Wet Seal Inc. Reports Operating Results (10-Q)

Wet Seal Inc. (WTSLA) filed Quarterly Report for the period ended 2010-05-01.

Wet Seal Inc. has a market cap of $384.1 million; its shares were traded at around $3.96 with a P/E ratio of 17.2 and P/S ratio of 0.7. WTSLA is in the portfolios of Columbia Wanger of Columbia Wanger Asset Management, Jim Simons of Renaissance Technologies LLC, John Buckingham of Al Frank Asset Management, Inc., Chuck Royce of Royce& Associates.

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 and high unemployment rates across all regions of the U.S. During the fourth calendar quarter of 2008 and the first and second calendar quarters of 2009, U.S. gross domestic product decreased 6.3%, 6.4% and 1.0%, respectively, on a year-over-year basis. Although U.S. gross domestic product showed improvement in the third and fourth calendar quarters of 2009 and the first calendar quarter of 2010, with increases of 3.5%, 5.6% and 3.2%, respectively, 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 U.S. Although our operating performance improved for the 13 weeks ended May 1, 2010, the uncertain and volatile conditions could adversely affect our ability to sustain or further improve our operating performance.

Our comparable store sales increased 2.0% for the 13 weeks ended May 1, 2010, driven by a 1.5% comparable store sales increase in our Wet Seal division and a 4.8% comparable store sales increase in our Arden B division. The Wet Seal division comparable store sales increase was primarily driven by an increase in average dollar sales, partially offset by decreases in Wet Seals transaction volume. The Arden B division comparable store sales increase was primarily driven by increases in units purchased per customer and transaction volumes, partially offset by a decline in average unit retail selling price.

In the first quarter of fiscal 2010, our effective income tax rate was approximately 55.6%. This rate was higher than the expected rate for future periods of approximately 40% due to $2.8 million in interest charges incurred upon the conversion of the our remaining Secured Convertible Notes (the Notes) and Series C Convertible Preferred Stock (the Preferred Stock), which are not tax-deductible. The impact of these non-deductible charges on the effective income tax rate was approximately 16%.

Cost of sales as a percentage of net sales decreased due primarily to an increase in merchandise margin as a result of higher initial markup rates in both divisions and a lower markdown rate in our Wet Seal division, partially offset by an increase in the markdown rate for our Arden B division, as compared to the prior year. Additionally, cost of sales as a percentage of sales was favorably impacted due a reduction in occupancy cost due to leverage from our comparable stores sales increase, as well as rent reductions upon certain lease renewals completed in the past several months, and a decrease in distribution costs due to operational efficiencies. Cost of sales was negatively impacted by an increase in buying, planning and allocation costs, as the prior year quarter included a favorable impact on stock-based compensation from forfeitures from previously employed executives and a change in stock compensation forfeiture rate from 10% to 15%.

We have NOL carry forwards available, subject to certain limitation, to offset our regular taxable income. We recognized a provision for income taxes that resulted in an effective tax rate of 55.6% for federal and state income taxes. This rate was higher than that expected for future periods due to $2.8 million in interest charges incurred upon the Note conversions, which are not tax-deductible. Excluding the effect on these non-deductible charges, the effective income tax rate for the first quarter would have been approximately 40%, which is the rate we currently expect to incur for the remainder of the fiscal year.

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