
 
On an annual basis, or at the commencement of an executive officer’s employment with us, our President and Chief Executive Officer and/or board of directors typically sets a target level of bonus compensation that is structured as a percentage of such executive officer’s annual base salary. Depending upon corporate performance, an executive officer may receive from 0% to 60% of his or her base salary or in the case of our President and Chief Executive Officer from 0% to 110%. In setting the percentage of base salary level, our President and Chief Executive Officer and/or board of directors set the target bonus levels (as a percentage of base salary) based upon each executive’s scope of responsibility and impact on the performance of the Company.
 
The actual bonuses awarded in any year, if any, may be more or less than the target, depending on the achievement of corporate objectives, as discussed below. In addition, our President and Chief Executive Officer and/or board of directors may adjust bonuses due to extraordinary or nonrecurring events, such as significant financings, equity offerings or acquisitions. We believe that establishing cash bonus opportunities helps us attract and retain qualified and highly skilled executives. These annual bonuses are intended to reward executive officers who have a positive impact on corporate results. Upon completion of this offering, the compensation committee will take a more significant role in this annual review and decision-making process.
 
Each year we establish our corporate financial performance objective and target amounts with reference to achieving pre-set levels of desired financial performance, and with consideration given to our annual and long-term financial plan, as well as to macroeconomic conditions. For fiscal year 2008, the annual cash bonus was linked to achievement of Adjusted EBITDA within a range of $28.9 million to $34.5 million. We believe this corporate performance objective and the proportionate weighting assigned, as discussed below, reflected our overall company goals for fiscal year 2008, which balanced the achievement of revenue growth and improving our operating efficiency. For purposes of our cash bonus program in fiscal year 2008, Adjusted EBITDA was defined as earnings before interest, taxes, depreciation and amortization, excluding approximately $800,000 in operating expense associated with the annual fee payable to Apax Partners, L.P. and a loss on the disposal of fixed assets in fiscal year 2008, which were not taken into account when setting fiscal year 2008 financial targets. Our President and Chief Executive Officer and/or board of directors determined that these unplanned costs were outside management’s control and excluded them when measuring Adjusted EBITDA achievement under the cash bonus program. For the Spring and Fall selling seasons, our actual Adjusted EBITDA, as calculated for the purpose of the annual cash bonus, was $14.7 million and $19.0 million, respectively. For the year ended January 31, 2009, our actual Adjusted EBITDA, as calculated for the purpose of the annual cash bonus, was $34.2 million.
 
The corporate performance objective is based upon the achievement of Adjusted EBITDA targets that are set at a threshold amount, a target amount and a maximum amount for each of our Spring and Fall selling seasons and for the fiscal year by our President and Chief Executive Officer and/or board of directors. For fiscal year 2008, we defined our Spring selling season as the performance period from February 2008 through


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July 2008 and our Fall selling season as the performance period from July 2008 through January 2009. For fiscal year 2008, each of our Spring and Fall selling seasons carried a weight of 25% of the total bonus target amount while our annual Adjusted EBITDA target carried a weight of 50% of the total bonus target amount. The corporate performance during each of the three performance periods is compared separately to the different target amounts.
 
The following table sets forth the Adjusted EBITDA targets for the Spring and Fall selling seasons and the fiscal year.
 
                         
    Fiscal Year
    Spring Season
    Fall Season
 
Adjusted EBITDA Amounts:
  Targets     Targets     Targets  
Threshold
  $ 28.9 million     $ 13.1 million     $ 15.8 million  
Target
  $ 31.1 million     $ 14.1 million     $ 17.0 million  
Maximum
  $ 34.5 million     $ 15.6 million     $ 18.9 million  
 
In November 2007, our President and Chief Executive Officer, in consultation with members of our board of directors, established a target bonus, expressed as a percentage of base salary, for each of our named executive officers, other than himself, with a minimum, threshold and maximum target bonus based upon the achievement of the Adjusted EBITDA target. For fiscal year 2008, Mr. Fisch’s target bonus amount was set in accordance with his employment agreement at 50%. Going forward, our board of directors will determine the actual cash bonus awarded to our President and Chief Executive Officer. The following table shows the target bonus pool amounts for each of our named executive officers for different levels of achievement of the Adjusted EBITDA target amounts, as shown in the table above, for each of the Spring and Fall selling seasons and the fiscal year:
 
                     
                  111%
          93%
  100%
  of Adjusted
          of Adjusted
  of Adjusted
  EBITDA
    Below
    EBITDA
  EBITDA
  Target or
    Threshold     Target   Target   Above
 
Robert N. Fisch
        25% salary   50% salary   110% salary
Kim A. Reynolds
        15% salary   30% salary   60% salary
Keith A. McDonough
        12.5% salary   25% salary   50% salary
John P. Bugnar
        12.5% salary   25% salary   50% salary
Michael A. Holland(1)
        12.5% salary   25% salary   50% salary
 
 
(1) Mr. Holland’s target bonus was increased from 20% to 25% in June 2008 as part of his promotion from Vice President to Senior Vice President.
 
Based upon our achievement of Adjusted EBITDA as calculated under our cash bonus program, each of our named executive officers received a bonus in the amount set forth in the Summary Compensation Table below.
 
Long-Term Equity-Based Compensation
 
Our President and Chief Executive Officer and/or board of directors believe that equity-based compensation is an important component of our executive compensation program and that providing a significant portion of our executive officers’ total compensation package in equity-based compensation aligns the incentives of our executives with the interests of our stockholders and with our long-term corporate success. Additionally, our President and Chief Executive Officer and/or board of directors believe that equity-based compensation awards enable us to attract, motivate, retain and adequately compensate executive talent. To that end, we have awarded equity-based compensation in the form of options to purchase shares of our common stock. Our President and Chief Executive Officer and/or board of directors believe stock options provide executives with a significant long-term interest in our success by rewarding the creation of stockholder value over time.
 
Generally, each executive officer is provided with a stock option grant when he or she joins our company based upon his or her position with us and his or her relevant prior experience. Prior to fiscal year 2008, these inducement grants generally vested over the course of five years with 20% of the shares vesting on the first


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anniversary of the applicable grant date and the remainder of the shares vesting annually in equal installments over the next four years, to encourage executive longevity and to compensate our executive officers for their contribution to our success over a period of time. Beginning in fiscal year 2008, each of our stock option grants generally vest over the course of four years with 25% of the shares vesting on the first anniversary of the applicable grant date and the remainder of the shares vesting annually in equal installments over the next three years. In addition to stock options granted upon commencement of employment with us, our compensation committee may grant additional stock options to retain our executives and to recognize the achievement of corporate and individual goals and/or strong individual performance.
 
Stock options are granted with an exercise price equal to or greater than the fair value of our stock on the applicable date of grant. Upon completion of this offering, we expect to determine fair value for purposes of stock option pricing based on the closing price of our common stock on The NASDAQ Global Select Market on the date of grant.
 
In general, stock option grants to our executive officers are determined at the discretion of our President and Chief Executive Officer in consultation with our board of directors. In addition, our President and Chief Executive Officer and/or board of directors also consider the executive officer’s current position with our company, the size of his or her total compensation package and the amount of existing vested and unvested stock options, if any, then held by the executive officer. No formal benchmarking efforts are made by our President and Chief Executive Officer and/or board of directors with respect to the size of option grants made to executive officers and, in general, the determination process is very informal. Historically, our President and Chief Executive Officer and/or board of directors has made all stock option grant decisions with respect to our executive officers, and we anticipate that, upon completion of this offering, our compensation committee will, subject to approval by our board of directors as deemed necessary by the compensation committee, determine the size and terms and conditions of option grants to our executive officers in accordance with the terms of the applicable plan and will approve them on an individual basis.
 
We did not grant any stock options during fiscal year 2008 to our named executive officers.
 
On July 24, 2009, we approved a grant of incentive stock options to each of our named executive officers, as well as certain other executive officers. The stock options were granted in accordance with our Amended and Restated 2003 Ownership Incentive Plan, or the 2003 Plan, as follows:
 
                 
    Number of Stock
       
    Options     Exercise Price  
 
Robert N. Fisch
    73,702     $ 11.80  
Kim A. Reynolds
    58,962     $ 11.80  
Keith A. McDonough
    29,481     $ 11.80  
John P. Bugnar
    14,740     $ 11.80  
Michael A. Holland
    14,740     $ 11.80  
 
The number of shares of common stock underlying each stock option grant was determined by our President and Chief Executive Officer based upon the outstanding equity grants held both by the individual and by our executives as a group, total compensation, performance, the vesting dates of outstanding grants, tax and accounting costs, potential dilution and other factors. The exercise price of the stock options equals 100% of the fair value in accordance with the terms of the 2003 Plan. Each grant of stock options vest in four equal annual installments beginning on the first anniversary of the date of grant. The term of the options is ten years.
 
2009 Omnibus Incentive Plan
 
Effective upon completion of this offering, we will implement the rue21, inc. 2009 Omnibus Incentive Plan, or the 2009 Plan. For more information relating to our 2009 Plan, see “—2009 Omnibus Incentive Plan.”
 
Our 2009 Plan will allow for the grant of other forms of equity incentives in addition to stock options, such as grants of restricted stock, restricted stock units and stock appreciation rights. In the future, our compensation committee may consider awarding such additional or alternative forms of awards to our executive officers, although no decision to use such other forms of award has yet been made.


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Other Executive Benefits and Perquisites
 
We provide the following benefits to our executive officers on the same basis as other eligible employees:
 
  •  health insurance;
 
  •  vacation, personal holidays and sick days;
 
  •  life insurance and supplemental life insurance;
 
  •  short-term and long-term disability; and
 
  •  a 401(k) profit-sharing plan with matching contributions.
 
We believe these benefits are generally consistent with those offered by other companies and specifically with those companies with which we compete for employees.
 
We also provide an automobile allowance to our executive officers and a housing allowance and the reimbursement of certain travel expenses of our President and Chief Executive Officer and his spouse.
 
Employment Agreements and Severance and Change in Control Benefits
 
We have entered into an employment agreement that contains severance benefits and change in control provisions with Mr. Fisch, our President and Chief Executive Officer, the terms of which are described under the heading “—Potential Payments Upon Termination or Change in Control.” We believe these severance and change in control benefits are essential elements of our executive compensation package and assist us in recruiting and retaining talented individuals. In addition, we may enter into an employment agreement with certain other executive officers.
 
Section 162(m) Compliance
 
Section 162(m) of the Code limits us to a deduction for federal income tax purposes of no more than $1 million of compensation paid to certain executive officers in a taxable year. Compensation above $1 million may be deducted if it is “performance-based compensation” within the meaning of the Code.
 
Our board of directors has determined that stock options granted under our Amended and Restated 2003 Ownership Incentive Plan, or 2003 Plan, with an exercise price at least equal to the fair value of our common stock on the date of grant should be treated as “performance-based compensation.” Our board of directors believes that we should be able to continue to manage our executive compensation program for our named executive officers so as to preserve the related federal income tax deductions, although individual exceptions may occur.


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2008 Summary Compensation Table
 
The following table sets forth certain information with respect to compensation for the year ended January 31, 2009 earned by, awarded to or paid to our named executive officers.
 
                                                                 
                        Non-Equity
       
                Stock
  Option
  Incentive Plan
  All Other
   
        Salary
  Bonus
  Awards
  Awards
  Compensation
  Compensation
  Total
Name and Principal Position
  Year   ($)   ($)   ($)   ($)(1)   ($)(2)   ($)(3)   ($)
 
Robert N. Fisch
                                                               
President and Chief Executive Officer
    2008       735,000                   7,708       736,497       79,220       1,558,425  
Kim A. Reynolds
                                                               
Senior Vice President and General Merchandise Manager
    2008       321,116 (4)                 8,115       184,106       1,506       514,843  
Keith A. McDonough
                                                               
Senior Vice President and Chief Financial Officer
    2008       220,942 (5)                 4,063       105,562       2,223       332,790  
John P. Bugnar
                                                               
Senior Vice President and Director of Stores
    2008       248,962 (6)                 3,051       118,992       11,533       382,538  
Michael A. Holland
                                                               
Senior Vice President of Information Technology
    2008       217,452 (7)                 2,562