UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

Commission File Number: 001-31314

 

 

 

 

AÉROPOSTALE, INC.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(646) 485-5410

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes o     No þ

 

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, and (2) has been subject to the filing requirements for at least the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

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

 

 

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

 

The aggregate market value of voting stock held by non-affiliates of the registrant as of August 4, 2007 was $1,844,189,531.

 

66,740,393 shares of Common Stock were outstanding at March 20, 2008.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive Proxy Statement, to be filed with the Securities and Exchange Commission within 120 days after the end of the registrant’s fiscal year covered by this Annual Report on Form 10-K, with respect to the Annual Meeting of Stockholders to be held on June 18, 2008, are incorporated by reference into Part III of this Annual Report on Form 10-K. This report consists of 59 sequentially numbered pages. The Exhibit Index is located at sequentially numbered page 57.

 

 

AÉROPOSTALE, INC.


TABLE OF CONTENTS

 

As used in this Annual Report on Form 10-K, unless the context otherwise requires, all references to “we”, “us”, “our”, “Aéropostale” or the “Company’ refer to Aéropostale, Inc., and its subsidiaries. The term “common stock” means our common stock, $.01 par value. Our website is located at www.aeropostale.com (this and any other references in this Annual Report on Form 10-K to Aéropostale.com is solely a reference to a uniform resource locator, or URL, and is an inactive textual reference only, not intended to incorporate the website into this Annual Report on Form 10-K). On our website, we make available, as soon as reasonably practicable after electronic filing with the Securities and Exchange Commission, our annual reports on Form 10-K, quarterly reports on Form 10-Q, annual Proxy filings and current reports on Form 8-K, and any amendments to those reports. All of these reports are provided to the public free of charge.

 

 

Overview

 

Aéropostale, Inc., a Delaware corporation, originally incorporated as MSS-Delaware, Inc. on September 1, 1995 and later changed to Aéropostale, Inc. on February 1, 2000, is a mall-based specialty retailer of casual apparel and accessories. We design, market and sell our own brand of merchandise principally targeting 14 to 17 year-old young women and young men. Jimmy’Z Surf Co., Inc., a wholly owned subsidiary of Aéropostale, Inc., is a California lifestyle-oriented brand targeting trend-aware young women and men aged 18 to 25. We also sell Aéropostale merchandise through our e-commerce website, www.aeropostale.com. As of February 2, 2008, we operated 828 stores, consisting of 802 Aéropostale stores in 47 states, 12 Aéropostale stores in Canada, and 14 Jimmy’Z stores in 11 states.

 

Our Aéropostale concept provides the customer with a focused selection of high-quality, active-oriented, fashion and fashion basic merchandise at compelling values. Our Jimmy’Z concept provides the customer with a broad selection of California lifestyle-oriented merchandise, targeting trend-aware young men and women. We maintain control over our proprietary brands by designing and sourcing all of our merchandise. Our Aéropostale products are sold only at our stores and online through our e-commerce website, www.aeropostale.com, while Jimmy’Z products are sold only at our Jimmy’Z stores. We strive to create a fun, high-energy shopping experience through the use of creative visual merchandising, colorful in-store signage, popular music and an enthusiastic well-trained sales force. Our average Aéropostale store is generally smaller than that of our mall-based competitors. We believe this enables us to achieve higher sales productivity and project a sense of greater action and excitement in the store.

 

The Aéropostale brand was established by R.H. Macy & Co., Inc., as a department store private label initiative, in the early 1980’s targeting men in their twenties. Macy’s subsequently opened the first mall-based Aéropostale specialty store in 1987. Over the next decade, Macy’s, and then Federated Department Stores, Inc. (now Macy’s, Inc.), expanded Aéropostale to over 100 stores. In August 1998, Federated sold its specialty store division to our management team and Bear Stearns Merchant Banking. In May of 2002, Aéropostale management took us public through an initial public offering and listed our common stock on the New York Stock Exchange. In July of 2003, we effectuated a secondary offering of our common stock. In April 2004 and then again in August 2007, we completed three-for-two stock splits on all shares of our common stock. Both of these stock splits were distributed in the form of a stock dividend. All prior period share and per share amounts presented in this report were restated to give retroactive recognition to these common stock splits.

 

Our fiscal year ends on the Saturday nearest to January 31. Fiscal 2007 was the 52-week period ended February 2, 2008, fiscal 2006 was the 53-week period ended February 3, 2007 and fiscal 2005 was the 52-week period ended January 28, 2006. Fiscal 2008 will be the 52-week period ending January 31, 2009.

 

Growth Strategy

 

Continue to open new Aéropostale stores.  We consider our merchandise and our stores as having broad national appeal that continues to provide substantial new store expansion opportunities. Over the last three fiscal

years we opened 281 new Aéropostale stores. We plan to continue our growth by opening a total of approximately 85 new Aéropostale stores during fiscal 2008, which will include approximately 15 new Aéropostale stores in Canada and our first three new stores in Puerto Rico. We plan to open stores both in markets where we currently operate stores, and in new markets. (see the section “Stores — Store design and environment” below).

 

Enhance our brand and increase our store productivity.  We seek to capitalize on the success of our core Aéropostale brand, while continuing to enhance our brand recognition through in-store as well as external marketing initiatives.

 

We seek to produce comparable store sales growth, increased net sales per average square foot, and increased average unit retail. We expect to continue employing our promotional pricing strategies, while also identifying and capitalizing upon developing trends in the market.

 

E-Commerce.  We launched our Aéropostale e-commerce business in May 2005. The Aéropostale web store is accessible at our website, www.aeropostale.com. A third party provides fulfillment services for our e-commerce business, including warehousing our inventory and fulfilling our customers’ sales orders. We purchase, manage and own the inventory sold through our website and we recognize revenue from the sale of these products when the customer receives the merchandise.

 

Jimmy’Z.  In 2004, we acquired the rights to and existing registrations for the JIMMY’Z^® and Woody Car Design brand and trademarks in the United States and Canada for clothing and related goods and services. In 2005, we opened our first 14 Jimmy’Z stores. These stores average approximately 3,800 square feet. Jimmy’Z is positioned as a California lifestyle-oriented brand, targeting trend-aware young men and women aged 18 to 25. Merchandise sold at Jimmy’Z stores is at initial price points higher than merchandise sold at our Aéropostale stores. We are not planning to open any new Jimmy’Z stores in fiscal 2008, but instead plan on further refining our merchandising and brand building strategies.

 

New Concept.  We are developing a new retail store concept that we believe will build upon our core competencies, while targeting a younger demographic than the Aéropostale customer. We anticipate opening the first stores of this new concept during fiscal 2009.

 

Stores

 

Existing stores.  We locate our stores primarily in shopping malls, outlet centers and, to a lesser degree, lifestyle and off-mall shopping centers, all located in geographic areas with the highest possible concentrations of our target customers. We generally locate our stores in mall locations near popular teen gathering spots, including food courts, music stores and other teen-oriented retailers. As of February 2, 2008, we operated 828 stores in the following 47 U.S. states and two Canadian provinces:

 

 

The following table highlights the number of stores opened and closed since the beginning of fiscal 2005:

 

 

Store design and environment.  We launched our new Aéropostale store design during fiscal 2006, and we currently operate 97 stores in this new format. We plan to design all of our new Aéropostale stores in this format. In addition, all Aéropostale stores planned for remodel will be renovated into the new format. We design our stores in an effort to create an energetic shopping environment, featuring powerful in-store promotional signage, creative visuals and popular music. The enthusiasm of our associates is integral to our store environment. Our stores feature display windows that provide high visibility for mall traffic. Our strategy is to create fresh and exciting merchandise assortments by updating our floor sets numerous times throughout the year. Visual merchandising directives are initiated at the corporate level, seeking to maintain consistency throughout all of our stores.

 

Store management.  Our stores are organized by region and further into districts. A regional manager manages each of our ten regions and each region encompasses approximately eight to ten districts. Each district is managed by a district manager and encompasses approximately seven to ten individual stores. Our corporate headquarters directs the merchandise assortments, merchandise pricing, store layout, inventory management and in-store visuals for our stores.

 

Expansion opportunities and site selection.  We focus on opening new stores in an effort to penetrate further the existing markets we are already in, as well as enter new markets. We plan to continue increasing our store base during fiscal 2008 by opening approximately 85 new Aéropostale stores, including approximately 15 new stores in Canada and our first three new stores in Puerto Rico (see the section “Growth Strategy” above).

 

In selecting a specific site, we generally target high traffic locations in malls, outlet centers and, to a lesser degree, lifestyle and off-mall shopping centers, with suitable demographics and favorable lease economics. As a result, we tend to locate our stores in malls in which comparable teen-oriented retailers have performed well. A primary site evaluation criterion includes average sales per square foot, co-tenancies, traffic patterns and occupancy costs.

 

We have implemented our store format across a wide variety of mall classifications and geographic locations. For new Aéropostale stores opened in fiscal 2007 under our new store design, our average net investment was

approximately $469,000 per store location, which included capital expenditures adjusted for landlord contributions and initial inventory at cost, net of payables (see the section “Store design and environment” above for a further discussion).

 

Aéropostale stores which we opened in fiscal 2006 and fiscal 2005 achieved, during their first twelve months of their operations, average net sales of approximately $1.8 million and net sales of $492 per average square foot.

 

Pricing

 

We believe that a key component of our success is our ability to understand what our customers want and what they can afford. Our merchandise, which we believe is of comparable quality to that of our primary competitors, is generally priced lower than our competitors’ merchandise. We conduct promotions in our stores throughout the year generally lasting anywhere from two to four weeks in length.

 

Design and Merchandising

 

Both our Aéropostale and Jimmy’Z design and merchandising teams focus on designing merchandise that meets the demands of their core customers’ lifestyles. We maintain separate design and merchandising groups for each of our brands and within those brands, for each of the young women’s, young men’s and accessories product lines.

 

Design.  We offer a focused collection of apparel, including graphic t-shirts, tops, bottoms, sweaters, jeans, outerwear and accessories. Our “design-driven, merchant-modified” philosophy, in which our designers’ visions are refined by our merchants’ understanding of the current market for our products, helps to ensure that our merchandise styles reflect the latest trends while not becoming too fashion-forward for our customers’ tastes. Much of our merchandise features our brands’ logos. We believe that both our Aéropostale and Jimmy’Z logo apparel appeals to our young customers and reinforces our brand image.

 

Merchandising and Planning.  Our merchandising organization, together with our planning organization, determines the quantities of units needed for each product category. By monitoring sales of each style and color and employing our flexible sourcing capabilities, we are able to adjust our merchandise assortments to capitalize upon emerging trends.

 

Sourcing

 

We seek to employ a sourcing strategy that expedites our speed to market and allows us to respond quickly to our customers’ preferences. We believe that we have developed strong relationships with our vendors, some of who rely upon us for a significant portion of their overall business.

 

During fiscal 2007, we sourced approximately 69% of our merchandise from our top five merchandise vendors. Most of our vendors maintain sourcing offices in the United States, with the majority of their production factories located in Europe, Asia and Central America. In an effort to minimize currency risk, all payments to our vendors and sourcing agents are made in U.S. dollars. We engage a third party independent contractor to visit the production facilities that supply us with our products. This independent contractor assesses the compliance of the facility with, among other things, local and United States labor laws and regulations as well as fair trade and business practices.

 

During fiscal 2007, we ceased doing business with South Bay Apparel Inc., previously one of our largest suppliers of graphic T-shirts and fleece. We have replaced this business both with new vendors and our existing vendor base (see Note 6 to the Notes to Consolidated Financial Statements for a further discussion).

 

Marketing and Advertising

 

We utilize numerous initiatives to increase our brand recognition and communicate our merchandise assortment. We view our stores as the primary means to communicate our message and provide our brand experience. Our marketing efforts are focused on in-store communications, promotions and internal as well as external advertising. We expand, test and modify our marketing efforts based on focus groups, surveys and consumer feedback.

We believe that the enthusiasm and commitment of our store-level employees is a key element in enhancing our brand with our target customers. We also view the use of our logo on our merchandise as a means for expanding our brand awareness and visibility. We market in-store with large images in the store-front windows and at the checkout area, information alongside product displays and other touch points such as handouts and shopping bags. We also invest in select external advertising during key selling periods. Our advertisements appear in publications and in malls and on the radio on a regional basis. Periodically, we also partner with select third parties such as magazines, television shows and musical bands, to create marketing programs which we believe will be appealing to our customers.

 

Our website, www.aeropostale.com supports all of our internet marketing and promotional initiatives and also offers a large portion of our merchandise assortment for purchase. We maintain a database of our customers and send emails and distribute information on special offers and promotions on a frequent basis.

 

Distribution

 

We maintain two distribution centers to process merchandise and to warehouse inventory needed to replenish our stores. We lease a 315,000 square foot distribution center facility in South River, New Jersey. We also lease a second distribution facility in Ontario, California with 360,000 square feet of space that began operations in September 2007.

 

The staffing and management of both distribution facilities are outsourced to a third party provider that operates each distribution facility and processes our merchandise. This third party provider employs personnel represented by a labor union. There have been no work stoppages or disruptions since the inception of our relationship with this third party provider in 1991, and we believe that the third party provider has a good relationship with its employees. In addition, we outsource the shipment of our merchandise through third party transportation providers. These third parties ship our merchandise from our distribution facilities to our stores.

 

We continue to invest in systems and automation to improve processing efficiencies, automate functions that were previously performed manually and to support our store growth. Our distribution facilities utilize automated sortation materials handling equipment to receive, process and ship goods to our stores. These facilities also serve our other warehousing needs, such as storage of new store merchandise, floor set merchandise and packaging supplies.

 

All of our products destined for our Canada stores are first shipped to the United States and processed through our distribution centers. We have engaged a third party to assist us in recapturing certain duties and tariffs which we paid on these goods.

 

Information Systems

 

Our management information systems provide a full range of retail, financial and merchandising applications. We utilize industry specific software systems to provide various functions related to:

 

 

We continue to invest in technology to align our systems with our business requirements and to support our continuing growth. In the past year we invested in, among other things, a roll-out across all of our stores of a new point-of-sale system and the development of a new merchandise allocation system. We plan to continue to invest strategically in our infrastructure in the future.

Trademarks

 

We own, through our wholly owned subsidiary, Aéropostale West, Inc., a Delaware corporation, federal trademark registrations in the U.S. Patent and Trademark Office for our principal marks AÉROPOSTALE^®, AÉRO^®, 87^® and other related marks for clothing, a variety of accessories, including sunglasses, belts, socks and hats, and as a service mark for retail clothing stores, as well as state registrations for these marks. We also have certain registrations pending for trademarks and service marks for clothing, retail stores and online services. Additionally, we have applied for or have already obtained a registration for the AÉROPOSTALE and related marks in over 60 foreign countries. We plan to continue this focus on expanding our international registrations of our marks in the future.

 

In 2004, we acquired the rights to and existing registrations for the JIMMY’Z^® and Woody Car Design brand and marks in the United States and Canada for clothing and related goods and services. We have also made further filings for the JIMMY’Z and Woody Car Design marks for use in the United States and Canada that are pending.

 

We regard our trademarks and other proprietary intellectual property as valuable assets of the Company that we continually maintain and protect.

 

Competition

 

The teen apparel market is highly competitive. We compete with a wide variety of retailers including other specialty stores, department stores, mail order retailers and mass merchandisers. Specifically, we compete with other teen apparel retailers including, but not limited to, American Eagle Outfitters^®, Hollister^®, Old Navy^®, Pacific Sunwear^®, and Tween Brands^®. Stores in our sector compete primarily on the basis of design, price, quality, service and selection.

 

Many of our competitors are considerably larger and have substantially greater financing, marketing, and other resources. We cannot assure you that we will be able to compete successfully in the future, particularly in geographic locations that represent new markets for us.

 

Employees

 

As of February 2, 2008, we employed 3,210 full-time and 7,945 part-time employees. We employed 500 of our employees at our corporate offices and in the field, and 10,655 at our store locations. The number of part-time employees fluctuates depending on our seasonal needs. None of our employees are represented by a labor union and we consider our relationship with our employees to be good.

 

Seasonality

 

Our business is highly seasonal, and historically we have realized a significant portion of our sales, net income and cash flows in the second half of the year, attributable to the impact of the back-to-school selling season in the third quarter, and the holiday selling season in the fourth quarter. As a result, our working capital requirements fluctuate during the year, increasing in mid-summer in anticipation of the third and fourth quarters. Our business is also subject, at certain times, to calendar shifts which may occur during key selling times such as school holidays, Easter and regional fluctuations in the calendar during the back-to-school selling season.

 

Available Information

 

We maintain an internet website, www.aeropostale.com, through which access is available to our annual reports on Form 10-K, quarterly reports on Form 10-Q, Proxy Statements and current reports on Form 8-K, and all amendments of these reports filed, or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, after they are filed with the Securities and Exchange Commission.

 

Our Corporate Governance Guidelines and the charters for our Audit Committee, Nominating and Corporate Governance Committee and Compensation Committee may also be found on our internet website at www.aeropostale.com. In addition, our website contains the Charter for our Lead Independent Director and Code

of Business Conduct and Ethics, which is our code of ethics and conduct for our directors, officers and employees. Any waivers to our Code of Business Conduct and Ethics will be promptly disclosed on our website.

 

In fiscal 2007, our Chief Executive Officer certified, in accordance with section 303.12(a) of the NYSE Listed Company Manual, that he was not aware of any violation by us of the NYSE’s corporate governance listing standards as of the date of such certification.

 

 

Cautionary Note Regarding Forward-Looking Statements

 

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements involve certain risks and uncertainties, including statements regarding our strategic direction, prospects and future results. Certain factors, including factors outside of our control, may cause actual results to differ materially from those contained in the forward-looking statements. The following risk factors should be read in connection with evaluating our business and future prospects. All forward looking statements included in this report are based on information available to us as of the date hereof, and we assume no obligation to update or revise such forward-looking statements to reflect events or circumstances that occur after such statements are made. Such uncertainties include, among others, the following factors:

 

If we were unable to identify and respond to consumers’ fashion preferences in a timely manner, our profitability would decline.

 

We may not be able to keep pace with the rapidly changing fashion trends and consumer tastes inherent in the teen apparel industry. We produce casual, comfortable apparel, a majority of which displays either the “Aéropostale” or “Aéro” logo. There can be no assurance that fashion trends will not move away from casual clothing or that we will not have to alter our design strategy to reflect changes in consumer preferences. Failure to anticipate, identify or react appropriately to changes in styles, trends, desired images or brand preferences, could have a material adverse effect on our sales, financial condition and results of operations.

 

Our retail store operations may be adversely affected by unfavorable local, regional or national economic conditions.

 

Our business is sensitive to consumer spending patterns and preferences. Various economic conditions affect the level of spending on the merchandise we offer, including general business conditions, interest rates, taxation, fuel costs, the availability of consumer credit and consumer confidence in future economic conditions. Accordingly, consumer purchases of discretionary items and retail products, including our products, may decline during recessionary periods and also may decline at other times when disposable income is lower. Therefore, our growth, sales and profitability may be adversely affected by unfavorable economic conditions on a local, regional or national level.

 

Fluctuations in comparable store sales and quarterly results of operations may cause the price of our common stock to decline substantially.

 

Our comparable store sales and quarterly results of operations have fluctuated in the past and are likely to continue to fluctuate in the future. In addition, there can be no assurance that we will be able to maintain our historic levels of comparable store sales. Our comparable store sales and quarterly results of operations are affected by a variety of factors, including:

 

 

 

If our future comparable store sales fail to meet the expectations of investors, then the market price of our common stock could decline substantially. You should refer to the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information.

 

Foreign suppliers manufacture most of our merchandise and the availability and costs of these products may be negatively affected by risks associated with international trade.

 

Trade restrictions such as increased tariffs or quotas, or both, could affect the importation of apparel generally and increase the cost and reduce the supply of merchandise available to us. Much of our merchandise is sourced directly from foreign vendors in Europe, Asia and Central America. In addition, many of our domestic vendors maintain production facilities overseas. Some of these facilities are also located in regions that may be affected by political instability that could cause a disruption in trade. Any reduction in merchandise available to us or any increase in its cost due to tariffs, quotas or local political issues could have a material adverse effect on our results of operations. If manufacturing costs were to rise significantly, our business may be adversely affected.

 

We rely on a small number of vendors to supply a significant amount of our merchandise.

 

During fiscal 2007, we sourced approximately 69% of our merchandise from our top five merchandise vendors. During fiscal 2006, we sourced approximately 66% of our merchandise from our top five merchandise vendors. Our relationships with our suppliers generally are not on a long-term contractual basis and do not provide assurances on a long-term basis as to adequate supply, quality or acceptable pricing. Most of our suppliers could discontinue selling to us at any time. If one or more of our significant suppliers were to sever their relationship with us, we may not be able to obtain replacement products in a timely manner, which would have a material adverse effect on our sales, financial condition and results of operations.

 

Our business could suffer as a result of a manufacturer’s inability to produce merchandise on time and to our specifications.

 

We do not own or operate any manufacturing facilities and therefore we depend upon independent third parties to manufacture all of our merchandise. We utilize both domestic and international manufacturers to produce our merchandise. The inability of a manufacturer to ship orders in a timely manner or meet our quality standards could cause delivery date requirements to be missed, which could result in lost sales. In addition, if manufacturing costs were to rise significantly, our business may be adversely affected.

 

Our ability to attract customers to our stores depends heavily on the success of the shopping malls in which we are located.

 

In order to generate customer traffic, we must locate our stores in prominent locations within successful shopping malls. We cannot control the development of new shopping malls, the availability or cost of appropriate locations within existing or new shopping malls, or the success of individual shopping malls. A significant decrease in shopping mall traffic could have a material adverse effect on our results of operations.

 

Failure of new business concepts would have a negative effect on our results of operations.

 

We expect that the introduction of new brand concepts and other business opportunities will play an important role in our overall growth strategy. The operation of any new retail concept, including our Jimmy’Z concept, is subject to numerous risks, including unanticipated operating problems, lack of prior experience, lack of customer acceptance, new vendor relationships, competition from existing and new retailers, and could also be a diversion of management’s attention from our core Aéropostale business. For example, the Jimmy’Z concept involves, among

other things, implementation of a retail apparel concept which is subject to many of the same risks as Aéropostale, as well as additional risks inherent with a more fashion-driven concept, including risks of difficulty in merchandising, uncertainty of customer acceptance, fluctuations in fashion trends and customer tastes, as well as the attendant markdown risks. Risks inherent in any new concept are particularly acute with respect to Jimmy’Z because this is the first significant new venture by us, and the nature of the Jimmy’Z business differs in certain respects from that of our core Aéropostale business. There can be no assurance that the Jimmy’Z stores will achieve sales and profitability levels justifying our investments in this business. Consolidated net income included net losses from our Jimmy’Z subsidiary of $12.4 million, or $0.17 per diluted share (includes asset impairment charges discussed below of $5.7 million after-tax, or $0.08 per diluted share) for fiscal 2007, $6.7 million, or $0.08 per diluted share for fiscal 2006 and $4.7 million, or $0.06 per diluted share for fiscal 2005.

 

We periodically evaluate the need to recognize impairment losses relating to long-lived assets. After the completion of the fiscal 2007 holiday season, which represented the largest quarterly sales and profit contribution for the year, we determined that each of our fourteen Jimmy’Z stores would not be able to recover the carrying value of the store property and equipment through expected cash flows over the remaining life of the related assets. As a result, we recorded asset impairment charges of $9.0 million ($5.7 million after-tax, or $0.08 per diluted share), in the fourth quarter of fiscal 2007 related to our Jimmy’Z store concept. In the event we were to decide to exit this business in the future, or close any or all of these stores, we may be required to record additional inventory impairment, lease termination charges, and severance and other charges.

 

Our business could suffer if a manufacturer fails to use acceptable labor practices.

 

Our sourcing agents and independent manufacturers are required to operate in compliance with all applicable foreign and domestic laws and regulations. While our vendor operating guidelines promote ethical business practices for our vendors and suppliers, we do not control these manufacturers or their labor practices. The violation of labor or other laws by an independent manufacturer, or by one of the sourcing agents, or the divergence of an independent manufacturer’s or sourcing agent’s labor practices from those generally accepted as ethical in the United States, could interrupt, or otherwise disrupt the shipment of finished products or damage our reputation. Any of these, in turn, could have a material adverse effect on our financial condition and results of operations. To help mitigate this risk, we engage a third party independent contractor to visit the production facilities from which we receive our products. This independent contractor assesses the compliance of the facility with, among other things, local and United States labor laws and regulations as well as foreign and domestic fair trade and business practices.

 

Our foreign sources of production may not always be reliable, which may result in a disruption in the flow of new merchandise to our stores.

 

The large majority of the merchandise we purchase is manufactured overseas. We do not have any long-term merchandise supply contracts with our vendors and the imports of our merchandise by our vendors are subject to existing or potential duties, tariffs and quotas. We also face a variety of other risks generally associated with doing business in foreign markets and importing merchandise from abroad, such as: (i) political instability; (ii) enhanced security measures at United States ports, which could delay delivery of goods; (iii) imposition of new legislation relating to import quotas that may limit the quantity of goods which may be imported into the United States from countries in a region within which we do business; (iv) imposition of additional or greater duties, taxes, and other charges on imports; (v) delayed receipt or non-delivery of goods due to the failure of our vendors to comply with applicable import regulations; and (vi) delayed receipt or non-delivery of goods due to unexpected or significant port congestion at United States ports. Any inability on our part to rely on our vendors and our foreign sources of production due to any of the factors listed above could have a material adverse effect on our business, financial condition and results of operations.

 

Our growth strategy relies on the continued addition of a significant number of new stores each year, which could strain our resources and cause the performance of our existing stores to suffer.

 

Our growth will largely depend on our ability to open and operate new stores successfully. We opened 88 Aéropostale stores in fiscal 2007, 74 Aéropostale stores in fiscal 2006 and 105 Aéropostale and 14 Jimmy’Z stores in fiscal 2005. We plan to open approximately 85 new Aéropostale stores in fiscal 2008, including approximately 15

new stores in Canada and our first three new stores in Puerto Rico. We expect to continue to open new stores in the future. We also anticipate remodeling a portion of our existing Aéropostale store base at the appropriate times. To the extent that our new store openings are in existing markets, we may experience reduced net sales volumes in previously existing stores in those same markets.

 

Our continued expansion plan is dependent on a number of factors which, if not implemented, could delay or prevent the successful opening of new stores and penetration into new markets.

 

Unless we continue to do the following, we may be unable to open new stores successfully and, in turn, our continued growth would be impaired:

 

 

In addition, we will open new stores in markets in which we currently have few or no stores. Our experience in these markets is limited and there can be no assurance that we will be able to develop our brand in these markets or adapt to competitive, merchandising and distribution challenges that may be different from those in our existing markets. Our inability to open new stores successfully and/or penetrate new markets would have a material adverse effect on our revenue and earnings growth.

 

The loss of the services of key personnel could have a material adverse effect on our business.

 

Our key executive officers have substantial experience and expertise in the retail industry and have made significant contributions to the growth and success of our brands. The unexpected loss of the services of one or more of these individuals could adversely affect us. Specifically, if we were to lose the services of Julian R. Geiger, our Chairman and Chief Executive Officer or Mindy C. Meads, our President and Chief Merchandising Officer, our business could be adversely affected. In addition, any significant departures by senior executives or other key performers in the Company could adversely affect our operations.

 

A substantial interruption in our information systems could have a material adverse effect on our business.

 

We depend on our management information systems for many aspects of our business. We will be materially adversely affected if our management information systems are disrupted or we are unable to improve, upgrade, maintain, and expand our management information systems.

 

There is an increased risk in operating stores in foreign countries.

 

During fiscal 2007, we opened 12 Aéropostale stores in Canada, and we plan to open approximately 15 additional new Canadian stores during fiscal 2008. There can be no assurance that we will be able to address in a timely fashion the risks of operating stores in foreign countries, such as governmental requirements over merchandise importation, employment, taxation and multi-lingual requirements. Additionally, since entering Canada, we will have to continue to obtain suitable store locations, hire personnel, establish distribution methods, and advertise our brand and its distinguishing characteristics to consumers who may not be familiar with them. There can be no assurance that we will be able to open and operate new stores in Canada on a timely and profitable basis. The costs associated with opening these new stores in Canada may negatively affect our profitability.

Our net sales and inventory levels fluctuate on a seasonal basis.

 

Our net sales and net income are disproportionately higher from August through January each year due to increased sales from back-to-school and holiday shopping. Sales during this period cannot be used as an accurate indicator for our annual results. Our net sales and net income from February through July are typically lower due to, in part, the traditional retail slowdown immediately following the winter holiday season. Any significant decrease in sales during the back-to-school and winter holiday seasons would have a material adverse effect on our financial condition and results of operations. In addition, in order to prepare for the back-to-school and holiday shopping seasons, we must order and keep in stock significantly more merchandise than we would carry during other parts of the year. Any unanticipated decrease in demand for our products during these peak shopping seasons could require us to sell excess inventory at a substantial markdown, which could reduce our net sales and gross margins and negatively impact our profitability. Additionally, our business is also subject, at certain times, to calendar shifts which may occur during key selling times such as school holidays, Easter and regional fluctuations in the calendar during the back-to-school selling season.

 

We rely on a third party to manage our distribution centers.

 

The efficient operation of our stores is dependent on our ability to distribute, in a timely manner, merchandise to our store locations throughout the United States. An independent third party operates our two distribution and warehouse facilities. We depend on this third party to receive, sort, pack and distribute substantially all of our merchandise. This third party employs personnel represented by a labor union. Although there have been no work stoppages or disruptions since the inception of our relationship with this third party provider beginning in 1991, there can be no assurance that work stoppages or disruptions will not occur in the future. We also use separate third party transportation companies to deliver our merchandise from our warehouse to our stores. Any failure by any of these third parties to respond adequately to our warehousing and distribution needs would disrupt our operations and negatively impact our profitability.

 

We rely on a third party to manage the warehousing and order fulfillment for our E-Commerce business.

 

We rely on one third party, GSI Commerce, pursuant to an e-commerce agreement, to host our e-commerce website, warehouse all of the inventory sold through our e-commerce website, and fulfill all of our e-commerce sales to our customers. Any significant interruption in the operations of GSI Commerce, over which we have no control, would have a material adverse effect on our e-commerce business.

 

Failure to protect our trademarks adequately could negatively impact our brand image and limit our ability to penetrate new markets.

 

We believe that our key trademarks AÉROPOSTALE^®, AERO^® and 87^® are integral to our logo-driven design strategy. We have obtained federal registrations of these trademarks in the United States and have applied for or obtained registrations in most foreign countries in which our vendors are located, as well as elsewhere. We use these trademarks in many constantly changing designs and logos even though we have not applied to register every variation or combination thereof for adult clothing. We also believe that the JIMMY’Z and Woody Car Design marks may become a part of our future growth strategy. We have acquired federal registrations in the United States and in Canada and have expanded the scope of our filings in the United States Patent and Trademark Office for a greater number of apparel and accessory categories. There can be no assurance that the registrations we own and have obtained will prevent the imitation of our products or infringement of our intellectual property rights by others. If any third party imitates our products in a manner that projects lesser quality or carries a negative connotation, our brand image could be materially adversely affected. Because we have not registered the AERO mark in all forms and categories and have not registered the “AÉROPOSTALE”, “JIMMY’Z” and Woody Car Design marks in all categories or in all foreign countries in which we now or may in the future source or offer our merchandise, international expansion and our merchandising of non-apparel products using these marks could be limited.

 

In addition, there can be no assurance that others will not try to block the manufacture, export or sale of our products as a violation of their trademarks or other proprietary rights. Other entities may have rights to trademarks that contain the word “AERO” or may have registered similar or competing marks for apparel and accessories in foreign countries in which our vendors are located. Our applications for international registration of the

AÉROPOSTALE^® mark have been rejected in several countries in which our products are manufactured because third parties have already registered the mark for clothing in those countries. There may also be other prior registrations in other foreign countries of which we are not aware. In addition, we do not own the Jimmy’Z brand outside of the United States and Canada. Accordingly, it may be possible, in those few foreign countries where we were not been able to register the AÉROPOSTALE^® mark, or in the countries where the Jimmy’Z brand is owned by a third party, for a third party owner of the national trademark registration for “AÉROPOSTALE”, “JIMMY’Z” or the Woody Car Design to enjoin the manufacture, sale or exportation of Aéropostale or Jimmy’Z branded goods to the United States. If we were unable to reach a licensing arrangement with these parties, our vendors may be unable to manufacture our products in those countries. Our inability to register our trademarks or purchase or license the right to use our trademarks or logos in these jurisdictions could limit our ability to obtain supplies from or manufacture in less costly markets or penetrate new markets should our business plan change to include selling our merchandise in those jurisdictions outside the United States.

 

Any disruption of our distribution activities could have a material adverse impact on our business.

 

We operate two distribution facilities, one in South River, New Jersey, and the other in Ontario, California. These distribution centers manage collectively the receipt, storage, sortation, packaging and distribution of our merchandise to all of our stores. Any significant interruption in the operation of either of our distribution centers due to natural disasters, accidents, system failures, economic and weather conditions, demographic and population changes or other unforeseen events and circumstances could have a material adverse effect on our business, financial condition and results of operations.

 

The effects of war or acts of terrorism could have a material adverse effect on our operating results and financial condition.

 

The continued threat of terrorism and the associated heightened security measures and military actions in response to acts of terrorism has disrupted commerce and has intensified uncertainties in the U.S. economy. Any further acts of terrorism or a future war may disrupt commerce and undermine consumer confidence, which could negatively impact our sales revenue by causing consumer spending and/or mall traffic to decline. Furthermore, an act of terrorism or war, or the threat thereof, or any other unforeseen interruption of commerce, could negatively impact our business by interfering with our ability to obtain merchandise from foreign vendors. Inability to obtain merchandise from our foreign vendors or substitute other vendors, at similar costs and in a timely manner, could adversely affect our operating results and financial condition.

 

 

None

 

 

We lease all of our store locations. Most of our stores are located in shopping malls throughout the U.S., and, beginning in 2007, Canada. Most of our store leases have a term of ten years, and require us to pay additional rent based on specified percentages of sales, after we achieve specified annual sales thresholds. Generally, our store leases do not contain extension options. Our store leases typically include a pre-opening period of approximately 60 days that allows us to take possession of the property to construct the store. Typically rent payment commences when the stores open. We recognize rent expense in our consolidated financial statements on a straight-line basis over the non-cancelable term of each individual underlying lease, commencing when we take possession of the property. Generally, our leases allow for termination by us after a certain period of time if sales at that site do not exceed specified levels.

 

We lease 89,000 square feet of office space at 112 West 34th Street in New York, New York. The facility is used as our corporate headquarters and for our design, sourcing and production teams. This lease expires in 2016.

 

We also lease 40,000 square feet of office space at 201 Willowbrook Boulevard in Wayne, New Jersey. This facility is used as administrative offices for finance, operations and information systems personnel. This lease expires in 2012, but provides us with a 5 year option to extend at the end of the initial term.

In addition, we lease a 315,000 square foot distribution and warehouse facility in South River, New Jersey. This lease expires in 2016. We also lease a second 360,000 square foot distribution facility in Ontario, California and began operating this distribution center in September 2007. This lease expires in 2015. These facilities are used to warehouse inventory needed to replenish and back-stock all of our stores, as well as to serve our general warehousing needs.

 

 

On January 15, 2008, we learned that the Securities and Exchange Commission (the “SEC”) had issued a formal order of investigation with respect to matters arising from those events disclosed in our Form 8-K, dated November 8, 2006, which resulted from the activities of Christopher L. Finazzo, our former Executive Vice President and Chief Merchandising Officer. The SEC’s investigation is a non-public, fact-finding inquiry to determine whether any violations of law have occurred. We are cooperating fully with the SEC in its investigation.

 

On November 30, 2007, we entered into an agreement (the “Agreement”) with Mr. Finazzo settling disputes between us. Pursuant to the terms of the Agreement, Mr. Finazzo has paid us $5.0 million, and in turn, we paid Mr. Finazzo, simultaneously with his payment to the Company, approximately $0.9 million, which represented the value of Mr. Finazzo’s benefits under our Supplemental Executive Retirement Plan.

 

We are also party to various litigation matters and proceedings in the ordinary course of business. In the opinion of our management, dispositions of these matters are not expected to have a material adverse affect on our financial position, results of operations or cash flows.

 

 

No matters were submitted to a vote of our shareholders during the fourth quarter of the fiscal year covered by this report.

 

 

Our common stock is traded on the New York Stock Exchange under the symbol “ARO”. The following table sets forth the range of high and low sales prices of our common stock as reported on the New York Stock Exchange since January 29, 2006. The stock prices below have been revised to reflect a three-for-two stock split effected in August 2007.

 

 

As of March 20, 2008, there were 60 stockholders of record. However, when including others holding shares in broker accounts under street name, we estimate the shareholder base at approximately 36,444.

PERFORMANCE GRAPH

 

The following graph shows the changes, for the period commencing January 31, 2003 and ended February 1, 2008 (the last trading day during fiscal 2007), in the value of $100 invested in shares of our common stock, the Standard & Poor’s MidCap 400 Composite Stock Price Index (the “S&P MidCap 400 Index”) and the Standard & Poor’s Apparel Retail Composite Index (the “S&P Apparel Retail Index”). The plotted points represent the closing price on the last trading day of the fiscal year indicated.

 

CUMULATIVE TOTAL RETURN
Based upon an initial investment of $100 on January 31, 2003
with dividends reinvested

 

 

 

Copyright^© 2008, Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved.

 

We have not paid a dividend on our common stock during our last three fiscal years, and we do not have any current intention to pay a dividend on our common stock.

We repurchase our common stock from time to time under a stock repurchase program. On November 12, 2007, our Board of Directors approved a $250.0 million increase in repurchase availability under the program, bringing total repurchase authorization, since inception of the program, to $600.0 million. We used a portion of this authorization to execute an Accelerated Share Repurchase program to repurchase $125.0 million of our common shares (see Note 13 to the Notes to Consolidated Financial Statements). The repurchase program may be modified or terminated by the Board of Directors at any time, and there is no expiration date for the program. The extent and timing of repurchases will depend upon general business and market conditions, stock prices, opening and closing of our stock trading window, and liquidity and capital resource requirements going forward. Our purchases of treasury stock for the fourth quarter of fiscal 2007 and remaining availability pursuant to our share repurchase program were as follows:

 

 

 

 

The following selected financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and with our consolidated financial statements and other financial information appearing elsewhere in this document:

 

 

 

Per share amounts have been restated to reflect the three-for-two splits of our common stock that were affected in August 2007 and April 2004.

 

 

 

 

 

Aéropostale, Inc. is a mall-based specialty retailer of casual apparel and accessories. Our target customers are both young women and young men from age 14 to 17, and we provide our customers with a selection of high-quality, active-oriented, fashion basic merchandise at compelling values in a high-energy store environment. We maintain control over our proprietary brand by designing and sourcing all of our own merchandise. Our products can be purchased in our stores, which sell Aéropostale merchandise exclusively and on-line through our e-commerce website, www.aeropostale.com. Jimmy’Z Surf Co., Inc., a wholly owned subsidiary of Aéropostale, Inc., is a California lifestyle-oriented brand targeting trend-aware young women and men aged 18 to 25. As of February 2, 2008, we operated 828 stores, consisting of 802 Aéropostale stores in 47 states, 12 Aéropostale stores in Canada, and 14 Jimmy’Z stores in 11 states, in addition to www.aeropostale.com, our e-commerce site (see the section “Growth Strategy” in Item I of this report for a further discussion).

 

Our fiscal year ends on the Saturday nearest to January 31. Fiscal 2007 was the 52-week period ended February 2, 2008, fiscal 2006 was the 53-week period ended February 3, 2007 and fiscal 2005 was the 52-week period ended January 28, 2006. Fiscal 2008 will be the 52-week period ending January 31, 2009.

 

On July 11, 2007, we announced a three-for-two stock split on all shares of our common stock that was completed on August 21, 2007 in the form of a stock dividend to all shareholders of record on August 6, 2007. All share and per share amounts presented in this report were retroactively adjusted for the common stock split, and all previously reported periods were restated for such.

 

The discussion in the following section is on a consolidated basis, unless indicated otherwise. In addition, comparable store sales data included in this section are compared to the corresponding period in the prior year, due to the 53rd week in the fiscal 2006 calendar. We believe that the disclosure of comparable store sales data on a pro-forma basis due to the 53rd week in fiscal 2006, which is a non-GAAP financial measure, provides investors useful information to help them better understand our results.

 

Overview

 

We achieved net sales of $1.591 billion during fiscal 2007 (52 weeks), an increase of $177.7 million or 12.6% from fiscal 2006 (53 weeks). Net sales for the fourth quarter of fiscal 2007 included $7.7 million of sales related to our initial recognition of gift card breakage. Gross profit, as a percentage of net sales, increased by 2.6 percentage points for fiscal 2007, primarily due to a 2.8 percentage point increase in merchandise margin. Selling, general and administrative expense, or SG&A, as a percentage of net sales, increased by 1.2 percentage points in fiscal 2007. We recorded asset impairment charges of $9.0 million during the fourth quarter related to our Jimmy’Z stores. Other operating income of $4.1 million in fiscal 2007 was the result of an agreement with our former Executive Vice President and Chief Merchandising Officer. Interest income decreased by $0.5 million in fiscal 2007 due primarily to an increase in share repurchases. The effective tax rate was 38.2% for fiscal 2007, compared with 39.0% for fiscal 2006. Net income for fiscal 2007 was $129.2 million, or $1.73 per diluted share, compared with net income of $106.6 million, or $1.32 per diluted share, for fiscal 2006.

 

As of February 2, 2008, we had working capital of $87.3 million, cash and cash equivalents of $111.9 million, no short-term investments and no third party debt outstanding. Merchandise inventories increased by 20% on a square foot basis as of February 2, 2008 compared to last year. Cash flows from operating activities were $171.1 million for fiscal 2007. We operated 828 total stores as of February 2, 2008, an increase of 11.6% from the same period last year.

We use a number of key indicators of financial condition and operating performance to evaluate the performance of our business, including the following:

 

 

Results of Operations

 

The following table sets forth our results of operations expressed as a percentage of net sales. We also use this information to evaluate the performance of our business:

 

 

Sales

 

Net sales consist of sales from comparable stores and non-comparable stores, and from our e-commerce business. A store is included in comparable store sales after 14 months of operation. We consider a remodeled or

relocated store with more than a 25% change in square feet to be a new store. Prior period sales from stores that have closed are not included in comparable store sales, nor are sales from our e-commerce business.

 

Net sales increased by $177.7 million, or by 12.6% in fiscal 2007 (52 weeks), as compared to fiscal 2006 (53 weeks). This increase was due to average square footage growth of 10.3%, as well as an increase in comparable store sales. Comparable store sales increased by $43.8 million, or by 3.3%, reflecting comparable store sales increases in our young men’s and women’s categories and a slight decrease in our accessories category. The comparable store sales increase reflected a 2.4% increase in units per sales transaction, a 3.4% increase in the number of sales transactions, and a 2.5% decrease in average unit retail. The decrease in the average unit retail reflected lower pricing in certain categories, in addition to a shift in sales mix. Non-comparable store sales increased by $126.1 million, or by 8.7%, primarily due to 86 more stores open at the end of fiscal 2007 versus fiscal 2006. Net sales for the fourth quarter of fiscal 2007 also included $7.7 million of sales related to our initial recognition of gift card breakage, of which $5.9 million related to gift cards issued in periods prior to fiscal 2007 (see Note 1 to the Notes to Consolidated Financial Statements for a further discussion).

 

Net sales increased by $208.9 million, or by 17.3% in fiscal 2006 (53 weeks), as compared to fiscal 2005 (52 weeks). Average square footage growth of 14% drove the net sales increase, as well as an increase in comparable store sales. Comparable store sales increased by $22.6 million, or by 2.0%, reflecting comparable store sales increases in our young men’s and accessories categories and a slight decrease in our young women’s category. The comparable store sales increase reflected a 3.0% increase in average unit retail, a 0.5% increase in the number of sales transactions, and a 1.5% decrease in units per sales transaction. The increase in the average unit retail reflected lower promotional activity. Non-comparable store sales increased by $186.3 million, or by 14.3%, primarily due to 71 more stores open at the end of fiscal 2006 versus fiscal 2005. The fifty-third week accounted for $16.4 million of the net sales increase during fiscal 2006.

 

Cost of Sales and Gross Profit

 

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

 

Gross profit, as a percentage of net sales, increased by 2.6 percentage points in fiscal 2007. This increase was due to a 2.8 percentage point increase in merchandise margin, primarily from lower unit costs from graphic tee shirts and improved levels and composition of our merchandise assortment. This increase was partially offset by a 0.2 percentage point increase in depreciation, primarily as a result of store growth and strategic investments, and occupancy costs.

 

Gross profit, as a percentage of net sales, increased by 2.1 percentage points in fiscal 2006, primarily due to a 2.5 percentage point increase in merchandise margin, and partially offset by a 0.4 percentage point increase in depreciation, primarily as a result of store growth and strategic investments, and occupancy costs. Merchandise margin for fiscal 2006 was favorably impacted by $7.4 million, or by 0.5 percentage points, of vendor concessions, primarily from an agreement with South Bay Apparel, Inc. (see Note 6 to the Notes to Consolidated Financial Statements for a further discussion). The remaining increase in merchandise margin was primarily due to decreased promotional activity.

 

SG&A

 

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

 

SG&A increased by $56.1 million, or by 1.2 percentage points, as a percentage of net sales, during fiscal 2007. The increase in SG&A was largely due to a $26.7 million increase in store-line expenses. The remainder of the

increase was due to higher store transaction costs and store operations costs of $13.4 million resulting primarily from new store growth and increased sales. The balance of the increase in SG&A was primarily due to a $13.8 million increase in corporate expenses consisting of higher incentive compensation of $4.9 million, stock-based compensation of $3.5 million, and other corporate expenses of $5.4 million. The SG&A increase during fiscal 2007, as a percentage of net sales, was primarily due to a 0.5 percentage point increase in store-line expenses, primarily resulting from increased payroll due to minimum wage increases and loss prevention initiatives; a 0.5 percentage point increase in corporate incentive and stock-based compensation; and a 0.4 percentage point increase in e-commerce expenses, resulting from growth in related sales.

 

SG&A increased by $62.7 million, or by 1.6 percentage points, as a percentage of net sales, during fiscal 2006. The increase in SG&A was due largely to a $28.0 million increase in payroll and benefits, consisting primarily of store payroll from new store growth. The remainder of the increase was predominantly due to increased store transaction costs of $8.8 million, resulting from both sales growth and new store growth, a $7.4 million increase in incentive compensation, a $5.9 million increase in marketing costs and a $4.1 million increase in stock-based compensation, primarily as a result of the adoption of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, a revision of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123(R)”) (see Note 11 to the Notes to Consolidated Financial Statements for a further discussion). The SG&A increase during fiscal 2006, as a percentage of net sales, was primarily due to a 0.5 percentage point increase in incentive compensation, a 0.3 percentage point increase in both stock-based compensation and marketing costs, and a 0.2 percentage point increase in store payroll.

 

Other Operating Income

 

We recognized $4.1 million in net other operating income during the fourth quarter of 2007 as a result of an agreement with our former Executive Vice President and Chief Merchandising Officer (see Note 6 to the Notes to Consolidated Financial Statements for a further discussion).

 

We recognized $2.1 million in other operating income during the second quarter of fiscal 2006 in connection with the resolution of a dispute with a vendor regarding the enforcement of our intellectual property rights.

 

Interest Income

 

Interest income, net of interest expense, decreased by $0.5 million in fiscal 2007. The decrease was primarily due to cash used for share repurchases of $266.7 million during 2007, including the ASR in the fourth quarter of 2007 (see below under Financing Activities for a further discussion).

 

Interest income, net of interest expense, increased by $3.4 million in fiscal 2006. Increases in interest rates and increases in cash and cash equivalents, together with short-term investments, were the primary drivers of the increase in net interest income. Cash and cash equivalents, together with short-term investments, increased by $51.0 million at the end of fiscal 2006.

 

Income Taxes

 

Our effective tax rate was 38.2% for fiscal 2007, compared to 39.0% for fiscal 2006, and 39.6% for fiscal 2005. The decrease in the effective tax rate during fiscal 2007 is primarily due to favorable state tax accrual adjustments. The decrease in the effective income tax rate during fiscal 2006 was primarily due to a decrease in certain net permanent differences. The tax rate for fiscal 2008 is estimated to approximate 40.0%.

 

Net Income and Earnings Per Share

 

Net income was $129.2 million, or $1.73 per diluted share, for fiscal 2007, compared with net income of $106.6 million, or $1.32 per diluted share, for fiscal 2006 and net income of $84.0 million, or $1.00 per diluted share, for fiscal 2005.

 

Net income for fiscal 2007 was favorably impacted by $7.7 million ($4.8 million after-tax, or $0.07 per diluted share), resulting from our initial recognition of gift card breakage (see Note 1 to the Notes to Consolidated Financial Statements for a further discussion). Net income for fiscal 2007 was also favorably impacted by $4.1 million

($2.6 million after-tax, or $0.04 per diluted share), from the above mentioned other operating income. The asset impairment charges unfavorably impacted net income for fiscal 2007 by $9.0 million ($5.7 million after-tax, or $0.08 per diluted share) (see Note 5 to the Notes to Consolidated Financial Statements for a further discussion).

 

Net income for fiscal 2006 was favorably impacted by $7.4 million ($4.5 million after-tax, or $0.05 per diluted share), resulting from the recognition of vendor concessions, primarily from an agreement with South Bay Apparel, Inc. (see Note 6 to the Notes to Consolidated Financial Statements for a further discussion). Net income for fiscal 2006 was also favorably impacted by $2.1 million ($1.3 million after-tax, or $0.02 per diluted share), from the above mentioned other operating income. The previously discussed adoption of SFAS No. 123(R) unfavorably impacted net income for fiscal 2006 by $2.2 million, or $0.03 per diluted share.

 

Consolidated net income included net losses from our Jimmy’Z subsidiary of $12.4 million, or $0.17 per diluted share, for fiscal 2007 (includes above mentioned asset impairment charges of $5.7 million after-tax, or $0.08 per diluted share), compared with net losses of $6.7 million, or $0.08 per diluted share, for fiscal 2006 and $4.7 million, or $0.06 per diluted share, for fiscal 2005.

 

Liquidity and Capital Resources

 

Our cash requirements are primarily for working capital, construction of new stores, remodeling of existing stores, and the improvement and enhancement of our information technology systems. Due to the seasonality of our business, we have historically realized a significant portion of our cash flows from operations during the second half of the year. Most recently, our cash requirements have been met primarily through cash and cash equivalents on hand during the first half of the year, and through cash flows from operations during the second half of the year. We expect to continue to meet our cash requirements for the next twelve months primarily through cash flows from operations, existing cash and cash equivalents and our credit facility. In addition, on November 13, 2007, we amended and restated our revolving credit facility (the “New Credit Facility”) with Bank of America, N.A. (“Bank of America”), which expanded our availability from a maximum of $75.0 million to $150.0 million (see Note 9 to the Notes to Consolidated Financial Statements). A portion of the availability under the New Credit Facility was used to fund the ASR to repurchase $125.0 million of our common shares (see Note 13 to the Notes to Consolidated Financial Statements). At February 2, 2008, we had working capital of $87.3 million and cash and cash equivalents of $111.9 million.

 

The following table sets forth our cash flows for the period indicated (in thousands):

 

 

Operating Activities

 

Cash flows from operating activities, our principal form of liquidity on a full-year basis, decreased by $6.4 million in fiscal 2007 and increased by $33.1 million in fiscal 2006, as compared to the prior fiscal year. The primary components of cash flows from operations for fiscal 2007 included an increase in net income, as adjusted for depreciation and amortization and other non-cash items, of $41.5 million. This increase was more than offset by an increase in cash used for accrued expenses, which resulted from the timing of income tax payments.

 

In accordance with the provisions of SFAS No. 123 (R), excess tax benefits from stock-based compensation of $5.5 million and $7.6 million were reported as a financing activity for fiscal 2007 and fiscal 2006, respectively. Excess tax benefits from stock-based compensation of $4.8 million in fiscal 2005 was reported as an operating activity.

The primary components of cash flows from operations for fiscal 2006 were net income, as adjusted for non-cash items, of $119.9 million, tenant allowances received from landlords of $13.4 million, and excess tax benefits from stock-based compensation of $7.6 million. The primary components of cash flows from operations for fiscal 2005 were net income, as adjusted for non-cash items, of $111.8 million, tenant allowances received from landlords of $21.1 million, and excess tax benefits from stock-based compensation of $4.8 million.

 

Working capital decreased to $87.3 million at February 2, 2008 from $234.0 million at February 3, 2007 primarily due to the increase in stock repurchases in fiscal 2007 (see below for further discussion). Total inventories increased by 20% on a square foot basis as of February 2, 2008 compared to last year. This increase was due to a change in the timing of our floor-sets, primarily resulting from an earlier Easter holiday in 2008.

 

Investing Activities

 

We invested $82.3 million in capital expenditures in fiscal 2007, primarily for the construction of 88 new Aéropostale stores, to remodel seven existing stores, to complete the rollout of upgraded point of sale systems to our store chain, to open a second distribution center and for certain other information technology investments. Our future capital requirements will depend primarily on the number of new stores we open, the number of existing stores we remodel and other strategic investments. We plan to invest approximately $80.0 million in capital expenditures in fiscal 2008. These plans include investments of approximately $50.0 million to open approximately 85 new Aéropostale stores in our new store format including approximately 15 in Canada and our first three new stores in Puerto Rico. Capital expenditure plans also include approximately $10.0 million to remodel approximately 18 existing stores to our new store format and approximately $20.0 million for other initiatives.

 

We had no short-term investments at February 2, 2008. We had $76.2 million in short-term investments as of February 3, 2007, consisting of auction rate debt and preferred stock securities. These securities were all sold during fiscal 2007.

 

Financing Activities

 

We repurchase our common stock from time to time under a stock repurchase program. The repurchase program may be modified or terminated by the Board of Directors at any time, and there is no expiration date for the program. The extent and timing of repurchases will depend upon general business and market conditions, stock prices, opening and closing of the stock trading window, and liquidity and capital resource requirements going forward. During fiscal 2007, including the ASR program, we repurchased 11.7 million shares of our common stock for $266.7 million, as compared to 4.7 million shares for $91.4 million during fiscal 2006 and 2.7 million shares for $44.5 million during fiscal 2005.

 

On November 12, 2007, our Board of Directors approved a $250.0 million increase in repurchase availability under the program, bringing total repurchase authorization, since inception of the program, to $600.0 million. We used a portion of the additional authorization to immediately execute an ASR program to repurchase $125.0 million of common shares as described below.

 

On November 13, 2007, we entered into a confirmation agreement with Bank of America. Pursuant to the ASR, Bank of America purchased shares of our common stock in the open market during the fourth quarter of fiscal 2007. The final number of shares repurchased by Bank of America under the ASR amounted to 4,786,759, which was based upon the volume weighted average share price of our common shares over the term of the ASR. The ASR was subject to collar provisions that established the minimum and maximum price for the shares, which in turn determined the final number of shares repurchased under the ASR. The initial price of the shares purchased by us from Bank of America was subject to a price adjustment based on the volume weighted average price of the shares during this period. The ASR transaction was completed on January 11, 2008.

 

With the latest increase in repurchase authorization, and after taking into account the $125.0 million ASR, total Company share repurchases since inception of the program are $466.2 million. Accordingly, we have approximately $133.8 million of repurchase authorization remaining under our share repurchase program as of February 2, 2008.

On November 13, 2007, we entered into an amended and restated revolving credit facility with Bank of America, N.A., as Lender which expanded availability from a maximum of $75.0 million to $150.0 million (the “New Credit Facility”). The New Credit Facility provides for a $150.0 million revolving credit line. The New Credit Facility is available for working capital and general corporate purposes, including the repurchase of our capital stock and for our capital expenditures. A portion of the availability under the New Credit Facility was used to fund our ASR to repurchase $125.0 million of our common shares. The New Credit Facility is scheduled to expire on November 13, 2012. At November 13, 2007, we had $31.3 million outstanding under the New Credit Facility that was repaid in full on November 27, 2007 (see Note 9 to the Notes to Consolidated Financial Statements for a further discussion, including covenants and events of default).

 

Inflation

 

We do not believe that our sales revenue or operating results have been materially impacted by inflation during the past three fiscal years. There can be no assurance, however, that our sales revenue or operating results will not be impacted by inflation in the future.

 

Contractual Obligations

 

The following table summarizes our contractual obligations as of February 2, 2008:

 

 

The operating leases included in the above table do not include contingent rent based upon sales volume, which represented approximately 16% of minimum lease obligations in fiscal 2007, or variable costs such as maintenance, insurance and taxes, which represented approximately 75% of minimum lease obligations in fiscal 2007.

 

Our open purchase orders are cancelable without penalty and are therefore not included in the above table.

 

In addition to the above table, we project making a benefit payment of approximately $14.6 million from our supplementary executive retirement plan in 2010, which reflects expected future service, and assumes retirement at age 65 (see Note 12 to the Notes to Consolidated Financial Statements for a further discussion).

 

There were no financial guarantees outstanding as of February 2, 2008. We had no commercial commitments outstanding as of February 2, 2008.

 

Effective at the beginning of the first quarter of 2007, we adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”) as described in Note 11 to the Notes to Consolidated Financial Statements. Our total liabilities for unrecognized tax benefits were $11.5 million at February 2, 2008. We cannot make a reasonable estimate of the amount and period of related future payments for $3.7 million of these liabilities. Therefore these liabilities were not included in the above table.

 

Off-Balance Sheet Arrangements

 

Other than operating lease commitments set forth in the table above, we are not a party to any material off-balance sheet financing arrangements. We have not created, and are not a party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating our business. We do not have any

arrangements or relationships with entities that are not consolidated into the financial statements that are reasonably likely to materially affect our liquidity or the availability of capital resources. As of February 2, 2008, we have not issued any letters of credit for the purchase of merchandise inventory or any capital expenditures.

 

Critical Accounting Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 consolidated financial statements. These estimates and assumptions also affect the reported amounts of revenues and expenses. Estimates by their nature are based on judgments and available information. Therefore, actual results could materially differ from those estimates under different assumptions and conditions.

 

Critical accounting policies are those that are most important to the portrayal of our financial condition and the results of operations and require management’s most difficult, subjective and complex judgments as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our most critical accounting policies have been discussed in Note 1 of the Notes to Consolidated Financial Statements. In applying such policies, management must use significant estimates that are based on its informed judgment. Because of the uncertainty inherent in these estimates, actual results could differ from estimates used in applying the critical accounting policies. Changes in such estimates, based on more accurate future information, may affect amounts reported in future periods.

 

Merchandise Inventory

 

Merchandise inventory consists of finished goods and is valued utilizing the cost method at lower of cost or market on a weighted-average basis. We use estimates during interim periods to record a provision for inventory shortage. We also make certain assumptions regarding future demand and net realizable selling price in order to assess that our inventory is recorded properly at the lower of cost or market. These assumptions are based on both historical experience and current information. We believe that the carrying value of merchandise inventory is appropriate as of February 2, 2008. However, actual results may differ materially from those estimated and could have a material impact on our consolidated financial statements. A 10% difference in our estimate of inventory at the lower of cost or market as of February 2, 2008 would have impacted net income by $0.8 million for the fiscal year ended February 2, 2008.

 

Defined Benefit Pension Plans

 

We maintain a Supplemental Executive Retirement Plan, or SERP, which is a non-qualified defined benefit plan for certain officers. The plan is non-contributory, is not funded and provides benefits based on years of service and compensation during employment. Pension expense is determined using various actuarial cost methods to estimate the total benefits ultimately payable to officers, and this cost is allocated to service periods. The actuarial assumptions used to calculate pension costs are reviewed annually. We believe that these assumptions have been appropriate and that, based on these assumptions, the SERP liability of $17.8 million is appropriately stated as of February 2, 2008. However, actual results may differ materially from those estimated and could have a material impact on our consolidated financial statements. If we had changed the expected discount rate by 0.5% in 2007, pension expense would have changed by less than $50,000. We adopted Statement of Financial Accounting Standards No. 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS No. 158”) during fiscal 2006.

 

Long-Lived Assets

 

We periodically evaluate the need to recognize impairment losses relating to long-lived assets. Long-lived assets are evaluated for recoverability whenever events or changes in circumstances indicate that an asset may have been impaired. Factors we consider important that could trigger an impairment review include the following:

 

 

 

In evaluating an asset for recoverability, we estimate the future cash flows expected to result from the use of the asset and eventual disposition. If the sum of the expected future cash flows is less than the carrying amount of the asset, we would write the asset down to fair value and we would record an impairment charge. Accordingly, we recorded an asset impairment charge of $9.0 million related to our Jimmy’Z stores during fiscal 2007 (see Note 5 to the Notes to Consolidated Financial Statements for a further discussion). We believe that the carrying values of finite-lived assets, and their useful lives, are appropriate as of February 2, 2008. However, actual results may differ materially from those estimated and could have a material impact on our consolidated financial statements.

 

Income Taxes

 

Income taxes are accounted for in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (“SFAS No. 109”). Under SFAS No. 109, income taxes are recognized for the amount of taxes payable for the current year and deferred tax assets and liabilities for the future tax consequence of events that have been recognized differently in the financial statements than for tax purposes. Deferred tax assets and liabilities are established using statutory tax rates and are adjusted for tax rate changes. We consider accounting for income taxes critical to our operations because management is required to make significant subjective judgments in developing our provision for income taxes, including the determination of deferred tax assets and liabilities, and any valuation allowances that may be required against deferred tax assets.

 

Effective at the beginning of the first quarter of fiscal 2007, we adopted FIN 48. This interpretation clarifies the accounting for uncertainty in income tax recognized in an entity’s financial statements in accordance with SFAS No. 109. FIN 48 requires companies to determine whether it is “more likely than not” that a tax position will be sustained upon examination by the appropriate taxing authorities before any part of the benefit can be recorded in the financial statements. For those tax positions where it is “not more likely than not” that a tax benefit will be sustained, no tax benefit is recognized. Where applicable, associated interest and penalties are also recorded. This interpretation also provides guidance on derecognition, classification, accounting in interim periods, and expanded disclosure requirements (see Note 14 to the Notes to Consolidated Financial Statements).

 

Recent Accounting Developments

 

See the section “Recent Accounting Developments” included in Note 1 in the Notes to Consolidated Financial Statements for a discussion of recent accounting developments and their impact on our consolidated financial statements.

 

 

At November 13, 2007, we had $31.3 million outstanding under the New Credit Facility that was repaid in full on November 27, 2007. Prior to November 13, 2007 we had no outstanding borrowings under the Prior Credit Facility since November 2002. In addition, we had no stand-by or commercial letters of credit issued under the New Credit Facility. To the extent that we may borrow pursuant to the New Credit Facility in the future, we may be exposed to market risk related to interest rate fluctuations.

 

We are exposed to foreign currency risk as a result of entering the Canadian market in July 2007. We are subject to changes in the foreign currency exchange rates in the Canadian dollar, which could impact our financial condition. Foreign exchange risk arises from our exposure to fluctuation in foreign currency exchange rates because our reporting currency is the U.S. dollar. We also face transactional currency exposures relating to merchandise that our Canadian subsidiary purchases using U.S. dollars. We do not hedge our exposure to this currency exchange fluctuation. A 10% movement in quoted foreign currency exchange rates could result in a fair value translation fluctuation of approximately $1.8 million in our net investment, which would be recorded in other comprehensive income as an unrealized gain or loss.

 

 

To the Board of Directors and Shareholders of Aéropostale, Inc.:

 

We have audited the accompanying consolidated balance sheets of Aéropostale, Inc. and its subsidiaries (the “Company”) as of February 2, 2008 and February 3, 2007, and the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended February 2, 2008. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of February 2, 2008 and February 3, 2007, and the results of its operations and its cash flows for each of the three years in the period ended February 2, 2008, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

 

As discussed in Note 1 to the Notes to Consolidated Financial Statements, the Company adopted Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, effective February 4, 2007. Also, as discussed in Note 1 to the Notes to Consolidated Financial Statements, the Company adopted Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, relating to the recognition and related disclosure provisions, effective February 3, 2007. Also, as discussed in Note 1 to the Notes to Consolidated Financial Statements, the Company adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, as revised, effective January 29, 2006.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of February 2, 2008, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated April 1, 2008 expressed an unqualified opinion on the Company’s internal control over financial reporting.

 

/s/ Deloitte & Touche LLP

 

New York, New York

April 1, 2008

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Shareholders of Aéropostale, Inc.:

 

We have audited the internal control over financial reporting of Aéropostale, Inc. and its subsidiaries (“the Company”) as of February 2, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the Company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, the Company maintained in all material respects effective internal control over financial reporting as of February 2, 2008, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended February 2, 2008, of the Company and our report dated April 1, 2008, expressed an unqualified opinion on those financial statements and the financial statement schedule and includes an explanatory paragraph relating to the Company’s adoption of Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, effective February 4, 2007.

 

/s/ Deloitte & Touche LLP

 

New York, New York

April 1, 2008

AÉROPOSTALE, INC.

 

 

See Notes to Consolidated Financial Statements.

AÉROPOSTALE, INC.

 

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

 

See Notes to Consolidated Financial Statements.