10-Q 1 wtslq3201410-q.htm 10-Q WTSL Q3 2014 10-Q
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
____________________________________________________
FORM 10-Q
____________________________________________________
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended November 1, 2014

OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 001-35634 
____________________________________________________
THE WET SEAL, INC.
(Exact name of registrant as specified in its charter)
____________________________________________________
Delaware
33-0415940
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
26972 Burbank, Foothill Ranch, CA
92610
(Address of principal executive offices)
(Zip Code)
(949) 699-3900
(Registrant’s telephone number, including area code)
____________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer:
¨
 
Accelerated filer:
ý
Non-accelerated filer:
¨
(Do not check if a smaller reporting company)
Smaller reporting company:
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
The number of shares outstanding of the registrant’s Class A common stock, par value $0.10 per share, at December 5, 2014, was 84,358,776. There were no shares outstanding of the registrant’s Class B common stock, par value $0.10 per share, at December 5, 2014.



THE WET SEAL, INC.
FORM 10-Q
Table of Contents
 
 
 
 
 
 
Page
 
 
 
 
Item 1.
 
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2
101.INS XBRL Instance Document
101.SCH XBRL Taxonomy Extension Schema Document
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF XBRL Taxonomy Extension Definition Linkbase Document
101.LAB XBRL Taxonomy Extension Label Linkbase Document
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document
 




PART I. Financial Information
Item 1.        Financial Statements (Unaudited)
THE WET SEAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
 
November 1, 2014
 
February 1, 2014
 
November 2, 2013
ASSETS
 
 
 
 
 
CURRENT ASSETS:
 
 
 
 
 
Cash and cash equivalents
$
19,058

 
$
38,772

 
$
30,084

Short-term investments

 
7,386

 
35,812

Income tax receivables

 
141

 
141

Other receivables
1,549

 
3,230

 
2,680

Merchandise inventories
31,578

 
31,209

 
42,587

Prepaid expenses and other current assets
13,235

 
12,742

 
13,289

Total current assets
65,420

 
93,480

 
124,593

EQUIPMENT AND LEASEHOLD IMPROVEMENTS:
 
 
 
 
 
Leasehold improvements
36,864

 
78,097

 
87,970

Furniture, fixtures and equipment
47,945

 
60,143

 
65,066

 
84,809

 
138,240

 
153,036

Less accumulated depreciation and amortization
(60,235
)
 
(81,951
)
 
(88,117
)
Net equipment and leasehold improvements
24,574

 
56,289

 
64,919

OTHER ASSETS:
 
 
 
 
 
Other assets
2,891

 
1,970

 
2,003

Total other assets
2,891

 
1,970

 
2,003

TOTAL ASSETS
$
92,885

 
$
151,739

 
$
191,515

LIABILITIES AND STOCKHOLDERS’ (DEFICIT) EQUITY
 
 
 
 
 
CURRENT LIABILITIES:
 
 
 
 
 
Current portion of convertible debt, net of discount of $2,808, at November 1, 2014
$
7,342

 
$

 
$

Accounts payable – merchandise
20,372

 
18,530

 
24,623

Accounts payable – other
7,189

 
8,814

 
11,361

Accrued liabilities
20,880

 
20,704

 
24,203

Current portion of deferred rent
3,632

 
3,508

 
3,909

Total current liabilities
59,415

 
51,556

 
64,096

LONG-TERM LIABILITIES:
 
 
 
 
 
Warrants and embedded derivatives
1,061

 

 

Senior convertible debt, net of discount of $1,501, at November 1, 2014
13,949

 

 

Deferred rent
28,992

 
31,066

 
31,092

Other long-term liabilities

 
1,784

 
1,796

Total long-term liabilities
44,002

 
32,850

 
32,888

Total liabilities
103,417

 
84,406

 
96,984

STOCKHOLDERS’ (DEFICIT) EQUITY:
 
 
 
 
 
Common stock, Class A, $0.10 par value, authorized 300,000,000 shares; 84,592,344 shares issued and 84,361,900 shares outstanding at November 1, 2014; 84,730,594 shares issued and 84,695,369 shares outstanding at February 1, 2014; and 84,730,594 shares issued and 84,724,419 shares outstanding at November 2, 2013
8,459

 
8,473

 
8,473

Common stock, Class B convertible, $0.10 par value, authorized 10,000,000 shares; no shares issued and outstanding

 

 

Paid-in capital
218,663

 
216,944

 
216,512

Accumulated deficit
(237,598
)
 
(157,864
)
 
(130,323
)
Treasury stock, 230,444, 35,225 and 6,175 shares, at cost, at November 1, 2014, February 1, 2014, and November 2, 2013, respectively
(56
)
 
(68
)
 
(4
)
Accumulated other comprehensive loss

 
(152
)
 
(127
)
Total stockholders’ (deficit) equity
(10,532
)
 
67,333

 
94,531

TOTAL LIABILITIES AND STOCKHOLDERS’ (DEFICIT) EQUITY
$
92,885

 
$
151,739

 
$
191,515

See notes to condensed consolidated financial statements.

1


THE WET SEAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited)
 
 
13 Weeks Ended
 
39 Weeks Ended
 
November 1, 2014
 
November 2, 2013
 
November 1, 2014
 
November 2, 2013
Net sales
$
104,295

 
$
114,878

 
$
316,326

 
$
358,245

Cost of sales
89,974

 
87,498

 
257,144

 
257,338

Gross margin
14,321

 
27,380

 
59,182

 
100,907

Selling, general, and administrative expenses
38,045

 
35,047

 
105,551

 
104,050

Asset impairment
12,586

 
4,761

 
29,324

 
6,156

Operating loss
(36,310
)
 
(12,428
)
 
(75,693
)
 
(9,299
)
Interest income
27

 
49

 
122

 
150

Interest expense
(1,372
)
 
(55
)
 
(3,088
)
 
(163
)
Interest expense, net
(1,345
)
 
(6
)
 
(2,966
)
 
(13
)
Gain on warrants and derivatives liabilities
1,695

 

 
4,630

 

Loss before provision for income taxes
(35,960
)
 
(12,434
)
 
(74,029
)
 
(9,312
)
Provision for income taxes
65

 
48

 
194

 
139

Loss from continuing operations
(36,025
)
 
(12,482
)
 
(74,223
)
 
(9,451
)
Income (loss) from discontinued operations, net of income taxes
$
81

 
$
(2,428
)
 
$
(5,511
)
 
$
(1,391
)
Net loss
$
(35,944
)
 
$
(14,910
)
 
$
(79,734
)
 
$
(10,842
)
Net loss per share from continuing operations
$
(0.43
)
 
$
(0.15
)
 
$
(0.88
)
 
$
(0.11
)
Net loss per share from discontinued operations, net of income taxes
$

 
$
(0.03
)
 
$
(0.07
)
 
$
(0.02
)
Net loss per share, basic
$
(0.43
)
 
$
(0.18
)
 
$
(0.95
)
 
$
(0.13
)
Net loss per share, diluted
$
(0.43
)
 
$
(0.18
)
 
$
(0.95
)
 
$
(0.13
)
Weighted-average shares outstanding, basic
84,289,028

 
83,729,646

 
84,192,836

 
86,028,985

Weighted-average shares outstanding, diluted
84,289,028

 
83,729,646

 
84,192,836

 
86,028,985

See notes to condensed consolidated financial statements.

2


THE WET SEAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
(Unaudited)

 
13 Weeks Ended
 
39 Weeks Ended
 
November 1, 2014

 
November 2, 2013

 
November 1, 2014

 
November 2, 2013

Net loss
$
(35,944
)
 
$
(14,910
)
 
$
(79,734
)
 
$
(10,842
)
Other comprehensive gain:
 
 
 
 
 
 
 
Gain on settlement of Supplemental Employee Retirement Plan Liability (1)

 

 
152

 

Comprehensive loss
$
(35,944
)
 
$
(14,910
)
 
$
(79,582
)
 
$
(10,842
)

(1) Amounts are shown net of income taxes. Due to the Company's valuation allowance, there is no tax impact. The entire Accumulated Other Comprehensive Loss ("AOCL") balance is related to the SERP liability. As such, the amount transferred out of AOCL in the 39 weeks ended November 1, 2014 relates entirely to the retirement of the SERP liability.
See notes to condensed consolidated financial statements.


3


THE WET SEAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ (DEFICIT) EQUITY
(In thousands, except share data)
(Unaudited)
 
 
Common Stock
 
Paid-In
Capital
 
Accumulated
Deficit
 
Treasury
Stock
 
Accumulated
Other
Comprehensive
Loss
 
Total
Stockholders’
(Deficit)
Equity
 
Class A
 
Class B
 
 
Shares
 
Par Value
 
Shares
 
Par Value
 
Balance at February 1, 2014
84,730,594

 
$
8,473

 

 
$

 
$
216,944

 
$
(157,864
)
 
$
(68
)
 
$
(152
)
 
$
67,333

Net loss

 

 

 

 

 
(79,734
)
 

 

 
(79,734
)
Stock issued pursuant to long-term incentive plans
213,442

 
21

 

 

 
(21
)
 

 

 

 

Stock-based compensation

 

 

 

 
1,609

 

 

 

 
1,609

Discount on convertible note due to increase in value of embedded conversion option

 

 

 

 
236

 

 

 

 
236

Settlement of SERP liability

 

 

 

 

 

 

 
152

 
152

Repurchase to cover employee tax withholding

 

 

 

 

 

 
(128
)
 

 
(128
)
Retirement of treasury stock
(351,692
)
 
(35
)
 

 

 
(105
)
 

 
140

 

 

Balance at November 1, 2014
84,592,344

 
$
8,459

 

 
$

 
$
218,663

 
$
(237,598
)
 
$
(56
)
 
$

 
$
(10,532
)
 
See notes to condensed consolidated financial statements.

4




THE WET SEAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands, except share data)
(Unaudited)
 
 
Common Stock
 
Paid-In
Capital
 
Accumulated
Deficit
 
Treasury
Stock
 
Accumulated
Other
Comprehensive
Loss
 
Total
Stockholders’
Equity
 
Class A
 
Class B
 
 
Shares
 
Par Value
 
Shares
 
Par Value
 
Balance at February 2, 2013
90,541,144

 
$
9,054

 

 
$

 
$
239,698

 
$
(119,481
)
 
$
(412
)
 
$
(127
)
 
$
128,732

Net loss

 

 

 

 

 
(10,842
)
 

 

 
(10,842
)
Stock issued pursuant to long-term incentive plans
496,292

 
50

 

 

 
(50
)
 

 

 

 

Stock-based compensation

 

 

 

 
1,212

 

 

 

 
1,212

Exercise of stock options
210,528

 
21

 

 

 
726

 

 

 

 
747

Repurchase of common stock

 

 

 

 

 

 
(25,318
)
 

 
(25,318
)
Retirement of treasury stock
(6,517,370
)
 
(652
)
 

 

 
(25,074
)
 

 
25,726

 

 

Balance at November 2, 2013
84,730,594

 
$
8,473

 

 
$

 
$
216,512

 
$
(130,323
)
 
$
(4
)
 
$
(127
)
 
$
94,531

See notes to condensed consolidated financial statements.

5


THE WET SEAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
39 Weeks Ended
 
November 1, 2014
 
November 2, 2013
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net loss
$
(79,734
)
 
$
(10,842
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
7,515

 
10,198

Amortization of debt discount
1,628

 

Amortization of premium on investments
6

 
123

Amortization of deferred financing costs
449

 
81

Gain on warrants and derivatives liabilities
(4,630
)
 

Gain on settlement of SERP liability
(696
)
 

Gain on termination of Arden B loyalty program
(237
)
 

Loss on disposal of equipment and leasehold improvements
202

 
83

Asset impairment
32,643

 
6,919

Stock-based compensation
1,609

 
1,212

Changes in operating assets and liabilities:
 
 
 
Income tax receivables
141

 
145

Other receivables
1,681

 
79

Merchandise inventories
(369
)
 
(8,799
)
Prepaid expenses and other current assets
30

 
73

Other non-current assets
1,549

 
29

Accounts payable and accrued liabilities
1,334

 
(3,295
)
Deferred rent
(1,950
)
 
576

Other long-term liabilities
(1,156
)
 
(112
)
Net cash used in operating activities
(39,985
)
 
(3,530
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchase of equipment and leasehold improvements
(9,331
)
 
(15,853
)
Proceeds from disposal of equipment and leasehold improvements
23

 

Investment in marketable securities

 
(9,500
)
Proceeds from maturity of marketable securities
7,380

 
41,259

Net cash (used in) provided by investing activities
(1,928
)
 
15,906

CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from exercise of stock options

 
747

Repurchase of common stock
(128
)
 
(25,318
)
Payment of deferred financing costs
(3,273
)
 

Proceeds from issuance of senior convertible note
27,000

 

Payment of principal on senior convertible note
(1,400
)
 

Net cash provided by (used in) financing activities
22,199

 
(24,571
)
NET DECREASE IN CASH AND CASH EQUIVALENTS
(19,714
)
 
(12,195
)
CASH AND CASH EQUIVALENTS, beginning of period
38,772

 
42,279

CASH AND CASH EQUIVALENTS, end of period
$
19,058

 
$
30,084

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
1,027

 
$
57

Income taxes
$
220

 
$
267

SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING TRANSACTIONS:
 
 
 
Retirement of treasury shares
$
140

 
$
25,726

Purchase of equipment and leasehold improvements unpaid at end of period
$
1,155

 
$
4,170

Initial fair value of warrants liability
$
3,610

 

Initial fair value of embedded derivatives liability
$
2,081

 

Discount on convertible note due to increase in value of embedded conversion option
$
236

 

See notes to condensed consolidated financial statements.

6

THE WET SEAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the 39 weeks ended November 1, 2014, and November 2, 2013
(Unaudited)


NOTE 1 – Summary of Significant Accounting Policies
Basis of Presentation
The information set forth in these condensed consolidated financial statements as of and for the 13 and 39 weeks ended November 1, 2014, and November 2, 2013 (collectively, the “Interim Financial Statements”), is unaudited. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information. Certain information and footnote disclosures normally included in The Wet Seal, Inc. (the “Company”) annual consolidated financial statements have been condensed or omitted, as permitted under applicable rules and regulations. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended February 1, 2014. All references in this Quarterly Report on Form 10-Q to “fiscal 2013” and “fiscal 2014” mean the fiscal years ended February 1, 2014 and ending January 31, 2015, respectively.
In the opinion of management, the Interim Financial Statements reflect all adjustments that are of a normal and recurring nature necessary to fairly present the Company’s financial position and results of operations and cash flows in all material respects as of the dates and for the periods presented. The results of operations presented in the Interim Financial Statements are not necessarily indicative of the results that may be expected for the fiscal year ending January 31, 2015.
On April 24, 2014, the Company committed to a plan to wind down the operations of its Arden B brand due to the long-term financial under-performance of the business. The Company evaluated the applicable accounting guidance for discontinued operations due to the wind down of the Arden B operations and concluded that the Arden B segment should be reported as discontinued operations. Arden B cash flows have ceased as of November 1, 2014, the end of the third quarter. The Company will not have any significant continuing involvement with the Arden B segment, and therefore, the Arden B segment has met the conditions to be reported as a discontinued operation beginning in the third quarter of fiscal 2014. Refer to Note 2, "Discontinued Operations."
In fiscal 2013 and the 39 weeks ended November 1, 2014, the Company incurred net losses of $38.4 million and $79.7 million and negative cash flow from operations of $17.6 million and $40.0 million, respectively.  As of November 1, 2014, the Company had cash and cash equivalents of $19.1 million compared to cash and cash equivalents of $38.8 million at February 1, 2014. For the three fiscal quarters ended November 1, 2014, the Company has experienced comparable store sales and gross margin performance that were worse than expected entering fiscal 2014, and a number of factors continue to negatively impact the Company and the retail fashion apparel industry in which it does business. The Company expects to report net losses and negative cash flow from operations through at least the fourth quarter of fiscal 2014, and may also incur significant net losses and negative cash flows beyond the fourth quarter. The Company’s negative cash flows from operations have adversely impacted the Company’s cash and liquidity reserves. Concerns about the Company’s financial condition have adversely impacted the terms the Company can obtain from some of its vendors, and some of its vendors and their factors are unwilling to continue to extend credit to the Company or otherwise now require that the Company obtain letters of credit or other forms of credit support. The Company has issued letters of credit as collateral to certain vendors and factors that provide financial support to certain vendors and may issue additional letters of credit, and these letters of credit have utilized, and may further utilize, a significant amount of the borrowing capacity under the Company’s senior revolving credit facility and reduce the amount of available borrowing capacity for general corporate and other purposes. As of the date of this filing, the total amount of our outstanding letters of credit has more than doubled since the end of our second fiscal quarter, increasing by approximately $6.9 million. The Company has also received notice from The NASDAQ OMX Group ("Nasdaq") indicating that the bid price of its common stock for the 30 consecutive business days ended August 15, 2014 had closed below the minimum $1.00 per share required for continued listing under Nasdaq listing rules, which could result in Nasdaq de-listing the Company’s common stock if not cured within a 180-day period, subject to additional applicable grace periods for which the Company may be eligible. If the Company’s common stock is not listed on the Nasdaq Global Select Market, the Nasdaq Global Market, the Nasdaq Capital Market or other eligible market, it would result in an event of default under the Company’s senior convertible note, which event of default would also result in a default under our senior revolving credit facility, whereupon the holder under the Company’s senior convertible note and the lender under the Company’s senior revolving credit facility could accelerate the indebtedness under such note and facility.
In an effort to address the Company’s immediate liquidity needs, the Company is, with the assistance of its strategic advisors, exploring various potential strategic and financial alternatives and is engaged in discussions with third parties, as well as key financial stakeholders, including lenders, stockholders, landlords and others. Such strategic and financial alternatives include,

7

THE WET SEAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the 39 weeks ended November 1, 2014, and November 2, 2013
(Unaudited)

among other things, consideration of out-of-court restructurings as well as bankruptcy court proceedings to recapitalize or restructure the Company’s indebtedness and other obligations. With the assistance of its advisors, the Company is attempting to raise new additional capital in the very near term to address its immediate liquidity needs. As of the date of this filing, the Company is evaluating its ability to successfully raise equity capital pursuant to its previously announced contemplated private placement and rights offering in light of its financial condition and immediate liquidity needs, the terms and conditions of such contemplated transactions and the related risks and uncertainties concerning such transactions. As a result of this evaluation, such transactions have been delayed and even if completed, we expect that such transactions will not close in the current fiscal year. Additionally, a number of factors may cause delays or difficulties with such transactions and the closings of such transactions are subject to conditions, some of which are outside of the Company’s control. Accordingly, no assurances can be given that these contemplated transactions will close. Furthermore, in order to address its immediate liquidity needs, the Company believes it needs to raise new additional capital in the form of equity and/or debt in the very near term.
    The Company has taken steps to reduce its costs, including reducing overhead costs. In this regard, in October 2014 the Company announced a workforce reduction resulting in the elimination of 78 filled and open positions and continues to evaluate how it can further rationalize the total number of its employees given its anticipated revenues, number of stores and organizational structure. Further, the Company is seeking ways it can reduce the number of its stores and is engaging in discussions with landlords seeking concessions from such landlords in the form of reduced monthly rent or suspended rental payments in an effort to reduce its rental obligations. In addition to these actions, the Company anticipates that it will critically evaluate any leases which by their terms expire in the near term and it anticipates not renewing the vast majority of such leases.
In November 2014, the Company entered into a commitment letter with the agent and the lender under its existing senior secured revolving credit facility which would, subject to the conditions set forth therein, among other things, extend the maturity date of the facility to the fifth anniversary of the closing date of the amendment and increase certain advance rates used to determine the borrowing base under the revolving credit facility. In addition, the Company entered into a commitment letter with a third party lender, pursuant to which the potential lender, subject to the conditions set forth therein, committed to provide the Company with a $10.0 million term loan secured by all of its assets, which loan would constitute a use of the incremental facility included in the Company’s senior revolving credit facility.
As of the date of this filing, the discussions and efforts described above have not resulted in a strategic or financial transaction, a recapitalization, a restructuring or the raising of new additional capital, and no assurances can be given that such discussions and efforts will successfully result in a transaction, recapitalization, restructuring or the raising of new additional capital, or if a transaction, recapitalization or restructuring is undertaken, or if new capital is raised, as to its terms or timing. Uncertainty exists as to the outcome of the efforts and discussions described above and a number of factors could impact the outcome of such efforts and discussions and cause the Company’s actual results to differ from its expectations. Concerns of vendors, landlords, employees, potential financing sources and others about the Company’s financial condition may make it more difficult for the Company to succeed in its efforts to address its immediate liquidity needs in the very near term. If the Company continues to experience negative cash flows from operations, the Company would deplete its cash reserves and working capital in the very near term and require other sources of financing to fund its operations, which sources might not be available, or if available, may not be on terms acceptable to the Company. If the Company is unsuccessful in the very near term in its efforts to address its immediate liquidity needs or otherwise experiences delays and difficulties in such efforts, the Company’s business, liquidity and financial condition would be materially and adversely affected and the Company may deem it advisable to seek a restructuring or other relief under the provisions of the U.S. Bankruptcy Code, which could lead to a significant and possibly total loss of investment for holders of the Company’s Class A common stock.
Each of the above factors, or a combination thereof, reflect risks and uncertainties that raise substantial doubt about the Company’s ability to continue as a going concern.
Significant Accounting Policies
Long-Lived Assets
The Company evaluates the carrying value of long-lived assets for impairment quarterly or whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Factors that are considered important that could result in the necessity to perform an impairment review include a current-period operating or cash flow loss combined with a history of operating or cash flow losses and a projection or forecast that indicates continuing losses or insufficient income associated with the realization of a long-lived asset or asset group. Other factors include a significant change in the manner of the

8

THE WET SEAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the 39 weeks ended November 1, 2014, and November 2, 2013
(Unaudited)

use of the asset or a significant negative industry or economic trend. This evaluation is performed based on estimated undiscounted future cash flows from operating activities compared with the carrying value of the related assets. If the estimated undiscounted future cash flows are less than the carrying value, an impairment loss is recognized, measured by the difference between the carrying value and the estimated fair value of the assets, based on discounted estimated future cash flows using the Company’s weighted average cost of capital. With regard to store assets, which are comprised of leasehold improvements, fixtures and computer hardware and software, the Company considers the assets at each individual store to represent an asset group. In addition, the Company has considered the relevant valuation techniques that could be applied without undue cost and effort and has determined that the discounted estimated future cash flow approach provides the most relevant and reliable means by which to determine fair value in this circumstance.
The Company conducts its quarterly impairment evaluation at the individual store level using the guidance under applicable accounting standards. The quarterly analysis includes the Company's estimates of future cash flows using only the cash inflows and outflows that are directly related to each store over the remaining lease term. Key assumptions made by the Company and included within the cash flow estimates are future sales and gross margin projections. The Company determines the future sales and gross margin projections by considering each store's recent and historical performance, the Company's overall performance trends and projections and the potential impact of strategic initiatives on future performance.
The Company's evaluations during the 13 and 39 weeks ended November 1, 2014, and November 2, 2013 included impairment testing of 67, 147, 38 and 55 stores and resulted in 53, 133, 22 and 28 stores being impaired, respectively, as their projected future cash flows were not sufficient to recover the net carrying value of their assets. Due to the Company's wind down of the Arden B brand, during the quarter ended May 3, 2014, it tested all Arden B stores with carrying value and the corporate assets associated with the Arden B website, which was also impaired as of May 3, 2014.
The Company recorded the following non-cash charges within asset impairment in the condensed consolidated statements of operations to write down the carrying values of impaired stores' long-lived assets to their estimated fair values (in thousands except for number of stores):
 
 
13 Weeks Ended
39 Weeks Ended
 
 
November 1, 2014
 
November 2, 2013
 
November 1, 2014
 
November 2, 2013
Aggregate carrying value of all long-lived assets impaired
 
$
12,586

 
$
5,418

 
$
29,738

 
$
7,054

Less: Impairment charges - stores
 
12,586

 
4,761

 
29,324

 
6,156

Aggregate fair value of all long-lived assets impaired
 
$

 
$
657

 
$
414

 
$
898

Number of stores with asset impairment
 
53

 
22

 
133

 
28

Of the 14 stores that were tested and determined not to be impaired during the 13 weeks ended November 1, 2014, 10 could be deemed to be at risk of future impairment. When making this determination, the Company considered the potential impact that reasonably possible changes to sales and gross margin performance versus the Company's current projections for these stores could have on their current estimated cash flows.
As noted above, the Company considers the potential impact expected from its strategic initiatives when determining the key assumptions to use within the projected cash flows for each store during its quarterly analysis. If the Company is not able to achieve its projected key financial metrics, and the strategic initiatives being implemented do not result in significant improvements in the Company's current financial performance trend, the Company may incur additional impairment in the future for those stores and corporate assets tested and not deemed to be impaired in its most recent quarterly analysis, as well as for additional stores not tested in its most recent quarterly analysis. In addition, we evaluated the corporate assets for 13 weeks ended November 1, 2014, noting no corporate asset impairments were required. Refer to Note 2, "Discontinued Operations."
Capitalized interest included in equipment and leasehold improvements, net, totaled less than $0.1 million during the 13 and 39 weeks ended November 1, 2014.

9

THE WET SEAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the 39 weeks ended November 1, 2014, and November 2, 2013
(Unaudited)

Discontinued Operations
The Company evaluated the applicable accounting guidance for discontinued operations due to the wind down of the Arden B operations and concluded that the Arden B segment should be reported as discontinued operations. Refer to Note 2, "Discontinued Operations."
Warrants for Common Stock and Embedded Derivatives
The Company’s common stock warrants and embedded derivatives have been bifurcated from the debt host and are classified as liabilities on the condensed consolidated balance sheet. The Company records the warrants and embedded derivatives liabilities at fair value and adjusts the carrying values to their estimated fair value at each reporting date, with the increases or decreases in the fair values at each reporting date recorded as a gain or (loss) in the condensed consolidated statements of operations. Refer to Note 5, "Senior Convertible Note and Warrants" and Note 6, "Fair Value Measurements and Disclosures."
Income Taxes
The Company accounts for income taxes in accordance with applicable accounting standards which require that the Company recognize deferred tax assets, which include net operating loss carryforwards (NOLs) and tax credits, and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities, using enacted tax rates in effect in the years the differences are expected to reverse. Deferred income tax expense or benefit results from the change in net deferred tax assets or deferred tax liabilities. Such guidance requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. Due to the Company's three-year cumulative operating losses, the Company established a valuation allowance against all of its deferred tax assets in fiscal 2012. In addition, the Company discontinued recording income tax benefits in the condensed consolidated statements of operations. The Company will not record income tax benefits until it is determined that it is more likely than not that the Company will generate sufficient taxable income to realize the deferred income tax assets. The Company remains in a cumulative three-year operating loss position and realization of its deferred income tax assets is not deemed to be more likely than not. Prospectively, as the Company continues to evaluate available evidence, it is possible that the Company may deem some or all of its deferred income tax assets to be realizable.
The Company has approximately $165.6 million of federal NOLs available to offset taxable income in fiscal 2014 and thereafter, subject to certain annual limitations based on the provisions of Section 382 of the Internal Revenue Code. It is possible that future financings, if completed, may result in additional ownership changes for purposes of Section 382, which could significantly impair the Company's ability to utilize the NOL. The Company's effective tax rates from continuing operations for the 13 and 39 weeks ended November 1, 2014, were approximately negative 0.2% and negative 0.3%, respectively, despite its net loss. These effective rates are due to certain state income taxes for fiscal 2014 that are not based on consolidated net income. The Company expects a negative 0.3% effective income tax rate for fiscal 2014, although a number of factors could cause its actual effective tax rate for fiscal 2014 to differ.
Other Comprehensive Income
Other comprehensive income refers to gains and losses that are recorded as an element of stockholders' equity but are excluded from net loss. Employers are required to recognize the over or under funded status of defined benefit plans and other postretirement plans in the statement of financial position and to recognize changes in the funded status in the year in which the changes occur through comprehensive (loss) income. Accumulated other comprehensive (loss) income in the condensed consolidated balance sheets as of November 1, 2014 is zero, due to the settlement of the Company’s supplemental employee retirement plan liability. Refer to Note 3, Stock-Based Compensation and Supplemental Employee Retirement Plan.
Business Segment
GAAP has established guidance for reporting information about a company's operating segments, including disclosures related to a company's products and services, geographic areas and major customers. As of November 1, 2014, the Company has a single operating and reportable segment, which includes net sales generated from its retail stores and e-commerce website.


10

THE WET SEAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the 39 weeks ended November 1, 2014, and November 2, 2013
(Unaudited)

Recent Accounting Pronouncements
In April 2014, the Financial Accounting Standards Board ("FASB") issued amended guidance on the presentation of financial statements and reporting discontinued operations and disclosures of disposals of components of an entity within property, plant and equipment. This guidance amends the definition of a discontinued operation and requires entities to disclose additional information about disposal transactions that do not meet the discontinued-operations criteria. The effective date is for disposals that occur in annual periods (and interim periods therein) beginning on or after December 15, 2014. Early adoption is permitted. As discussed under "Basis of Presentation" above, the Company evaluated its wind down of the Arden B brand under the existing discontinued operations guidance and did not elect early adoption of this amended guidance.
In May 2014, the FASB issued a new accounting standard which amends the existing accounting standards for revenue recognition. This new standard is based on principles that govern the recognition of revenue at an amount to which an entity expects to be entitled when products are transferred to customers. The Company is required to adopt this new standard for annual and interim periods beginning after December 15, 2016. Early adoption is not permitted. The new revenue accounting standard may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption. Based on the Company’s evaluation of this standard, adoption is not expected to have a material impact on the Company’s consolidated financial statements.
In June 2014, the FASB issued a new stock compensation accounting standard, which requires an entity to treat a performance target that affects vesting and that could be achieved after the requisite service period as a performance condition. Under this new standard, the performance target should not be reflected in estimating the grant-date fair value of the award, and compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved, and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered; if the performance target becomes probable of being achieved before the end of the requisite service period, then the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest, and should be adjusted to reflect those awards that ultimately vest. The Company is required to adopt this new standard for annual and interim periods beginning after December 15, 2015. The Company does not expect the adoption of this new standard to have a material impact on its consolidated financial statements.
In August 2014, the FASB issued a new accounting standard which requires management to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern for each annual and interim reporting period. If substantial doubt exists, additional disclosure is required. This new standard will be effective for the Company for annual and interim periods beginning after December 15, 2016. Early adoption is permitted. The Company expects to adopt this new standard for the fiscal year ending February 3, 2018 and the Company will continue to assess the impact on its consolidated financial statements.
In November 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update 2014-16, Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity (a consensus of the FASB Emerging Issues Task Force). This update does not change the current criteria in GAAP for determining when separation of certain embedded derivative features in a hybrid financial instrument is required, but clarifies how current GAAP should be interpreted in the evaluation of the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share, reducing existing diversity in practice. The Company is evaluating this update to determine if this guidance will have a material impact on the Company’s condensed consolidated financial statements.
NOTE 2 – Discontinued Operations
On April 24, 2014, the Company committed to a plan to wind down the operations of its Arden B brand (the "Plan") due to the long-term financial under-performance of the business. As of August 2, 2014, the Company operated 51 Arden B stores. During the Company's third quarter, 30 of the Arden B stores became Wet Seal Plus stores, and 18 of the Arden B stores became Wet Seal stores, one of the Arden B stores continues to operate under the Arden B name, but has been transitioned to carry Wet Seal product, and the 2 remaining stores closed in August 2014. The Company closed down the Arden B website in the third fiscal quarter of 2014.

11

THE WET SEAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the 39 weeks ended November 1, 2014, and November 2, 2013
(Unaudited)

The Company evaluated the applicable accounting guidance for discontinued operations due to the wind down of the Arden B operations and concluded that the Arden B segment should be reported as discontinued operations. Arden B cash flows have ceased as of November 1, 2014, the end of the third quarter. The Company will not have any significant continuing involvement with the Arden B segment, and therefore, the Arden B segment has met the conditions to be reported as a discontinued operation beginning in the third quarter of fiscal 2014. The Company maintains its intellectual property rights in the Arden B brand and affiliated trademarks and is exploring opportunities to preserve or monetize those rights. Financial information for the 13 and 39 weeks ended November 1, 2014, and November 2, 2013 has been adjusted for the presentation of discontinued operations.

The operating results of discontinued operations for Arden B included in the accompanying condensed consolidated statements of operations are as follows:
 
13 Weeks Ended
 
39 Weeks Ended
 
November 1, 2014
 
November 2, 2013
 
November 1, 2014
 
November 2, 2013
Net Sales
$
441

 
$
12,786

 
$
26,314

 
$
47,113

Income (loss) before income taxes
77

 
(2,427
)
 
(5,501
)
 
(1,379
)
(Benefit) provision for income taxes
(4
)
 
1

 
10

 
12

Income (loss) from discontinued operations
$
81

 
$
(2,428
)
 
$
(5,511
)
 
$
(1,391
)
The income (loss) from discontinued operations for the 13 and 39 weeks ended November 1, 2014 and November 2, 2013, include asset impairments of none, $3.3 million, $0.3 million and $0.8 million, respectively. The asset impairment of $3.3 million for the 39 weeks ended November 1, 2014 included $0.4 million of impairments for the Arden B website. Upon ceasing these operations, the Company transitioned most of the Arden B store employees to Wet Seal and Wet Seal Plus stores.
NOTE 3 – Stock-Based Compensation and Supplemental Employee Retirement Plan
The Company has one stock incentive plan under which shares were available for grant at November 1, 2014: the 2005 Stock Incentive Plan (the “2005 Plan”). The Company previously granted share awards under its 1996 Long-Term Incentive Plan (the “1996 Plan”) that remain unvested and/or unexercised as of November 1, 2014. The 1996 Plan expired during fiscal 2006, and no further share awards may be granted under the 1996 Plan. The 2005 Plan and the 1996 Plan are collectively referred to as the “Plans.”
The 2005 Plan permits the granting of options, restricted common stock, performance share awards, restricted and performance stock units, or other equity-based awards to the Company’s employees, officers, directors, and consultants. The Company believes the granting of equity-based awards helps to align the interests of its employees, officers and directors with those of its stockholders. The Company has a practice of issuing new shares to satisfy stock option exercises, as well as for restricted stock, performance share grants and other awards made or settled in the form of Company stock. The 2005 Plan was approved by the Company’s stockholders on January 10, 2005, as amended with stockholder approval on July 20, 2005, for the issuance of incentive awards covering 12,500,000 shares of Class A common stock. Additionally, an amended and restated 2005 Plan was approved by the Company’s stockholders on May 19, 2010, which increased the incentive awards capacity to 17,500,000 shares of Class A common stock. The Company amended the 2005 Plan in August 2014 to permit the grant of up to 4,000,000 shares as inducement grants. An aggregate of 22,495,528 shares of Class A common stock have been issued or may be issued pursuant to the Plans. As of November 1, 2014, 4,094,743 shares were available for future grants under the 2005 Plan.
Stock Options
The Plans provide that the per-share exercise price of a stock option may not be less than the fair market value of the Company’s Class A common stock on the date the option is granted. Under the Plans, outstanding options vest over periods ranging from three to five years from the grant date and expire from five to ten years after the grant date. Certain stock option and other equity-based awards provide for accelerated vesting if there is a change in control (as defined in the Plans). The Company records compensation expense for employee stock options based on the estimated fair value of the options on the date of grant using the

12

THE WET SEAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the 39 weeks ended November 1, 2014, and November 2, 2013
(Unaudited)

Black-Scholes option-pricing model. The Company uses historical data, the implied volatility of market-traded options and other factors to estimate the expected price volatility, option lives, and forfeiture rates.
The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant and the estimated life of the option. The following weighted-average assumptions were used to estimate the fair value of options granted during the periods indicated using the Black-Scholes option-pricing model:
 
13 Weeks Ended
 
39 Weeks Ended
 
November 1, 2014
 
November 2, 2013
 
November 1, 2014
 
November 2, 2013
Dividend Yield
%
 
%
 
%
 
%
Expected Volatility
41.66
%
 
40.73
%
 
41.66
%
 
40.89
%
Risk-Free Interest Rate
1.04
%
 
1.00
%
 
1.02
%
 
0.63
%
Expected Life of Options (in Years)
3.3

 
3.3

 
3.3

 
3.3

At November 1, 2014, there was $0.3 million of total unrecognized compensation expense related to nonvested stock options under the Company’s share-based payment plans, which will be recognized over an average period of 2.5 years, representing the remaining vesting periods of such options through fiscal 2017.
The following table summarizes the Company’s stock option activities with respect to its Plans for the 39 weeks ended November 1, 2014 (aggregate intrinsic value in thousands):
Options
Number of
Shares
 
Weighted-
Average
Exercise
Price Per
Share
 
Weighted-
Average
Remaining
Contractual Life
(in years)
 
Aggregate
Intrinsic
Value
Outstanding at February 1, 2014
882,333

 
$
3.82

 
 
 
 
Granted
1,980,241

 
$
1.24

 
 
 
 
Exercised

 
$

 
 
 
 
Canceled
(1,453,602
)
 
$
3.76

 
 
 
 
Outstanding at November 1, 2014
1,408,972

 
$
1.99

 
3.90
 
$

Vested and expected to vest in the future at November 1, 2014
1,186,232

 
$
2.17

 
3.76
 
$

Exercisable at November 1, 2014
436,927

 
$
3.82

 
2.29
 
$

Options vested and expected to vest in the future are comprised of all options outstanding at November 1, 2014, net of estimated forfeitures. Additional information regarding stock options outstanding as of November 1, 2014, is as follows:
 
Options Outstanding
 
Options Exercisable
Range of Exercise Prices
Number
Outstanding
as of
November 1, 2014
 
Weighted-
Average
Remaining
Contractual Life
(in years)
 
Weighted-
Average
Exercise
Price Per
Share
 
Number
Exercisable
as of
November 1, 2014
 
Weighted-
Average
Exercise
Price Per
Share
$ 0.38 - $ 0.63
514,995

 
4.89
 
$
0.52

 

 
$

$ 0.86 - $ 1.32
30,000

 
4.57
 
$
1.09

 

 
$

$ 1.52 - $ 2.36
340,378

 
4.46
 
$
1.56

 

 
$

$ 2.45 -  $ 3.76
240,666

 
3.04
 
$
3.20

 
173,996

 
$
3.20

$ 4.15 - $ 4.97
282,933

 
2.08
 
$
4.26

 
262,931

 
$
4.23

$ 0.38 - $ 4.97
1,408,972

 
3.90
 
$
1.99

 
436,927

 
$
3.82

The weighted-average grant-date fair value of options granted during the 13 and 39 weeks ended November 1, 2014, and November 2, 2013, was $0.27, $0.27, $1.13 and $1.13, respectively. No options were exercised during the 13 and 39 weeks ended November 1, 2014. The total intrinsic values for options exercised during the 13 and 39 weeks ended November 2, 2013, was less than $0.1 million and $0.2 million, respectively.

13

THE WET SEAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the 39 weeks ended November 1, 2014, and November 2, 2013
(Unaudited)

Cash received from option exercises under the Plans for the 39 weeks ended November 2, 2013, was $0.7 million. The Company did not realize tax benefits for the tax deductions from option exercises as it must first utilize its regular NOL prior to realizing the excess tax benefits.
Restricted Stock Units, Restricted Common Stock, Performance Stock Units, and Performance Share Awards
Under the 2005 Plan, the Company grants directors, certain executives and other key employees restricted common stock and restricted stock units with vesting contingent upon completion of specified service periods ranging from one to three years. The Company also grants certain executives performance share awards and performance stock units with vesting contingent upon a combination of specified service periods and the Company’s achievement of a specified corporate performance objective or future share price. Restricted stock units awarded to employees represent the right to receive one share of the Company's Class A common stock upon vesting.
During the 39 weeks ended November 1, 2014, and November 2, 2013, the Company granted 3,386,263 and 249,338 of restricted stock units, respectively, to certain employees under the Plans. The weighted-average grant-date fair value of the restricted stock units during the 39 weeks ended November 1, 2014, and November 2, 2013, was $1.03 and $3.67 per share, respectively. Additionally, during the 39 weeks ended November 2, 2013, the Company granted 234,759 shares of restricted common stock to certain employees and directors under the Plans, with a weighted-average grant-date fair value of $3.03 per share. During the 39 weeks ended November 1, 2014, the Company did not grant restricted common stock to its employees.
During the 39 Weeks Ended November 1, 2014, the Company granted 3,595,178 performance stock units to certain employees under the Plans with a weighted-average grant-date fair value of $0.42 per share. During the 39 weeks ended November 2, 2013, the Company granted 183,758 performance stock units to certain employees under the 2005 Plan, with a weighted-average grant-date fair value of $3.09 per share. Additionally, the Company granted 261,533 performance share awards under the 2005 Plan during the 39 weeks ended November 2, 2013, with a grant-date fair value of $2.95 per share. All of the performance share awards and performance stock units granted in fiscal 2013 were subsequently forfeited due to the failure to achieve the performance metric.
The fair value of nonvested restricted common stock units and restricted stock awards is equal to the price of the Company’s Class A common stock on the grant date. The following table summarizes activity with respect to the Company’s restricted stock units, restricted common stock and performance stock units during the 39 weeks ended November 1, 2014:
Restricted Stock Units, Restricted Common Stock, and Performance Stock Units
Number of Shares
 
Weighted-Average Grant-Date Fair Value
Nonvested at February 1, 2014
899,939

 
$
3.06

Granted
6,981,441

 
$
0.71

Vested
(436,345
)
 
$
2.87

Forfeited
(751,510
)
 
$
1.98

Nonvested at November 1, 2014
6,693,525

 
$
0.74

On September 3, 2014, the Company accelerated the vesting of 100,000 restricted stock awards as part of the severance agreement for the former CEO. At November 1, 2014, there was $2.3 million of total unrecognized compensation expense related to nonvested restricted common stock and restricted stock units under the Plans. That cost is expected to be recognized over a weighted-average period of 2.4 years, representing the remaining vesting periods of such stock awards through fiscal 2017.
The following tables summarize stock-based compensation recorded in the condensed consolidated statements of operations (in thousands):
 
13 Weeks Ended
 
39 Weeks Ended
 
November 1, 2014
 
November 2, 2013
 
November 1, 2014
 
November 2, 2013
Stock options
$
26

 
$
89

 
$
108

 
$
211

Restricted stock awards and units
444

 
278

 
1,467

 
1,001

Performance share units
34

 

 
34

 

Stock-based compensation
$
504

 
$
367

 
$
1,609

 
$
1,212


14

THE WET SEAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the 39 weeks ended November 1, 2014, and November 2, 2013
(Unaudited)

 
13 Weeks Ended
 
39 weeks ended
 
November 1, 2014
 
November 2, 2013
 
November 1, 2014
 
November 2, 2013
Cost of sales
$
81

 
$
117

 
$
157

 
$
239

Selling, general, and administrative expenses
423

 
250

 
1,452

 
973

Stock-based compensation
$
504

 
$
367

 
$
1,609

 
$
1,212


Supplemental Employee Retirement Plan
The Company maintained a defined benefit Supplemental Employee Retirement Plan (the “SERP”) for a former Chairman of the Board of Directors of the Company. The Company funded the SERP in prior years through contributions to a trust fund known as a “Rabbi” trust. Funds were held in a Rabbi trust for the SERP consisting of a life insurance policy reported at cash surrender value. On May 21, 2014, the Company surrendered the life insurance policy for its cash value of $1.4 million, settled its SERP plan liability by transferring the obligation to a transferee in exchange for a cash payment of $1.1 million to the transferee, and recognized a gain of $0.7 million as a result of such transfer, which is included in the selling, general, and administrative expenses line in the condensed consolidated statements of operations.
NOTE 4 – Senior Revolving Credit Facility
The Company maintains a $35.0 million senior revolving credit facility (the “Facility”), which can be increased up to $50.0 million in the absence of any default and upon the satisfaction of certain conditions precedent specified in the Facility. The Facility expires in February 2016. Under the Facility, the Company is subject to borrowing base limitations on the amount that can be borrowed and certain customary covenants, including, under certain circumstances, covenants limiting the ability to incur additional indebtedness, make investments and acquisitions, grant liens, pay dividends, repurchase its Class A common stock, close stores, and dispose of assets, without the lender’s consent. The ability of the Company to borrow and request the issuance of letters of credit is subject to the requirement that the Company maintain an excess of the borrowing base over the outstanding credit extensions of the greater of 10% of the aggregate amount of the Facility or $4.0 million. The annual interest rate on the revolving line of credit under the Facility is (i) the higher of the lender’s prime rate, the Federal funds rate plus 0.5% or the one month London InterBank Offered Rate (LIBOR) plus 1.0%, collectively referred to as the “Base Rate”, plus the applicable margin ranging from 0.5% to 1.0% or, (ii) if the Company elects, either the one, two, three or six months LIBOR plus a margin ranging from 1.5% to 2.0%. The applicable Base Rate or LIBOR margin is based on the level of average excess availability, as defined under the Facility, at the time of election, as adjusted quarterly. The Company also incurs fees on outstanding letters of credit under the Facility at an annual rate equal to the applicable LIBOR margin for standby letters of credit and 23.0% of the applicable LIBOR margin for commercial letters of credit. Additionally, the Company is subject to commitment fees at an annual rate of 0.25% on the unused portion of the line of credit under the Facility.
Borrowings under the Facility are secured by cash, cash equivalents, investments, receivables and inventory held by the Company and three of its wholly owned subsidiaries, The Wet Seal Retail, Inc. and Wet Seal Catalog, Inc., each of which may be a borrower under the Facility, and Wet Seal GC, LLC, which is a guarantor of the obligations owing under the Facility.
At November 1, 2014, the amount outstanding under the Facility consisted of $3.1 million in documentary letters of credit related to merchandise purchases and $9.3 million in standby letters of credit, and the Company had $22.6 million available under the Facility for cash advances and/or the issuance of additional letters of credit, subject to the borrowing limitations noted above.
On September 2, 2014, the Company executed a consent agreement with the agent under its senior revolving credit facility whereby the agent and lenders under the senior revolving credit facility (a) consented to (i) the replacement of the Company's senior convertible note and warrants (see Note 5, "Senior Convertible Note and Warrants") with the new note and new warrant as described below and (ii) the consummation of the rights offering and the related equity issuances and the other transactions contemplated by the private placement (see Note 1, Summary of Significant Accounting Policies), (b) agreed that any reference in the credit agreement and the other loan documents to the "Senior Convertible Note and Warrants" shall be deemed to refer to the new note and new warrant and acknowledge and agree that the indebtedness evidenced by the new note and new warrant constitutes "Permitted Indebtedness", and (c) agreed that the related equity issuance and the issuances of equity interests in connection with the rights offering shall not be deemed to be a "Prepayment Event" under the credit agreement; provided that, in the event that a cash dominion event shall have occurred and be continuing at the time of receipt by the Company of any proceeds from the related

15

THE WET SEAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the 39 weeks ended November 1, 2014, and November 2, 2013
(Unaudited)

equity issuance and the issuances of equity interests in connection with the rights offering, the Company shall cause such proceeds to be deposited in the concentration account as required under the credit agreement evidencing the senior revolving credit facility.
On October 3, 2014, the Company entered into a Second Amendment to Amended and Restated Credit Agreement (the “Second Amendment”), pursuant to which the Company and the other borrowers, lenders and agents party thereto agreed to amend (i) certain conditions precedent to credit extensions and (ii) the Company’s representations and warranties related to the absence of certain material adverse changes to provide that such representation will be made with respect to changes occurring since February 1, 2014. Refer to Note 1, "Summary of Significant Accounting Policies."
At November 1, 2014, the Company was in compliance with all covenant requirements under the Facility.
NOTE 5 – Senior Convertible Note and Warrants
On March 26, 2014, the Company sold a $27.0 million senior convertible note and issued warrants to purchase up to 8,804,348 shares of the Company's Class A common stock in a private placement to a single institutional investor with proceeds to the Company, net of $1.9 million of deferred financing costs, of $25.1 million. The Company is using the proceeds for general corporate purposes.
On September 3, 2014, the Company entered into an Amendment, Consent and Exchange Agreement (the “Exchange Agreement”) whereby the Company agreed to issue a new senior convertible note in principal amount equal to $27 million in exchange for the initial note and a new warrant to purchase up to 8,804,348 shares of the Company's Class A common stock in exchange for the initial warrants. The new note is convertible into shares of the Company's Class A common stock and is entitled to earn interest, which may be paid in cash or in shares of common stock. The new warrant is exercisable into shares of the Company's Class A common stock.
The new note and the new warrant are identical in all material respects to the initial note and the initial warrants, respectively, except:
The new note clarifies what certifications must be made by the Company upon payment of interest in shares of common stock;
The investor’s “maximum percentage” in each of the new note and the new warrant was increased from 4.99% to 9.99%;
Changes to the installment amount due under the new note as described below;
The initial exercise price of the new warrant is $1.76 per share, which is $0.36 less than the initial exercise price of the initial warrant, and adjusts on stock splits, combinations or similar events but not on certain dilutive issuances provided for in the initial note. The new warrant becomes exercisable six months and one day after its issuance;
The new note and the new warrant limit the investors’ right to participate in a rights offering by the Company during a certain limited time period. The new note bears interest at a rate of 6% per year, subject to certain adjustments, and matures in March 2017. The new note is convertible, at the invester's option, into shares of the Company's Class A common stock at a price of $1.84 per share, subject to customary adjustments. Interest on the new note is payable monthly and the principal amount of the new note will amortize monthly with payments beginning September 26, 2014. The installment amount due under the new note for each month during a six-month time period beginning on September 26, 2014 is $700,000, which is $350,000 per month higher than the installment amount due under the initial note, and if the Company distributes rights to its stockholders pursuant to a rights offering before March 31, 2015, with proceeds to the Company of not less than $11.5 million, then such amortization payments shall equal $1,050,000 for each such installment date during such 6-month period. On March 26, 2015, the Company’s scheduled amortization payment will be $350,000. For each of the subsequent 12 installment dates, the Company’s scheduled amortization payment will be $1,000,000. For each of the final 12 installment dates, the Company’s scheduled principal amortization payment will be an amount equal to the lesser of $1,075,000 and the remaining principal amount outstanding on such installment date.

16

THE WET SEAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the 39 weeks ended November 1, 2014, and November 2, 2013
(Unaudited)

The following table shows remaining amortization payments by fiscal year as of November 1, 2014 under the terms of the initial note and as of November 1, 2014 under the terms of the new note (in thousands):
Fiscal Year
 
As of November 1, 2014 under the initial note
 
As of November 1, 2014 under the new note (1)
2014
 
$
1,050

 
$
2,100

2015
 
10,700

 
11,050

2016
 
12,750

 
12,450

2017
 
1,800

 

(1) If the Company distributes rights to its stockholders pursuant to a rights offering before March 31, 2015, with proceeds to the Company of not less than $11.5 million, the Company is required to make an additional payment at that time of $350,000 times the number of payments made prior to the rights offering and an additional $350,000 for any further payments due through February 26, 2015.
Monthly interest and principal payments may be settled in cash or shares of the Company's Class A common stock, at its option, subject to certain conditions including: (i) the daily dollar trading volume of the Company's common stock for the average of the daily weighted average prices during the twenty (20) day trading period prior to the payment shall be at least $1.0 million; (ii) the daily dollar trading volume of the Company's common stock for each trading day during the ten (10) trading day period ending on the trading day immediately prior to the applicable date of determination shall be at least $0.5 million; and (iii) on each trading day during the twenty (20) day trading period prior to the payment, the weighted average price of the Company's common stock equals or exceeds $1.00. Also subject to certain conditions, at any time from and after April 26, 2015, solely if the Company is making the scheduled amortization payment for such scheduled amortization date in shares of common stock, the holder may accelerate a limited amount of scheduled amortization payments. As of November 1, 2014, the above three conditions are not being met due to the Company's stock price. Accordingly, the Company must make all principal payments in cash until conditions are achieved.
In connection with the Exchange Agreement, the Company issued the new warrants to purchase up to 8,804,348 shares of the Company's Class A common stock. The warrants will be exercisable beginning six months and one day after issuance through March 4, 2020 at $1.76 per share, which is $0.36 less than the initial exercise price of the initial warrants, subject to potential future adjustments.
The senior convertible note was initially recorded net of a discount of $5.7 million, reflecting the fair value of the warrants and embedded derivatives within the senior convertible note on the issuance date. Refer to Note 6, "Fair Value Measurements and Disclosures." for further detail on the fair value of the warrants and derivatives. The $5.7 million debt discount will be amortized through interest expense on the condensed consolidated statements of operations, using the effective interest method, over the term of the senior convertible note. The Company incurred $1.9 million of deferred financing costs through November 1, 2014 and, net of $0.4 million of amortization to date, has included the current portion of $0.6 million in "prepaid expenses and other current assets" and the non-current portion of $0.9 million in "other assets" in the condensed consolidated balance sheets as of November 1, 2014.
The Company concluded that the Exchange Agreement was a modification of the existing senior convertible note, and as such, have expensed all third party fees associated with entering into the Exchange Agreement. As of November 1, 2014, the Company has expensed less than $0.1 million of fees associated with the Exchange Agreement. In addition, the Company added the increase in the fair value of the embedded conversion option of $0.2 million to the debt discount balance, which will be amortized over the remaining life of the new note.
The $5.7 million fair values of the warrants and embedded derivatives, which require bifurcation from the debt host, were recorded within long-term liabilities on the condensed consolidated balance sheets. The embedded derivatives are comprised of the conversion option, redemption in the case of an event of default and redemption in the case of a change in control features of the senior convertible note. The warrants and embedded derivatives are marked to market quarterly, with any change recorded as an adjustment to the carrying value of these liabilities and the gain or (loss) on warrants and derivatives liabilities recorded in the condensed consolidated statements of operations. The fair value of the warrants and embedded derivatives declined $1.7 million for the 13 weeks ended November 1, 2014 and declined $4.6 million from the issuance date to November 1, 2014. Accordingly,

17

THE WET SEAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the 39 weeks ended November 1, 2014, and November 2, 2013
(Unaudited)

these amounts were recorded as gains on warrants and derivatives liabilities in the condensed consolidated statements of operations. Refer to Note 6, "Fair Value Measurements and Disclosures."
NOTE 6 – Fair Value Measurements and Disclosures
Fair value is defined as the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date and in the principal or most advantageous market for that asset or liability. The fair value should be calculated based on assumptions that market participants would use in pricing the asset or liability, not on assumptions specific to the entity. In addition, the fair value of liabilities should include consideration of non-performance risk, including the Company's own credit risk.
Inputs used in measuring fair value are prioritized into a three-level hierarchy based on whether the inputs to those measurements are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's market assumptions. The fair-value hierarchy requires the use of observable market data when available and consists of the following levels:
Level 1 – Quoted prices for identical instruments in active markets;
Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs are observable in active markets; and
Level 3 – Valuations derived from valuation techniques in which one or more significant inputs are unobservable.
The following tables present information on the Company’s financial instruments (in thousands):
 
Carrying
Amount as of
November 1, 2014
 
Fair Value Measurements
at Reporting Date Using
Level 1
 
Level 2
 
Level 3
Financial assets:
 
 
 
 
 
 
 
Money market funds
$
7,521

 
$

 
$
7,521

 
$

Cash equivalents
7,521

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial liability:
 
 
 
 
 
 
 
Senior convertible note
$
21,291

 
$

 
$

 
$
14,923

 
Carrying
Amount as of
February 1,
2014
 
Fair Value Measurements
at Reporting Date Using
Level 1
 
Level 2
 
Level 3
Financial assets:
 
 
 
 
 
 
 
Money market funds
$
22,427

 
$

 
$
22,427

 
$

Cash equivalents
22,427

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposits
3,084

 

 
3,079

 

US government securities
4,302

 

 
4,300

 

Short-term investments
$
7,386

 


 


 



18

THE WET SEAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the 39 weeks ended November 1, 2014, and November 2, 2013
(Unaudited)

 
Carrying
Amount as of
November 2, 2013
 
Fair Value Measurements
at Reporting Date Using
Level 1
 
Level 2
 
Level 3
Financial assets:
 
 
 
 
 
 
 
Money market funds
$
13,986

 
$

 
$
13,986

 
$

Cash equivalents
13,986

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
5,490

 

 
5,476

 

US treasury securities
4,994

 

 
5,000

 

US government securities
25,328

 

 
25,303

 

Short-term investments
35,812

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Long-term tenant allowances receivable
$
1,029

 
$

 
$

 
$
1,029

Cash equivalents are carried at either cost or amortized cost, which approximates fair value, due to their short term maturities. The Company's money market funds are valued at $1, which is generally the net asset value of these funds and are represented at Level 2. Units are redeemable on a daily basis and redemption requests generally can be received the same day as the effective date. The Company’s short-term investments consist of interest-bearing bonds of various U.S. Government agencies, U.S. treasury securities and certificates of deposit, have maturities that are less than one year and are carried at amortized cost plus accrued income. Short-term investments are carried at amortized cost due to the Company’s intent to hold to maturity. The fair value of the Company’s short-term investments was determined based on quoted prices for similar instruments in active markets. The carrying value of the senior convertible note at November 1, 2014 is net of the unamortized discount of $4,309. The fair value of the senior convertible note was determined using a discounted cash flow analysis with Level 3 inputs of comparable yields from various high yield debt indices made up of companies with similar size, industry, credit rating and debt maturities. The Company believes the carrying amounts of other receivables and accounts payable approximate fair value. The fair value of the tenant allowances receivable was determined by discounting to present value using an incremental borrowing rate of 9.26%, at the time of recording, over their five year collection period. As of November 1, 2014 and February 1, 2014, they are included in other receivables within the condensed consolidated balance sheets.
On a non-recurring basis, the Company measures certain of its long-lived assets at fair value based on Level 3 inputs consisting of, but not limited to, projected sales growth, estimated gross margins, projected operating costs and an estimated weighted-average cost of capital. As of November 1, 2014, sales projections are based on current trend with annual improvement up to a maximum 3.0% increase in annual sales. Gross margin projections assume annual merchandise margin improvement up to historical peak merchandise margins and occupancy costs are based on lease terms. Projected operating costs are based on the current trend and maintaining consistent percentage of sales ratios for future periods. The weighted-average cost of capital is based on the Company's cost of debt and equity weighted in proportion to the amounts of debt and equity. For the 13 weeks ended November 1, 2014, the Company's weighted-average cost of capital was 22.9%. During the 13 and 39 weeks ended November 1, 2014, and November 2, 2013, the Company recorded $12.6 million, $29.3 million, $4.8 million and $6.2 million of impairment charges from continuing operations, respectively, in the accompanying condensed consolidated statements of operations. Refer to Note 1, “Summary of Significant Accounting Policies.”
Recurring Fair Value Measurements
Warrants Liability
The warrants to purchase the Company's Class A common stock are required to be measured at fair value each reporting period. Refer to Note 5, "Senior Convertible Note and Warrants." The fair value of the warrants was estimated using the Black-Scholes option-pricing model as of November 1, 2014. The Company uses historical data to estimate the expected price volatility. The risk-free rate is based on the U.S. Treasury yield curve in effect as of November 1, 2014.

19

THE WET SEAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the 39 weeks ended November 1, 2014, and November 2, 2013
(Unaudited)

As of November 1, 2014, the following assumptions were used to estimate the fair value of the warrants using the Black-Scholes option-pricing model. As of March 26, 2014, the fair value of the warrants was estimated using a Monte Carlo simulation model that requires Level 3 inputs, which are highly subjective. The following significant assumptions were used as of November 1, 2014 and March 26, 2014:
 
November 1, 2014
 
March 26, 2014
Stock price
$
0.34

 
$
1.16

Exercise price
$
1.76

 
$
2.12

Exercise price floor
N/A
 
$
1.76

Expected volatility
54.36
%
 
54.00
%
Expected term (in years)
5.3

 
5.5

Risk free interest rate
1.64
%
 
1.86
%
Expected dividend yield
%
 
%

The following table presents the activity recorded for the warrants liability since inception (in thousands):
 
November 1, 2014
Beginning balance as of March 26, 2014
$
3,610

Less: Gain from change in fair value
264

Balance as of May 3, 2014
$
3,346

Less: Gain from change in fair value
1,409

Balance as of August 2, 2014
$
1,937

Less: Gain from change in fair value
1,566

Balance as of November 1, 2014
$
371

Derivatives Liability
The embedded derivatives liability is required to be measured at fair value each reporting period. Refer to Note 5, "Senior Convertible Note and Warrants." The fair value of the embedded derivatives was estimated using a binomial lattice model, incorporating the “with-and-without” method to bifurcate the embedded derivatives, which requires Level 3 inputs that are highly subjective and determined using the following significant assumptions:
 
November 1, 2014
 
March 26, 2014
Stock price
$
0.34

 
$
1.16

Conversion price
1.84

 
1.84

Expected volatility
65.66
%
 
52.0
%
Expected term (in years)
2.3

 
3.0

Risk free interest rate
0.57
%
 
0.89
%
Expected dividend yield
%
 
%
Bond yield
16.6
%
 
4.2
%
Recovery rate
45.0
%
 
45.0
%


20

THE WET SEAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the 39 weeks ended November 1, 2014, and November 2, 2013
(Unaudited)

The following table presents the activity recorded for the derivative liability since inception (in thousands):
 
November 1, 2014
Beginning balance as of March 26, 2014
$
2,081

Less: Gain from change in fair value
175

Balance as of May 3, 2014
$
1,906

Less: Gain from change in fair value
1,087

Balance as of August 2, 2014
819

Less: Gain from change in fair value
129

Balance as of November 1, 2014
$
690

Changes in the fair value of the warrants and derivatives liabilities are included in gain on warrants and derivatives liabilities in the accompanying condensed consolidated statement of operations. It is possible that even small changes in any of the above assumptions could have a significant impact on the Company's financial results.
NOTE 7 – Net Loss Per Share
Net loss per share, basic, is computed based on the weighted-average number of common shares outstanding for the period, including consideration of the two-class method with respect to certain of the Company’s other equity securities (see below). Net loss per share, diluted, is computed based on the weighted-average number of common and potentially dilutive common equivalent shares outstanding for the period, also with consideration given to the two-class method.
While the Company historically has paid no cash dividends, participants in the Company’s equity compensation plans who were granted restricted stock and performance shares are allowed to receive cash dividends paid on unvested restricted stock and unvested performance shares. Holders of the Company's note and warrants are entitled to participation in any dividends, and therefore the note and warrants are participating securities. The Company’s unvested restricted stock and unvested performance shares also qualify as participating securities and are included in the computation of earnings per share pursuant to the two-class method. Restricted and performance stock units are not participating securities.
For the dilutive computation, under the two-class method, determination of whether the unvested share-based payment awards are dilutive is based on the application of the “treasury stock” method and whether the performance criteria has been met. For the dilutive computation of the warrants, under the two-class method, determination of the weighted average number of warrants not yet converted will be added to the basic weighted average number of shares whenever the period’s average price is higher than the exercise price of $1.76 per share as of November 1, 2014. The "treasury stock" method will be applied to determine the incremental number of convertible shares that are assumed to be converted into common stock. The warrants will only have a dilutive effect when they are “in the money." As of November 1, 2014, the warrants were not exercisable until March 2015 and therefore, they have not been included in the table below. The dilutive effect of the senior convertible note, including the interest, is included in the diluted share calculation based on the "if-converted method." Interest charges applicable to the convertible debt are added back as an adjustment to the numerator, net of tax. The payment of the principal and interest of the note is presumed to be settled in common stock (versus cash) and the potentially issued shares resulting from this settlement are included in the diluted share calculation.
For the 13 and 39 weeks ended November 1, 2014, the Company incurred a net loss and there was no dilutive effect of any unvested share-based payment awards, warrants or senior convertible note.
The computations of net loss per share, diluted, excluded the following potentially dilutive securities exercisable into Class A common stock for the 13 and 39 weeks ended November 1, 2014, and November 2, 2013, respectively, because their effect would have been anti-dilutive.

21

THE WET SEAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the 39 weeks ended November 1, 2014, and November 2, 2013
(Unaudited)

 
13 Weeks Ended
 
39 Weeks Ended
 
November 1, 2014
 
November 2, 2013
 
November 1, 2014
 
November 2, 2013
Stock options outstanding
389,774

 
567,225

 
965,746

 
471,806

Unvested restricted and performance stock awards and units
2,386,996

 
1,389,281

 
1,818,883

 
1,290,574

Conversion of interest on senior convertible note
5,285,081

 

 
4,278,399

 

Conversion of senior convertible note
14,293,478

 

 
11,570,911

 

Total
22,355,329

 
1,956,506

 
18,633,939

 
1,762,380

The discontinued operations net loss per share was calculated in the same manner as described above.
NOTE 8 – Commitments and Contingencies
On May 9, 2011, a complaint was filed in the Superior Court of the State of California for the County of Alameda on behalf of certain of the Company's current and former employees who were employed and paid by the Company from May 9, 2007 through the present. The Company was named as a defendant. The complaint alleges various violations under the State of California Labor Code and the State of California Business and Professions Code. Plaintiffs are seeking statutory penalties, civil penalties, injunctive relief, and attorneys' fees and costs. On February 3, 2012, the court granted the Company’s motion to transfer venue to the County of Orange. On July 13, 2012, the Court granted the Company's motion to compel arbitration. Plaintiffs appealed and oral argument was heard on September 23, 2013. On November 15, 2013, the Court of Appeals issued an order in which it affirmed in part and reversed in part the trial court’s order granting the Company’s motion to compel arbitration. Specifically, the Court of Appeal affirmed the trial court’s order compelling arbitration of individual claims but held that the Private Attorney General Action (PAGA) claim can only be brought as a representative action. The Company filed a petition for review to the California Supreme Court that was denied on February 11, 2014. The matter was remitted to the Superior Court for additional proceedings and on April 29, 2014, the Superior Court granted the Company’s motion and issued an order to stay the case. On May 20, 2014, Plaintiffs filed a Request for Clarification of the Superior Court’s order staying the case, On June 12, 2014, the Superior Court denied Plaintiffs’ request and reaffirmed that a stay is in effect. On June 26, 2014, Plaintiffs filed a Petition for Writ of Mandate with the Court of Appeals requesting that the stay of non-arbitral claims be lifted. On August 5, 2014, the Court of Appeals issued an order denying Plaintiffs’ Writ. A hearing to review the status of the stay took place in Superior Court on August 26, 2014 during which the Court continued the stay for an additional 90 days in order for the parties to proceed with arbitration of the individual claims.  As of the date of this filing, the parties are in the process of initiating arbitration proceedings. In addition, on July 18, 2012, the Company received notice that Plaintiffs filed charges with the National Labor Relations Board (NLRB) under Section 7 of the National Labor Relations Board Act based on the arbitration agreements Plaintiffs signed upon their hiring with the Company. Plaintiffs alleged that the Company’s arbitration agreements unlawfully compel employees to waive their rights to participate in class or representative actions against the Company. On September 20, 2012, the NLRB dismissed Plaintiffs' claims.

On October 27, 2011, a complaint was filed in the Superior Court of the State of California for the County of Los Angeles on behalf of certain of the Company’s current and former employees who were employed in California during the time period from October 27, 2007 through the present. The Company was named as a defendant. Plaintiffs are seeking unpaid wages, civil and statutory penalties, restitution, injunctive relief, interest, and attorneys' fees and costs. The complaint alleges various violations under the State of California Labor Code and the State of California Business and Professions Code. On March 28, 2012, the court entered an Order denying the Company’s motion to compel arbitration. On September 21, 2012, the Company filed a notice of appeal that is still pending.

As of November 1, 2014, the Company has accrued less than $0.1 million for loss contingencies in connection with the litigation matters enumerated above and other pending legal matters. The Company is vigorously defending the pending matters and will continue to evaluate its potential exposure and estimated costs as these matters progress. Future developments may require the Company to record accruals for these matters, or other legal matters, which could have a material negative effect on its results of operations or financial condition.

From time to time, the Company is involved in other litigation matters relating to claims arising out of its operations in the normal course of business. The Company believes that, in the event of a settlement or an adverse judgment on certain of these claims, insurance may cover a portion of such losses. However, certain matters could arise for which the Company does not have

22

THE WET SEAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the 39 weeks ended November 1, 2014, and November 2, 2013
(Unaudited)

insurance coverage or for which insurance provides only partial coverage. These matters could have a material negative effect on its results of operations or financial condition.

NOTE 9 – Treasury Stock
During the 39 weeks ended November 1, 2014, the Company tendered 111,928 shares of its Class A common stock upon restricted stock vesting to satisfy employee withholding tax obligations for a total cost of $0.1 million, as well as 434,983 shares reacquired by the Company, at no cost, upon employee forfeitures of stock-based compensation.
Effective August 21, 2014, the Company retired 351,692 shares of its Class A common stock held in treasury. In accordance with Delaware law and the terms of the Company’s certificate of incorporation, upon retirement, such treasury shares resumed the status of authorized and unissued shares of Company Class A common stock.

Item 2.        Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our unaudited condensed consolidated financial statements and the notes thereto. The following discussion and analysis contains forward-looking statements. Forward-looking statements include statements that are predictive in nature, which depend upon or refer to future events or conditions, and/or which include words such as “believes,” “plans,” “intends,” “anticipates,” “estimates,” “expects,” “may,” “will,” or similar expressions. In addition, any statements concerning future financial performance, ongoing strategies or prospects, and possible future actions, which may be provided by our management, are also forward-looking statements. Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties, and assumptions about the Company, economic and market factors and the industry in which we do business, among other things. These statements are not guarantees of future performance and we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.
Actual events and results may differ materially from those expressed or forecasted in forward-looking statements due to a number of factors. Factors that could cause our actual performance, future results and actions to differ materially from any forward-looking statements include, but are not limited to, those discussed in “Risk Factors” included in this Quarterly Report on Form 10-Q and elsewhere in this Quarterly Report, and in our other filings with the Securities and Exchange Commission. All forward-looking statements included in this Quarterly Report speak only as of the date of this Quarterly Report and we do not undertake any obligation to update forward-looking statements to reflect subsequent events or circumstances, except as required by law.
All references to “we,” “our,” “us,” and “the Company” in this Quarterly Report on Form 10-Q mean The Wet Seal, Inc. and its wholly owned subsidiaries. All references in this Quarterly Report on Form 10-Q to “fiscal 2013” and “fiscal 2014” mean the fiscal years ended February 1, 2014 and ending January 31, 2015, respectively.
Executive Overview
We are a national multi-channel specialty retailer selling fashion apparel and accessory items designed for female customers aged 18 to 24 years old through our stores and e-commerce website. In the first and second quarters of fiscal 2014, we operated two nationwide, primarily mall-based, chains of retail stores under the names “Wet Seal” and “Arden B.” In the third quarter of fiscal 2014, we transitioned all Arden B stores into either Wet Seal, Wet Seal Plus, or closed the stores, in accordance with our Plan to wind down the Arden B operations. At November 1, 2014, we had 528 Wet Seal retail stores in 47 states and Puerto Rico. All but one of the Arden B stores were closed or transitioned as of November 1, 2014. One of the Arden B stores continues to operate under the Arden B name, but has transitioned to carrying Wet Seal product. Our merchandise can also be purchased online through the Wet Seal website.
In fiscal 2013 and the 39 weeks ended November 1, 2014, we incurred net losses of $38.4 million and $79.7 million and negative cash flow from operations of $17.6 million and $40.0 million, respectively.  As of November 1, 2014, we had cash and cash equivalents of $19.1 million compared to cash and cash equivalents of $38.8 million at February 1, 2014. For the three fiscal quarters ended November 1, 2014, we have experienced comparable store sales and gross margin performance that were worse than expected entering fiscal 2014, and a number of factors continue to negatively impact us and the retail fashion apparel industry in which we do business. We expect to report net losses and negative cash flow from operations through at least the fourth quarter of fiscal 2014, and may also incur significant net losses and negative cash flows beyond the fourth quarter. Our negative cash flows from operations have adversely impacted our cash and liquidity reserves. Concerns about our financial condition have adversely impacted the terms we can obtain from some of our vendors, and some of our vendors and their factors are unwilling

23


to continue to extend credit to us or otherwise now require that we obtain letters of credit or other forms of credit support. We have issued letters of credit as collateral to certain vendors and factors that provide financial support to certain of our merchandise vendors and may issue additional such letters of credit, which letters of credit have utilized, and may further utilize, a significant amount of the borrowing capacity under our senior revolving credit facility and reduce the amount of available borrowing capacity for general corporate and other purposes. As of the date of this filing, the total amount of our outstanding letters of credit has more than doubled since the end of our second fiscal quarter, increasing by approximately $6.9 million. We have also received notice from The NASDAQ OMX Group ("Nasdaq") indicating that the bid price of our common stock for the 30 consecutive business days ended August 15, 2014 had closed below the minimum $1.00 per share required for continued listing under Nasdaq listing rules, which could result in Nasdaq de-listing our common stock if not cured within a 180-day period, subject to additional applicable grace periods for which we may be eligible. If our common stock is not listed on the Nasdaq Global Select Market, the Nasdaq Global Market, the Nasdaq Capital Market or other eligible market, it would result in an event of default under our senior convertible note, which event of default would also result in a default under our senior revolving credit facility, whereupon the holder under our senior convertible note and the lender under our senior revolving credit facility could accelerate the indebtedness under such note and facility.
In an effort to address our immediate liquidity needs, we are, with the assistance of our strategic advisors, exploring various potential strategic and financial alternatives and are engaged in discussions with third parties, as well as key financial stakeholders, including lenders, stockholders, landlords and others. Such strategic and financial alternatives include, among other things, consideration of out-of-court restructurings as well as bankruptcy court proceedings to recapitalize or restructure our indebtedness and other obligations. With the assistance of our advisors, we are attempting to raise new additional capital in the very near term to address our immediate liquidity needs. As of the date of this filing, we are evaluating our ability to successfully raise equity capital pursuant to our previously announced contemplated private placement and rights offering in light of our financial condition and immediate liquidity needs, the terms and conditions of such contemplated transactions and the related risks and uncertainties concerning such transactions. As a result of this evaluation, such transactions have been delayed and even if completed, such transactions will not close in the current fiscal year. A number of factors may cause delays or difficulties with such transactions and the closings of such transactions are subject to conditions, some of which are outside of our control. Accordingly, no assurances can be given that these contemplated transactions will close. Furthermore, in order to address our immediate liquidity needs, we believe we need to raise new additional capital in the form of equity and/or debt in the very near term.
    We have taken steps to reduce our costs, including reducing overhead costs. In this regard, in October 2014 we announced a workforce reduction resulting in the elimination of 78 filled and open positions and continue to evaluate how we can further rationalize the total number of our employees given our anticipated revenues, number of stores and organizational structure. Further, we are seeking ways we can reduce the number of our stores and are engaging in discussions with landlords seeking concessions from such landlords in the form of reduced monthly rent or suspended rental payments in an effort to reduce our rental obligations. In addition to these actions, we anticipate that we will critically evaluate any leases which by their terms expire in the near term and we anticipate not renewing the vast majority of such leases.
In November 2014, we entered into a commitment letter with the agent and the lender under our existing senior secured revolving credit facility which would, subject to the conditions set forth therein, among other things, extend the maturity date of the facility to the fifth anniversary of the closing date of the amendment and increase certain advance rates used to determine the borrowing base under the revolving credit facility. In addition, we entered into a commitment letter with a third party lender, pursuant to which the potential lender, subject to the conditions set forth therein, committed to provide us with a $10.0 million term loan secured by all of our assets, which loan would constitute a use of the incremental facility included in our senior revolving credit facility
As of the date of this filing, the discussions and efforts described above have not resulted in a strategic or financial transaction, a recapitalization, a restructuring or the raising of new additional capital, and no assurances can be given that such discussions and efforts will successfully result in a transaction, recapitalization, restructuring or the raising of new additional capital, or if a transaction, recapitalization, or restructuring is undertaken, or if new capital is raised, as to its terms or timing. Uncertainty exists as to the outcome of the efforts and discussions described above and a number of factors, including those described elsewhere in this Form 10-Q (including under Part II, Item 1A - Risk Factors below) and in our other filings with the SEC could impact the outcome of such efforts and discussions and cause our actual results to differ from our expectations. Concerns of vendors, landlords, employees, potential financing sources and others about our financial condition may make it more difficult for us to succeed in our efforts to address our immediate liquidity needs in the very near term. If we continue to experience negative cash flows from operations, we would deplete our cash reserves and working capital in the very near term and require other sources of financing to fund our operations, which sources might not be available, or if available, may not be on terms acceptable to us. If we are unsuccessful in the very near term in our efforts to address our immediate liquidity needs or otherwise experiences delays and difficulties in such efforts, our business, liquidity and financial condition would be materially and adversely affected and we

24


may deem it advisable to seek a restructuring or other relief under the provisions of the U.S. Bankruptcy Code, which could lead to a significant and possibly total loss of investment for holders of our Class A common stock.
Each of the above factors, or a combination thereof, reflect risks and uncertainties that raise substantial doubt about our ability to continue as a going concern.
Operating Strategies
In addition to our efforts to address our immediate liquidity needs as described elsewhere in this Form 10-Q, we are attempting to revise our merchandise strategy and inventory management in an effort to re-focus on fashion-forward merchandise, revise our pricing and markdown strategies, and seek to rebrand through a new marketing strategy. While we have been able to implement selected portions of these strategies in small increments, the success of our efforts will not be known until sometime in Spring 2015.
With respect to our primary merchandise strategy and inventory management, we intend to re-focus our merchandise on new fashion and to return to a “fast fashion” model that emphasizes fashion product with a broader, shallower assortment of merchandise designed to provide new fashion for our customers. In this regard, we intend to add new brands to our merchandise line-up, update our Wet Seal private label strategy and add an “athleisure” category of athletic and leisure clothing. We intend to focus on women in the age range of 18 and 24 years old and who are passionate about fashion as a major part of our customer base. We also intend to focus on inventory management by limiting quantities to create more scarcity and increase consumer urgency in purchasing items. We have already begun to change our pricing and markdown strategies and we are focusing on both higher average unit retail (AUR), the average price at which an item is sold, and lower markdowns with greater assortments of products. With respect to our new marketing strategy, we intend to focus on increasing and enhancing our e-commerce, marketing and social media efforts in an effort to improve our online sales. Our new digital marketing strategy is designed to expand the breadth and depth of our online merchandise offering, enhance user experience through a mobile optimized website and create better visual content as well as a more integrated digital merchandising process.
There is no assurance that such new operating strategies will result in increased sales as quickly or to the extent intended. Furthermore, our financial condition is negatively impacting our efforts to implement such strategies and we must successfully address our immediate liquidity needs in the very near term in order for us to have the time and resources to be able to fully implement these strategies.
Arden B Brand
On April 24, 2014, we committed to a plan to wind down the operations of our Arden B brand due to the long-term financial under-performance of the business. As of August 2 2014, we operated 51 Arden B stores. During the third quarter, 30 of the Arden B stores became Wet Seal Plus stores, 18 of the Arden B stores became Wet Seal stores, one of the Arden B stores continues to operate under the Arden B name, but have been transitioned to carry Wet Seal product, and the 2 remaining stores continued to operate as Arden B stores until their closure in August 2014. We closed down the Arden B website in the third fiscal quarter of 2014.
As of November 1, 2014, we have evaluated the applicable accounting guidance for discontinued operations due to the wind down of the Arden B operations and concluded that the Arden B segment should be reported as discontinued operations. Arden B cash flows have ceased as of November 1, 2014, the end of the third quarter. We will not have any significant continuing involvement with the Arden B segment, and therefore, the Arden B segment has met the conditions to be reported as a discontinued operation beginning in the third quarter of fiscal 2014. We maintain our intellectual property rights in the Arden B brand and affiliated trademarks and are exploring opportunities to preserve or monetize those rights.
The total amount of charges incurred in our condensed consolidated statement of operations during the 13 and 39 weeks ended November 1, 2014, in connection with the winding down of the Arden B brand, including charges for employee severance and retention plans, transitioning the stores from Arden B to Wet Seal merchandise, lease amendment and early termination fees, and non-cash asset impairments, was less than $0.1 million and $4.1 million, respectively. We estimate the amount of charges to our condensed consolidated statement of operations that will result in future cash expenditures during the remainder of 2014 fiscal year, comprised of lease amendment and early termination fees, will be approximately $0.3 million. As of November 1, 2014, we also estimate that we will incur future cash expenditures during fiscal 2014 and 2015 of approximately $0.2 million that will not affect our condensed consolidated statement of operations, which are comprised of reimbursements to landlords of unamortized tenant allowances upon our early termination of certain leases for former Arden B store locations.

25


Key Performance Indicators
We consider the following to be key performance indicators in evaluating our performance:
Comparable store sales—For purposes of measuring comparable store sales, sales include merchandise sales as well as membership fee revenues recognized under our Wet Seal division’s frequent buyer program during the applicable period. Stores are deemed comparable stores on the first day of the month following the one-year anniversary of their opening or significant remodel/relocation, which we define to be a square footage increase or decrease of at least 20%. Stores that are remodeled or relocated with a resulting square footage change of less than 20% are maintained in the comparable store base with no interruption. However, stores that are closed for three or more days in a fiscal month, due to remodel, relocation or other reasons, are removed from the comparable store base for that fiscal month as well as for the comparable fiscal month in the following fiscal year. Beginning with the first quarter of fiscal 2014, we began including ecommerce sales in our comparable store sales results and have revised the third quarter and year to date fiscal 2013 comparable store sales results included herein to also include e-commerce sales. Comparable store sales results are important in achieving operating leverage on expenses such as store payroll, occupancy, depreciation and amortization, general and administrative expenses, and other costs that are at least partially fixed. Positive comparable store sales results generate greater operating leverage on expenses while negative comparable store sales results negatively affect operating leverage. Comparable store sales results also have a direct impact on our total net sales, cash and working capital.
Average transaction counts—We consider the trend in the average number of sales transactions occurring in our stores to be a key performance metric. To the extent we are able to increase transaction counts in our stores that more than offset the decrease, if any, in the average dollar sale per transaction, we will generate increases in our comparable store sales.
Gross margins — We analyze the components of gross margin, specifically cumulative mark-on, markups, markdowns, inventory shrink, buying costs, distribution costs and store occupancy costs. Any inability to obtain acceptable levels of initial markups, a significant increase in our use of markdowns or in inventory shrink, or an inability to generate sufficient sales leverage on other components of cost of sales could have an adverse impact on our gross margin results and results of operations.
Operating (loss) income — We view operating (loss) income as a key indicator of our financial success. The key drivers of operating (loss) income are comparable store sales, gross margins and the changes we experience in operating costs.
Cash flow and liquidity (working capital) — We evaluate cash flow from operations, capital expenditures, liquidity and working capital to determine our short-term operational and long-term capital financing needs.
Business Segment
We currently report our results as one reportable segment representing the Wet Seal retail division, including net sales from our retail stores and e-commerce store. Prior to our third quarter ended November 1, 2014, we reported two business segments. As discussed further in the Executive Overview, we have completed the wind down of the Arden B business and are reporting the Arden B segment as a discontinued operation.

26


Current Trends and Outlook
Our soft sales trends that started in the second half of 2013 continued through our third fiscal quarter of 2014, with continued softness in mall traffic, an intense promotional environment throughout the specialty retail apparel segment, weakness in retail trends and in fast fashion merchandise in general, and challenging economic conditions, especially for our middle and lower-middle income target customers, contributing negatively to our retail sales. Our comparable store sales decreased 14.5% and 14.1% during the 13 and 39 weeks ended November 1, 2014, respectively. Additionally, the stores we converted from Arden B to Wet Seal Plus and Wet Seal stores have significantly underperformed our expectations. Our comparable store sales declines, along with merchandise margin weakness from efforts to compete in the current promotional environment, have resulted in significant operating losses and use of cash in operating activities in each of the past five fiscal quarters. In the 39 weeks ended November 1, 2014, we incurred net losses of $79.7 million and negative cash flow from operations of $40.0 million. We expect to report net losses and negative cash flow from operations through at least the fourth quarter of fiscal 2014, and may also incur significant net losses and negative cash flows beyond the fourth quarter. We expect that our liquidity and working capital will be adversely impacted in the fourth quarter of the current fiscal year as a result of our fourth quarter expected net losses and negative cash flow from operations, planned reductions in inventory and cash which will have the effect of reducing our borrowing base for determining our borrowing availability under our senior revolving credit facility, and the letters of credit which are expected to be outstanding as collateral for our obligations to certain vendors and their factors. See “Executive Overview” and “Liquidity and Capital Resources” herein for further discussion.
Our comparable store sales decrease was primarily attributable to a decrease in transaction volume and a decrease in average dollar sales per transaction, which was driven by a decrease in average unit selling price, partially offset by an increase in units purchased per customer.
Our e-commerce net sales compared to the prior year quarter, which is included in calculating our comparable store sales, increased 18.9% for the 13 weeks ended November 1, 2014. Since the implementation of our new Demandware e-commerce platform in November 2013, we have shown improved mobile traffic and mobile conversion rates compared to periods before implementation. Improving the mobile shopping experience for our customers continues to be a key element of our e-commerce growth strategy.
Store Openings and Closures
For fiscal 2014, we have opened 9 new Wet Seal stores, primarily in outlet and off-mall centers, and expect to close approximately 60 stores primarily upon lease expiration in the fourth quarter of fiscal 2014. Of the 60 stores expected to close, 44 are Wet Seal stores and 16 are Arden B transition stores operating as Wet Seal or Wet Seal Plus stores. In August 2014, we converted 30 Arden B stores into Wet Seal Plus stores, 19 Arden B stores into Wet Seal stores, and the remaining stores operating as Arden B stores closed in August 2014. Excluding the Arden B stores that were converted to Wet Seal or Wet Seal Plus stores, at Wet Seal we closed 2 stores during the 13 weeks ended November 1, 2014.
Critical Accounting Policies and Estimates
Our condensed consolidated financial statements were prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.
The preparation of financial statements in conformity with U.S. GAAP requires the appropriate application of accounting policies, some of which require us to make estimates and assumptions about future events and their impact on amounts reported in our condensed consolidated financial statements. Since future events and their impact cannot be determined with absolute certainty, the actual results will inevitably differ from our estimates.
We believe the application of our accounting policies, and the estimates inherently required therein, are reasonable. Our accounting policies and estimates are reevaluated on an ongoing basis, and adjustments are made when facts and circumstances dictate a change. Our accounting policies are more fully described in Note 1, "Summary of Significant Accounting Policies" and in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended February 1, 2014.
The policies and estimates discussed below involve the selection or application of alternative accounting policies that are material to our condensed consolidated financial statements. Management has discussed the development and selection of these critical accounting policies and estimates with the Audit Committee of our Board of Directors.

27


We have certain accounting policies that require more significant management judgment and estimates than others. These include our accounting policies with respect to revenue recognition, merchandise inventories, long-lived assets, stock-based compensation, accounting for income taxes, legal loss contingencies, insurance reserves and warrants and embedded derivatives liabilities. There have been no significant additions to or modifications of the application of the critical accounting policies described in our Annual Report on Form 10-K for the fiscal year ended February 1, 2014, except for the following updates for our critical accounting policies for long-lived assets, accounting for income taxes, warrants and embedded derivatives liabilities and business segment.
Long-Lived Assets
We evaluate the carrying value of long-lived assets for impairment quarterly or whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Factors that are considered important that could result in the necessity to perform an impairment review include a current-period operating or cash flow loss combined with a history of operating or cash flow losses and a projection or forecast that indicates continuing losses or insufficient income associated with the realization of a long-lived asset or asset group. Other factors include a significant change in the manner of the use of the asset or a significant negative industry or economic trend. During the 13 and 39 weeks ended November 1, 2014, and November 2, 2013, we recorded $12.6 million, $29.3 million, $4.8 million and $6.2 million, respectively, of impairment charges from continuing operations. Additional information required by this item is incorporated herein by reference to Note 1, "Summary of Significant Accounting Policies," to the condensed consolidated financial statements included elsewhere in this report.
Accounting for Income Taxes
We have approximately $165.6 million of federal NOLs available to offset taxable income in fiscal 2014 and thereafter, subject to certain annual limitations based on the provisions of Section 382 of the Internal Revenue Code. Our effective tax rates for the 13 and 39 weeks ended November 1, 2014, were approximately negative 0.2% and 0.3%, respectively, despite our net loss. These effective rates are due to certain state income taxes for fiscal 2014 that are not based on consolidated net income. We have not recorded a federal or state tax benefit for pretax losses during the 13 and 39 weeks ended November 1, 2014 due to the valuation allowance against our deferred tax assets. We expect a negative 0.3% effective income tax rate for fiscal 2014, although a number of factors could cause our actual effective tax rate for fiscal 2014 to differ from our expected effective tax rate. Additional information required by this item is incorporated herein by reference to Note 1, "Summary of Significant Accounting Policies," to the condensed consolidated financial statements included elsewhere in this report.
Warrants and Embedded Derivatives Liabilities
During the first quarter of 2014, we issued a $27.0 million senior convertible note and warrants to purchase up to 8,804,348 shares of our Class A common stock to a single institutional investor, with proceeds to us, net of $1.9 million of deferred financing costs, of $25.1 million. The senior convertible note was initially recorded net of a discount of $5.6 million, reflecting the fair value of the warrants and embedded derivatives within the senior convertible note on the issuance date. The $5.6 million debt discount will be amortized through interest expense on the consolidated statements of operations, using the effective interest method, over the term of the senior convertible note. The $1.9 million of deferred financing costs will be amortized through interest expense on our condensed consolidated statements of operations over the term of the senior convertible note.

The initial $5.6 million fair value of the warrants and embedded derivatives was recorded in the first quarter of 2014, within long-term liabilities on the condensed consolidated balance sheets. The warrants and embedded derivatives are marked to market quarterly, with any change recorded as an adjustment to the carrying value of these liabilities and the gain or (loss) on warrants and derivatives liabilities recorded in the condensed consolidated statements of operations. The change in the value of the warrants and embedded derivatives liabilities from time to time cannot be predicted and may be significant, which could have a significant effect on our financial results. Events that could cause the valuation to change include changes in our stock price and the risk free interest rate. The fair value of the warrants and embedded derivatives from the issuance date to the end of the third quarter declined $4.6 million. Accordingly, this amount was recorded as a gain on warrants and derivatives liabilities in our condensed consolidated statements of operations.

The initial senior convertible note and warrants were exchanged in September 2014 for the new note and the new warrant as more fully described in under Management's Discussion and Analysis - Liquidity and Capital Resources - Subsequent Events.

28


Recent Accounting Pronouncements
The information required by this item is incorporated herein by reference to Note 1, "Summary of Significant Accounting Policies," to the condensed consolidated financial statements included elsewhere in this report.

Results of Operations
The following table sets forth selected condensed consolidated statements of operations data as a percentage of net sales for the periods indicated. Refer to Note 2, "Discontinued Operations" for discussion of discontinued operations. The discussion that follows should be read in conjunction with the table below:
 
13 Weeks Ended
 
39 Weeks Ended
 
November 1, 2014
 
November 2, 2013
 
November 1, 2014
 
November 2, 2013
Net sales
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Cost of sales
86.3

 
76.2

 
81.3

 
71.8

Gross margin
13.7

 
23.8

 
18.7

 
28.2

Selling, general, and administrative expenses
36.5

 
30.5

 
33.4

 
29.0

Asset impairment
12.1

 
4.1

 
9.3

 
1.7

Operating loss
(34.9
)
 
(10.8
)
 
(24.0
)
 
(2.5
)
Interest expense, net
(1.3
)
 

 
(0.9
)
 

Gain on warrants and derivatives liabilities
1.6

 

 
1.5

 

Loss before provision for income taxes
(34.6
)
 
(10.8
)
 
(23.4
)
 
(2.5
)
Provision for income taxes
0.1

 

 
0.1

 

Net loss from continuing operations
(34.7
)%
 
(10.8
)%
 
(23.5
)%
 
(2.5
)%
Thirteen Weeks Ended November 1, 2014, Compared to Thirteen Weeks Ended November 2, 2013
Net sales
 
13 Weeks Ended November 1, 2014
 
Change From
Prior Fiscal Period
 
13 Weeks Ended November 2, 2013
 
 
 
($ in millions)
 
 
Net sales
$
104.3

 
$
(10.6
)
 
(9.2
)%
 
$
114.9

Comparable store sales decrease
 
 
 
 
(14.5
)%
 
 
Net sales for the 13 weeks ended November 1, 2014 decreased primarily as a result of a comparable store sales decrease of 14.5%, which included the benefit of an e-commerce sales increase of 18.9%, or $1.1 million, to $7.1 million this year from $6.0 million last year. The non-comparable stores include the Arden B conversion stores and outlet stores, which have significantly underperformed expectations.
The comparable store sales decrease during the 13 weeks ended November 1, 2014 was due to a 13.5% decrease in comparable store average transactions and a 1.3% decrease in comparable store average dollar sale per transaction. Comparable store average dollar sale per transaction decreased mainly due to a 7.3% decrease in average unit retail prices, partially offset by a 6.4% increase in the number of units purchased per customer.

29


Cost of sales
 
13 Weeks Ended November 1, 2014
 
Change From
Prior Fiscal Period
 
13 Weeks Ended November 2, 2013
 
 
 
($ in millions)
 
 
Cost of sales
$
90.0

 
$
2.5

 
2.9
%
 
$
87.5

Percentage of net sales
86.3
%
 
 
 
1,010 bps

 
76.2
%
Cost of sales includes the cost of merchandise; markdowns; inventory shortages; inventory valuation adjustments; inbound freight; payroll expenses associated with buying, planning and allocation; processing, receiving and other warehouse costs; rent and other occupancy costs; and depreciation and amortization expense associated with our stores and distribution center.
Cost of sales during the third quarter of fiscal 2014 when expressed as a percentage of net sales increased due primarily to an increase in occupancy costs as a percentage of net sales of 500 basis points reflecting the deleveraging effect of our comparable store sales decline as well as a decrease in merchandise margin of 460 basis points as a result of higher markdown rates including the impact of a $3.9 million increase in the current quarter in the markdown reserve due to efforts to reduce clearance inventory, and an increase in buying costs as a percent of sales of 50 basis points due to de-leveraging.
Selling, general, and administrative expenses (SG&A)
 
13 Weeks Ended November 1, 2014
 
Change From
Prior Fiscal Period
 
13 Weeks Ended November 2, 2013
 
 
 
($ in millions)
 
 
Selling, general, and administrative expenses
$
38.0

 
$
3.0

 
8.6
%
 
$
35.0

Percentage of net sales
36.5
%
 
 
 
600 bps

 
30.5
%
Our SG&A expenses are comprised of two components. Selling expenses include store and field support costs, including personnel, advertising and merchandise delivery costs, as well as e-commerce processing costs. General and administrative expenses include the cost of corporate functions such as executives, legal, finance and accounting, information systems, human resources, real estate and construction, marketing, loss prevention and other centralized services.
Selling expenses increased $1.3 million to $28.3 million in the third quarter of fiscal 2014. As a percentage of net sales, selling expenses were 27.2% of net sales, or 370 basis points higher than the comparable prior year period.
The following contributed to the current quarter increase in selling expenses:
A $1.2 million increase in store and field wages and benefits due to agreed upon initiatives with the U.S. Equal Employment Opportunity Commission (“EEOC”) to implement new salary guidelines and an increase in state-mandated minimum hours worked regardless of sales volumes;
A $0.3 million increase in store supplies due to transition of the Arden B stores to Wet Seal and Wet Seal Plus stores;
A $0.2 million increase in advertising due primarily to an increase in e-commerce advertising, offset by a decrease in publication placement advertising for stores; and
$0.1 million increase in merchandise delivery costs due to rate increases.
The increases in selling expenses were partially offset by the following decreases:
A $0.4 million decrease in store and field bonuses due to operating performance; and
A $0.1 million decrease in bags and boxes due to decreased sales volume.
General and administrative expenses increased $1.7 million from the prior year quarter, to $9.7 million. As a percentage of net sales, general and administrative expenses were 9.3%, or 230 basis points higher than a year ago.
The following contributed to the current quarter increase in general and administrative expenses:
A $1.4 million increase due to severance;
A $0.6 million increase in bonuses due to bonus accrual reversal in the prior year due to declining operating performance; and
A $0.2 million net increase in stock compensation expense due to accelerated vesting of the prior CEO's grants and grants for new executives.

30


The increases in general and administrative expenses were partially offset by the following:
A $0.3 million decrease in legal fees and legal settlement charges due to resolving significant employment litigation in the prior year;
A $0.1 million decrease in travel; and
A $0.1 million of miscellaneous other G&A.
Asset impairment
 
13 Weeks Ended November 1, 2014
 
Change From
Prior Fiscal Period
 
13 Weeks Ended November 2, 2013
 
($ in millions)
Asset impairment
$
12.6

 
$
7.8

 
162.5
%
 
$
4.8

Percentage of net sales
12.1
%
 
 
 
800 bps

 
4.1
%
Based on our quarterly assessments of the carrying value of long-lived assets, during the 13 weeks ended November 1, 2014, and November 2, 2013, we identified certain retail stores with carrying values of their assets, including leasehold improvements, furniture, fixtures, and equipment, in excess of such assets' respective forecasted undiscounted cash flows. Accordingly, during the third quarter of fiscal 2014 we reduced their respective carrying values to their estimated fair market values, resulting in non-cash charges of $12.6 million compared to charges of $4.8 million in the third quarter of fiscal 2013.
Interest expense, net
We incurred interest expense, net, of $1.3 million during the 13 weeks ended November 1, 2014, and less than $0.1 million during the 13 weeks ended November 2, 2013. The increase in interest expense was due to the interest expense and deferred financing cost amortization for our senior convertible note and warrants that began in 2014.
Gain on warrants and derivatives liabilities
We recorded a non-cash gain of $1.7 million for the decrease in fair value of our warrants and derivatives liabilities in the third quarter of fiscal 2014.
Provision for income taxes
 
13 Weeks Ended November 1, 2014
 
Change From
Prior Fiscal Period
 
13 Weeks Ended November 2, 2013
 
 
 
($ in thousands)
 
 
Provision for income taxes
$
65

 
$
17

35.4
%
 
$
48

As a result of our evaluation of the realizability of our net deferred tax assets as of February 2, 2013, we concluded, based upon review of all evidence, that it was more likely than not that our deferred tax assets will not be realized and we recorded a valuation allowance against our deferred tax assets. Accordingly, we did not record a tax benefit for pretax losses during the 13 weeks ended November 1, 2014. We recognized a provision for income taxes that resulted in an effective tax rate of negative 0.2% during the 13 weeks ended November 1, 2014 for federal and state income taxes. This effective rate is due to certain state income taxes for fiscal 2014 that are not based on consolidated net income. We have net operating loss carryforwards (NOLs) available, subject to certain limitations, to offset our regular taxable income.
Thirty-Nine Weeks Ended November 1, 2014, Compared to Thirty-Nine Weeks Ended November 2, 2013
Net sales
 
39 Weeks Ended November 1, 2014
 
Change From
Prior Fiscal Period
 
39 Weeks Ended November 2, 2013
 
 
 
($ in millions)
 
 
Net sales
$
316.3

 
$
(41.9
)
 
(11.7
)%
 
$
358.2

Comparable store sales decrease
 
 
 
 
(14.1
)%
 
 
Net sales for the 39 weeks ended November 1, 2014 decreased primarily as a result of a comparable store sales decrease of 14.1%, which included the benefit of an e-commerce sales increase of 16.9%, or $3.0 million, to $20.8 million this year from

31


$17.8 million last year. The non-comparable stores include the outlet stores and Arden B conversion stores, which have significantly underperformed expectations.
The comparable store sales decrease during the 39 weeks ended November 1, 2014 was due to a 10.1% decrease in comparable store average transactions and a 4.5% decrease in comparable store average dollar sales per transaction. Comparable store average dollar sales per transaction decreased mainly due to a 7.9% decrease in average unit retail prices, partially offset by a 3.5% increase in the number of units purchased per customer.
Cost of sales
 
39 Weeks Ended November 1, 2014
 
Change From
Prior Fiscal Period
 
39 Weeks Ended November 2, 2013
 
 
 
($ in millions)
 
 
Cost of sales
$
257.1

 
$
(0.2
)
 
(0.1
)%
 
$
257.3

Percentage of net sales
81.3
%
 
 
 
950 bps

 
71.8
%
Cost of sales for the 39 weeks ended November 1, 2014, as a percentage of net sales, increased due primarily to a decrease in merchandise margin of 400 basis points as a result of higher markdown rates including the impact of a $3.9 million increase in the markdown reserve due to efforts to reduce clearance inventory, and an increase in occupancy costs as a percentage of net sales of 500 basis points, primarily due to the deleveraging effect of our comparable store sales decline.
Selling, general, and administrative expenses (SG&A)
 
39 Weeks Ended November 1, 2014
 
Change From
Prior Fiscal Period
 
39 Weeks Ended November 2, 2013
 
 
 
($ in millions)
 
 
Selling, general, and administrative expenses
$
105.6

 
$
1.5

 
1.4
%
 
$
104.1

Percentage of net sales
33.4
%
 
 
 
440 bps

 
29.0
%
Selling expenses decreased $0.2 million from the prior year to $79.9 million. As a percentage of net sales, selling expenses were 25.3% of net sales, or 290 basis points higher than a year ago.
The following contributed to the current year decrease in selling expenses:
A $0.7 million decrease in store and field bonuses due to operating performance;
A $0.5 million decrease in store and field meetings due to efforts to reduce meeting costs this year;
A $0.4 million decrease in inventory service due to timing of physical inventory counts;
A $0.3 million decrease in store and field wages and benefits due to controlled store payroll hours; and
A $0.3 million decrease in bags and boxes usage due to decreased sales volume.
The decreases in selling expenses were partially offset by the following:
A $0.6 million increase in advertising and marketing expenditures due to more exposure to build e-commerce;
A $0.4 million increase in store supplies due to transition of the Arden B stores to Wet Seal and Wet Seal Plus stores;
A $0.3 million increase in our field support wages due to increased head count in store operations and customer service;
A $0.3 million increase in merchandise delivery costs due to freight rate increases;
A $0.2 million increase in store and field travel due to the new role of area managers created in the current year;
A $0.1 million increase in field stock compensation expense due to more vestings in the current year; and
A $0.1 million net increase in other selling expenses.
General and administrative expenses increased $1.7 million from the comparable prior year period, to $25.7 million. As a percentage of net sales, general and administrative expenses were 8.1%, or 150 basis points higher than a year ago.
The following contributed to the current year increase in general and administrative expenses:
A $1.3 million increase due to severance costs;
A $0.9 million increase in legal fees and legal settlement charges due to a prior year $3.5 million benefit to adjust loss contingency for several legal matters; offset by a $2.3 million decrease in legal fees, driven mainly by resolving significant employment litigation in the prior year;

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A $0.4 million increase in depreciation primarily due to a recently placed-in-service internet software and hardware platform;
A $0.2 million net increase in stock compensation expense due to accelerated vesting of our prior CEO's grants and grants for new executives;
A $0.2 million increase in audit fees; and
A $0.5 million increase in various expenses including computer maintenance, public reporting, insurance, and other general and administrative expenses.
The increases in general and administrative expenses were partially offset by the following:
A $1.2 million decrease in other general and administrative expenses related to the $0.7 million gain on settlement of the SERP liability, $0.4 million of miscellaneous other income, and $0.1 million in insurance proceeds;
A $0.6 million decrease in consulting expenses, corporate deferred rent due to a favorable lease renewal, and corporate travel.
Asset impairment
 
39 Weeks Ended November 1, 2014
 
Change From
Prior Fiscal Period
 
39 Weeks Ended November 2, 2013
 
($ in millions)
Asset impairment
$
29.3

 
$
23.1

 
372.6
%
 
$
6.2

Percentage of net sales
9.3
%
 
 
 
760 bps

 
1.7
%
Based on our quarterly assessments of the carrying value of long-lived assets, during the 39 weeks ended November 1, 2014, and November 2, 2013, we identified certain retail stores with carrying values of their assets, including leasehold improvements, furniture, fixtures, and equipment, in excess of such assets' respective forecasted undiscounted cash flows, due to continued deterioration of store performance. Accordingly, we reduced their respective carrying values to their estimated fair market values, resulting in non-cash charges of $29.3 million and $6.2 million, respectively.
Interest expense, net
We incurred interest expense, net, of $3.0 million during the 39 weeks ended November 1, 2014, and less than $0.1 million during the 39 weeks ended November 2, 2013. The increase in interest expense was due to the interest expense and deferred financing cost amortization for our senior convertible note and warrants.
Gain on warrants and derivatives liabilities
We recorded a non-cash gain of $4.6 million to reflect for the decrease in fair value of our warrants and derivatives liabilities during the 39 weeks ended November 1, 2014.
Provision for income taxes
 
39 Weeks Ended November 1, 2014
 
Change From
Prior Fiscal Period
 
39 Weeks Ended November 2, 2013
 
 
 
($ in millions)
 
 
Provision for income taxes
$
0.2

 
$
0.1

100.0
%
 
$
0.1

As a result of our evaluation of the realizability of our net deferred tax assets as of February 2, 2013, we concluded, based upon review of all evidence, that it was more likely than not that our deferred tax assets will not be realized and we recorded a valuation allowance against our deferred tax assets. Accordingly, we did not record a tax benefit for pretax losses during the 39 weeks ended November 1, 2014. We recognized a provision for income taxes that resulted in an effective tax rate of negative 0.3% during the 39 weeks ended November 1, 2014 for federal and state income taxes. This effective rate is due to certain state income taxes for fiscal 2014 that are not based on consolidated net income. We have net operating loss carryforwards (NOLs) available, subject to certain limitations, to offset our regular taxable income.
Liquidity and Capital Resources
In fiscal 2013 and the 39 weeks ended November 1, 2014, we incurred net losses of $38.4 million and $79.7 million and negative cash flow from operations of $17.6 million and $40.0 million, respectively.  As of November 1, 2014, we had cash and cash equivalents of $19.1 million. In addition, we have a $35.0 million senior revolving credit facility with $22.6 million of

33


availability as of November 1, 2014. Including cash and cash equivalents and availability on our senior revolving credit facility, our total available liquidity as of November 1, 2014 was $41.7 million. As of the date of this filing, the total amount of our outstanding letters of credit has more than doubled since the end of our second fiscal quarter, increasing by approximately $6.9 million. We expect that our liquidity and working capital will be adversely impacted in the fourth quarter of the current fiscal year as a result of our fourth quarter expected net losses and negative cash flow from operations, planned reductions in inventory and cash which will have the effect of reducing our borrowing base for determining our borrowing availability under our senior revolving credit facility, and the letters of credit which are expected to be outstanding as collateral for our obligations to certain vendors and their factors.
In an effort to address our immediate liquidity needs, we are, with the assistance of our strategic advisors, exploring various potential strategic and financial alternatives and are engaged in discussions with third parties, as well as key financial stakeholders, including lenders, stockholders, landlords and others, as described under “Executive Overview” above. As of the date of this filing, the discussions and efforts described in such section have not resulted in a strategic or financial transaction, a recapitalization, a restructuring or the raising of new additional capital, and no assurances can be given that such discussions and efforts will successfully result in a transaction, recapitali