Wet Seal, Inc. is a nationwide specialty retailer of fashionable andcontemporary apparel and accessory items designed for consumers with a young, active lifestyle. The company operates stores under the following names: Contemp Casual; Wet Seal; Arden B. ; and Limbo Lounge. The companyalso operates a catatlog and an e-commerce under Blue Asphalt brand name. Wet Seal Inc. has a market cap of $280.5 million; its shares were traded at around $2.89 with a P/E ratio of 13.8 and P/S ratio of 0.5.
Highlight of Business Operations:Comparable store salesFor purposes of measuring comparable store sales, sales include merchandise sales as well as membership fee revenues recognized under our Wet Seal divisions frequent buyer program during the applicable period. Stores are deemed comparable stores on the first day of the month following the one-year anniversary of their opening or significant remodel/relocation, which we define to be a square footage increase or decrease of at least 20%. Stores that are remodeled or relocated with a resulting square footage change of less than 20% are maintained in the comparable store base with no interruption. However, stores that are closed for four or more days in a fiscal month, due to remodel, relocation or other reasons, are removed from the comparable store base for that fiscal month as well as for the comparable fiscal month in the following fiscal year. Comparable store sales results are important in achieving operating leverage on certain expenses such as store payroll, occupancy, depreciation and amortization, general and administrative expenses, and other costs that are at least partially fixed. Positive comparable store sales results generate greater operating leverage on expenses while negative comparable store sales results negatively affect operating leverage. Comparable store sales results also have a direct impact on our total net sales, cash, and working capital.
We currently operate in a challenging retail environment driven by several factors, including disruptions in the U.S. housing and financial markets, increasing unemployment rates across all regions of the U.S. and significant declines in consumer confidence and spending. During the fourth calendar quarter of 2008 and the first and second calendar quarters of 2009, U.S. gross domestic product decreased 6.3%, 1.0% and 6.4%, respectively, on a year-over-year basis. Although U.S. gross domestic product showed improvement in the third calendar quarter of 2009, with an increase of 3.5% on a year-over-year basis, we continue to experience a volatile, and generally weak, retail environment. Our operating performance is susceptible to these general economic conditions, which have impacted consumer confidence and discretionary consumer spending in the United States. These trends have led to a highly promotional retail environment, negatively impacting our margins. If the conditions remain uncertain or continue to be volatile, our operating performance may continue to be adversely affected.
Our comparable store sales decreased 6.2% for the 13 weeks ended October 31, 2009, driven by a 7.6% comparable store sales decline in our Wet Seal division, partially offset by a 1.3% comparable store sales increase in our Arden B division. The Wet Seal division comparable store sales decline was primarily driven by average unit retail price and transaction volume declines. These declines were partially offset by an increase in Wet Seals units purchased per customer. The Arden B division comparable store sales increase was primarily driven by a significant increase in transaction volumes, partially offset by a decline in comparable store average dollar sales, which were both due to our strategic decision to lower price points approximately 20% to 25% across all product categories in January 2009.
In the first quarter of fiscal 2009, based on historical analysis, we modified the estimated annual forfeiture rate used in recognizing stock-based compensation expense for our executives and other employees, from a 10% forfeiture rate to a 15% forfeiture rate. See Note 2 of the Notes to Condensed Consolidated Financial Statements for further information.
Currently, we maintain a 100% valuation allowance against our net deferred income tax assets, which are comprised primarily of our NOL carry forwards. As of October 31, 2009, evidence does not support realization of these net deferred income tax assets. As we continue to evaluate available evidence, it is possible that some or all of our deferred income tax assets may be deemed realizable and, accordingly, the valuation allowance recorded against those deferred income tax assets may be reversed at or before the end of the current fiscal year. If such valuation allowance is reversed, we would record an immediate benefit to income taxes for a substantial majority of the reversal and would record an increase to additional paid-in capital for the remainder of the reversal. Prospectively, we would then report an effective income tax rate much closer to statutory rates, which we estimate to be in the range of 38% to 39%. However, this would not change our current expectation that we will not incur significant cash income tax payments in fiscal 2009 or fiscal 2010 as we continue to utilize available NOL carry forwards.
Cost of sales as a percentage of net sales increased due primarily to a decrease in merchandise margin as a result of lower initial markup and a higher markdown rate in our Wet Seal division, partially offset by a decrease in the markdown rate for our Arden B division, compared to the prior year. Additionally, cost of sales was negatively impacted by an increase in occupancy costs, primarily due to normal inflation of rents and common area maintenance charges for new stores and remodels/relocations and the deleveraging effect on occupancy cost from our comparable stores sales decrease in our Wet Seal division. Cost of sales was positively impacted by a decrease in buying, planning and allocation costs, primarily due to eliminated positions upon restructuring of the Arden B buying and design organization, favorable impact on stock-based compensation from forfeitures from previously employed executives and a change in stock compensation forfeiture rate from 10% to 15% based on historical analysis, a reduction in recruiting as the prior year quarter included a recruiting retainer fee to search for a chief merchandise officer in the Wet Seal division and a decrease in distribution costs due to operational efficiencies.
Read the The complete ReportWTSLA is in the portfolios of John Buckingham of AL FRANK ASSET MANAGEMENT INC.