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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

 

FORM 10-Q

(Mark One)

 

 

For the transition period from                          to                         .

 

Commission File Number 001-31390

 

CHRISTOPHER & BANKS CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

(763) 551-5000

(Registrant’s telephone number, including area code)

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

YES      x             NO      o

 

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

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

YES      o              NO      x

 

As of September 26, 2008, 35,499,805 shares of the registrant’s common stock were outstanding.

 

 

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CHRISTOPHER & BANKS CORPORATION

 

QUARTERLY REPORT ON FORM 10-Q

 

TABLE OF CONTENTS

 

PART I FINANCIAL INFORMATION
		Page
Item 1.	Financial Statements:
	Condensed Consolidated Balance Sheet (Unaudited)
	As of August 30, 2008, March 1, 2008 and September 1, 2007	3
	Condensed Consolidated Statement of Income (Unaudited)
	For the Three Months Ended August 30, 2008 and September 1, 2007	4
	Condensed Consolidated Statement of Income (Unaudited)
	For the Six Months Ended August 30, 2008 and September 1, 2007	5
	Condensed Consolidated Statement of Cash Flows (Unaudited)
	For the Six Months Ended August 30, 2008 and September 1, 2007	6
	Notes to Condensed Consolidated Financial Statements (Unaudited)	7
Item 2.	Management’s Discussion and Analysis of
	Financial Condition and Results of Operations	17
Item 3.	Quantitative and Qualitative Disclosures
	About Market Risk	27
Item 4.	Controls and Procedures	28
PART II OTHER INFORMATION
Item 1.	Legal Proceedings	28
Item 1A.	Risk Factors	28
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	28
Item 3.	Defaults Upon Senior Securities	29
Item 4.	Submission of Matters to a Vote of Security Holders	29
Item 5.	Other Information	30
Item 6.	Exhibits	30
	Signatures	31
	Index to Exhibits	32

 

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PART I — FINANCIAL INFORMATION

 

ITEM 1.

FINANCIAL STATEMENTS

 

CHRISTOPHER & BANKS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEET

(Unaudited)

 

		August 30,			March 1,			September 1,
		2008			2008			2007
ASSETS
Current assets:
Cash and cash equivalents		$	84,036,754		$	78,492,297		$	47,421,468
Short-term investments		—			—			43,450,000
Accounts receivable		4,311,102			5,222,976			5,713,892
Merchandise inventories		51,531,569			43,840,338			50,164,552
Prepaid expenses		12,176,189			11,597,280			10,970,362
Other current assets		6,221,750			9,482,393			8,813,608
Total current assets		158,277,364			148,635,284			166,533,882
Property, equipment and improvements, net		131,771,577			133,598,580			132,583,350
Long-term investments		18,535,577			23,350,000			—
Goodwill		—			—			3,587,052
Other assets		6,680,785			6,207,858			3,065,575
Total assets		$	315,265,303		$	311,791,722		$	305,769,859
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	11,289,914		$	15,380,692		$	12,407,603
Accrued salaries, wages and related expenses		9,192,422			9,246,050			8,158,886
Other accrued liabilities		27,356,950			28,040,623			20,046,848
Total current liabilities		47,839,286			52,667,365			40,613,337
Non-current liabilities:
Deferred lease incentives		24,190,711			24,854,278			23,332,654
Deferred rent obligations		10,880,462			11,720,689			11,429,871
Other		4,450,236			3,722,195			3,607,544
Total non-current liabilities		39,521,409			40,297,162			38,370,069
Commitments		—			—			—
Stockholders’ equity:
Preferred stock — $0.01 par value, 1,000,000 shares authorized, none outstanding		—			—			—
Common stock — $0.01 par value, 74,000,000 shares authorized, 45,324,403, 45,050,290 and 44,950,343 shares issued and 35,520,605, 35,259,572 and 35,772,325 shares outstanding at August 30, 2008, March 1, 2008 and September 1, 2007, respectively		453,244			450,503			449,503
Additional paid-in capital		111,510,432			110,359,847			107,812,881
Retained earnings		229,814,314			221,928,654			224,233,794
Common stock held in treasury, 9,803,798, 9,790,718 and 9,178,018 shares at cost at August 30, 2008, March 1, 2008 and September 1, 2007, respectively		(112,858,959		)	(112,711,809		)	(105,709,725		)
Accumulated other comprehensive income (loss)		(1,014,423		)	(1,200,000		)	—
Total stockholders’ equity		227,904,608			218,827,195			226,786,453
Total liabilities and stockholders’ equity		$	315,265,303		$	311,791,722		$	305,769,859

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

 

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CHRISTOPHER & BANKS CORPORATION

CONDENSED CONSOLIDATED STATEMENT OF INCOME

(Unaudited)

 

		Three Months Ended
		August 30,			September 1,
		2008			2007
Net sales		$	131,636,653		$	141,127,615
Costs and expenses:
Merchandise, buying and occupancy, exclusive of depreciation and amortization		81,453,282			90,594,806
Selling, general and administrative		41,414,130			40,626,872
Depreciation and amortization		7,967,103			5,510,041
Total costs and expenses		130,834,515			136,731,719
Operating income		802,138			4,395,896
Interest income		586,025			1,160,228
Income before income taxes		1,388,163			5,556,124
Income tax provision		552,489			2,166,888
Net income		$	835,674		$	3,389,236
Basic earnings per common share:
Net income		$	0.02		$	0.09
Basic shares outstanding		35,098,661			35,846,747
Diluted earnings per common share:
Net income		$	0.02		$	0.09
Diluted shares outstanding		35,122,385			35,948,514
Dividends per share		$	0.06		$	0.06

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

 

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CHRISTOPHER & BANKS CORPORATION

CONDENSED CONSOLIDATED STATEMENT OF INCOME

(Unaudited)

 

 

		Six Months Ended
		August 30,			September 1,
		2008			2007
Net sales		$	291,279,457		$	290,498,949
Costs and expenses:
Merchandise, buying and occupancy, exclusive of depreciation and amortization		171,926,286			177,510,927
Selling, general and administrative		86,226,867			79,705,995
Depreciation and amortization		14,425,446			10,805,168
Total costs and expenses		272,578,599			268,022,090
Operating income		18,700,858			22,476,859
Interest income		1,412,592			2,219,251
Income before income taxes		20,113,450			24,696,110
Income tax provision		8,005,153			9,631,483
Net income		$	12,108,297		$	15,064,627
Basic earnings per common share:
Net income		$	0.35		$	0.42
Basic shares outstanding		35,086,015			35,900,270
Diluted earnings per common share:
Net income		$	0.34		$	0.42
Diluted shares outstanding		35,111,930			36,010,301
Dividends per share		$	0.12		$	0.12

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

 

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CHRISTOPHER & BANKS CORPORATION

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited)

 

		Six Months Ended
		August 30,			September 1,
		2008			2007
Cash flows from operating activities:
Net income		$	12,108,297		$	15,064,627
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		13,204,896			10,805,168
Impairment of store assets		1,220,550			—
Deferred income taxes		(1,207,223		)	(6,725,847		)
Excess income tax benefit on exercise of stock options		—			(21,152		)
Stock-based compensation expense		1,153,326			940,808
Loss on disposal of furniture, fixtures and equipment		348,350			114,707
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable		911,874			(1,232,268		)
Decrease (increase) in merchandise inventories		(7,691,231		)	2,190,392
Increase in prepaid expenses		(578,909		)	(303,941		)
Decrease in other current assets		3,914,466			300,320
(Increase) decrease in other assets		6,338			(60,353		)
Decrease in accounts payable		(4,090,778		)	(3,953,255		)
Increase (decrease) in accrued liabilities and income taxes payable		(884,451		)	(1,756,477		)
Increase (decrease) in deferred lease incentives		(663,567		)	(313,607		)
Increase (decrease) in deferred rent obligations		(840,227		)	751,530
Increase in other liabilities		728,041			3,607,544
Net cash provided by operating activities		17,639,752			19,408,196
Cash flows from investing activities:
Purchases of property, equipment and improvements		(12,872,658		)	(15,599,274		)
Purchases of investments		—			(61,100,000		)
Sales of investments		5,000,000			65,925,000
Net cash used in investing activities		(7,872,658		)	(10,774,274		)
Cash flows from financing activities:
Proceeds from exercise of stock options		—			43,073
Dividends paid		(4,222,637		)	(4,314,790		)
Excess income tax benefit on exercise of stock options		—			21,152
Acquisition of common stock held in treasury		—			(10,953,287		)
Net cash used in financing activities		(4,222,637		)	(15,203,852		)
Net increase (decrease) in cash and cash equivalents		5,544,457			(6,569,930		)
Cash and cash equivalents at beginning of period		78,492,297			53,991,398
Cash and cash equivalents at end of period		$	84,036,754		$	47,421,468

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

 

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CHRISTOPHER & BANKS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 1 — BASIS OF PRESENTATION

 

The unaudited condensed consolidated financial statements included in this Form 10-Q have been prepared by Christopher & Banks Corporation and subsidiaries (the “Company”) pursuant to the rules and regulations of the United States Securities and Exchange Commission.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed, or omitted, pursuant to such rules and regulations.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited financial statements and related notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 1, 2008.

 

The results of operations for the interim periods shown in this report are not necessarily indicative of results to be expected for the full fiscal year.  In the opinion of management, the information contained herein reflects all adjustments necessary to present fairly the Company’s financial position as of August 30, 2008 and September 1, 2007, and its results of operations and cash flows for the six month periods ended August 30, 2008 and September 1, 2007.  All such adjustments are of a normal, recurring nature.

 

Recently Issued Accounting Pronouncements

 

                In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”).  SFAS No. 157 establishes a single definition of fair value and a framework for measuring fair value, sets out a fair value hierarchy to be used to classify the source of information used in fair value measurements, and requires new disclosures of assets and liabilities measured at fair value based on their level in the hierarchy.  This statement applies under other accounting pronouncements that require or permit fair value measurements.  In February 2008, the FASB issued Staff Positions (“FSPs”) No. 157-1 and No. 157-2, which, respectively, remove leasing transactions from the scope of SFAS No. 157 and defer its effective date for one year relative to certain nonfinancial assets and liabilities. As a result, the application of the definition of fair value and related disclosures of SFAS No. 157 (as impacted by these two FSPs) was effective for the Company beginning March 2, 2008 on a prospective basis with respect to fair value measurements of (a) nonfinancial assets and liabilities that are recognized or disclosed at fair value in the Company’s financial statements on a recurring basis (at least annually) and (b) all financial assets and liabilities. This adoption did not have a material impact on the Company’s consolidated results of operations or financial condition for the six months ended August 30, 2008. The remaining aspects of SFAS No. 157 for which the effective date was deferred under FSP No. 157-2 are currently being evaluated by the Company.  Areas impacted by the deferral relate to nonfinancial assets and liabilities that are measured at fair value but are recognized or disclosed at fair value on a nonrecurring basis. This deferral applies to such items as nonfinancial assets and liabilities initially measured at fair value in a business combination (but not measured at fair value in subsequent periods) or nonfinancial long-lived asset groups measured at fair value for an impairment assessment.  The effects of these remaining aspects of SFAS No. 157 are to be applied by the Company to fair value measurements prospectively beginning March 1, 2009. The Company does not expect them to have a material impact on the Company’s consolidated results of operations or financial condition.  Please refer to Note 12 for disclosures related to our initial adoption of SFAS No. 157.

 

                In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”).  SFAS No. 159 permits an entity to choose, at specified election dates, to measure eligible financial instruments and certain other items at fair value that are not currently required to be measured at fair value. An entity reports unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date.  Upfront costs and fees related to items for which the fair value option is elected are recognized in earnings as incurred and not deferred.  SFAS No. 159 also established presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities.  SFAS No. 159 was effective for financial statements issued for fiscal years beginning after November 15, 2007 (March 2, 2008 for the Company).  At the effective date, an entity could elect the fair value option for eligible items that existed at that date.  If an entity elected the fair value option, the entity was required to report the effect of the first remeasurement to fair value as a cumulative-effect adjustment to the opening balance of retained earnings. The Company did not elect the fair value option for eligible items that existed as of March 2, 2008.

 

 

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NOTE 2 — EXIT OF ACORN BUSINESS

 

                On July 31, 2008, the Company announced its decision to exit its Acorn division business when management concluded, after a comprehensive review and evaluation, that the concept had not demonstrated the potential to deliver an acceptable long-term return on the Company’s investment.  On July 30, 2008, the Company’s Board of Directors authorized a plan to close all of the Company’s 36 Acorn stores by December 31, 2008.  This decision will allow the Company to focus its resources on its two core brands, Christopher & Banks and C.J. Banks.

 

                In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”) and SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”), during the three months ended August 30, 2008, the Company recorded a pre-tax charge of $1.2 million related to the impairment of long-lived Acorn assets, including approximately $1.1 million of property and equipment and $0.1 million of other intangible assets.  The non-cash charge is reported as a component of depreciation and amortization expense in the Company’s Condensed Consolidated Statement of Income.

 

                In accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” (“SFAS No. 146”), in the third and fourth quarters of fiscal 2009 the Company estimates it will recognize between $5.4 million and $8.4 million of pre-tax cash charges consisting of real estate operating lease termination-related costs, retention and severance expenses and miscellaneous store closing and other associated costs.  These estimated costs and charges are preliminary and may vary materially based on various factors, including timing in execution of the exit plan, the outcome of lease termination negotiations with landlords, the degree of success in liquidating the Acorn inventory, the amount of retention and severance payments ultimately made to Acorn employees and changes in management’s assumptions and projections.

 

                In the third quarter of fiscal 2009, upon the substantial completion of the Company’s exit strategy, the Company anticipates it will report its Acorn operations as discontinued operations in the consolidated financial statements for all periods presented in accordance with SFAS No. 144.

 

NOTE 3 — INVESTMENTS

 

The Company’s investments consisted of the following:

 

		August 30,			March 1,			September 1,
Description		2008			2008			2007
Tax-advantaged, auction rate, available-for-sale securities:
Short-term		$	—		$	—		$	43,450,000
Long-term		18,535,577			23,350,000			—
		$	18,535,577		$	23,350,000		$	43,450,000

 

                As of August 30, 2008, the Company had approximately $18.5 million of long-term investments, which consisted solely of $19.5 million of auction rate securities (“ARS”) at cost, less a temporary valuation allowance of $1.0 million.  This valuation allowance was based on an analysis of other-than-temporary impairment factors, resulting in management’s estimate of fair value, given the current lack of liquidity of these investments, while taking into account the current credit quality of the underlying securities.

 

                ARS are long-term debt instruments with interest rates that may reset through scheduled and successful auctions which may occur every seven, 28 or 35 days.  Holders of ARS can either sell into the auction, bid based on a desired interest rate or hold and accept the reset rate.  If there are insufficient buyers, then the auction “fails” and holders are unable to liquidate their investment through the auction.  A failed auction is not a default of the debt instrument. The result of a failed auction is that the ARS continues to pay interest in accordance with its original terms. Liquidity, however, for holders is limited until there is a successful auction, until such time as another market for ARS develops or the ARS are called by the issuer. Auctions continue to be held as scheduled until the ARS matures or until the issue is called. All of the Company’s ARS are collateralized by student loans and currently have AAA (S&P) or Aaa (Moody’s) credit ratings.

 

 

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                As of August 30, 2008, the repayment of approximately 80% of the student loans, which serve as collateral for the ARS held by the Company, is substantially backed by the United States government.  Until February 2008, the ARS market was liquid and auctions for ARS held by the Company did not fail. However, in February 2008, a substantial number of auctions failed, meaning there was not enough demand to sell the entire issue at auction.  Auctions for the ARS held by the Company began to fail in February 2008 and have continued to fail up to and as of the date of this report.

 

                Based on current market conditions, management believes that it is likely that auctions related to the Company’s ARS will continue to be unsuccessful for the near term.  Unsuccessful auctions have limited the Company’s ability to access these funds.  Management anticipates the liquidity of the ARS will continue to be restricted until there is a successful auction or until such time as another market for the ARS develops or until the ARS are called by the issuer.

 

                All of the ARS owned by the Company were purchased from UBS Financial Services, Inc., a subsidiary of UBS AG (“UBS”) and are held, for the benefit of the Company, by UBS.  On August 8, 2008, UBS announced a settlement in principle with the Securities and Exchange Commission, the New York Attorney General and other state regulatory agencies to restore liquidity to remaining clients who hold ARS.  Under the settlement, the Company will be able to redeem its ARS at par during a two-year time period beginning June 30, 2010.  During this time, the Company may choose to continue to hold some or all of its ARS and earn interest or sell some or all of them to UBS at par plus accrued interest.

 

                The Company reclassified its ARS to long-term investments at March 1, 2008 to reflect the lack of liquidity of these investments.  As of August 30, 2008, the Company had approximately $84.0 million of cash and cash equivalents.  Management believes the Company has sufficient balances of cash and cash equivalents to meet the Company’s working capital requirements and liquidity needs in fiscal 2009.

 

                The Company reviews impairments associated with its ARS in accordance with EITF 03-1 and FASB Staff Position SFAS Nos. 115-1 and 124-1, “The Meaning of Other-Than-Temporary-Impairment and Its Application to Certain Investments,” to determine the classification of the impairment as “temporary” or “other-than-temporary.”  A temporary impairment charge results in an unrealized loss being recorded in the other comprehensive income component of stockholders’ equity.  The unrealized loss does not reduce net income for the applicable accounting period because the loss is not viewed as other-than-temporary.  The Company’s management currently believes that all of the impairment related to its ARS is temporary.  The factors evaluated to differentiate between temporary and other-than-temporary include an assessment of the credit quality of the underlying collateral, credit ratings actions and the Company’s ability to hold the securities to maturity.  No tax benefit has been provided for this allowance because a loss, if any, would be a capital loss.

 

NOTE 4 — MERCHANDISE INVENTORIES AND SOURCES OF SUPPLY

 

Merchandise inventories consisted of the following:

 

		August 30,			March 1,			September 1,
Description		2008			2008			2007
Merchandise - in store		$	39,959,578		$	37,303,879		$	40,159,538
Merchandise - in transit		11,571,991			6,536,459			10,005,014
		$	51,531,569		$	43,840,338		$	50,164,552

 

The Company does not have long-term purchase commitments or arrangements with any of its suppliers or agents.  The Company purchased approximately 13% and 14% of its merchandise from its largest overseas supplier during the first six months of fiscal 2009 and 2008, respectively.  Although the Company has an established operating history with its largest vendor, there can be no assurance that this relationship can be maintained in the future or that the vendor will continue to supply merchandise to the Company.  If there should be any significant disruption in the supply of merchandise from this vendor, management believes that it will be able to shift production to other suppliers so as to continue to secure the required volume of product.  Nevertheless, it is possible that any significant disruption in supply could have a material adverse impact on the Company’s financial position and results of operations.

 

 

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In the three and six month periods ended August 30, 2008, the Company purchased approximately 33% and 42% of its merchandise through one buying agent (the “Agent”), respectively.  The Company has begun the process of establishing relationships with additional primary suppliers, which are intended to reduce its reliance on the Agent.  The Agent also has informed the Company that it desires to cease serving as an intermediary with manufacturers on behalf of Christopher & Banks.  Therefore, the Company and the Agent have agreed that their current arrangement will be discontinued at the end of December 2008.  While management believes the actions it is taking to mitigate the risks of reliance on the Agent will be successful, any significant disruption in supply from vendors working through the Agent could have a material adverse impact on the Company’s financial position and results of operations.

 

NOTE 5 — PROPERTY, EQUIPMENT AND IMPROVEMENTS, NET

 

Property, equipment and improvements, net consisted of the following:

 

		Estimated		August 30,			March 1,			September 1,
Description		Useful Life		2008			2008			2007
Land		—		$	1,596,898		$	1,596,898		$	1,596,898
Corporate office, distribution center and related building improvements		25 years		12,014,667			12,014,667			11,823,129
Store leasehold improvements		Term of related lease, typically 10 years		100,131,040			97,525,439			90,623,054
Store furniture and fixtures		Three to 10 years		116,741,484			113,585,852			105,637,453
Computer hardware and software		Three to five years		27,696,814			21,595,000			15,985,314
Corporate office and distribution center furniture, fixtures and equipment		Seven years		2,978,430			3,055,898			2,868,716
Construction in progress		—		8,955,510			9,474,738			10,410,235
				270,114,843			258,848,492			238,944,799
Less accumulated depreciation and amortization				138,343,266			125,249,912			106,361,449
Net property, equipment and improvements				$	131,771,577		$	133,598,580		$	132,583,350

 

NOTE 6 — ACCRUED LIABILITIES

 

Other accrued liabilities consisted of the following:

 

		August 30,			March 1,			September 1,
Description		2008			2008			2007
Gift card, certificate and store credit liabilities		$	8,432,457		$	13,545,500		$	8,104,900
Accrued un-invoiced merchandise inventory receipts		9,523,134			4,949,370			2,095,685
Accrued workers compensation self-insurance liability		2,449,579			2,252,571			1,895,162
Accrued income, sales and other taxes payable		2,434,385			2,161,038			2,934,270
Accrued occupancy-related expenses		1,632,248			992,584			1,219,971
Other		2,885,147			4,139,560			3,796,860
		$	27,356,950		$	28,040,623		$	20,046,848

 

NOTE 7 — CREDIT FACILITY

 

                The Company maintains an Amended and Restated Revolving Credit Facility (the “Credit Facility”) with Wells Fargo Bank, National Association (“Wells Fargo”).  The Credit Facility provides the Company with revolving credit loans and letters of credit of up to $50.0 million, in the aggregate, subject to a borrowing base formula based on inventory levels.

 

 

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In the first quarter of fiscal 2009, the Company and Wells Fargo entered into a Second Amendment to the Credit Facility (the “Second Amendment”).  The Second Amendment extended the maturity date of the Credit Facility by three years from June 30, 2008 to June 30, 2011.  In addition, the Second Amendment reduced the interest rate under the Credit Facility from the prime rate plus 0.25% to the prime rate minus 0.25%.  As of August 30, 2008, Wells Fargo’s prime rate was 5.0%.  The Second Amendment also provided the Company with the ability to borrow under the Credit Facility at an interest rate tied to the London Interbank Market Offered Rate (LIBOR), which was 3.2% as of August 30, 2008.

 

                Interest under the Credit Facility is payable monthly in arrears.  The Credit Facility carries a facility fee of 0.25%, based on the unused portion as defined in the agreement, and a collateral monitoring fee.  For the six months ended August 30, 2008, fees related to the Credit Facility totaled $17,900.  Borrowings under the Credit Facility are collateralized by the Company’s equipment, intangible assets, inventory, inventory letters of credit and letter of credit rights.  The Company had no revolving credit loan borrowings under the Credit Facility during the first six months of fiscal 2009.  Historically, the Credit Facility has been utilized by the Company only to open letters of credit to facilitate the import of merchandise.  The borrowing base at August 30, 2008 was $38.1 million.  As of August 30, 2008, the Company had outstanding letters of credit in the amount of $12.4 million.  Accordingly, the availability of revolving credit loans under the Credit Facility was $25.7 million at August 30, 2008.

 

The Credit Facility contains certain restrictive covenants, including restrictions on incurring additional indebtedness and limitations on certain types of investments, as well as requiring the maintenance of certain financial covenants.  As of August 30, 2008, the most recent measurement date, the Company was in compliance with all of these restrictive covenants under the Credit Facility.

 

NOTE 8 — STOCKHOLDERS’ EQUITY

 

In fiscal 2008, the Company’s Board of Directors authorized and subsequently announced a one-year stock repurchase program enabling the Company to purchase up to $20 million of its common stock, subject to market conditions.  As of May 24, 2008, the expiration date of the repurchase program, the Company had repurchased 948,800 shares of its common stock under the program for a total cost, including commissions, of approximately $12.1 million.  No repurchases were made under the program in the first six months of fiscal 2009.

 

NOTE 9 — STOCK-BASED COMPENSATION

 

                The Company accounts for stock-based compensation in accordance with the provisions of SFAS No. 123R, “Share-Based Payment” (“SFAS 123R”).  Under this transition method, stock-based compensation expense recognized for share-based awards includes: (a) compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of, February 25, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation expense for all stock-based compensation awards granted subsequent to February 25, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R.

 

Total pre-tax compensation expense related to stock-based awards for the three months ended August 30, 2008 and September 1, 2007 was approximately $524,000 and $482,000, respectively.  For the six months ended August 30, 2008 and September 1, 2007, pre-tax stock-based compensation expense totaled approximately $1.2 million and $941,000, respectively.  Stock-based compensation expense was included in merchandise, buying and occupancy expenses for the Company’s buying and distribution employees and in selling, general and administrative expenses for all other employees.

 

Methodology Assumptions

 

                The Company uses the Black-Scholes option-pricing model to value the Company’s stock options for grants to its employees and non-employee directors.  Using this option-pricing model, the fair value of each stock option award is estimated on the date of grant.  The fair value of the Company’s stock option awards, which are generally subject to pro-rata vesting, is expensed on a straight-line basis over the vesting period of the stock options.  The expected volatility assumption is based on the historical volatility of the Company’s stock over a term equal to the expected term of the option granted.  The expected term of stock option awards granted is derived from historical exercise experience.  The expected term assumption incorporates the contractual term of an option grant, as well as the vesting period of an award.  The risk-free interest rate is based on the implied yield on a U.S. Treasury constant maturity with a remaining term equal to the expected term of the option granted.

 

 

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The weighted average assumptions relating to the valuation of the Company’s stock option grants for the three and six month periods ended August 30, 2008 and September 1, 2007 were as follows:

 

		Three Months Ended				Six Months Ended
		August 30,		September 1,		August 30,		September 1,
		2008		2007		2008		2007
Expected divdend yield		2.56	%	1.43	%	2.34	%	1.35	%
Expected volatility		52.02	%	44.38	%	49.31	%	44.77	%
Risk-free interest rate		3.02	%	4.43	%	2.72	%	4.51	%
Expected term in years		3.36		4.07		4.38		4.17

 

Stock-Based Compensation Activity

 

                The following table presents a summary of the Company’s stock option activity for the six months ended August 30, 2008:

 

													Weighted
				Weighted									Average
		Number		Average			Aggregate			Weighted			Remaining
		of		Exercise			Intrinsic			Average			Contractual
		Shares		Price			Value			Fair Value			Life
Outstanding, beginning of period		1,889,454		$	18.83		$	156,593		$	6.79
Vested		1,485,011		19.34			156,593			6.83
Unvested		404,443		16.97			—			6.63
Granted		394,250		10.02			114,941			3.59
Exercised		—		—			—			—
Canceled - Vested		(215,198	)	22.54			7,461			7.44
Canceled - Unvested (Forfeited)		(32,231	)	15.95			—			6.00
Outstanding, end of period		2,036,275		16.83			264,073			6.12			6.13
Vested		1,339,705		18.87			149,132			6.78			4.52
Unvested		696,570		12.90			114,941			4.87			9.21
Exercisable, end of period		1,339,705		18.87			149,132			6.78			4.52

 

                The Company may also grant shares of restricted stock to its employees and non-employee members of its Board of Directors.  Restricted stock awards are independent of option grants and are generally subject to forfeiture if employment or service terminates prior to the lapse of the restrictions.  In addition, certain of the Company’s restricted stock awards have performance-based vesting provisions and are subject to forfeiture if these performance conditions are not achieved.  The Company assesses, on an ongoing basis, the probability of whether the performance criteria are projected to be achieved and, if it is deemed probable, recognizes compensation expense over the relevant performance period.  For those awards not subject to performance criteria, the Company expenses the cost of the restricted stock awards, which is determined to be the fair market value of the shares at the date of grant, on a straight-line basis over the vesting period.  The fair market value of the Company’s restricted stock is determined based on the closing price of the Company’s common stock on the grant date.

 

                The following table presents a summary of the Company’s restricted stock activity for the six months ended August 30, 2008:

 

		Number		Aggregate			Weighted
		of		Intrinsic			Average
		Shares		Value			Fair Value
Unvested, beginning of period		118,484		$	1,139,816		$	16.26
Granted		307,733		2,960,391			9.79
Vested		(41,666	)	400,827			12.28
Canceled - Unvested (Forfeited)		(15,575	)	149,832			14.70
Unvested, end of period		368,976		3,549,549			11.38

 

 

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NOTE 10 — INCOME TAXES

 

                The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN No. 48”), on March 4, 2007.  FIN No. 48 prescribes a minimum recognition threshold and measurement process for recording uncertain tax positions in the financial statements.  Additionally, FIN No. 48 provides guidance on derecognition, classification, accounting and disclosure related to uncertain tax positions.

 

                As of August 30, 2008, the Company’s liability for unrecognized tax benefits associated with uncertain tax positions was approximately $4.5 million and the total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $2.5 million.   The Company recognizes interest and penalties related to unrecognized tax benefits as components of income tax expense.  At August 30, 2008 the Company had accrued approximately $0.8 million for the potential payment of interest and penalties.

 

                The Company and its subsidiaries are subject to U.S. federal income tax and the income tax of various state and local jurisdictions.  The Internal Revenue Service has completed its audit for tax years through fiscal 2006.  The Company is not subject to state income tax examination by taxing authorities for taxable years prior to fiscal 2004.  At August 30, 2008, the Company did not expect its liability for unrecognized tax benefits to significantly increase or decrease over the next year.

 

NOTE 11 — NET INCOME PER SHARE

 

Basic earnings per share (“EPS”) is computed based on the weighted average number of shares of common stock outstanding during the applicable periods, while diluted EPS is computed based on the weighted average number of shares of common stock and common equivalent shares outstanding.  The Company’s reconciliation of EPS includes the individual share effects of all securities affecting EPS which consist solely of the effects of dilution from awards granted under the Company’s stock-based compensation plans.

 

The following is a reconciliation of the number of shares and per share amounts used in the basic and diluted EPS computations:

 

		Three Months Ended
		August 30, 2008					September 1, 2007
				Net					Net
				Income					Income
		Shares		Per Share			Shares		Per Share
Basic		35,098,661		$	0.02		35,846,747		$	0.09
Effect of dilution from stock-based compensation plans		23,724		—			101,767		—
Diluted		35,122,385		$	0.02		35,948,514		$	0.09
		Six Months Ended
		August 30, 2008					September 1, 2007
				Net					Net
				Income					Income
		Shares		Per Share			Shares		Per Share
Basic		35,086,015		$	0.35		35,900,270		$	0.42
Effect of dilution from stock-based compensation plans		25,915		(0.01		)	110,031		—
Diluted		35,111,930		$	0.34		36,010,301		$	0.42

 

 

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Stock options of 2,135,890 and 2,137,323 were excluded from the shares used in the computation of diluted EPS for the three and six month periods ended August 30, 2008, respectively, as they were anti-dilutive.  Stock options of 1,711,179 and 1,639,179 were excluded from the shares used in the computation of diluted EPS for the three and six month periods ended September 1, 2007 as they were anti-dilutive.

 

NOTE 12 — FAIR VALUE MEASUREMENTS

 

                As discussed in Note 1, the Company adopted SFAS No. 157, “Fair Value Measurements,” (as impacted by FSP Nos. 157-1 and 157-2) effective March 1, 2008, with respect to fair value measurements of (a) nonfinancial assets and liabilities that are recognized or disclosed at fair value in the Company’s financial statements on a recurring basis (at least annually) and (b) all financial assets and liabilities.

 

                Under SFAS No. 157, fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. SFAS No. 157 also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.  Observable inputs are inputs market participants would use in valuing the asset or liability developed based on market data obtained from sources independent of the Company.  Unobservable inputs are inputs that reflect the Company’s assumptions about the factors market participants would use in valuing the asset or liability developed based upon the best information available in the circumstances.  The hierarchy is broken down into three levels.  Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active and inputs (other than quoted prices) that are observable for the asset or liability, either directly or indirectly.  Level 3 inputs are unobservable inputs for the asset or liability.   Categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

 

Assets and Liabilities that are Measured at Fair Value on a Recurring Basis:

 

                For the Company, effective March 1, 2008, fair value under SFAS No. 157 (as impacted by FSP Nos. 157-1 and 157-2) principally applied to financial assets and liabilities such as available-for-sale investments (included in short and long-term investments in the Consolidated Balance Sheet).  These items were previously and will continue to be marked-to-market at each reporting period; however, the definition of fair value used for these mark-to-markets is now applied using SFAS No. 157.  The information in the following paragraphs and tables primarily addresses matters relative to these financial assets and liabilities.  Separately, there were no material fair value measurements with respect to nonfinancial assets or liabilities that are recognized or disclosed at fair value in the Company’s financial statements on a recurring basis subsequent to the effective date of SFAS No. 157 (as impacted by FSP Nos. 157-1 and 157-2).

 

                Following is a description of the valuation methodologies used for financial assets and liabilities measured at fair value:

 

Available-for-sale investment securities — auction rate securities (“ARS”):

 

                As discussed in Note 3, auctions for ARS held by the Company failed beginning in February 2008 and have continued to fail through the date of this report.  As a result, investments in ARS are valued to reflect the current lack of liquidity of these investments while taking into account the credit quality of the underlying securities.

 

                The following table provides information by level for assets and liabilities that are measured at fair value, as defined by SFAS No. 157, on a recurring basis.

 

		Fair Value at			Fair Value Measurements Using Inputs Considered as
Description		August 30, 2008			Level 1			Level 2			Level 3
Assets:
Available-for-sale investments
Auction Rate Securities		$	18,535,577		$	—		$	—		$	18,535,577
Liabilities:		—			—			—			—

 

 

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