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EBHI Holdings, Inc. 10-Q 2008 Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended June 28, 2008
OR
For the transition period from to
Commission file number 001-33070
Eddie Bauer Holdings, Inc.
(Exact name of registrant as specified in its charter)
10401 NE 8th Street, Suite 500
Bellevue, WA 98004 (425) 755-6544 (Address and telephone number, including area code, of registrant’s principal executive offices) 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. þ Yes o 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. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act.). Yes o No þ
Indicate by check mark whether the registrant filed all documents
and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934
subsequent to the distribution of securities under a plan confirmed by a court. þ Yes o No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of
the latest practicable date.
Eddie Bauer Holdings, Inc.
Form 10-Q
For the quarterly period ended June 28, 2008
TABLE OF CONTENTS
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PART I— FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Eddie Bauer Holdings, Inc.
Consolidated Balance Sheets ($ in thousands, except per share data) (Unaudited)
The accompanying notes are an integral part of these consolidated financial statements.
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EDDIE BAUER HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS ($ in thousands, except per share data) (Unaudited)
The accompanying notes are an integral part of these consolidated financial statements.
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Eddie Bauer Holdings, Inc.
Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss) (In thousands) (Unaudited)
The accompanying notes are an integral part of these consolidated financial statements.
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Eddie Bauer Holdings, Inc.
Consolidated Statements of Cash Flows ($ in thousands) (Unaudited)
The accompany notes are an integral part of these consolidated financial statements.
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EDDIE BAUER HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ($ in thousands except per share amounts, unless otherwise noted) (1) Description of Business
Eddie Bauer Holdings, Inc. (“Eddie Bauer”, “Eddie Bauer Holdings”, “Company”) is a specialty
retailer that sells mens’ and womens’ outerwear, apparel and accessories for the active outdoor
lifestyle. Eddie Bauer products are sold through retail and outlet stores located in the U.S. and
Canada and through its direct sales channel, which consists of its Eddie Bauer catalogs and its
website located at www.eddiebauer.com. The accompanying consolidated financial statements include
the results of Eddie Bauer, Inc. and its subsidiaries, as well as the related supporting operations
that provide logistics support, call center support and information technology support to Eddie
Bauer. The related supporting operations of the Company include the following: Eddie Bauer
Fulfillment Services, Inc. (“EBFS”) which provides catalog and retail distribution services for
Eddie Bauer; Eddie Bauer Information Technology, LLC; and Eddie Bauer Customer Services Inc.
(“EBCS”), which provides call center support.
(2) Basis of Presentation
Interim Financial Statements
These consolidated interim financial statements have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission (“SEC”) that permit reduced disclosure for
interim periods. Management believes that the consolidated financial statements include all
adjustments, consisting of normal recurring accruals, necessary to present fairly the results for
the interim periods shown. The results for the interim periods are not necessarily indicative of
the results for the full year. These interim financial statements should be read in conjunction
with the consolidated annual financial statements for the fiscal year ended December 29, 2007.
Seasonality
Historically, the Company’s operations have been seasonal, with a disproportionate amount of
net sales occurring in the fourth fiscal quarter, reflecting increased demand during the year-end
holiday selling season. The impact of seasonality on results of operations is more pronounced as a
result of the level of fixed costs such as occupancy and overhead expenses that do not vary with
sales. The Company’s quarterly results of operations also may fluctuate based upon such factors as
the timing of certain holiday seasons and promotions, the number and timing of new store openings,
the amount of net sales contributed by new and existing stores, the timing and level of markdowns,
store closings, refurbishments and relocations, competitive factors, weather and general economic
conditions. Accordingly, results for the individual quarters are not necessarily indicative of the
results to be expected for the entire fiscal year.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting
principles (“GAAP”) requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses during the reporting
period. Significant estimates are used when accounting for certain items, including inventory
valuation, allowance for doubtful accounts, fair values of goodwill and other intangible assets,
long-lived asset impairments, future gift certificate redemptions, customer loyalty program
accruals, legal reserves, sales returns and allowances, deferred tax valuation allowances, deferred
revenue, royalty receivables, stock based compensation expenses, and the fair value of the
Company’s derivative instruments.
(3) Recent Accounting Pronouncements
In June 2008, the Financial Accounting Standards Board (“FASB”) issued FSP EITF 03-6-1,
Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating
Securities, (“FSP EITF 03-6-1”). FSP EITF 03-6-1 states that unvested share-based payment awards
that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid)
are participating securities and shall be included in the computation of earnings per share
pursuant to the two-class method. FSP EITF 03-6-1 is effective for financial statements issued for
fiscal years beginning after December 15, 2008 and interim periods within those
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years. FSP EITF 03-6-1 requires that all prior-period earnings per share data presented shall
be adjusted retrospectively to conform to the provisions of the FSP. The Company does not
anticipate FSP EITF 03-6-1 to have a material impact on its earnings per share calculations as per
the Company’s 2005 Stock Incentive Plan, holders of unvested share-based payment awards do not have
any of the rights of a holder with respect to any shares of the Company’s common stock subject to
such award unless and until such holder has satisfied all requirements for vesting or exercise of
the share-based payment award.
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting
Principles, (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the
framework for selecting the principles to be used in the preparation of financial statements of
nongovernmental entities that are presented in conformity with generally accepted accounting
principles (GAAP) in the United States. SFAS 162 is currently effective for financial statements
presented in conformity with GAAP in the United States. The adoption of SFAS 162 did not have a
material impact to the Company’s results of operations or financial position.
In May 2008, the FASB issued FSP APB 14-1, Accounting for Convertible Debt Instruments That
May Be Settled in Cash upon Conversion (Including Partial Cash Settlement), (“FSP APB 14-1”). FSP
APB 14-1 amends previous guidance associated with convertible debt instruments that at conversion
may be settled wholly or partly with cash. Convertible debt that at conversion must always be
settled entirely in shares (other than fractional shares) and convertible debt instruments deemed
to have an embedded derivative under SFAS 133 are outside the scope of FSP APB 14-1. FSP APB 14-1
requires cash-settleable convertible instruments to be separated into their debt and equity
components at issuance and prohibits the use of the fair-value option for such instruments. The
value assigned to the debt component is the estimated value of a similar debt instrument without
conversion features as of the issuance date. The difference between the net proceeds for the
convertible debt issued and the amount reflected as a debt liability must be recorded as additional
paid-in capital. Any difference between the amount recorded for the debt liability and the
principal amount of the debt (e.g. debt discount) must be amortized to interest expense over the
expected life of the debt, thereby reflecting a market rate of interest. Upon extinguishment of the
debt, either by conversion to shares, cash settlement or a combination of cash and shares, a gain
or loss is recognized for the difference between the fair value of the debt component at the
extinguishment date and its carrying value on the balance sheet. Excess consideration is recorded
as a reduction to additional paid-in capital. FSP APB 14-1 is effective for financial statements
issued for fiscal years beginning after December 15, 2008 and must be applied retrospectively to
all periods presented. The Company is currently assessing the impact of the adoption of FSP APB
14-1, but does not expect it to have a material impact on its results of operations or financial
condition.
In April 2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of Intangible
Assets, (“FSP FAS 142-3”). FSP FAS 142-3 amends the list of factors an entity should consider in
developing renewal or extension assumptions when determining the useful life of recognized
intangible assets under FASB No. 142, Goodwill and Other Intangible Assets, (“FAS 142”). FSP FAS
142-3 applies to (i) intangible assets that are acquired individually or with a group of other
assets and (ii) intangible assets acquired in both business combinations and asset acquisitions.
FAS FASP 142-3 removes the requirement in FAS 142 for an entity to consider whether an intangible
asset can be renewed without substantial cost or material modifications to the existing terms and
conditions. FSP FAS 142-3 replaces the previous useful-live assessment criteria with a requirement
that an entity consider its own experience in renewing similar arrangements. FSP FAS 142-3 is
effective for financial statements issued for fiscal years beginning after December 15, 2008 and
must be applied prospectively only to intangible assets acquired after the FSP’s effective date.
The Company will adhere to FSP FAS 142-3 for intangible assets acquired after the FSP’s effective
date.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and
Hedging Activities — an amendment of FASB Statement No. 133, (“SFAS 161”). SFAS 161 requires
enhanced disclosures about an entity’s derivative and hedging activities, including disclosing the
fair values of derivative instruments and their gains and losses in a tabular format to provide a
more complete picture of the location in an entity’s financial statements of both the derivative
positions existing at period end and the effect of using derivatives during the reporting period.
Entities are required to provide enhanced disclosures about (i) how and why an entity uses
derivative instruments, (ii) how derivative instruments and related hedged items are accounted for
under Statement 133 and its related interpretations, and (iii) how derivative instruments and
related hedged items affect an entity’s financial position, financial performance, and cash flows.
SFAS 161 is effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008. The Company is currently evaluating the effect of SFAS 161 on
its results of operations and financial position and will adhere to the enhanced disclosures
effective with the first quarter of fiscal 2009.
In February 2008, the FASB issued FSP FAS 157-2, Effective Date of FASB Statement No. 157
(“FSP FAS 157-2”). FSP FAS 157-2 delays the effective date of FASB Statement No. 157, Fair Value
Measurements (see further discussion of SFAS 157 below), for nonfinancial assets and nonfinancial
liabilities, except for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually). For purposes of FSP FAS 157-2, nonfinancial
assets and nonfinancial liabilities would include all assets and liabilities other than those
meeting the definition of a financial asset or financial liability as defined in
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paragraph 6 of FASB Statement No. 157. FSP FAS 157-2 defers the effective date for items
within its scope to fiscal years beginning after November 15, 2008. See Note 8 for further
discussion of the Company’s adoption of SFAS 157 and related pronouncements.
In February 2008, the FASB issued FSP FAS 157-1, Application of FASB Statement No. 157 to FASB
Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for
Purposes of Lease Classification or Measurement under Statement 13 (“FSP FAS 157-1”). FSP FAS 157-1
amends FASB Statement No. 157, Fair Value Measurements, (see further discussion of SFAS 157 below)
to exclude FASB Statement No. 13, Accounting for Leases, and other accounting pronouncements that
address fair value measurements for purposes of lease classification or measurement under FASB
Statement No. 13. However, this scope exception does not apply to assets acquired and liabilities
assumed in a business combination that are required to be measured at fair value under FASB
Statement No. 141R (see further discussion of FASB Statement No. 141R below). FSP FAS 157-1 is
effective with an entity’s initial adoption of SFAS 157. See Note 8 for further discussion of the
Company’s adoption of SFAS 157 and related pronouncements.
In December 2007, the FASB issued SFAS No. 141R, Business Combinations (“SFAS 141R”). SFAS
141R replaces and revises previously issued SFAS No. 141, Business Combinations. SFAS 141R
establishes principles and requirements for how an acquirer recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling
interest in the acquiree and the goodwill acquired. SFAS 141R also establishes disclosure
requirements to enable the evaluation of the nature and financial effects of the business
combination. SFAS 141R will significantly change the accounting for business combinations in a
number of areas including the treatment of contingent consideration, contingencies, acquisition
costs, in-process research and development and restructuring costs. In addition, under SFAS 141R,
changes in deferred tax asset valuation allowances and acquired income tax uncertainties in a
business combination after the measurement period will impact income tax expense. SFAS 141R is
effective as of the beginning of an entity’s fiscal year that begins after December 15, 2008.
Accordingly, the Company will adhere to the requirements of SFAS 141R for any business combinations
entered into subsequent to its fiscal year beginning January 3, 2009.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
Financial Statements — an amendment of Accounting Research Bulletin No. 51 (“SFAS 160”). SFAS 160
establishes accounting and reporting standards for ownership interests in subsidiaries held by
parties other than the parent, the amount of consolidated net income attributable to the parent and
to the noncontrolling interest, changes in a parent’s ownership interest and the valuation of
retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS 160 will
change the current accounting and reporting for minority interests, which will be recharacterized
as noncontrolling interests and classified as a component of equity. SFAS 160 also establishes
disclosure requirements that clearly identify and distinguish between the interests of the parent
and the interests of the noncontrolling owners. SFAS 160 is effective as of the beginning of an
entity’s fiscal year that begins after December 15, 2008, and will be adopted by the Company in the
first quarter of fiscal 2009. As the Company has no noncontrolling interests, it does not expect
the adoption of SFAS 160 to have a material impact on its consolidated results of operations and
financial condition.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities (“SFAS 159”). SFAS 159 provides companies with an option to report selected
financial assets and liabilities at fair value. SFAS 159 also establishes presentation and
disclosure requirements designed to facilitate comparisons between companies that choose different
measurement attributes for similar types of assets and liabilities and to provide additional
information that will help investors and other financial statement users to more easily understand
the effect of the company’s choice to use fair value on its earnings. Finally, SFAS 159 requires
entities to display the fair value of those assets and liabilities for which the company has chosen
to use fair value on the face of the balance sheet. The Company’s adoption of SFAS 159 during the
first quarter ended March 29, 2008 did not have a material impact on the Company’s financial
condition or results of operations.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS
157 provides enhanced guidance for using fair value to measure assets and liabilities and also
expands information about the extent to which companies measure assets and liabilities at fair
value, the information used to measure fair value, and the effect of fair value measurements on
earnings. SFAS 157 applies whenever other accounting standards require or permit assets and
liabilities to be measured at fair value and does not expand the use of fair value in any new
circumstances. See Note 8 for further discussion of the Company’s adoption of SFAS 157 and related
pronouncements.
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(4) Earnings per Share
The following table presents the computation of net income (loss) per basic and diluted share
for the three and six months ended June 28, 2008 and June 30, 2007:
(5) Sale of SAC Securitization Interests
In December 2007, the Company sold the remaining interest in its financing receivables, which
were held by its SAC subsidiary, for an aggregate sales price of $113.9 million. Seventy percent,
or $79.7 million, of the aggregate selling price was received by the Company in December 2007.
Ninety percent of the cash received in December, net of expenses, or $69.3 million, was paid to the
Spiegel Creditor Trust, while 10% of the cash received in December, net of expenses, or $7.4
million, was retained by SAC. The remaining 30% of the aggregate selling price, or $34.2 million,
was placed in escrow (“holdback”) and was used to satisfy, (i) purchase price adjustments; (ii)
breaches of SAC’s representation and warranties; and (iii) SAC’s obligation to indemnify the buyers
against certain losses or damages, if any. Under the terms of the sale agreement, one-half of the
remaining holdback was paid during the first quarter of 2008 and one-half was paid during the
second quarter of 2008 with the exception of $200 which remains held in escrow until final release
in mid-2009. Upon receipt of the holdback amounts from escrow during 2008, the Company was required
to pay 90% to the Spiegel Creditor Trust.
In June 2008, the Company received payment of the remaining one-half of the holdback amount
from escrow of $17,088, of which 90%, or $15,380, was paid to the Spiegel Creditor Trust.
Additionally, in June, upon receipt of the final holdback amount, all purchase price adjustments
were settled, which resulted in the Company recognizing an additional gain on sale of the net
receivables of $113 as the final purchase price adjustments were less than originally estimated and
reserved for. The additional gain was reflected in other income (expense) on the Company’s
statement of operations during the second quarter. In February 2008, the Company received payment
of the first one-half of the holdback amount from escrow of $17,044, of which 90%, or $15,339, was
paid to the Spiegel Creditor Trust. Under the terms of the Company’s senior term loan, $1,709 and
$1,684 of the June and February proceeds, respectively, was required to be used to pay down the
principal amount of its senior term loan (see Note 7).
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(6) Investment in Eddie Bauer Germany
The Company had a 40% interest in Eddie Bauer GmbH & Co. (“Eddie Bauer Germany”), a joint
venture established to sell Eddie Bauer merchandise in Germany. The remaining 60% was held by
Heinrich Heine GmbH and Sport-Scheck GmbH (both former Spiegel affiliates and subsidiaries of Otto
KG). In February 2008, the Company received a required one-year notice from its joint venture
partners in Eddie Bauer Germany of their decision to terminate the joint venture arrangement, and
as a result, the joint venture, together with a companion license arrangement, would have
terminated in February 2009. Due to the receipt of the termination notice, the Company performed an
impairment review of its investment in Eddie Bauer Germany during the first quarter of 2008 and
determined that an other-than-temporary impairment existed. Accordingly, the Company recognized an
impairment charge of $3.9 million during the first quarter of 2008, which was reflected within
equity in losses of foreign joint ventures. The impairment charge reduced the Company’s investment
in Eddie Bauer Germany to zero and also reflected the Company’s legal obligation to fund its
proportionate share of Eddie Bauer Germany’s losses for its fiscal year ending February 29, 2008.
In June 2008, the Company and the other joint venture partners completed the transfer,
effective March 1, 2008, of their interests in the joint venture to a third party in return for a
release of past and future liabilities. As part of the transfer of the joint venture interest, the
Company terminated the prior licensing agreement with Eddie Bauer Germany and entered into a new
licensing arrangement to license the use of its tradename and trademarks to Eddie Bauer Germany for
a five-year period in exchange for specified royalties. As a result of the transfer of the joint
venture interest during the second quarter of 2008, the Company recorded a loss of $606 associated
with the write-off of the receivable from Eddie Bauer Germany during the second quarter within
selling, general and administrative expenses.
(7) Debt
Senior Secured Revolving Credit Facility
On June 21, 2005, Eddie Bauer, Inc. executed a loan and security agreement with Bank of
America, N.A., General Electric Capital Corporation and The CIT Group/Business Credit, Inc (“the
Revolver”). The Revolver is comprised of a revolving line of credit consisting of revolving loans
and letters of credit up to $150 million to fund working capital needs.
Advances under the Revolver may not exceed a borrowing base equal to various percentages of
Eddie Bauer, Inc.’s eligible accounts receivable balances and eligible inventory, less specified
reserves. The Revolver is secured by a first lien on Eddie Bauer, Inc.’s inventory and certain
accounts receivable balances and by a second lien on all of Eddie Bauer, Inc.’s other assets other
than the Company’s Groveport, Ohio distribution facility. The Revolver is guaranteed by Eddie Bauer
and certain of its subsidiaries. The Company’s availability under the Revolver was $74.0 million as
of June 28, 2008. As of June 28, 2008, the Company had no amounts drawn under the Revolver and had
$8.5 million of letters of credit outstanding.
Borrowings under the Revolver bear interest at:
The Company is required to pay an unused commitment fee of 0.25% per annum on the unused
amount, plus a letter of credit fee. The Revolver is scheduled to mature on June 21, 2010.
The agreement requires that at any time the availability under the agreement is less than 10%
of the maximum revolver available, the Company is required to maintain a consolidated fixed charge
coverage ratio (as defined therein) of at least 1.25:1.00. The agreement also limits the Company’s
capital expenditures (net of landlord contributions) to $60 million in 2008, and $70 million in
2009 and 2010. Finally, there are additional covenants that restrict the Company from entering into
certain merger, consolidation and sale transactions outside the normal course of business; from
making certain distributions or changes in its capital stock; from entering into certain
guarantees; from incurring debt and liens subject to limits specified within the agreement; and
other customary covenants. As of June 28, 2008, the Company’s availability under the agreement was
not less than 10% of the maximum revolver available.
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Senior Secured Term Loan
On June 21, 2005, Eddie Bauer, Inc. entered into a $300 million senior secured term loan
agreement (“Prior Term Loan”) upon its emergence from bankruptcy. On April 4, 2007, Eddie Bauer,
Inc. entered into an Amended and Restated Term Loan Agreement with various lenders, Goldman Sachs
Credit Partners L.P., as syndication agent, and JP Morgan Chase Bank, N.A., as administrative agent
(the “Amended Term Loan”). The Amended Term Loan amends the Prior Term Loan. In connection with the
Amended Term Loan, $48.8 million of the loans were prepaid, reducing the principal balance of the
Prior Term Loan from $273.8 million to $225 million. The Company recognized a loss on
extinguishment of debt of $3.3 million in April 2007, which represented the unamortized deferred
financing fees of the Prior Term Loan and was reflected within other income (expense) on the
Company’s statement of operations. The Amended Term Loan extends the maturity date of the Prior
Term Loan to April 1, 2014, and amends certain covenants of the Prior Term Loan. As of June 28,
2008, $192.8 million was outstanding under the Amended Term Loan.
Interest under the Amended Term Loan is calculated as the greater of the prime rate or the
Federal funds effective rate plus one-half of one percent plus 2.25% in the case of base rate
loans, or LIBOR plus 3.25% for Eurodollar loans. Interest requirements for both base rate loans and
Eurodollar loans are reset on a monthly basis. As of June 28, 2008, the Amended Term Loan had
interest rates of LIBOR ranging from 2.47% to 2.90% plus 3.25% depending upon the term of the LIBOR
tranche. Interest is payable quarterly on the last day of each March, June, September and December
for base rate loans, and for Eurodollar loans having an interest period of three months or less,
the last day of such interest period or for Eurodollar loans having an interest period of longer
than three months, each day that is three months after the first day of such interest period.
The Amended Term Loan is secured by a first lien on certain real estate assets and trademarks
and by a second lien on substantially all of the other assets of the Company, Eddie Bauer, Inc. and
its subsidiaries.
In accordance with the Amended Term Loan, the Company is required to repay $562.5 on a
quarterly basis from June 30, 2007 through December 31, 2013, with the remaining balance due upon
maturity of the loan on April 1, 2014. The Amended Term Loan includes mandatory prepayment
provisions, including prepayment requirements related to asset sales, future indebtedness, capital
transactions, and a requirement that 50% (reduced to 25% if the Company’s consolidated senior
secured leverage ratio (as defined therein) on the last day of the relevant fiscal year is not
greater than 2.00 to 1.00) of any “excess cash flows,” as defined in the Amended Term Loan and
measured on an annual basis be applied to repayment of the loan. The Company is required to make
repayments to the Amended Term Loan resulting from “excess cash flows” and “asset sales”, as such
are defined within the Amended Term Loan agreement. In the event the Company makes voluntary
prepayments or mandatory prepayments as a result of asset sales or other transactions as specified
within the agreement, future principal payments are reduced in accordance with the terms of the
Amended Term Loan. As discussed in Note 5, the Company sold its interest in its financing
receivables in December 2007. As a result of this asset sale, the Company was required to use the
net cash proceeds received from the sale as a payment under its Amended Term Loan. Accordingly, the
Company repaid $7,713, $1,684 and $1,709 of its outstanding term loan balance in December 2007 and
during the first and second quarters of 2008, respectively. As a result of the Company’s
prepayments made related to the sale of its financing receivables and a $20 million voluntary
prepayment in December 2007, the Company is not required to make any of the scheduled repayments
under the terms of the Amended Term Loan and accordingly the remaining balance outstanding under
the Amended Term Loan is not required to be repaid until the Amended Term Loan’s maturity date on
April 1, 2014.
The financial covenants under the Amended Term Loan agreement include:
The Company’s consolidated senior secured leverage ratio calculated on a trailing basis must
be equal to or less than:
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In addition, the Company’s consolidated fixed charge coverage ratio (as defined therein)
calculated on a trailing four fiscal quarter basis must be equal to or greater than:
Certain of the financial covenants under the Amended Term Loan are less restrictive than the
financial covenants contained within the Prior Term Loan. The Amended Term Loan also limits the
capital expenditures of the Company and its subsidiaries (net of landlord contributions) to $50
million in 2008, $60 million in 2009, and $70 million in 2010 through 2014. There are additional
covenants that restrict the Company and its subsidiaries from entering into certain merger,
consolidation and sale transactions outside the normal course of business, making certain
distributions, including paying any dividends, or changes in its capital stock, entering into
certain guarantees, incurring debt and liens subject to limits specified within the agreement, and
other customary covenants. As of June 28, 2008, the Company’s most recent quarterly compliance
reporting date, the Company was in compliance with the covenants of the Amended Term Loan.
Convertible Notes
On April 4, 2007, the Company closed its offering of $75 million aggregate principal amount of
convertible senior notes. The convertible notes have a maturity date of April 1, 2014 and pay
interest at an annual rate of 5.25% semiannually in arrears on April 1 and October 1 of each year,
beginning October 1, 2007 unless earlier redeemed, repurchased or converted.
The convertible notes are fully and unconditionally guaranteed by all of the Company’s
existing and future subsidiaries that are parties to any domestic credit facilities, whether as a
borrower, co-borrower or guarantor, including Eddie Bauer, Inc. The convertible notes are unsecured
and senior obligations of the Company and rank equally in right of payment with all existing and
future senior unsecured indebtedness and senior in right of payment to any subordinated
indebtedness. The Company has not provided separate financial statements for the guarantor
subsidiaries or consolidating financial statements of the Company as Eddie Bauer Holdings, Inc. and
the non-guarantor subsidiaries do not conduct any operations and do not have significant assets.
Under the indenture governing the convertible notes, the convertible notes are not
convertible, except upon the occurrence of certain specified corporate transactions, prior to the
termination of the Company’s ownership limitations contained in its certificate of incorporation,
which will occur not later than January 4, 2009. See
Note 14 below for further discussion of the Company’s ownership
limitations. Following the termination of the ownership
limitations and prior to April 1, 2013, holders may convert all or a portion of their notes under
the following circumstances: (i) during any calendar quarter commencing after June 30, 2007 if the
last reported sale price of the Company’s common stock is greater than or equal to 120% of the
conversion price for at least 20 trading days in the period of 30 consecutive trading days ending
on the last trading day of the preceding calendar quarter; (ii) during the five business day period
after any 10 consecutive trading-day period (“measurement period”) in which the trading price per
$1,000 principal amount of notes for each day in the measurement period was less than 98% of the
product of the last reported sale price of the Company’s common stock and the conversion rate on
such day; or (iii) upon the occurrence of specified corporate transactions, as set forth in the
indenture governing the convertible notes. On or after April 1, 2013, holders may convert their
notes at any time prior to 5:00 pm, New York City time, on the business day immediately preceding
the maturity date. The initial conversion rate, which is subject to adjustment, for the notes was
73.8007 shares per $1,000 principal amount of notes (which represented an initial conversion price
of approximately $13.55 per share). Upon conversion, the Company has the right to deliver, in lieu
of shares of common stock, cash or a combination of cash and shares of its common stock, provided
that if the notes are converted prior to termination of the ownership limitations, the Company must
pay cash in settlement of the converted notes. A holder will receive cash in lieu of any fractional
shares.
Upon the occurrence of certain fundamental changes, including certain change of control
transactions as set forth in the indenture, the Company will be required to offer to repurchase the
convertible notes for cash at 100% of the principal amount thereof plus accrued and unpaid interest
and additional interest, if any, to but not including the date of repurchase. In the event of
certain events of default under the indenture, either the trustee thereunder or the holders of at
least 25% in principal amount of the then-outstanding convertible notes may declare 100% of the
principal of the convertible notes and accrued and unpaid interest, including additional interest,
to be due and payable.
As a result of the requirement that the Company settle any conversion of the notes occurring
prior to the termination of the ownership limitations contained in its certificate of incorporation
in cash, the conversion features contained within the convertible notes are deemed to be an
embedded derivative under SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities (“SFAS 133”). In accordance with SFAS 133, the embedded derivative related to the
conversion features requires bifurcation from the debt component of the convertible notes and a
separate valuation. The Company recognizes the embedded derivative as an asset or
liability on its balance sheet and measures it at its estimated fair value, and recognizes
changes in its estimated fair value in other
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income (expense) in the period of change. See Note 8
for a discussion of the Company’s adoption of SFAS 157, including the estimated fair value
calculation for the embedded derivative liability associated with the Company’s convertible notes.
As a result of the bifurcation of the embedded derivative related to the conversion features
of the notes under SFAS 133, the carrying value of the convertible notes at issuance was $53,775.
The Company is accreting the difference between the face value of the notes and the carrying value,
which totaled $18,511 as of June 28, 2008, as a charge to interest expense using the effective
interest rate method over the term of the convertible notes. The Company recognized $567 and $1,118
of discount amortization during the three and six months ended June 28, 2008, respectively, and
$518 during the three and six months ended June 30, 2007 within interest expense, which resulted in
an effective interest rate of approximately 11.05% related to the convertible notes.
(8) Fair Value of Financial Instruments
The Company adopted SFAS 157 during the first quarter of fiscal 2008, which resulted in no
material impact to its financial statements. SFAS 157 applies to all assets and liabilities that
are being measured and reported on a fair value basis, with the exception of nonfinancial assets
and nonfinancial liabilities, for which fair value measurement requirements were deferred in
accordance with FSP FAS 157-2 (See Note 3). SFAS 157 enables the reader of the financial statements
to assess the inputs used to develop fair value measurements by establishing a hierarchy for
ranking the quality and reliability of the information used to determine fair values. SFAS 157
requires that assets and liabilities carried at fair value be classified and disclosed in one of
the following three categories:
Level 1: Quoted market prices in active markets for identical assets or liabilities.
Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data. Level 3: Unobservable inputs that are not corroborated by market data. Level 1 primarily consists of financial instruments whose value is based on quoted market
prices. This category also includes financial instruments that are valued using alternative
approaches but for which independent external valuation information is available. The Company
currently has no assets or liabilities for which it utilizes Level 1 inputs.
Level 2 includes financial instruments that are valued using models or other valuation
methodologies. These models are primarily industry-standard models that consider various
assumptions, including time value, yield curve, volatility factors, current market and contractual
prices for the underlying financial instruments, as well as other relevant economic measures.
Substantially all of these assumptions are observable in the marketplace, can be derived from
observable data or are supported by observable levels at which transactions are executed in the
marketplace. The Company’s assets and liabilities that utilize Level 2 inputs include their
interest rate swap and embedded derivative liability associated with its convertible notes as
discussed further below.
Level 3 is comprised of financial instruments whose fair value is estimated based on
internally developed models or methodologies utilizing significant inputs that are generally less
readily observable. The Company’s fair value measurements that utilize Level 3 inputs consist
primarily of nonfinancial assets and nonfinancial liabilities for which the provisions of SFAS 157
have been deferred in accordance with FSP FAS 157-2.
The following table summarizes the estimated fair values of the Company’s interest rate swap
and embedded derivative related to its convertible notes as of June 28, 2008, both of which
primarily utilize Level 2 inputs:
The Company uses derivative instruments primarily to manage exposure to fluctuations in
interest rates, to lower its overall costs of financing and to manage the mix of floating- and
fixed-rate debt in its portfolio. The Company’s derivative instruments as of June 28, 2008 included
an interest rate swap agreement and an embedded derivative related to its convertible notes.
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Interest Rate Swap Agreement
The Company’s interest rate swap agreement had a notional amount of $98,750 as of June 28,
2008. The interest rate swap agreement effectively converts a portion of the outstanding amount
under the Amended Term Loan, which has a floating rate of interest, to a fixed-rate by having the
Company pay fixed-rate amounts in exchange for the receipt of the amount of the floating-rate
interest payments. Under the terms of the interest rate swap agreement, a monthly net settlement is
made for the difference between the fixed rate of 5.05% and the variable rate based upon the
monthly LIBOR rate on the notional amount of the interest rate swap. On a quarterly basis, the
Company assesses and measures the effectiveness of the cash flow hedge using the changes in
variable discounted cash flows method. In performing its assessment as of June 28, 2008, the fair
value of the interest rate swap was determined to be a liability of $4,186 and the changes in the
cash flows of the derivative hedging instrument were within 80 to 125 percent of the opposite
change in the cash flows of the hedged forecasted transaction and therefore the Company concluded
that the hedge was highly effective. Accordingly, the Company recorded the effective portion of the
cash flow hedge, which totaled $4,186 ($2,567 net of tax) as of June 28, 2008 within other
comprehensive loss on its balance sheet. No amount of the cash flow hedge was determined to be
ineffective. The amounts reflected in other comprehensive loss will be reclassified into interest
expense in the same period in which the hedged debt affects interest expense. The Company expects
the cash flow hedge to be highly effective and therefore estimates that no amounts will be
reclassified into interest expense within the next 12 months. No amounts were recognized in the
statement of operations resulting from a cash flow hedge for which it was not probable that the
original forecasted transaction would occur. The interest rate swap agreement is scheduled to
terminate in April 2012.
The valuation of the Company’s interest rate swap agreement in accordance with SFAS 157 is
determined using widely accepted valuation techniques, including discounted cash flow analysis on
the expected cash flows of the interest rate swap and the offsetting hedged transaction. The fair
valuation uses the market standard methodology of netting the discounted future fixed cash payments
(or receipts) and the discounted expected cash receipts (or payments). This analysis reflects the
contractual terms of the derivative, including the period to maturity, and uses observable
market-based inputs, including forward LIBOR rates based upon Eurodollar futures rates. To comply
with the provisions of SFAS 157, the Company incorporates credit valuation adjustments to
appropriately reflect both its own nonperformance risk and the respective counterparty’s
nonperformance risk in the fair value measurement. Although the Company has determined that the
majority of the inputs used to value its interest rate swap fall within Level 2 of the fair value
hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs.
However, as of June 28, 2008, the Company assessed the significance of the effect of the credit
valuation adjustments on the overall valuation of its interest rate swap and determined that the
credit valuation adjustments are not significant to the overall valuation. As a result, the Company
concluded that the valuation of its interest rate swap is classified in Level 2 of the fair value
hierarchy.
Convertible Note Embedded Derivative Liability
As discussed in Note 7 above, the conversion features contained within the Company’s
convertible notes are deemed to be an embedded derivative under SFAS 133, and accordingly are
reflected at their fair value on the Company’s balance sheet. The Company is required to update the
fair value as of each reporting date with any difference reflected within other income (expense).
The Company estimates the fair value of the embedded derivative using a Black-Scholes model. The
Black-Scholes model used to estimate the fair value of the conversion features of the Company’s
convertible notes incorporates the following assumptions, which are deemed to be Level 2 inputs:
(i) trading price of its common stock; (ii) exercise price upon maturity; (iii) risk free rate of
return; and (iv) volatility of the Company’s common stock price and stock price of its peer
companies. SFAS 157 also requires that the fair value measurement of a liability reflect credit
valuation adjustments, including the nonperformance risk of the entity. The fair value of the
conversion features of the Company’s convertible notes reflected the nonperformance risk of the
Company when issued in April 2007. The Company has concluded that changes in the Company’s
creditworthiness since issuance of the convertible notes would not result in a material impact to
the fair value of the conversion features as of June 28, 2008. The Company estimated the fair value
of the liability associated with the conversion features to be $8,243 as of June 28, 2008 and
recognized ($1,376) and $2,499 within other income (expense) during the three and six months ended
June 28, 2008, respectively. The decline in the estimated fair value of the Company’s derivative
liability of $21,255 associated with the conversion features since the issuance date for the
convertible notes was primarily a result of the decline in the Company’s common stock price.
(9) Income Taxes
The Company’s income tax benefits for the three and six months ended June 28, 2008 were $7,052
and $18,756, respectively. The Company’s income tax benefit for year-to-date 2008 represents an
effective tax rate of 49.2% and is higher than the Company’s benefit at the U.S. Federal statutory
tax rate plus a blended state tax rate primarily due to a reduction to 2007 taxable income
associated with its Canadian subsidiaries. During the second quarter of 2008, the Company
completed a study related to the transfer
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pricing of costs to its two Canadian subsidiaries. As a
result of this study, when completing its 2007 Canadian tax return in the second quarter of 2008,
the Company determined that $8.2 million of taxable income for 2007 previously allocated to its
Canadian subsidiaries should be included in its U.S. taxable income. The transfer of this income
resulted in a tax benefit totaling $5.0 million including $2.9 million of Canadian tax benefit from
the reduction in Canadian taxable income and an additional $2.1 million U.S. deferred tax benefit as these earnings were previously determined to be foreign earnings that would be
repatriated to the U.S in a future period. The corresponding increase in U.S. taxable income for
2007 had no impact on the effective tax rate as it was offset by a reduction in the valuation
allowance against the net operating loss carryforward.
Due to the significance of nondeductible expenses relative to the Company’s pretax loss and
also due to the seasonality of the Company’s business, the Company’s effective tax rate for the
first half of 2008 was based upon the Company’s actual year-to-date effective tax rate as opposed
to the estimated effective tax rate for the full year of 2008. The Company will continue to
evaluate its effective tax rate each quarter during fiscal 2008. Excluding the impact of the
above-mentioned adjustment related to the Company’s Canadian subsidiaries, the Company’s
year-to-date tax benefit of $13,790 is less than the Company’s benefit at the U.S. Federal
statutory tax rate plus a blended state tax rate primarily due to the Company’s former joint
venture in Germany. Included in the Company’s pretax loss for the first half of 2008 was a $3.9
million impairment charge related to the Company’s investment in Eddie Bauer Germany, as discussed
further in Note 6. Due to the uncertainty in the Company’s ability to recognize the tax benefit
associated with this loss, the Company provided a full valuation allowance against the
corresponding deferred tax asset during the first quarter of 2008.
The Company’s income tax benefits for the three and six months ended June 30, 2007 were $582
and $1,697, respectively. The Company’s income tax benefit for year-to-date 2007 represented an
effective tax rate of 2.5%, which was lower than its benefit at the U.S. Federal statutory tax rate
and blended state tax rate primarily due to non-deductible interest accretion expense on its
securitization interest liability which the Company sold in December 2007.
(10) Other Income (Expense)
(11) Employee Benefit Plans
Historically, the Company participated in certain Spiegel employee benefit plans. Upon the
Company’s emergence from bankruptcy, the Spiegel post-retirement, defined-benefit healthcare and
life insurance plans and pension plan were transferred to and assumed in total by Eddie Bauer
Holdings. Accordingly, on such date, the liabilities associated with these plans, in addition to
those liabilities related to the Company’s employees, were reflected in the consolidated balance
sheet of the Company. The life insurance plan is closed to new participants and provides benefits
for existing participants until death. The medical benefits under the post-retirement medical plan
continue until the earlier of death or age 65. In accordance with the terms of the Spiegel pension
plan, no new participants have been or will be added to the pension plan subsequent to the
Company’s emergence from bankruptcy.
Adoption of SFAS 158 Measurement Provisions
During the first quarter of fiscal 2008, the Company adopted the measurement provisions of
SFAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (an
amendment of FASB Statements No. 87, 88, 106, and 132R) (“SFAS 158”). The measurement provisions of
SFAS 158 require a company to measure a plan’s assets and its obligations that determine its
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funded
status as of the end of the employer’s fiscal year. Prior to adopting the measurement provisions of
SFAS 158, the Company measured the plan assets and obligations for its post-retirement health and
welfare plans and its pension plan as of the end of its third fiscal quarter.
In accordance with SFAS 158, in lieu of remeasuring the plan assets and obligations as of
January 1, 2008, the Company utilized the measurements determined as of September 30, 2007. The
periodic benefit cost for the period of October 1, 2007 through the end of Company’s current fiscal
year (e.g. January 3, 2009) has been allocated between the portion to be recognized as an
adjustment to retained earnings (equal to three-fifteenths of net periodic benefit cost) upon
adoption of the measurement provisions and the portion to be reflected in the Company’s statement
of operations during fiscal 2008 (equal to twelve-fifteenths of net periodic benefit cost). As a
result, the Company recognized a pre-tax reduction to retained earnings of $148 ($91 net of tax)
related to its post-retirement health and welfare plans and a pre-tax increase to retained earnings
of $245 ($150 net of tax) related to its pension plan as of January 1, 2008.
Post-retirement Healthcare and Life Insurance Plans
The components of the Company’s net periodic benefit cost related to its post-retirement
healthcare and life insurance plans were as follows:
Contributions to the post-retirement benefit plans totaled $230 and $380 for the three and six
months ended June 28, 2008, respectively. Contributions to the post-retirement benefit plans
totaled $163 and $202 for the three and six months ended June 30, 2007, respectively. In fiscal
2008, total contributions to the post-retirement benefit plans are expected to be $572.
Pension Plan
The components of the Company’s net periodic benefit related to the former Spiegel pension
plan were as follows:
The Company made no contributions to the pension plan during the three or six months ended
June 28, 2008. The Company made contributions to the pension plan during the three and six months
ended June 30, 2007 of $691. In fiscal 2008, the Company expects to make no contributions to the
pension plan.
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(12) Stock Based Compensation
The impact of stock options, stock-only stock appreciation rights (“SOSARs”) and restricted
stock units (“RSUs”) on net income (loss) was as follows:
During the first quarter of fiscal 2008, the Company granted inducement awards for newly hired
employees of 25,500 stock options with exercise prices ranging from $5.64 per share to $6.69 per
share, which vest ratably annually over four years, and 12,018 RSU awards, which cliff vest after
four years. Under the 2007 Amendment and Restatement of Eddie Bauer Holdings, Inc. 2005 Stock
Incentive Plan (the “Stock Incentive Plan”), during the first quarter of 2008 the Company granted
529,481 SOSARs with a per share price of $4.30 to eligible corporate employees. The SOSARs give the
grantee the right to receive, in shares of the Company’s common stock, the difference between (x)
the closing price of the Company’s stock on the date of grant multiplied by a specified number of
SOSARs and (y) the closing price of the Company’s stock on the date of exercise, multiplied by the
same specified number of SOSARs. The grantee will receive a number of shares of the Company’s
common stock equal to the difference between the two amounts [(x) and (y) above], divided by the
closing price of the stock on the date of exercise. The SOSARs granted vest ratably annually over
four years. Also during the first quarter of 2008, the Company granted under the Stock Incentive
Plan RSU awards totaling 277,520 shares, which cliff vest after four years, to eligible corporate
employees.
During the second quarter of fiscal 2008, the Company granted 25,000 SOSARs to the Company’s
CEO with an exercise price of $3.91, which vest ratably annually over four years, and 25,000 RSU
awards which cliff vest after four years. Additionally, the Company granted each non-employee
director 25,575 RSU awards, for a total grant of 230,175 RSU awards, which vest one-third on May 2,
2009, one-third on May 2, 2010 and one-third on May 2, 2011.
Prior to 2008, the Company’s volatility assumptions used in determining the fair values of its
stock options was based upon historical and implied volatility for other companies in the retail
industry due to the Company’s limited stock price history. Effective with 2008, the Company’s
volatility assumptions include both (i) the Company’s one-year historical volatility and (ii)
six—year historical volatility levels and implied volatility for peer companies in the retail
industry. The change in volatility assumptions to include the Company’s historical volatility did
not have a material impact on the fair values of the Company’s stock options and SOSARs granted
during 2008.
Unrecognized compensation costs related to stock options/SOSARs and RSUs totaled approximately
$4,586 and $3,455, respectively, as of June 28, 2008, which are expected to be recognized over
weighted average periods of 2.7 and 3.1 years, respectively. No cash was received from stock option
exercises during the six months ended June 28, 2008.
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(13) Commitments, Guarantees and Contingencies
Litigation
In June 2006, a class action suit captioned Tara Hill v. Eddie Bauer, Inc., was filed
in Los Angeles Superior Court, State of California. The suit alleged that the Company violated the
California Labor Code and Business and Professions Code relating to the adequacy of wage
statements, reimbursements for business expenses, meal and rest periods and other claims, on behalf
of a class comprised of all employees in the Company’s California stores. The Company reached a
settlement with the plaintiff in April 2007, and has provided notice to class members regarding the
potential settlement. A hearing on final court approval of the settlement occurred on July 10,
2008, at which the plaintiff in the Scherer v. Eddie Bauer, Inc. suit referenced below
objected to the settlement on various grounds. The court took the parties’ positions under
advisement and the Company expects a ruling to be issued during the third quarter of 2008. In
connection with the proposed settlement, the Company accrued $1.6 million in the first quarter of
2007 to cover settlement payments and attorneys’ fees. The settlement payments are proposed to be
made partly in cash and partly in Company gift cards.
In September 2007, a purported class action suit captioned Kristal Scherer, on behalf of
herself, all others similarly situated v. Eddie Bauer, Inc. and Does 1 to 100 was filed in
Superior Court of California, County of San Diego, alleging violations of the California Labor Code
and Business and Professions Code relating to the payment of incentive bonuses and the Company’s
policy on forfeiture of personal days. The case has been removed to U.S. District Court, Southern
District of California. In December 2007, the Company filed a partial motion to dismiss certain
counts of plaintiff’s complaint for failure to state a claim. That motion was denied in June 2008.
The complaint was amended in January 2008 to add an additional named plaintiff. The Company filed
an answer in July 2008 denying the claims made.
In the ordinary course of business, the Company may be subject from time to time to various
other proceedings, lawsuits, disputes or claims. These actions may involve commercial, intellectual
property, product liability, labor and employment related claims and other matters. Although the
Company cannot predict with assurance the outcome of any litigation, the Company does not believe
there are currently any such actions that, if resolved unfavorably, would have a material impact on
the Company’s financial condition or results of operations except as disclosed herein.
Guarantees
The Company has applied the measurement and disclosure provisions of FASB Interpretation No.
45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees of the
Indebtedness of Others,” to agreements that contain guarantee and certain other indemnification
clauses. FIN 45 requires that upon issuance of a guarantee, the guarantor must disclose and
recognize a liability for the fair value of the obligation it assumes under the guarantee. The
Company is party to various contractual agreements under which it may be obligated to indemnify the
other party for certain matters. These contracts include commercial contracts, operating leases,
trademarks, financial agreements and various other agreements. Under these contracts, the Company
may provide certain routine indemnifications relating to representations and warranties. The terms
of these indemnifications range in duration and may not be explicitly defined. The Company is
unable to estimate the potential liability for these types of indemnifications as the agreements
generally do not specify a maximum amount, and the amounts are often dependent on the outcome of
future events, the nature and likelihood of which cannot be determined at this time; however the
Company believes that the initial fair value of any of these guarantees would be immaterial.
Historically, the Company has not made any significant indemnification payments under such
agreements and no amounts have been accrued in the Company’s financial statements.
(14) Subsequent Event
On August 4, 2008, the Company announced its intent to contact certain stockholders and
holders of the Company’s 5.25% convertible senior notes to ascertain their willingness to approve
an extension from January 4, 2009 to a date not later than January 1, 2012 of the current
limitation on direct or indirect ownership of the Company’s equity securities contained in the
Company’s certificate of incorporation (the “Ownership Limitation”). The Ownership Limitation was
established upon the Company’s emergence from bankruptcy to provide the Company’s board of
directors with the ability to prevent the occurrence of an ownership change under Section 382 of
the Internal Revenue Code, as amended. An ownership change as defined by Section 382 may
significantly limit a corporation’s ability to use its pre-change net operating loss carryovers
(“NOLs”) and other pre-change tax attributes to offset its post-change income.
An extension of the Ownership Limitation would involve an amendment to the indenture for the
convertible notes, which would require the written consent of the holders of a majority in value of
the outstanding convertible notes, and an amendment to the Company’s certificate of incorporation,
which would require the approval of a majority of the Company’s outstanding common stock. The
Company does not anticipate a significant change in the valuation allowance currently recorded
against these NOLs should such extension of the Ownership Limitation
occur. See Note 7 and Note 8 above for further discussion of the convertible notes.
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The information in this Management’s Discussion and Analysis contains certain forward-looking
statements, which reflect our current view with respect to future events and financial performance.
Any such forward-looking statements are subject to risks and uncertainties that could cause our
actual results of operations to differ materially from historical results or current expectations.
This discussion and analysis should be read in conjunction with the unaudited consolidated
financial statements and notes thereto in this quarterly report on Form 10-Q and the audited
financial statements, together with the notes thereto, and Management’s Discussion and Analysis of
Financial Condition and Results of Operation contained in our Annual
Report on Form 10-K for the fiscal year ended December
29, 2007 filed with
the SEC on March 13, 2008 and with our Quarterly Report on Form 10-Q for the three months ended
March 29, 2008 filed with the SEC on May 8, 2008.
EXECUTIVE OVERVIEW
Business Summary
Eddie Bauer is a specialty retailer that sells mens’ and womens’ outerwear, apparel and
accessories for the active outdoor lifestyle. Our primary target customers are women and men who
are 30-54 years old with an average annual household income of $75,000. Eddie Bauer is a nationally
recognized brand that stands for high quality, innovation, style and customer service. Eddie Bauer
was ranked as the number four outerwear brand in a Women’s Wear Daily survey in July 2008, and 26th
in a companion Women’s Wear Daily Top 100 Brands survey, also in July 2008.
We sell our products through three interdependent sales channels that share product sourcing,
design and marketing resources:
As of June 28, 2008, we operated 371 stores in the U.S. and Canada, consisting of 252 retail
stores and 119 outlet stores. During the first half of 2008, we had 14.4 million visits to our
websites and circulation of approximately 34.3 million catalogs.
2008 Business Developments — Five Key Initiatives
Our management team has set five key initiatives, formulated strategies to achieve these
initiatives, and begun to take action to implement the initiatives in 2008, with the goal of
rebuilding the Eddie Bauer brand as a leader in outerwear and apparel for an active outdoor
lifestyle. Given the 12- to 18-month lead time to develop and introduce merchandise into our sales
channels, the turnaround of the Eddie Bauer business will be a multi-year effort.
Our five key initiatives are:
In the second quarter of 2008, we have:
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Real Estate
The table below represents our retail and outlet store activity during the first half of
fiscal 2008 and 2007:
We currently anticipate opening three additional retail and four additional outlet stores
during the remainder of the year, for total retail and outlet store openings in fiscal 2008 of
eight and six, respectively. We anticipate closing two additional outlet stores in the remainder of
the year, and may close other, underperforming stores during the year as leases expire or the
opportunity to exit becomes available.
Second Quarter 2008 Overview
Net merchandise sales for the second quarter and first half of 2008 increased 3.8% and 1.5%,
respectively. The increase in our net merchandise sales was driven by total comparable store sales
(retail and outlet) increases of 8.6% and 4.9% for the second quarter and first half of 2008,
respectively, which included retail comparable store sales increases of 11.2% and 7.5% and outlet
comparable store sales increases of 4.3% and 0.9%, respectively. Net merchandise sales in our direct channel
decreased 2.1% and 0.9% during the
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second quarter and first half of 2008, respectively. The
decrease in our direct channel net merchandise sales was primarily due to lower net merchandise
sales from our catalogs, which was driven by a planned reduction in circulation.
Our gross margin and gross margin percentage improved during the second quarter and first half
of 2008 primarily due to decreases in our occupancy and net customer loyalty program costs (e.g.
the net difference between accruals to costs of sales for points earned and reduction to costs of
sales for points redeemed and reflected as a reduction to net merchandise sales). Additionally,
during the second quarter of 2008, our gross margins reflected an improvement in our merchandise
margins.
SG&A expenses declined $4.0 million during the second quarter versus the prior year quarter
primarily as a result of less outsourced professional services, and lower advertising and promotion
costs and depreciation expenses. SG&A expenses declined $20.7 million during the first half of
2008 versus the prior year due to $16.4 million of non-recurring expenses we incurred during the
first half of 2007 related to a terminated merger agreement, resignation of our former CEO and an
estimated litigation settlement and also due to the cost cutting measures implemented in the first
quarter of 2008 and the items mentioned above. Additionally, depreciation expenses in the current year were lower than the prior
year period.
Results of Operations
The following is a discussion of our results of operations for the three and six months ended
June 28, 2008 and June 30, 2007.
Three and Six Months Ended June 28, 2008 compared to Three and Six Months Ended June 30, 2007
Revenues
Three Months Ended June 28, 2008 Compared to Three Months Ended June 30, 2007
Net merchandise sales increased $8.0 million, or 3.8%, in the second quarter of 2008 versus
the prior year quarter, which included an increase of $9.3 million, or 6.2%, in our retail and
outlet store sales and a decrease of $1.3 million, or 2.1%, in our catalog and internet sales. Net
merchandise sales in our retail and outlet stores increased due to a strong response to various
promotions during the second quarter, including the Adventurer Ripstop product event and the Ultimate Summer Sale, as well as
new summer product introductions.
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The decrease in our direct channel net merchandise sales was
primarily due to lower net merchandise sales from our catalogs, which was driven by a planned
reduction in circulation.
Total comparable store sales, which includes sales from both our retail and outlet stores,
during the second quarter of 2008 increased 8.6%, or $11.2 million. Comparable store sales in our
retail and outlet stores increased 11.2% and 4.3%, respectively. Non-comparable store sales, which
includes sales associated with new, closed, non-comparable remodeled stores and certain financial
adjustments, decreased $1.9 million, or 9.3%, which reflected the greater impact in the current
year quarter from customer loyalty rewards redeemed. Total comparable store sales in the second
quarter of 2007 increased 0.9%, which included an increase in retail comparable store sales of 4.6%
and a decrease in outlet comparable store sales of 4.5%.
Licensing revenues in the second quarter of 2008 decreased $0.8 million primarily due to
decreases in licensing revenues associated with our licensing
partners that sell SUVs and home
furnishing products.
The decrease in our foreign royalty revenues during the second quarter of 2008 versus the
prior year quarter reflects the reduction in royalty revenues from our former joint venture in
Eddie Bauer Germany. In June 2008, we and the other joint venture partners in our Eddie Bauer
Germany joint venture transferred our interests in the joint venture, effective March 1, 2008, to a
third party in return for a release of liabilities. As part of the transfer of the joint venture
interest, we transferred our royalty receivables to the third party and terminated the prior
license agreement with Eddie Bauer Germany and entered into a new licensing arrangement to license
the use of our tradename and trademarks to Eddie Bauer Germany for a five-year period in exchange
for specified royalties. During 2007, we recognized $1.9 million of royalty revenues from Eddie
Bauer Germany. As a result of the termination of the prior licensing agreement and the execution
of a new agreement with a reduced royalty rate for the first two years, we anticipate that our
results of operations during fiscal 2008 will reflect a decrease in licensing royalty revenues.
Six Months Ended June 28, 2008 Compared to Six Months Ended June 30, 2007
Net merchandise sales increased $6.3 million, or 1.5%, in the first half of 2008 versus the
prior year period, which included an increase of $7.4 million, or 2.6%, in our retail and outlet
store sales and a decrease of $1.1 million, or 0.9%, in our catalog and internet sales. Total
comparable store sales during the first half of 2008 increased 4.9%, or $11.8 million. Comparable
store sales in our retail and outlet stores for the first half of 2008 increased 7.5% and 0.9%,
respectively. Total comparable store sales for the first half of 2007 increased 4.7%, which
included an increase in retail comparable store sales of 9.6% and a decrease in outlet comparable
store sales of 2.4%. Non-comparable store sales decreased $4.3 million, or 8.8%. The decrease in
non-comparable store sales was driven by a higher level of sales from closed and non-comparable
stores during the first half of 2007 versus the first half of 2008 and a larger impact of sales
reductions resulting from financial adjustments in the current year, which primarily includes
merchandise purchased through our direct channel that is returned to our stores, adjustments for
the accrual we make for returned goods, and the impact of our customer loyalty program. These
decreases to our non-comparable sales were partially offset by an increase in the sales associated
with new stores in the current year versus the prior year.
Cost of Goods Sold, Including Buying and Occupancy and Gross margin and gross margin %
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Three Months Ended June 28, 2008 Compared to Three Months Ended June 30, 2007
Our gross margin for the second quarter of 2008 was $83.6 million, an increase of $8.3
million, or 11.0%, from our second quarter of 2007 gross margin of $75.3 million, driven by higher
margin sales in the current year quarter and decreases in our occupancy and net customer loyalty
program costs (e.g. the net difference between accruals to costs of sales for points earned and
reduction to costs of sales for points redeemed and reflected as a reduction to net merchandise
sales).
The $0.3 million decrease in our costs of sales during the second quarter of 2008 versus the
prior year quarter, which reflected:
These decreases were partially offset by:
Our gross margin percentage increased to 37.9% in the second quarter of 2008 from 35.4% in the
second quarter of 2007. The 2.5 percentage point increase in our gross margin percentage was due
primarily to a 1.2 percentage point increase in our merchandise margins. Additionally, costs for
customer loyalty program rewards accrued and occupancy costs as a percentage of our net merchandise
sales decreased 0.9 and 0.5 percentage points, respectively.
Six Months Ended June 28, 2008 Compared to Six Months Ended June 30, 2007
Our gross margin for the first half of 2008 was $138.4 million, an increase of $4.5 million,
or 3.3%, from our gross margin of $133.9 million during the first half of 2007, primarily as a
result of decreases in our occupancy costs and costs for customer loyalty program rewards accrued
as discussed above.
Our costs of sales increased $1.8 million during the first half of 2008 versus the prior year
primarily due to an increase of $7.0 million in our merchandise costs, driven by an increase in
units sold, which was partially offset by a benefit related to a higher amount of customer loyalty
costs reclassified from costs of sales to reduce net merchandise sales in the current year quarter
for certificates redeemed. This increase was partially offset by decreases of $3.9 million and $2.1
million in our occupancy costs and customer loyalty program rewards accrued, respectively.
Our gross margin percentage increased to 33.0% in the first half of 2008 from 32.4% in the
first half of 2007. The 0.6 percentage point increase in our gross margin percentage reflected 1.2
percentage point and 0.5 percentage point improvements in our occupancy costs and customer loyalty
program rewards accrued as a percentage of our net merchandise sales. These improvements were
partially offset by a 1.0 percentage point decline in our
merchandise margins, which reflected
higher markdowns taken to liquidate 2007 holiday product during the first quarter of 2008.
Our warehousing and distribution expenses (excluding occupancy costs related to our
warehouses) and shipping costs are included in selling, general and administrative expenses. As a
result, our gross margin and gross margin percentages may not be comparable to
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those of other
retailers. Our warehousing and distribution expenses reflected in selling, general and
administrative expenses for the three and six months ended June 28, 2008 were $7.6 million and
$14.9 million, respectively. Our warehousing and distribution expenses reflected in selling,
general and administrative expenses for the three and six months ended June 30, 2007 were $7.1
million and $15.1 million, respectively. Our shipping costs reflected in selling, general and
administrative expenses for the three and six months ended June 28, 2008 were $6.1 million and
$12.6 million, respectively. Our shipping costs reflected in selling, general and administrative
expenses for the three and six months ended June 30, 2007 were $5.8 million and $11.7 million,
respectively.
Selling, general and administrative expenses
Three Months Ended June 28, 2008 Compared to Three Months Ended June 30, 2007
SG&A expenses for the second quarter of 2008 were $95.5 million, representing a decrease of
$4.0 million, or 4.1% from the prior year quarter. SG&A expenses as a percentage of net merchandise
sales for the second quarter of 2008 were 43.2%, down from 46.8% in the prior year quarter. The
decline in SG&A expenses in the second quarter of 2008 included:
These decreases in SG&A expenses during the second quarter of 2008 versus the prior year quarter
were partially offset by:
Six Months Ended June 28, 2008 Compared to Six Months Ended June 30, 2007
SG&A expenses for the first half of 2008 were $190.6 million, representing a decrease of $20.7
million, or 9.8% from the prior year period. SG&A expenses as a percentage of net merchandise sales
for the first half of 2008 were 45.5%, down from 51.2% in the prior year period, which primarily
reflected the impact of the non-recurring expenses we incurred during the first quarter of 2007.
SG&A expenses for the first half of 2007 included $16.4 million of non-recurring expenses including
(i) the $5 million termination fee we were required to pay as a result of our stockholders not
approving a proposed merger agreement; (ii) $8.4 million of expense,
including $3.2 million of accelerated stock-based compensation expense, related to the
resignation of our former CEO; (iii) $1.4 million of legal and other costs related to our
terminated merger agreement; and (iv) a $1.6 million charge related to an estimated
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settlement of
litigation. SG&A expenses for the first half of 2008 included $2.5 million in severance charges
associated with the workforce reduction in corporate support personnel and the $0.6 million
write-off of the receivable from Eddie Bauer Germany noted above. The remaining approximately $7.4
million decrease in SG&A expenses for the first half of 2008 versus the prior year period resulted
from:
These decreases in SG&A for the first half of 2008 versus the prior year were partially offset by:
Equity in earnings (losses) of foreign joint ventures
Three Months Ended June 28, 2008 Compared to Three Months Ended June 30, 2007
Losses of foreign joint ventures for the second quarter of 2008 included losses from Eddie
Bauer Japan of $0.4 million. As discussed further below, effective March 1, 2008, we completed the
transfer of our ownership interest in Eddie Bauer Germany. Earnings of foreign joint ventures for
the second quarter of 2007 of $1.3 million included earnings related to Eddie Bauer Germany of $1.0
million and earnings from Eddie Bauer Japan of $0.3 million. Equity earnings from Eddie Bauer
Germany for the second quarter of 2007 included earnings of approximately $0.7 million related to
updated estimates of previously recorded losses related to the store closing reserves recorded by
Eddie Bauer Germany in prior periods.
Six Months Ended June 28, 2008 Compared to Six Months Ended June 30, 2007
Losses of foreign joint ventures for the first half of 2008 of $4.8 million included losses
related to Eddie Bauer Germany of $4.1 million and $0.7 million from Eddie Bauer Japan. In February
2008, the Company received a required one-year notice from its joint venture partners in Eddie
Bauer Germany of their decision to terminate the joint venture arrangement, and as a result, the
joint venture, together with a companion license arrangement, would have terminated in February
2009. In June 2008, we and the other joint venture partners completed the transfer, effective March
1, 2008, of our interests in the joint venture to a third party in return for a release of past
and future liabilities. As a result of the above mentioned termination notice, we performed an
impairment review of our investment in Eddie Bauer Germany during the first quarter of 2008 and
determined that an other-than-temporary impairment existed. Accordingly, we recognized an
impairment charge of $3.9 million during the first quarter of 2008, which reduced our investment in
Eddie Bauer Germany to zero and also reflected our legal obligation to fund our proportionate share
of Eddie Bauer Germany’s losses for their fiscal year ending February 29, 2008.
Losses of foreign joint ventures for the first half of 2007 of $0.2 million included losses
related to Eddie Bauer Germany of $0.5 million and earnings from Eddie Bauer Japan of $0.3 million.
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Interest expense
Three Months Ended June 28, 2008 Compared to Three Months Ended June 30, 2007
Interest expense during the second quarter of 2008 decreased $0.8 million from the prior year
quarter primarily as a result of a $1.2 million decrease in interest expense associated with our
senior term loan driven primarily by a lower average interest rate during the current year quarter
versus the prior year quarter, and to a lesser extent from a lower average balance outstanding due
to principal payments made (including both voluntary prepayments and payments resulting from asset
sales) during the fourth quarter of 2007. This decrease in interest expense was partially offset by
a $0.4 million decrease in interest capitalized during the current year quarter due to a lower
average construction-in-progress balance driven by in-progress amounts in the prior year quarter
related to the Company’s move to their new corporate headquarters building in mid-2007.
Six Months Ended June 28, 2008 Compared to Six Months Ended June 30, 2007
Interest expense during the first half of 2008 decreased $2.1 million as compared to the prior
year primarily as a result of a $4.3 million decrease in interest expense associated with our
senior term loan due to lower average interest rates and also due to a lower average balance
outstanding resulting from the refinancing in April 2007 and prepayments made during the fourth
quarter of 2007. This decrease was partially offset by an increase of $1.5 million of interest
expense, including the discount amortization, related to the $75 million of convertible notes we
issued in April 2007 and a $0.5 million decrease in interest capitalized during the first half of
2008 versus the prior year period.
Other income (expense)
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Three Months Ended June 28, 2008 Compared to Three Months Ended June 30, 2007
Other expense of $1.4 million for the second quarter of 2008 primarily included the $1.4
million market value adjustment on the embedded derivative liability associated with our
convertible notes which was partially offset by an additional gain we recorded on the sale of our
net financing receivables. See Note 5 to our interim financial statements included in this document
for further discussion of the $0.1 million adjustment we recorded during the second quarter of 2008
to the gain related to the sale of our net financing receivables. Other expense of $7.7 million for
the second quarter of 2007 included $6.1 million of expense associated with the adjustment to
market value we recorded on the embedded derivative liability associated with our convertible notes
and a $3.3 million loss on debt extinguishment related to the refinancing of our senior term loan
as discussed further below. These expenses were partially offset by $1.3 million of net accretion
income from the receivables and liabilities associated with our securitization interests (which
were subsequently sold in December 2007), $0.3 million of interest income and $0.1 million of
income associated with the termination of our interest rate swap agreement.
Six Months Ended June 28, 2008 Compared to Six Months Ended June 30, 2007
Other income of $2.9 million for the first half of 2008 included a $2.5 million market value
adjustment on the embedded derivative liability associated with our convertible notes, $0.2 million
of interest income and the $0.1 million additional gain recorded on the sale of our net financing
receivables. Other expense of $6.1 million for the first half of 2007 included $6.1 million of
expense associated with the adjustment to market value we recorded on the embedded derivative
liability associated with our convertible notes and the $3.3 million loss on debt extinguishment
related to the refinancing of our senior term loan. These expenses were partially offset by $2.4
million of net accretion income from the receivables and liabilities associated with our
securitization interests, $0.6 million of interest income, and $0.2 million of income associated
with our interest rate swap agreement, which we terminated in April 2007.
Income tax benefit
Three Months Ended June 28, 2008 Compared to Three Months Ended June 30, 2007
Our income tax benefit for the second quarter of 2008 was $7.1 million, representing an
effective tax rate of 99.0%, compared to an income tax benefit of $0.6 million for the second
quarter of 2007. Our income tax benefit for the second quarter of 2008 was higher than our benefit
at the U.S. Federal statutory tax rate plus a blended state tax rate primarily due to a $5.0
million tax benefit recorded in the second quarter related to our 2007 taxable income associated
with our Canadian subsidiaries as discussed further below. Our income tax benefit for the second
quarter of 2007 was lower than our benefit at the U.S. Federal statutory tax rate plus a blended
state tax rate primarily due to non-deductible interest accretion expense on our securitization
interest liability which we sold in December 2007.
Six Months Ended June 28, 2008 Compared to Six Months Ended June 30, 2007
Our income tax benefit for the first half of 2008 was $18.8 million compared to an income tax
benefit of $1.7 million for the first half of 2007. Our income tax benefit for year-to-date 2008
represented an effective tax rate of 49.2% and is higher than our benefit at the U.S. Federal
statutory tax rate plus a blended state tax rate primarily due to a
reduction to 2007 taxable
income associated with our Canadian subsidiaries. During the second quarter of 2008, we completed
a study related to the transfer pricing of costs of our two Canadian subsidiaries. As a result of
this study, when completing our 2007 Canadian tax return in the second quarter of 2008, we
determined that $8.2 million of taxable income for 2007 previously allocated to our Canadian
subsidiaries should be included in our U.S. taxable income. The transfer of this income resulted in
a tax benefit totaling $5.0 million including $2.9 million of Canadian tax benefit from the reduction
in Canadian taxable income and an additional $2.1 million
U.S. deferred tax benefit as these
earnings were previously determined to be foreign earnings that would be repatriated to the
U.S. in a future period. The corresponding increase
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in U.S. taxable income for 2007 had no impact on the effective tax rate as it was offset by a
reduction in the valuation allowance against the net operating loss carryforward.
Due to the significance of nondeductible expenses relative to our pretax loss and also due to
the seasonality of our business, the effective tax rate for the first half of 2008 was based upon
our actual year-to-date effective tax rate as opposed to the estimated effective tax rate for the
full year of 2008. We will continue to evaluate our effective tax rate each quarter during fiscal
2008. Excluding the impact of the above mentioned adjustment related to our Canadian subsidiaries,
our year-to-date tax benefit of $13.8 million is less than our benefit at the U.S. Federal
statutory tax rate plus a blended state tax rate primarily due to our former joint venture in
Germany. Included in our pretax loss for the first half of 2008 was a $3.9 million impairment
charge related to our investment in Eddie Bauer Germany. Due to the uncertainty in our ability to
recognize the tax benefit associated with this loss, we provided a full valuation allowance against
the corresponding deferred tax asset during the first quarter of 2008.
Our income tax benefit for year-to-date 2007 represented an effective tax rate of 2.5%, which
was lower than our benefit at the U.S. Federal statutory tax rate and blended state tax rate
primarily due to non-deductible interest accretion expense on our securitization interest liability
which we sold in December 2007.
Liquidity and Capital Resources
Cash Flow Analysis
Six Months ended June 28, 2008 Compared to Six Months ended June 30, 2007
Net cash provided by (used in) operating activities
Net cash provided by operating activities for the six months ended June 28, 2008 was $9.1
million compared with net cash used in operating activities of $17.3 million for the six months
ended June 30, 2007.
Cash generated from our operations when excluding non-cash expenses (i.e., depreciation and
amortization, gains/losses and impairments of property and equipment, equity in earnings (losses)
of joint ventures, stock-based compensation expenses, market value adjustments on our embedded
derivative liability, loss on extinguishment of debt and deferred income taxes) and other non-cash
income totaled a negative $6.6 million for the six months ended June 28, 2008 compared to negative
$28.2 million for the six months ended June 30, 2007. This improvement in cash generated from
operations resulted primarily from an increase in our operating income. Changes in our working
capital for the six months ended June 28, 2008 resulted in $12.2 million of positive cash flow
versus $9.9 million of positive cash flow for the six months ended June 30, 2007. The $12.2
million of positive cash flow during the first half of 2008 primarily resulted from a $35.6 million
reduction in our inventory levels since the end of fiscal 2007. The significant decline in our
inventory levels since year-end was driven by higher than forecasted sales during the second
quarter; better inventory management with a more concentrated effort to avoid excess inventories;
and the timing of receipt of our Fall product inventory. The positive cash flow generated from
reducing our inventory levels was partially offset by a use of working capital cash of $27.4
million related to our accrued expenses, including reductions of $7.1 million, $5.4 million, $5.3
million and $5.1 million in our allowance for sales returns, current taxes payable, deferred
revenues, and sales and use taxes payable, respectively. The decrease in our accrued
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expenses reflects the seasonality of our business. The $9.9 million of positive cash flow
during the first half of 2007 primarily resulted from an $11.9 million increase in our deferred
rent obligations due to construction allowances received for both our stores and our new corporate
headquarters; decreases of $5.4 million and $5.3 million in our inventory and accounts receivable
balances due to seasonality; and a net $5.3 million in cash collected related to our financing
receivables, which we sold in December 2007. These positive cash flows during the first half of
2007 were partially offset by a $19.5 million decrease in our accrued expenses, which included
decreases of $8.0 million, $8.2 million and $3.7 million in our sales returns and allowances, sales
and payroll tax accruals and our current tax liability, respectively. Additionally, during the
first half of 2008 we collected $3.4 million in net sales proceeds related to receipt of the final
holdback amounts received from the sale of our financing receivables.
Net cash used in investing activities
Net cash used in investing activities for the six months ended June 28, 2008 included $10.5
million of capital expenditures, primarily related to new stores and store remodeling costs. Net
cash used in investing activities for the six months ended June 30, 2007 totaled $28.1 million,
which primarily included $28.5 million of capital expenditures primarily related to our new
corporate facilities and expenditures related to the new stores we opened during the first half of
2007.
Net cash provided by (used in) financing activities
Net cash used in financing activities for the six months ended June 28, 2008 totaled $5.8
million and included $3.4 million of repayments under our senior term loan and a $2.4 million
decrease in our bank overdraft position. Net cash provided by financing activities for the six
months ended June 30, 2007 totaled $15.6 million, which primarily included the $71.3 million of net
proceeds from our $75 million convertible notes offering in April 2007, partially offset by the
$52.3 million repayment of our senior term loan, including financing fees associated with the
refinancing and a $3.4 million decrease in our bank overdraft position.
Sources of Liquidity
As of August 1, 2008 we had $277.9 million in outstanding debt from three credit vehicles,
including $192.8 million outstanding on our Amended and Restated Term Loan; $10.1 million
outstanding on our Senior Secured Revolving Credit Facility; and $75 million in 5.25% senior convertible notes. As of June
28, 2008, we had cash balances of $20.4 million. Our primary source of cash is the cash generated
from our operations and borrowings under our Revolver. We expect that our cash and cash
equivalents, combined with our cash flows from operations and available borrowings under our
Revolver, will be sufficient to fund working capital, capital expenditures and other cash
requirements during the next twelve months. If sales and operating cash flow do not increase over
time, we may not have sufficient capital resources to fund our operating plan, which may result in
our need to seek additional sources of liquidity through the sale of assets, the assumption of
additional debt or the issuance of equity. There can be no assurance that we would be successful in
borrowing additional funds at reasonable rates of interest or issuing equity at a favorable
valuation, or at all.
Senior Secured Revolving Credit Facility
On June 21, 2005, Eddie Bauer, Inc. executed a loan and security agreement with Bank of
America, N.A., General Electric Capital Corporation and The CIT Group/Business Credit, Inc (“the
Revolver”). The Revolver is comprised of a revolving line of credit consisting of revolving loans
and letters of credit up to $150 million to fund working capital needs.
Advances under the Revolver may not exceed a borrowing base equal to various percentages of
Eddie Bauer, Inc.’s eligible accounts receivable balances and eligible inventory, less specified
reserves. The Revolver is secured by a first lien on Eddie Bauer, Inc.’s inventory and certain
accounts receivable balances and by a second lien on all of Eddie Bauer, Inc.’s other assets other
than our Groveport, Ohio distribution facility. The Revolver is guaranteed by Eddie Bauer and
certain of its subsidiaries. Our availability under the Revolver was $74.0 million as of June 28,
2008. As of June 28, 2008, we had no amounts drawn under the Revolver and had $8.5 million of
letters of credit outstanding.
Borrowings under the Revolver bear interest at:
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We are required to pay an unused commitment fee of 0.25% per annum on the unused amount, plus
a letter of credit fee. The Revolver is scheduled to mature on June 21, 2010.
The agreement requires that at any time the availability under the agreement is less than 10%
of the maximum revolver available, we are required to maintain a consolidated fixed charge coverage
ratio (as defined therein) of at least 1.25:1.00. The agreement also limits our capital
expenditures (net of landlord contributions) to $60 million in 2008, and $70 million in 2009 and
2010. Finally, there are additional covenants that restrict us from entering into certain merger,
consolidation and sale transactions outside the normal course of business; from making certain
distributions or changes in our capital stock; from entering into certain guarantees; from
incurring debt and liens subject to limits specified within the agreement; and other customary
covenants. As of June 28, 2008, our availability under the agreement was not less than 10% of the
maximum revolver available.
Senior Secured Term Loan
On June 21, 2005, Eddie Bauer, Inc. entered into a $300 million senior secured term loan
agreement (“Prior Term Loan”) upon its emergence from bankruptcy. On April 4, 2007, Eddie Bauer,
Inc. entered into an Amended and Restated Term Loan Agreement with various lenders, Goldman Sachs
Credit Partners L.P., as syndication agent, and JP Morgan Chase Bank, N.A., as administrative agent
(the “Amended Term Loan”). The Amended Term Loan amends the Prior Term Loan. In connection with the
Amended Term Loan, $48.8 million of the loans were prepaid, reducing the principal balance of the
Prior Term Loan from $273.8 million to $225 million. We recognized a loss on extinguishment of debt
of $3.3 million in April 2007, which represented the unamortized deferred financing fees of the
Prior Term Loan and was reflected within other income (expense) on our statement of operations. The
Amended Term Loan extends the maturity date of the Prior Term Loan to April 1, 2014, and amends
certain covenants of the Prior Term Loan. As of June 28, 2008, $192.8 million was outstanding under
the Amended Term Loan.
Interest under the Amended Term Loan is calculated as the greater of the prime rate or the
Federal funds effective rate plus one-half of one percent plus 2.25% in the case of base rate
loans, or LIBOR plus 3.25% for Eurodollar loans. Interest requirements for both base rate loans and
Eurodollar loans are reset on a monthly basis. As of June 28, 2008, the Amended Term Loan had
interest rates of LIBOR ranging from 2.47% to 2.90% plus 3.25% depending upon the term of the LIBOR
tranche. Interest is payable quarterly on the last day of each March, June, September and December
for base rate loans, and for Eurodollar loans having an interest period of three months or less,
the last day of such interest period or for Eurodollar loans having an interest period of longer
than three months, each day that is three months after the first day of such interest period.
The Amended Term Loan is secured by a first lien on certain real estate assets and trademarks
and by a second lien on substantially all of the other assets of the Company, Eddie Bauer, Inc. and
its subsidiaries.
In accordance with the Amended Term Loan, we are required to repay $0.6 million on a quarterly
basis from June 30, 2007 through December 31, 2013, with the remaining balance due upon maturity of
the loan on April 1, 2014. The Amended Term Loan includes mandatory prepayment provisions,
including prepayment requirements related to asset sales, future indebtedness, capital
transactions, and a requirement that 50% (reduced to 25% if our consolidated senior secured
leverage ratio (as defined therein) on the last day of the relevant fiscal year is not greater than
2.00 to 1.00) of any “excess cash flows,” as defined in the Amended Term Loan and measured on an
annual basis be applied to repayment of the loan. We are required to make repayments to the Amended
Term Loan resulting from “excess cash flows” and “asset sales”, as such are defined within the
Amended Term Loan agreement. In the event we make voluntary prepayments or mandatory prepayments as
a result of asset sales or other transactions as specified within the agreement, future principal
payments are reduced in accordance with the terms of the Amended Term Loan. As discussed in Note 5
to our interim financial statements included in this document, we sold our interest in our
financing receivables in December 2007. As a result of this asset sale, we were required to use the
net cash proceeds received from the sale as a payment under our Amended Term Loan. Accordingly, we
repaid $7.7 million, $1.7 million and $1.7 million of our outstanding term loan balance in December
2007 and during the first and second quarters of 2008, respectively. As a result of our prepayments
made related to the sale of our financing receivables and a $20 million voluntary prepayment in
December 2007, we are not required to make any of the scheduled repayments under the terms of the
Amended Term Loan and accordingly the remaining balance outstanding under the Amended Term Loan is
not required to be repaid until the Amended Term Loan’s maturity date on April 1, 2014.
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The financial covenants under the Amended Term Loan agreement include:
Our consolidated senior secured leverage ratio calculated on a trailing basis must be equal to
or less than:
In addition, our consolidated fixed charge coverage ratio (as defined therein) calculated on a
trailing four fiscal quarter basis must be equal to or greater than:
Certain of the financial covenants under the Amended Term Loan are less restrictive than the
financial covenants contained within the Prior Term Loan. The Amended Term Loan also limits our
capital expenditures (net of landlord contributions) to $50 million in 2008, $60 million in 2009
and $70 million in 2010 through 2014. There are additional covenants that restrict us from entering
into certain merger, consolidation and sale transactions outside the normal course of business,
making certain distributions or changes in our capital stock, entering into certain guarantees,
incurring debt and liens subject to limits specified within the agreement and other customary
covenants. As of June 28, 2008, our most recent quarterly compliance reporting date, we were in
compliance with the covenants of the Amended Term Loan.
Convertible Notes
On April 4, 2007, we closed our offering of $75 million aggregate principal amount of
convertible senior notes. The convertible notes have a maturity date of April 1, 2014 and pay
interest at an annual rate of 5.25% semiannually in arrears on April 1 and October 1 of each year,
beginning October 1, 2007 unless earlier redeemed, repurchased or converted.
The convertible notes are fully and unconditionally guaranteed by all of our existing and
future subsidiaries that are parties to any domestic credit facilities, whether as a borrower,
co-borrower or guarantor, including Eddie Bauer, Inc. The convertible notes are unsecured and
senior obligations of us and rank equally in right of payment with all existing and future senior
unsecured indebtedness and senior in right of payment to any subordinated indebtedness.
The convertible notes are not convertible prior to the termination of the ownership
limitations contained in our certificate of incorporation, which will occur not later than January
4, 2009 except upon the occurrence of specified corporate transactions, as set forth in the
indenture governing the convertible notes. See “Note 14 - Notes to Consolidated Financial Statements” included in this document for further
discussion of our ownership limitations. Following the termination of the ownership limitations
and prior to April 1, 2013, holders may convert all or a portion of their notes under the following
circumstances: (i) during any calendar quarter commencing after June 30, 2007 if the last reported
sale price of our common stock is greater than or equal to 120% of the conversion price for at
least 20 trading days in the period of 30 consecutive trading days ending on the last trading day
of the preceding calendar quarter; (ii) during the five business day period after any 10
consecutive trading-day period (“measurement period”) in which the trading price per $1,000
principal amount of notes for each day in the measurement period was less than 98% of the product
of the last reported sale price of our common stock and the conversion rate on such day; or (iii)
upon the occurrence of specified corporate transactions, as set forth in the indenture governing
the convertible notes. On or after April 1, 2013, holders may convert their notes at any time prior
to 5:00 pm, New York City time, on the business day immediately preceding the maturity date. The
initial conversion rate, which is subject to adjustment, for the notes was 73.8007 shares per
$1,000 principal amount of notes (which represented an initial conversion price of approximately
$13.55 per share). Upon conversion, we have the right to deliver, in lieu of shares of common
stock, cash or a combination of cash and shares of our common stock, provided that if the notes are
converted prior to termination of the ownership limitations, we must pay cash in settlement of the
converted notes. A holder will receive cash in lieu of any fractional shares.
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Upon the occurrence of certain fundamental changes, including certain change of control
transactions as set forth in the indenture governing the convertible notes, we will be required to
offer to repurchase the convertible notes for cash at 100% of the principal amount thereof plus
accrued and unpaid interest and additional interest, if any, to but not including the date of
repurchase. In the event of certain events of default under the indenture either the trustee
thereunder or the holders of at least 25% in principal amount of the then-outstanding convertible
notes may declare 100% of the principal of the convertible notes and accrued and unpaid interest,
including additional interest, to be due and payable.
As a result of the requirement that we settle any conversion of the notes occurring prior to
the termination of the ownership limitations contained in our certificate of incorporation in cash,
the conversion features contained within the convertible notes are deemed to be an embedded
derivative under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS
133”). In accordance with SFAS 133, the embedded derivative related to the conversion features
requires bifurcation from the debt component of the convertible notes and a separate valuation. We
recognize the embedded derivative as an asset or liability on our balance sheet and measure it at
its estimated fair value, and recognize changes in its estimated fair value in other income
(expense) in the period of change.
With the assistance of a third party, we estimated the fair value of the embedded derivative
primarily using the Black-Scholes model and other valuation methodologies which resulted in an
estimated fair value of $8.2 million as of June 28, 2008. The estimated fair value of the
conversion features is recorded with the convertible note liability on our balance sheet. We
recognized ($1.4) million and $2.5 million within other income (expense) during the three and six
months ended June 28, 2008 related to the fair value adjustment of the liability since the end of
fiscal 2007. The decline in the estimated fair value of our derivative liability of $21.2 million
as of the issuance date for the convertible notes was primarily a result of the decline in our
common stock price.
As a result of the bifurcation of the embedded derivative related to the conversion features
of the notes under SFAS 133, the carrying value of the convertible notes at issuance was $53.8
million. We are accreting the difference between the face value of the notes and the carrying
value, which totaled $18.5 million as of June 28, 2008, as a charge to interest expense using the
effective interest rate method over the term of the convertible notes. We recognized $0.6 million
and $1.1 million of discount amortization within interest expense during the three and six months
ended June 28, 2008, respectively, which resulted in an effective interest rate of approximately
11.05% related to the convertible notes.
Interest Rate Swap Agreement
We use derivative instruments primarily to manage exposures to fluctuations in interest rates,
to lower our overall costs of financing and to manage the mix of floating- and fixed-rate debt in
our portfolio. Our derivative instruments as of June 28, 2008 included an interest rate swap
agreement. Additionally, our convertible notes included an embedded derivative as discussed further
above. The interest rate swap agreement had a notional amount of $98.8 million as of June 28, 2008.
The interest rate swap agreement effectively converts a portion of the outstanding amount under the
Amended Term Loan, which has a floating rate of interest, to a fixed-rate by having us pay
fixed-rate amounts in exchange for the receipt of the amount of the floating rate interest
payments. Under the terms of the interest rate swap agreement, a monthly net settlement is made for
the difference between the fixed rate of 5.05% and the variable rate based upon the monthly LIBOR
rate on the notional amount of the interest rate swap. No portion of the interest rate swap was
excluded from the assessment of the hedge’s effectiveness. Because all critical terms of the
derivative hedging instrument and the hedged forecasted transaction were not identical, the
interest rate swap did not qualify for the “shortcut method” of accounting as defined in SFAS 133.
On a quarterly basis, we assess and measure the effectiveness of the cash flow hedge using the
changes in variable cash flows method. In performing our assessment as of June 28, 2008, the fair
value of the interest rate swap was determined to be a liability of $4.2 million and the changes in
the cash flows of the derivative hedging instrument were within 80 to 125 percent of the opposite
change in the cash flows of the hedged forecasted transaction and therefore we concluded that the
hedge was highly effective. Accordingly, we recorded the effective portion of the cash flow hedge,
which totaled $4.2 million ($2.6 million net of tax) as of June 28, 2008 within other comprehensive
loss on our balance sheet. No amount of the cash flow hedge was determined to be ineffective. The
amounts reflected in other comprehensive loss will be reclassified into interest expense in the
same period in which the hedged debt affects interest expense. We expect the cash flow hedge to be
highly effective and therefore estimate that no amounts will be reclassified into interest expense
within the next 12 months. The interest rate swap agreement is scheduled to terminate in April
2012.
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Financial Condition
At June 28, 2008 Compared to December 29, 2007
Our total assets were $712.0 million as of June 28, 2008, down $99.4 million, or 12.3% from
December 29, 2007. Current assets as of June 28, 2008 were $192.8 million, down $81.3 million from
$274.1 million as of December 29, 2007. The decline in our current assets was driven primarily by a
$7.2 million decrease in our cash and cash equivalents (see further discussion above under
“Liquidity and Capital Resources — Cash Flow Analysis” ); a $30.7 million decrease in our
restricted cash as a result of the collection of the holdback amounts related to the sale of our
financing receivables; and a $36.1 million decrease in our inventory balance, which is also
discussed above within our “Liquidity and Capital Resources — Cash Flow Analysis.
Non-current assets as of June 28, 2008 were $519.3 million, down $18.0 million from $537.3
million as of December 29, 2007. The decline in our non-current assets was driven primarily by
decreases of $11.5 million and $3.5 million in our property and equipment and other intangible
assets, respectively, due to depreciation and amortization expense recognized during the first half
of 2008.
Our total liabilities were $472.1 million as of June 28, 2008, a decrease of $83.1 million, or
15.0%, from December 29, 2007. Current liabilities as of June 28, 2008 were $137.8 million, down
$64.5 million from $202.3 million as of December 29, 2007. The decline in our current liabilities
was driven by a $21.8 million decrease in our accrued expenses which included decreases of $7.1
million in our allowance for sales returns; $5.4 million in current taxes payable; $5.3 million in
deferred revenues; and $5.1 million in sales and use taxes payable. In addition, our current
liabilities to the Spiegel Creditor Trust decreased $30.7 million as a result of our payments made
associated with the holdback amounts we received during the first and second quarters of 2008. See
further discussion of the sale of our financing receivables and holdback amounts received in Note 5
to our unaudited financial statements included in this document.
Non-current liabilities as of June 28, 2008 were $334.3 million, a decrease of $18.6 million
from $352.9 million as of December 29, 2007. The decrease in our non-current liabilities resulted
from a $12.6 million decrease in our noncurrent deferred tax liabilities driven by the deferred tax
benefit we recognized during the first half of 2008 and a $3.4 million decrease in our senior term
loan resulting from the repayments we made during the first and second quarters of 2008.
Our stockholders’ equity as of June 28, 2008 totaled $240.0 million, down $16.3 million from
December 29, 2007, driven primarily by our net loss recorded for the first half of 2008 which was
partially offset by stock based compensation expense recorded.
Cash Requirements
Our primary cash requirements for fiscal 2008 are to fund working capital to support
anticipated merchandise sales increases; capital expenditures to open new stores, refurbish
existing stores, and maintain our distribution center and information technology systems; and to
make interest payments on our Amended Term Loan and convertible notes. We anticipate that our
capital expenditures for 2008 will be approximately $28.9 million (or $24.0 million net of landlord
contributions), of which approximately 61% relates to opening and remodeling of stores in
accordance with our plans to realign our stores, as compared to capital expenditures of $56.6
million during fiscal 2007, which included capital expenditures related to new store openings,
store remodels and capital expenditures related to the move of our corporate headquarters in
mid-2007. In 2008, we plan to spend up to an additional $2.5 million to refixture our existing
stores to support new merchandise initiatives in outerwear and activewear.
We anticipate opening eight new retail and six new outlet stores during fiscal 2008, of which
five retail and two outlet stores have been opened through the first half of this year. We finance
the opening of the new stores through cash provided by operations and our revolving credit
facility. We estimate that capital expenditures to open a store will approximate $1.0 million and
$0.6 million per store for retail and outlet stores, respectively. In substantially all instances,
this capital investment is funded partially by the landlords of the leased sites. The portion
funded by landlords typically ranges from 30% to 60%. Additionally, we expect initial inventory
purchases for the new retail and outlet stores to average approximately $0.2 million.
Our liquidity levels and the need to fund our cash requirements through the use of our
revolving credit facility will be driven by our net sales and profitability levels, changes in our
working capital, the timing of our capital expenditures and by interest payments on our term loan
and convertible notes. Cash generated from our net sales and profitability, and somewhat to a
lesser extent our changes in working capital, are driven by the seasonality of our business, with a
disproportionate amount of net merchandise sales and operating cash flows occurring in the fourth
fiscal quarter of each year. Additionally, cash generated from our net sales and profitability are
impacted by the levels of and timing of markdowns that we take in order to drive sales. Seasonality
also impacts the levels of our working capital, in that we typically experience higher levels of
net accounts receivables and sales driven accrued expenses, such as sales and use taxes, sales
allowances, and deferred revenues during the fourth quarter of each year. Conversely, we typically
experience a decline in both our net accounts receivable and sales driven accrued expenses during
the first and second
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quarters of each year. Additionally, we normally increase our inventory levels during the
third quarter in anticipation of higher sales during the third and fourth quarters.
We do not anticipate significant cash requirements for U.S. Federal income tax payments during
2008 due to existing, unutilized NOL carryforwards we assumed when Spiegel transferred ownership of
its subsidiaries, FSAC and SAC, to us upon our emergence from bankruptcy. We are required to make
tax payments associated with income we generate related to our Canadian operations. We do not
anticipate paying any dividends on our common stock in the foreseeable future. In addition,
covenants in our term loan agreement and revolving credit facility restrict our ability to pay
dividends and may prohibit certain other payments.
Contractual Obligations
Our contractual obligations primarily consist of long-term debt and the related interest
payments, operating leases, purchase orders for merchandise inventory and other agreements to
purchase goods and services that are legally binding and that require minimum quantities to be
purchased. These contractual obligations impact our short and long-term liquidity and capital
resource needs. A table representing the scheduled maturities of our contractual obligations as of
December 29, 2007 was included under the heading “Contractual Obligations” within our Form 10-K
filed with the SEC on March 13, 2008. The only significant change in our contractual obligations
since December 29, 2007, other than those which occur in the normal course of business (primarily
changes in our merchandise inventory-related purchase obligations, which fluctuate throughout the
year as a result of the seasonal nature of our operations) resulted from our anticipated interest
payments under the variable portion of our senior term loan as a result of changes in interest
rates since year-end. Taking into consideration the interest rate changes and the hedged portion of
our Amended Term Loan, interest requirements are anticipated to be $14.3 million during 2008, $30.1
million during 2009-2010, $31.6 million during 2011-2012, and $19.8 million thereafter, for total
interest requirements of $95.8 million.
In addition to the above contractual obligations, we had $8.5 million of letters of credit
outstanding as of June 28, 2008. See further discussion of our letters of credit under “Off-Balance
Sheet Arrangements” below.
Other Contractual Obligations
Insurance and Self-insurance
We use a combination of insurance and self-insurance to cover a number of risks, including
worker’s compensation, general liability, property and automobile liability and employee-related
health care benefits, a portion of which is reimbursed by our employees. Liabilities associated
with these risks are estimated in part by considering historical claims experience, demographic
factors, severity factors and other actuarial assumptions. We believe that we have taken reasonable
steps to ensure that we are adequately accrued for costs incurred related to these programs at June
28, 2008.
Pension and Other Post-retirement Benefit Obligations
We assumed the Spiegel pension and other post-retirement plans as of our emergence from
bankruptcy. Our funding obligations and liabilities under the terms of the plans are determined
using certain actuarial assumptions, including a discount rate and an expected long-term rate of
return on plan assets. These assumptions are reviewed and updated annually. Prior to fiscal 2008,
our annual measurement date was the end of the third quarter. The third quarter measurement results
were subsequently reflected in our fiscal year end financial statements.
During the first quarter of fiscal 2008, we adopted the measurement provisions of SFAS 158,
Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (an amendment of
FASB Statements No. 87, 88, 106, and 132R) (“SFAS 158”). The measurement provisions of SFAS 158
require a company to measure a plan’s assets and its obligations that determine its funded status
as of the end of the employer’s fiscal year.
In accordance with SFAS 158, in lieu of remeasuring the plan assets and obligations as of
January 1, 2008, we utilized the measurements determined as of September 30, 2007. The periodic
benefit cost for the period of October 1, 2007 through the end of our current fiscal year (e.g.
January 3, 2009) has been allocated between the portion to be recognized as an adjustment to
retained earnings (equal to three-fifteenths of net periodic benefit cost) upon adoption of the
measurement provisions and the portion to be reflected in our statement of operations during fiscal
2008 (equal to twelve-fifteenths of net periodic benefit cost). As a result, we recognized a
pre-tax debit to retained earnings of $0.1 million related to our post-retirement health and
welfare plans and a pre-tax credit to retained earnings of $0.2 million related to our pension plan
as of January 1, 2008.
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We assumed a discount rate of 6.00% for our pension obligation and 6.14% for our other
post-retirement obligations, as of September 30, 2007, our most recent measurement date, based upon
an analysis of the Moody’s AA corporate bond rate.
Our expected long-term rate of return on plan assets assumption for our pension plan was
derived from a study conducted by our actuaries and investment managers. The study included a
review of anticipated future long-term performance of individual asset classes and consideration of
the appropriate asset allocation strategy given the anticipated requirements of the plan to
determine the average rate of earnings expected on the funds invested to provide for the pension
plan benefits. While the study gives appropriate consideration to recent fund performance and
historical returns, the assumption is primarily a long-term, prospective rate. Based upon the most
recent study, we have assumed a long-term return of 8.5% related to our pension assets as of the
September 30, 2007 measurement date.
As of September 30, 2007, our most recent measurement date, our estimated unfunded pension
obligation was approximately $2.1 million and our estimated unfunded obligation related to the
assumed post-retirement benefit plans was $8.0 million. Our contributions to the post-retirement
benefit plans and pension plan are estimated to total $0.6 million and $0, respectively, for fiscal
2008.
Off-Balance Sheet Arrangements
As of June 28, 2008, we had $8.5 million in outstanding stand-by letters of credit. We had no
other off-balance sheet financing arrangements as of June 28, 2008. We use stand-by letters of
credit to support our worker’s compensation insurance and import customs bond programs. Letters of
credit, primarily merchandise vendor letters of credit, are important to our operations because
they allow us to have payment on our behalf guaranteed by a bank which then pays the vendor a given
amount of money upon presentation of specific documents demonstrating that merchandise has shipped.
We subsequently record the payable to the vendor on our balance sheet at the time of merchandise
title transfer. We had no letters of credit outstanding as of June 28, 2008 for the sourcing or
purchase of inventory, and at this time, we are not aware of any material future risks to the
availability of letters of credit.
Seasonality
Historically, our operations have been seasonal, with a disproportionate amount of net
merchandise sales occurring in the fourth fiscal quarter, reflecting increased demand during the
year-end holiday selling season. During fiscal 2007, the fourth fiscal quarter accounted for
approximately 38% of our net merchandise sales. As a result of this seasonality, any factors
negatively affecting us during the fourth fiscal quarter of any year, including adverse weather or
unfavorable economic conditions, could have a material adverse effect on our financial condition
and results of operations for the entire year. The impact of seasonality on results of operations
is more pronounced since the level of certain fixed costs, such as occupancy and overhead expenses,
do not vary with sales. Our quarterly results of operations also may fluctuate based upon such
factors as the timing of certain holiday seasons, the number and timing of new store openings, the
amount of net merchandise sales contributed by new and existing stores, the timing and level of
markdowns, store closings, refurbishments and relocations, competitive factors, weather and general
economic conditions. Accordingly, results for individual quarters are not necessarily indicative of
the results to be expected for the entire fiscal year.
Critical Accounting Policies and Estimates
The preparation of financial statements and related disclosures in conformity with generally
accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and
liabilities as of the date of the financial statements and revenues and expenses during the periods
reported. We base our estimates on historical experience, where applicable and other assumptions
that we believe are reasonable under the circumstances. Actual results may differ from our
estimates under different assumptions or conditions.
There are certain estimates that we believe require significant judgment in the preparation of
our financial statements. We consider an accounting estimate to be critical if:
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The changes to our critical accounting policies and estimates as disclosed in our Annual
Report on Form 10-K filed with the SEC on March 13, 2008 included the adoption of SFAS 157, Fair
Value Measurements, which defined how fair value is to be calculated for our nonfinancial assets
and nonfinancial liabilities, which included the valuation of our derivative instruments. The
adoption of SFAS 157 did not have a material impact to the fair value determination of our
derivative instruments.
Additionally, effective with 2008, we changed the volatility assumptions used in determining
the fair values of our stock options. Prior to 2008, our volatility assumptions used in determining
the fair values of our stock options was based upon historical and implied volatility for other
companies in the retail industry due to our limited stock price history. During the current year,
our volatility assumptions include both (i) our one-year historical volatility and (ii) six—year
historical volatility levels and implied volatility for peer companies in the retail industry. The
change in volatility assumptions to include our historical volatility did not have a material
impact on the fair values of our stock options and SOSARs granted during 2008.
Inflation
The rate of inflation over the past several years has not had a significant impact on our
sales or profitability.
Recent Accounting Pronouncements
See Note 3 to our interim financial statements included in this report for a discussion of
recent accounting pronouncements.
Related Party Transactions
We had no material related party transactions during the three or six months ended June 28,
2008.
Subsequent
Event
See
Note 14 to our interim financial statements included in this
report for a discussion of a subsequent event.
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Our primary exposures to market risk relate to interest rates, changes in the value of our
common stock and foreign exchange rates. We use certain derivative financial instruments, primarily
interest rate swaps, to manage our interest rate risks. We do not use any derivatives to manage our
foreign exchange risks. We do not use derivatives for trading purposes, to generate income or to
engage in speculative activity.
Market Risk — Interest Rates
We are exposed to interest rate risk associated with our revolving credit facility, the
Amended Term Loan agreement which we entered into in April 2007 and the convertible notes we issued
in April 2007.
Revolving Credit Facility
Our Revolver bears interest at variable rates based on LIBOR plus a spread. As of June 28,
2008, our availability was approximately $74.0 million and no amounts had been drawn under the
Revolver.
Senior Secured Term Loan
On April 4, 2007, we amended and restated the Prior Term Loan. As of June 28, 2008, the
outstanding amount of our Amended Term Loan totaled $192.8 million. Interest on the Amended Term
Loan is calculated as the greater of the prime rate or the Federal funds effective rate plus
one-half of one percent plus 2.25% in the case of base rate loans, or LIBOR plus 3.25% for
Eurodollar loans. Interest requirements for both base rate loans and Eurodollar loans are reset on
a monthly basis. As of June 28, 2008, the Amended Term Loan had interest rates of LIBOR ranging
from 2.47% to 2.90% plus 3.25% depending upon the term of the LIBOR tranche. See “Management’s
Discussion and Analysis of Financial Condition — Sources of Liquidity” for a more detailed
description of our Amended Term Loan Agreement.
As of June 28, 2008, we had an interest rate swap agreement with a notional amount of $98.8
million, which had been designated as a cash flow hedge of Amended Term Loan. The interest rate
swap agreement effectively converts a portion of the outstanding amount under the Amended Term
Loan, which has a floating-rate of interest to a fixed-rate by having us pay fixed-rate amounts in
exchange for the receipt of the amount of the floating-rate interest payments. Under the terms of
the interest rate swap agreement, a monthly net settlement is made for the difference between the
fixed rate of 5.05% and the variable rate based upon the monthly LIBOR rate on the notional amount
of the interest rate swap. The new interest rate swap agreement is scheduled to terminate in April
2012. The fair value of the interest rate swap agreement was estimated to be a liability of $4.2
million as of June 28, 2008. Assuming a 10% increase in interest rates, the fair value of the new
interest rate swap would be a liability of approximately ($2.9) million at June 28, 2008. Assuming
a 10% decrease in interest rates, the fair value of the interest rate swap would be a liability of
approximately ($5.5) million at June 28, 2008.
Convertible Notes
On April 4, 2007, we closed our offering of $75 million aggregate principal amount of
convertible senior notes. The convertible notes have a maturity date of April 1, 2014 and pay
interest at an annual rate of 5.25% unless earlier redeemed, repurchased or converted. Generally,
the fair market value of fixed interest rate debt will increase as interest rates fall and decrease
as interest rates rise.
Market Risk — Change in Value of our Common Stock
Our convertible notes contain certain features that allow the holder to convert their notes
into shares of our common stock upon the occurrence of certain conditions. See further discussion
above under “Management’s Discussion and Analysis of Financial Condition — Sources of Liquidity —
Convertible Notes” for a detailed description of the terms of conversion. The fair market value of
the convertible notes is subject to market risk due to the convertible feature of the notes. The
fair market value of the convertible notes will generally increase as the market price of our
common stock increases and decrease as the market price falls.
As a result of the requirement that we settle any conversion of notes prior to the termination
of the ownership limitations contained in our certificate of incorporation in cash, the conversion
features contained within the convertible notes are deemed to be an embedded derivative under SFAS
133. In accordance with SFAS 133, the embedded derivative related to the conversion features
requires bifurcation from the debt component of the convertible notes and a separate valuation. We
recognize the embedded derivative as a liability on our balance sheet and measure it at its
estimated fair value, and recognize changes in its estimated fair value in other
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income (expense) in the period of change. We determine the estimated fair value of the
embedded derivative primarily using the Black-Scholes model and other valuation methodologies which
resulted in an estimated fair value of $21.2 million as of the issuance date for the convertible
notes. The Black-Scholes model and other valuation methodologies are complex and require
significant judgments. In applying the Black-Scholes model, changes and volatility in our common
stock price and the stock price of other comparable retailers and changes in risk-free interest
rates could significantly affect the fair value of this derivative instrument. We estimated the
fair value of the conversion features to be $8.2 million as of June 28, 2008 and recognized ($1.4)
million and $2.5 million, respectively, within other income (expense) during the three and six
months ended June 28, 2008.
Market Risk — Foreign Exchange
Our foreign currency risks relate primarily to stores that we operate in Canada and with our
joint venture investment in Japan, for which we apply the equity method of accounting as we do not
control this entity. Additionally, we have foreign currency risks associated with the purchase of
merchandise from foreign entities. We believe that the potential exposure from foreign currency
risks is not material to our financial condition or results of operations.
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Evaluation of Disclosure Controls and Procedures
As of June 28, 2008, the Company’s management, with participation of its Chief Executive
Officer and Chief Financial Officer, reviewed and evaluated the effectiveness of the design and
operation of the Company’s “disclosure controls and procedures” (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) as of the end of the period covered by this report (the “Evaluation
Date”). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures are
adequate and effective to reasonably assure that material information relating to the Company,
including its consolidated subsidiaries, would be communicated to management by others within those
entities in a timely manner to allow decisions to be made regarding required disclosure.
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act
of 1934. Internal control over financial reporting includes policies and procedures that provide
reasonable assurance regarding the accuracy and reliability of financial reporting and the
preparation of the Company’s financial statements to accurately and fairly reflect the transactions
and dispositions of the Company’s assets; provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in accordance with U.S.
generally accepted accounting principles; ensure that receipts and expenditures are being made only
in accordance with the authorization of management; and provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisitions, use or disposition of the Company’s
assets that could have a material effect on our financial statements. There are inherent
limitations in the effectiveness of internal control over financial reporting, including the
possibility that misstatements may not be prevented or detected. Accordingly, even the most
effective internal controls over financial reporting can provide only reasonable assurances with
respect to financial statement preparation. Furthermore, the effectiveness of internal controls can
change with changes in circumstances.
Management conducted an evaluation of the effectiveness of our internal control over financial
reporting based on the framework and criteria established in Internal Control-Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this
evaluation, management concluded that our internal control over financial reporting was effective
as of June 28, 2008.
Changes in Internal Control over Financial Reporting
There have been no significant changes in our internal control over financial reporting during
the three months ended June 28, 2008 that have materially affected or are reasonably likely to
materially affect, our internal control over financial reporting.
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PART II—OTHER INFORMATION
In
June 2006, a class action suit captioned Tara Hill v. Eddie
Bauer, Inc., was filed in Los
Angeles Superior Court, State of California. The suit alleged that we violated the California Labor
Code and Business and Professions Code relating to the adequacy of wage statements, reimbursements
for business expenses, meal and rest periods and other claims, on behalf of a class comprised of
all employees in our California stores. We reached a settlement with the plaintiff in April 2007,
and have provided notice to class members regarding the potential settlement. A hearing on final
court approval of the settlement occurred on July 10, 2008, at
which the plaintiff in the Scherer
v. Eddie Bauer, Inc. suit referenced below objected to the settlement on various grounds. The
court took the parties’ positions under advisement and we expect a ruling to be issued during the
third quarter of 2008. In connection with the proposed settlement, we accrued $1.6 million in the
first quarter of 2007 to cover settlement payments and attorneys’ fees. The settlement payments
are proposed to be made partly in cash and partly in Company gift cards.
In
September 2007, a purported class action suit captioned Kristal Scherer, on behalf of
herself, all others similarly situated v. Eddie Bauer, Inc. and Does
1 to 100 was filed in Superior
Court of California, County of San Diego, alleging violations of the California Labor Code and
Business and Professions Code relating to the payment of incentive bonuses and our policy on
forfeiture of personal days. The case has been removed to U.S. District Court, Southern District of
California. In December 2007, we filed a partial motion to dismiss certain counts of plaintiff’s
complaint for failure to state a claim. That motion was denied in June 2008. The complaint was
amended in January 2008 to add an additional named plaintiff. We filed an answer in July 2008
denying the claims made.
In the ordinary course of business, we may be subject from time to time to various other
proceedings, lawsuits, disputes or claims. These actions may involve commercial, intellectual
property, product liability, labor and employment related claims and other matters. Although we
cannot predict with assurance the outcome of any litigation, we do not believe there are currently
any such actions that, if resolved unfavorably, would have a material impact on our financial
condition or results of operations except as disclosed herein.
Our Annual Report on Form 10-K for the fiscal year ended December 29, 2007 (our “Form 10-K”),
contains a detailed discussion of certain risk factors that could materially adversely affect our
business, our operating results, and/or our financial condition. There have been no material
changes in our risk factors from those disclosed on our Form 10-K.
At the Company’s Annual Meeting of Stockholders held on May 2, 2008, the stockholders elected
each nominee to the Board of Directors for a one-year term, casting votes as follows:
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The Company’s stockholders ratified the selection of BDO Seidman, LLP as the Company’s
independent registered public accounting firm for the fiscal year ending January 3, 2009, casting
their votes as follows:
Item 5. OTHER INFORMATION
The Company and Neil Fiske are parties to a Letter Agreement dated June 12, 2007, relating to
Mr. Fiske’s employment (the “Letter Agreement”). On August 5, 2008, the parties amended the Letter
Agreement to extend the period for certain relocation benefits described in the Letter Agreement to
provide that reimbursement of relocation costs and payment of temporary housing costs are available
for 24 months, and certain closing and home sale related benefits are available for 36 months, each
measured from commencement of Mr. Fiske’s employment on July 9, 2007.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
Date: August 7, 2008
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