CURV 10-Q
Torrid Holdings Inc. (CURV)
10-Q
2021-12-08
For: 2021-10-30
View Original
Added on
April 07, 2026
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the quarterly period ended October 30, 2021
OR
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For transition period from to
Commission File Number 001-40571
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) | |||||||
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol | Name of each exchange on which registered | ||||||||||||
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☐ | Accelerated filer | ☐ | ||||||||
| ☒ | Smaller reporting company | ||||||||||
| Emerging growth company | |||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ☐ No ☒
As of December 7, 2021, there were approximately 110,091,816 shares of the registrant's common stock outstanding.
Table of Contents
| PAGE | ||||||||
| Item 1. | Financial Statements (unaudited) | |||||||
Condensed Consolidated Balance Sheets as of January 30, 2021 and October 30, 2021 | ||||||||
nine months ended October 31, 2020 and October 30, 2021 | ||||||||
October 31, 2020 and October 30, 2021 | ||||||||
Condensed Consolidated Statements of Cash Flows for the nine months ended October 31, 2020 and October 30, 2021 | ||||||||
| Item 2. | ||||||||
| Item 3. | ||||||||
| Item 4. | ||||||||
| Item 1. | ||||||||
| Item 1A. | ||||||||
| Item 2. | ||||||||
| Item 3. | ||||||||
| Item 4. | ||||||||
| Item 5. | ||||||||
| Item 6. | ||||||||
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical fact included in this Quarterly Report are forward-looking statements. Forward-looking statements give our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe,” “may,” “will,” “should,” “can have,” “likely” and other words and terms of similar meaning (including their negative counterparts or other various or comparable terminology) in connection with any discussion of the timing or nature of future operating or financial performance or other events. For example, all statements we make relating to our estimated and projected costs, expenditures, cash flows, growth rates and financial results, our plans and objectives for future operations, growth or initiatives, strategies or the expected outcome or impact of pending or threatened litigation are forward-looking statements. All forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we expected, including:
•successfully manage risks relating to the spread of COVID-19, including any adverse impacts on our supply chain, workforce, facilities, customer services and operations;
•changes in consumer spending and general economic conditions;
•our ability to identify and respond to new and changing product trends, customer preferences and other related factors;
•our dependence on a strong brand image;
•damage to our reputation arising from our use of social media, email and text messages;
•increased competition from other brands and retailers;
•our reliance on third parties to drive traffic to our website;
•the success of the shopping centers in which our stores are located;
•our ability to adapt to consumer shopping preferences and develop and maintain a relevant and reliable omni-channel experience for our customers;
•our dependence upon independent third parties for the manufacture of all of our merchandise;
•availability constraints and price volatility in the raw materials used to manufacture our products;
•interruptions of the flow of our merchandise from international manufacturers causing disruptions in our supply chain;
•our sourcing a significant amount of our products from China;
•shortages of inventory, delayed shipments to our e-Commerce customers and harm to our reputation due to difficulties or shut-down of our distribution facilities (including as a result of COVID-19);
•our reliance upon independent third-party transportation providers for substantially all of our product shipments;
•our growth strategy;
•our leasing substantial amounts of space;
•our failure to find store employees that reflect our brand image and embody our culture;
•our reliance on third-parties for the provision of certain services, including distribution and real estate management;
•our dependence upon key executive management;
•our reliance on information systems;
•system security risk issues that could disrupt our internal operations or information technology services;
•unauthorized disclosure of sensitive or confidential information, whether through a breach of our computer system or otherwise;
•our failure to comply with federal and state laws and regulations and industry standards relating to privacy, data protection, advertising and consumer protection;
•payment-related risks that could increase our operating costs or subject us to potential liability;
•claims made against us resulting in litigation;
•changes in laws and regulations applicable to our business;
•regulatory actions or recalls arising from issues with product safety;
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•our inability to protect our trademarks or other intellectual property rights;
•our substantial indebtedness and lease obligations;
•restrictions imposed by our indebtedness on our current and future operations;
•changes in tax laws or regulations or in our operations that may impact our effective tax rate;
•the possibility that we may recognize impairments on long-lived assets;
•our failure to maintain adequate internal controls; and
•the threat of war, terrorism or other catastrophes that could negatively impact our business.
We derive many of our forward-looking statements from our operating budgets and forecasts, which are based upon many detailed assumptions. While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors, and, it is impossible for us to anticipate all factors that could affect our actual results. Important factors that could cause actual results to differ materially from our expectations, or cautionary statements, are disclosed under the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Quarterly Report on Form 10-Q. All written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by the cautionary statements as well as other cautionary statements that are made from time to time in our other filings with the Securities and Exchange Commission and public communications. You should evaluate all forward-looking statements made in this Quarterly Report on Form 10-Q in the context of these risks and uncertainties.
We caution you that the important factors referenced above may not contain all of the factors that are important to you. In addition, we cannot assure you that we will realize the results or developments we expect or anticipate or, even if substantially realized, that they will result in the consequences or affect us or our operations in the way we expect. The forward-looking statements included in this Quarterly Report on Form 10-Q are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise.
Investors and others should note that we may announce material information to our investors using our investor relations website (https://investors.torrid.com), SEC filings, press releases, public conference calls and webcasts. We use these channels, as well as social media, to communicate with our investors and the public about our company, our business and other issues. It is possible that the information that we post on social media could be deemed to be material information. We therefore encourage investors to visit these websites from time to time. The information contained on such websites and social media posts is not incorporated by reference into this filing. Further, our references to website URLs in this filing are intended to be inactive textual references only.
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Part I - Financial Information
Item 1. Financial Statements (Unaudited)
TORRID HOLDINGS INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In thousands, except share and per share data)
| January 30, 2021 | October 30, 2021 | ||||||||||
| Assets | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | $ | |||||||||
| Restricted cash | |||||||||||
| Inventory | |||||||||||
| Prepaid expenses and other current assets | |||||||||||
| Prepaid income taxes | |||||||||||
| Total current assets | |||||||||||
| Property and equipment, net | |||||||||||
| Operating lease right-of-use assets | |||||||||||
| Deposits and other noncurrent assets | |||||||||||
| Deferred tax assets | |||||||||||
| Intangible asset | |||||||||||
| Total assets | $ | $ | |||||||||
| Liabilities and stockholders' deficit | |||||||||||
| Current liabilities: | |||||||||||
| Accounts payable | $ | $ | |||||||||
| Accrued and other current liabilities | |||||||||||
| Operating lease liabilities | |||||||||||
| Current portion of term loan | |||||||||||
| Due to related parties | |||||||||||
| Income taxes payable | |||||||||||
| Total current liabilities | |||||||||||
| Noncurrent operating lease liabilities | |||||||||||
| Term loan | |||||||||||
| Deferred compensation | |||||||||||
| Lease incentives and other noncurrent liabilities | |||||||||||
| Total liabilities | |||||||||||
| Commitments and contingencies (Note 15) | |||||||||||
| Stockholders' deficit | |||||||||||
Common shares: $ | |||||||||||
| Additional paid-in capital | |||||||||||
| Accumulated deficit | ( | ( | |||||||||
| Accumulated other comprehensive (loss) income | ( | ||||||||||
| Total stockholders' deficit | ( | ( | |||||||||
| Total liabilities and stockholders' deficit | $ | $ | |||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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TORRID HOLDINGS INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
(In thousands, except per share data)
| Three Months Ended October 31, 2020 | Three Months Ended October 30, 2021 | Nine Months Ended October 31, 2020 | Nine Months Ended October 30, 2021 | ||||||||||||||||||||
| Net sales | $ | $ | $ | $ | |||||||||||||||||||
| Cost of goods sold | |||||||||||||||||||||||
| Gross profit | |||||||||||||||||||||||
| Selling, general and administrative expenses | |||||||||||||||||||||||
| Marketing expenses | |||||||||||||||||||||||
| Income from operations | |||||||||||||||||||||||
| Interest expense | |||||||||||||||||||||||
| Interest income, net of other (income) expense | ( | ( | ( | ||||||||||||||||||||
| Income before provision for income taxes | |||||||||||||||||||||||
| Provision for income taxes | |||||||||||||||||||||||
| Net income (loss) | $ | $ | ( | $ | $ | ( | |||||||||||||||||
| Comprehensive income (loss): | |||||||||||||||||||||||
| Net income (loss) | $ | $ | ( | $ | $ | ( | |||||||||||||||||
| Other comprehensive income (loss): | |||||||||||||||||||||||
| Foreign currency translation adjustment | ( | ||||||||||||||||||||||
| Total other comprehensive income (loss) | ( | ||||||||||||||||||||||
| Comprehensive income (loss) | $ | $ | ( | $ | $ | ( | |||||||||||||||||
| Net earnings (loss) per share: | |||||||||||||||||||||||
| Basic | $ | $ | ( | $ | $ | ( | |||||||||||||||||
| Diluted | $ | $ | ( | $ | $ | ( | |||||||||||||||||
| Weighted average number of shares: | |||||||||||||||||||||||
| Basic | |||||||||||||||||||||||
| Diluted | |||||||||||||||||||||||
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TORRID HOLDINGS INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT
(UNAUDITED)
(In thousands)
| Three and Nine Months Ended October 31, 2020 | |||||||||||||||||||||||||||||||||||
| Common Shares | Additional Paid-In Capital | Accumulated Deficit | Accumulated Other Comprehensive (Loss) Income | Total Stockholders' Deficit | |||||||||||||||||||||||||||||||
| Shares | Amount | ||||||||||||||||||||||||||||||||||
| Balance at February 1, 2020 | $ | $ | $ | ( | $ | ( | $ | ( | |||||||||||||||||||||||||||
| Net income | — | — | — | — | |||||||||||||||||||||||||||||||
| Capital distribution to Torrid Holding LLC for incentive units | — | — | ( | ( | — | ( | |||||||||||||||||||||||||||||
| Other comprehensive loss | — | — | — | — | ( | ( | |||||||||||||||||||||||||||||
| Balance at May 2, 2020 | ( | ( | ( | ||||||||||||||||||||||||||||||||
| Net income | — | — | — | — | |||||||||||||||||||||||||||||||
| Capital contribution from Torrid Holding LLC for incentive units | — | — | — | — | |||||||||||||||||||||||||||||||
| Other comprehensive income | — | — | — | — | |||||||||||||||||||||||||||||||
| Balance at August 1, 2020 | ( | ( | ( | ||||||||||||||||||||||||||||||||
| Net income | — | — | — | — | |||||||||||||||||||||||||||||||
| Capital contribution from Torrid Holding LLC for incentive units | — | — | — | — | |||||||||||||||||||||||||||||||
| Other comprehensive income | |||||||||||||||||||||||||||||||||||
| Balance at October 31, 2020 | $ | $ | $ | ( | $ | ( | $ | ( | |||||||||||||||||||||||||||
| Three and Nine Months Ended October 30, 2021 | |||||||||||||||||||||||||||||||||||
| Common Shares | Additional Paid-In Capital | Accumulated Deficit | Accumulated Other Comprehensive (Loss) Income | Total Stockholders' Deficit | |||||||||||||||||||||||||||||||
| Shares | Amount | ||||||||||||||||||||||||||||||||||
| Balance at January 30, 2021 | $ | $ | $ | ( | $ | ( | $ | ( | |||||||||||||||||||||||||||
| Net income | — | — | — | — | |||||||||||||||||||||||||||||||
| Capital contribution from Torrid Holding LLC for incentive units | — | — | — | — | |||||||||||||||||||||||||||||||
| Other comprehensive income | — | — | — | — | |||||||||||||||||||||||||||||||
| Balance at May 1, 2021 | ( | ( | |||||||||||||||||||||||||||||||||
| Net income | — | — | — | — | |||||||||||||||||||||||||||||||
| Capital distribution to Torrid Holding LLC | — | — | ( | ( | — | ( | |||||||||||||||||||||||||||||
| Capital contribution from Torrid Holding LLC for incentive units | — | — | — | — | |||||||||||||||||||||||||||||||
| Issuance of common shares and withholding tax payments related to vesting of restricted stock awards and restricted stock units | ( | — | — | ( | |||||||||||||||||||||||||||||||
| Share-based compensation | — | — | — | — | |||||||||||||||||||||||||||||||
| Other comprehensive loss | — | — | — | — | ( | ( | |||||||||||||||||||||||||||||
| Balance at July 31, 2021 | ( | ( | |||||||||||||||||||||||||||||||||
| Net loss | — | — | — | ( | — | ( | |||||||||||||||||||||||||||||
| Issuance of common shares and withholding tax payments related to vesting of restricted stock awards | ( | — | — | ( | |||||||||||||||||||||||||||||||
| Share-based compensation | — | — | — | — | |||||||||||||||||||||||||||||||
| Other comprehensive income | — | — | — | — | |||||||||||||||||||||||||||||||
| Balance at October 30, 2021 | $ | $ | $ | ( | $ | $ | ( | ||||||||||||||||||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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TORRID HOLDINGS INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
| Nine Months Ended October 31, 2020 | Nine Months Ended October 30, 2021 | ||||||||||
| OPERATING ACTIVITIES | |||||||||||
| Net income (loss) | $ | $ | ( | ||||||||
| Adjustments to reconcile net income (loss) to net cash provided by operating activities: | |||||||||||
| Write down of inventory | |||||||||||
| Operating right-of-use assets amortization | |||||||||||
| Depreciation and other amortization | |||||||||||
| Write off of unamortized original issue discount and deferred financing costs for Amended Term Loan Credit Agreement | |||||||||||
| Share-based compensation | ( | ||||||||||
| Deferred taxes | |||||||||||
| Other | ( | ||||||||||
| Changes in operating assets and liabilities: | |||||||||||
| Inventory | ( | ( | |||||||||
| Prepaid expenses and other current assets | ( | ( | |||||||||
| Prepaid income taxes | ( | ( | |||||||||
| Deposits and other noncurrent assets | ( | ||||||||||
| Accounts payable | |||||||||||
| Accrued and other current liabilities | |||||||||||
| Operating lease liabilities | ( | ( | |||||||||
| Lease incentives and other noncurrent liabilities | ( | ||||||||||
| Deferred compensation | |||||||||||
| Due to related parties | |||||||||||
| Income taxes payable | ( | ||||||||||
| Net cash provided by operating activities | |||||||||||
| INVESTING ACTIVITIES | |||||||||||
| Purchases of property and equipment | ( | ( | |||||||||
| Net cash used in investing activities | ( | ( | |||||||||
| FINANCING ACTIVITIES | |||||||||||
| Capital distribution to Torrid Holding LLC | ( | ||||||||||
| Proceeds from revolving credit facility | |||||||||||
| Payments on revolving credit facility | ( | ||||||||||
| Deferred financing costs for revolving credit facility | ( | ||||||||||
| Proceeds from Amended Term Loan Credit Agreement, net of original issue discount and deferred financing costs | ( | ||||||||||
| Principal payments on and repayment of Amended Term Loan Credit Agreement and related costs | ( | ( | |||||||||
| Proceeds from New Term Loan Credit Agreement, net of original issue discount and deferred financing costs | |||||||||||
| Proceeds from issuances under share-based compensation plans | |||||||||||
| Withholding tax payments related to vesting of restricted stock units and awards | ( | ||||||||||
| Net cash used in financing activities | ( | ( | |||||||||
| Effect of foreign currency exchange rate changes on cash, cash equivalents and restricted cash | ( | ( | |||||||||
| Increase (decrease) in cash, cash equivalents and restricted cash | ( | ||||||||||
| Cash, cash equivalents and restricted cash at beginning of period | |||||||||||
| Cash, cash equivalents and restricted cash at end of period | $ | $ | |||||||||
| SUPPLEMENTAL INFORMATION | |||||||||||
| Cash paid during the period for interest related to the credit facility and term loans | $ | $ | |||||||||
| Cash paid during the period for income taxes | $ | $ | |||||||||
| SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES | |||||||||||
| Property and equipment purchases included in accounts payable and accrued liabilities | $ | $ | |||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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TORRID HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1. Basis of Presentation and Description of the Business
Corporate Structure
Torrid Holdings Inc. is a Delaware corporation formed on October 29, 2019 and capitalized on February 20, 2020. Sycamore Partners Management, L.P. (“Sycamore”) owns a majority of the voting power of Torrid Holdings Inc.’s outstanding common stock. Prior to the IPO (as defined below), Torrid Holdings Inc. was a wholly owned subsidiary of Torrid Holding LLC, which is majority-owned by investment funds managed by Sycamore. Torrid Parent Inc. is a Delaware corporation formed on June 4, 2019 and is a wholly owned subsidiary of Torrid Holdings Inc. Torrid Intermediate LLC, formerly known as Torrid Inc., is a Delaware limited liability company formed on June 18, 2019 and a wholly owned subsidiary of Torrid Parent Inc. Torrid LLC is a wholly owned subsidiary of Torrid Intermediate LLC. Substantially all of Torrid Holdings Inc.'s financial position, operations and cash flows are generated through its wholly owned indirect subsidiary, Torrid LLC.
Throughout these financial statements, the terms “Torrid,” “we,” “us,” “our,” the “Company” and similar references refer to Torrid Holdings Inc. and its consolidated subsidiaries.
Reorganization
On July 1, 2021, Torrid Holding LLC, our then parent, completed a reorganization pursuant to which (i) Torrid Holding LLC contributed, assigned, transferred and delivered its issued and outstanding equity interest in Torrid Parent Inc. to Torrid, and (ii) Torrid assumed the obligations of Torrid Holding LLC under the related party promissory notes due to Torrid Parent Inc. (together, the “Reorganization”). The Reorganization was accounted for as a combination of entities under common control in accordance with subsections of Accounting Standards Codification (“ASC”) 805-50, Business Combinations (“ASC 805-50”). Consequently, the equity interests of Torrid Parent Inc. contributed by Torrid Holding LLC to Torrid were recorded at historical carrying amounts and our financial position, results of operations and cash flows prior to the Reorganization have been adjusted to reflect the retrospective combination of the entities for all periods presented as if the combination had been in effect since the inception of common control.
Stock Split
On June 22, 2021, Torrid's stockholder approved an amendment to Torrid's certificate of incorporation to (i) effect a 110,000 -for-1 stock split of all shares of the issued and outstanding common stock, which was effected on June 22, 2021 and (ii) authorize 5.0 million shares of preferred stock. All share and per-share data in the financial statements and notes to the financial statements has been retroactively adjusted to reflect the stock split for all periods presented. The par value of the common stock was not adjusted as a result of the stock split.
Initial Public Offering
Our registration statement on Form S-1 related to our initial public offering (“IPO”) was declared effective on June 30, 2021, and our common stock began trading on the New York Stock Exchange on July 1, 2021. On July 6, 2021, subsequent to the Reorganization, we completed the IPO and certain of our shareholders sold 12,650,000 shares of common stock at a public offering price of $21.00 per share, including 1,650,000 shares of common stock after full exercise of the underwriters' option, for net proceeds of $248.4 million, after deducting underwriting discounts of $17.3 million. The offering costs of approximately $6.0 million were borne by us. We did not receive any proceeds from the sale of our shares of common stock by the selling stockholders.
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Basis of Presentation and Principles of Consolidation
Description of Business
We are a direct-to-consumer brand of apparel, intimates and accessories targeting the 25- to 40-year-old woman who is curvy and wears sizes 10 to 30. We generate revenues primarily through our e-Commerce platform www.torrid.com and our stores in the United States of America, Puerto Rico and Canada.
COVID-19
In March 2020, the World Health Organization declared the outbreak of COVID-19 a pandemic, which continues to spread throughout the United States and globally. The COVID-19 health crisis poses significant and widespread risks to our business as well as to the business environment and the markets in which we operate. In response to the public health crisis posed by COVID-19, individual states across the United States, including California where our headquarters are located, imposed a variety of regulatory restrictions including stay-at-home requirements. Consequently, we temporarily closed our headquarters and all retail store locations on March 17, 2020. In response to the impact of COVID-19, in March 2020, we implemented a number of precautionary measures to minimize cash outlays. These precautionary measures included managing workforce costs, delaying planned capital expenditures, including store openings, minimizing discretionary expenses and deferring lease payments while we negotiate concessions for certain of our retail locations. Please refer to “Note 8—Leases” for further discussion regarding these lease concessions. On May 15, 2020, we began to reopen our retail store locations in phases. Our decision to reopen retail store locations is affected by a number of factors including applicable regulatory restrictions. As of August 1, 2020, all of our retail store locations impacted by COVID-19 had reopened subject to local and state restrictions including limited hours and curbside order pick-up for certain locations. While our retail store locations were closed, we continued to serve customers virtually through our Torrid app and online at www.torrid.com.
In addition to our planned closures and reopenings, we have had to unexpectedly close some of our physical locations for brief periods of time in response to COVID-19 exposures. We may face new closure requirements with respect to some or all of our physical locations for prolonged periods of time due to, among other factors, evolving federal, state and local restrictions and shelter-in-place orders. Even though we have reopened our physical locations, changes in consumer behavior and health concerns may continue to impact customer traffic at our retail locations and may make it more difficult for us to staff these locations.
Our business operations, including net sales, were substantially affected by COVID-19 in the prior year and the extent of future impacts of COVID-19 on our business, including the duration and impact on overall customer demand, is uncertain as current circumstances are dynamic and depend on future developments, including, but not limited to, the duration and spread of COVID-19, the emergence of new variants of the coronavirus and the availability and acceptance of effective vaccines or medical treatments.
During the third quarter of fiscal year 2021, global supply chain disruption caused significant product delays resulting in limited product availability to our customers. Increased port congestion and COVID-19-related factory closures, most notably
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in the Asia-Pacific region where we source a significant amount of product, impacted our results of operations for the three- and nine-months ended October 30, 2021.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law, and has resulted in significant changes to the U.S. federal corporate tax law. The CARES Act provides numerous tax provisions and other stimulus measures, including temporary changes regarding the prior and future utilization of net operating losses, temporary changes to the prior and future limitations on interest deductions, temporary suspension of certain payment requirements for the employer portion of Social Security taxes, technical corrections from prior tax legislation for tax depreciation of certain qualified improvement property, and the creation of certain refundable employee retention credits. Additionally, several state and foreign jurisdictions have enacted additional legislation to comply with federal changes. On December 27, 2020, the Consolidated Appropriations Act (“CAA”) was enacted in further response to the COVID-19 pandemic. The CAA, among other things, revised certain tax measures enacted under the CARES Act, such as the deductibility of payroll tax credits, charitable contributions for corporate taxpayers, certain meals and entertainment expenses paid or incurred in calendar years 2020 and 2021, and employment retention credit claims. On March 11, 2021, the American Rescue Plan Act (“ARPA”) was signed into law with additional funding for COVID-19 pandemic relief. The ARPA includes the expansion of employment retention credit claims and other pandemic funding provisions. We have considered the applicable CARES Act, CAA and ARPA tax law changes in our tax provision for the period ended October 30, 2021 and continue to evaluate the impact of these tax law changes on future periods.
Segment Reporting
Note 2. Accounting Standards
Recently Adopted Accounting Standards during the Nine-Month Period Ended October 30, 2021
In December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2019-12, Simplifying the Accounting for Income Taxes. The ASU is intended to enhance and simplify aspects of the income tax accounting guidance in ASC 740 as part of the FASB’s simplification initiative. This guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2020 with early adoption permitted. Our adoption of this guidance on January 31, 2021 did not have a material impact on our condensed consolidated financial position or results of operations.
Note 3. Inventory
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Note 4. Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consist of the following (in thousands):
| January 30, 2021 | October 30, 2021 | ||||||||||
| Prepaid and other information technology expenses | |||||||||||
| Prepaid advertising | |||||||||||
| Prepaid casualty insurance | |||||||||||
| Other | |||||||||||
| Prepaid expenses and other current assets | $ | $ | |||||||||
Note 5. Property and Equipment
Property and equipment are summarized as follows (in thousands):
| January 30, 2021 | October 30, 2021 | ||||||||||
| Property and equipment, at cost | |||||||||||
| Leasehold improvements | $ | $ | |||||||||
| Furniture, fixtures and equipment | |||||||||||
| Software and licenses | |||||||||||
| Construction-in-progress | |||||||||||
| Less: Accumulated depreciation and amortization | ( | ( | |||||||||
| Property and equipment, net | $ | $ | |||||||||
We recorded depreciation expense related to our property and equipment in the amounts of $8.5 million and $25.2 million during the three- and nine-month periods ended October 31, 2020, respectively. We recorded depreciation expense related to our property and equipment in the amounts of $8.5 million and $25.6 million during the three- and nine-month periods ended October 30, 2021, respectively.
We group and evaluate long-lived assets for impairment at the individual store level, which is the lowest level at which individual cash flows can be identified. During the three- and nine-month periods ended October 31, 2020 and October 30, 2021, we did no
Note 6. Implementation Costs Incurred in Cloud Computing Arrangements that are Service Contracts
Our cloud computing arrangements that are service contracts primarily consist of arrangements with third party vendors for our internal use of their software applications that they host. We defer implementation costs incurred in relation to such arrangements, including costs for software application coding, configuration, integration and customization, while associated process reengineering, training, maintenance and data conversion costs are expensed. Subsequent implementation costs are deferred only to the extent that they constitute major enhancements. The short-term portion of deferred implementation costs are included in prepaid expenses and other current assets in the condensed consolidated balance sheets, while the long-term portion of deferred costs are included in deposits and other noncurrent assets. Amortized implementation costs incurred in cloud computing arrangements that are service contracts are recognized in selling, general and administrative expenses in the condensed consolidated statements of operations and comprehensive income (loss).
Deferred implementation costs incurred in cloud computing arrangements that are service contracts are summarized as follows (in thousands):
| January 30, 2021 | October 30, 2021 | ||||||||||
| Internal use of third party hosted software, gross | $ | $ | |||||||||
| Less: Accumulated amortization | ( | ( | |||||||||
| Internal use of third party hosted software, net | $ | $ | |||||||||
During the three- and nine-month periods ended October 31, 2020, we amortized approximately $0.3 million and $0.8 million, respectively, of implementation costs incurred in cloud computing arrangements that are service contracts. During the
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Note 7. Accrued and Other Current Liabilities
Accrued and other current liabilities consist of the following (in thousands):
| January 30, 2021 | October 30, 2021 | ||||||||||
| Accrued payroll and related expenses | $ | $ | |||||||||
| Accrued inventory-in-transit | |||||||||||
| Accrued loyalty program | |||||||||||
| Accrued sales return allowance | |||||||||||
| Gift cards | |||||||||||
| Deferred revenue | |||||||||||
| Accrued sales and use tax | |||||||||||
| Accrued freight | |||||||||||
| Term loan interest payable | |||||||||||
| Accrued marketing | |||||||||||
| Accrued self-insurance liabilities | |||||||||||
| Other | |||||||||||
| Accrued and other current liabilities | $ | $ | |||||||||
Note 8. Leases
Our lease costs reflected in the tables below include minimum base rents, common area maintenance charges and heating, ventilation and air conditioning charges. We recognize such lease costs in the applicable expense category in either cost of goods sold, or selling, general and administrative expenses in the condensed consolidated statements of operations and comprehensive income (loss).
Our lease costs during the three- and nine-month periods ended October 31, 2020 and October 30, 2021 consist of the following (in thousands):
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| October 31, 2020 | October 30, 2021 | October 31, 2020 | October 30, 2021 | ||||||||||||||||||||
| Operating (fixed) lease cost | $ | $ | $ | $ | |||||||||||||||||||
| Short-term lease cost | |||||||||||||||||||||||
| Variable lease cost | |||||||||||||||||||||||
| Total lease cost | $ | $ | $ | $ | |||||||||||||||||||
In response to the COVID-19 pandemic, the FASB issued interpretive guidance in April 2020, which provides entities the option to elect to account for lease concessions as though the enforceable rights and obligations existed in the original lease terms. We elected this option; accordingly, we do not remeasure the lease liabilities or record a change to the right-of-use (“ROU”) assets for any concessions we receive for our retail store leases. Rather, deferred lease payments are recorded to operating lease liabilities until paid and lease concessions are recorded in the period they are negotiated or when the lower lease expense is paid.
As of the end of fiscal year 2020 and as of the end of the third quarter of fiscal years 2020 and 2021, we recorded deferred fixed lease payments of $5.8 million, $14.8 million and $2.0 million, respectively, in current operating lease liabilities in the condensed consolidated balance sheets. During the three- and nine-month periods ended October 31, 2020, we recorded a reduction to lease costs of $7.5 0.2 million and $1.2 million, respectively, as a result of negotiated lease concessions.
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Other supplementary information related to our leases is reflected in the table below (in thousands except lease term and discount rate data):
| Nine Months Ended | |||||||||||
| October 31, 2020 | October 30, 2021 | ||||||||||
| Cash paid for amounts included in the measurement of lease liabilities: | |||||||||||
| Operating cash flows for operating leases | $ | $ | |||||||||
| Right-of-use assets obtained in exchange for new operating lease liabilities | $ | $ | |||||||||
| Decrease in right-of-use assets resulting from operating lease modifications or remeasurements | $ | ( | $ | ( | |||||||
| Weighted average remaining lease term - operating leases | |||||||||||
| Weighted average discount rate - operating leases | % | % | |||||||||
Note 9. Revenue Recognition
We recognize revenue when our performance obligations under the terms of a contract or an implied arrangement with a customer are satisfied, which is when the merchandise is transferred to the customer and the customer obtains control of it. The amount of revenue we recognize reflects the total consideration we expect to receive for the merchandise, which is the transaction price.
Our revenue, disaggregated by product category, consists of the following (in thousands):
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| October 31, 2020 | October 30, 2021 | October 31, 2020 | October 30, 2021 | ||||||||||||||||||||
| Apparel | $ | $ | $ | $ | |||||||||||||||||||
| Non-apparel | |||||||||||||||||||||||
| Total net sales | $ | $ | $ | $ | |||||||||||||||||||
Amounts within Apparel include revenues earned from the sale of tops, bottoms, dresses, intimates, sleep wear, swim wear and outerwear. Amounts within Non-apparel include revenues earned from the sale of accessories, footwear and beauty.
We recognize a contract liability when we receive consideration from a customer before our performance obligations under the terms of a contract or an implied arrangement with the customer are satisfied. During the nine-month period ended October 31, 2020, we recognized revenue of approximately $7.9 million and $4.2 million related to our accrued loyalty program and gift cards, respectively, that existed at the beginning of fiscal year 2020. During the nine-month period ended October 30, 2021, we recognized revenue of approximately $10.1 million and $4.7 million related to our accrued loyalty program and gift cards, respectively, that existed at the beginning of fiscal year 2021.
Note 10. Loyalty Program
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Note 11. Related Party Transactions
Services Agreements with Hot Topic
Hot Topic Inc. (“Hot Topic”) is an entity indirectly controlled by affiliates of Sycamore. From June 2, 2017 until its termination on March 21, 2019, we had a services agreement (“Third Party Services Agreement”) with Hot Topic, pursuant to which Hot Topic provided us (or caused applicable third parties to provide) certain services, including information technology, distribution and logistics management, real estate leasing and construction management and other services as may have been specified. On March 21, 2019, we entered into an amended and restated services agreement (“Amended and Restated Services Agreement”) with Hot Topic under which Hot Topic provides us (or causes applicable third parties to provide) substantially similar services to those provided under the Third Party Services Agreement. The term of the Amended and Restated Services Agreement is three years , unless we or Hot Topic extend the agreement, or we terminate the agreement (or certain services under the agreement). We may terminate the various services upon written notice. Rates and costs related to the services provided under the Amended and Restated Services Agreement may change with approval from both parties. Each month, we are committed to pay Hot Topic for these services and reimburse Hot Topic for certain costs it incurs in the course of providing these services. We record payments made to Hot Topic under these service agreements in the applicable expense category in either cost of goods sold, or selling, general and administrative expenses. On August 1, 2019, in connection with the IT Asset Purchase Agreement (as defined below), we entered into a services agreement (“Reverse Services Agreement”) with Hot Topic, under which Torrid provides Hot Topic with certain information technology services. The term of the Reverse Services Agreement is three years , unless we or Hot Topic extend the agreement, or Hot Topic terminates the agreement. Torrid provides Hot Topic with the specified information technology services at no cost for the first three years of the Reverse Services Agreement, however Hot Topic bears certain capital and operating expenses that it incurs. Costs incurred in connection with providing the specified information technology services to Hot Topic are expensed as incurred in our condensed consolidated statements of operations and comprehensive income (loss). During the three- and nine-month periods ended October 31, 2020, we incurred costs of $0.7 million and $2.2 million, respectively, in connection with providing these information technology services to Hot Topic. During the three- and nine-month periods ended October 30, 2021, we incurred costs of $0.8 million and $2.5 million, respectively, in connection with providing these information technology services to Hot Topic. In connection with the Reverse Services Agreement, we entered into an amendment to the Amended and Restated Services Agreement (“Amendment to Amended and Restated Services Agreement”) with Hot Topic on August 1, 2019, pursuant to which sections pertaining to Hot Topic’s provision of information technology services to Torrid were removed.
During the three-month periods ended October 31, 2020 and October 30, 2021, Hot Topic charged us $3.2 million and $1.9 million, respectively, for various services under the applicable services agreements, of which $2.5 million and $1.3 million, respectively, were recorded as components of cost of goods sold, and the remaining $0.7 million and $0.6 million, respectively, were recorded as selling, general and administrative expenses. During the nine-month periods ended October 31, 2020 and October 30, 2021, Hot Topic charged us $10.5 million and $5.8 million, respectively, for various services under the applicable services agreements, of which $8.5 million and $3.8 million, respectively, were recorded as components of cost of goods sold, and the remaining $2.0 million and $2.0 million, respectively, were recorded as selling, general and administrative expenses. As of the end of fiscal year 2020, we did no t owe any amount to Hot Topic for these services, and as of the end of the third quarter of fiscal year 2021, we owed $0.8 million to Hot Topic for these services.
Hot Topic incurs certain direct expenses on our behalf, such as payments to our non-merchandise vendors and each month, we pay Hot Topic for these pass-through expenses. As of the end of fiscal year 2020, we had prepaid Hot Topic $0.4 million for these expenses, which were included in prepaid expenses and other current assets in our condensed consolidated balance sheets. As of the end of the third quarter of fiscal year 2021, the net amount we owed Hot Topic for these expenses was $1.2 million, which are included in due to related parties in our condensed consolidated balance sheets.
IT Asset Purchase Agreement with Hot Topic
On June 14, 2019, we entered into an asset purchase agreement (“IT Asset Purchase Agreement”) with Hot Topic pursuant to which we purchased certain information technology assets from Hot Topic for $29.5 million on August 1, 2019. Funds obtained from the Term Loan Credit Agreement (as defined in “Note 12—Debt Financing Arrangements”) were used to make the purchase. We accounted for the purchase in accordance with subsections of ASC 805-50, related to transactions between entities under common control. Consequently, we recorded the information technology assets we purchased from Hot Topic at their historical carrying amounts totaling $3.5 million and recognized the difference between the historical carrying amounts and the purchase price in equity. In addition, certain information technology-related obligations and personnel, along with associated assets of $1.4 million and liabilities of $0.1 million, were transferred from Hot Topic to Torrid. In connection with the IT Asset Purchase Agreement, we and Hot Topic agreed to enter into the Reverse Services Agreement and Amendment to Amended and Restated Services Agreement upon the closing date of the IT Asset Purchase Agreement, which was August 1, 2019.
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Promissory Notes Receivable from Parent
From time to time prior to the Reorganization, our former parent, Torrid Holding LLC, issued promissory notes receivable to Torrid Parent Inc., our current subsidiary. Due to the nature of these promissory notes receivable, we considered them to be in-substance distributions to Torrid Holding LLC and accounted for them as contra-equity in accordance with ASC 310, Receivables. Consequently, these promissory notes receivable were reflected within equity in our condensed consolidated balance sheets as reductions in additional paid-in capital, within capital distribution to Torrid Holding LLC, net of contribution, in our condensed consolidated statements of stockholders' deficit, and within capital distribution to Torrid Holding LLC, net of contribution, in our condensed consolidated statements of cash flows as financing cash outflows.
Pursuant to the Reorganization, we assumed the obligations of Torrid Holding LLC under the related party promissory notes due to Torrid Parent Inc. These obligations represent intercompany transactions and have been eliminated in consolidation. No principal or interest payments had been made to Torrid Parent Inc. by our former parent prior to the Reorganization.
On December 20, 2018, Torrid Holding LLC issued a $61.4 million promissory note to us in exchange for cash, due on or before December 20, 2024 (“$61.4 M Related Party Promissory Note Receivable”). The funds realized from the $61.4 M Related Party Promissory Note Receivable were invested by Torrid Holding LLC in HTI (as defined below) and used by HTI (as defined below) and Hot Topic for the partial redemption of Hot Topic’s 9.25 % senior secured notes (“Notes”). The $61.4 M Related Party Promissory Note Receivable accrued interest at an annual compounding rate of 3.06 % upon its maturity. As of the end of fiscal year 2020, there was a $61.4 million lump sum principal payment due to us upon the December 20, 2024 maturity date. The total amount of interest Torrid Holding LLC owed us as of the end of fiscal year 2020 was $4.0 million.
On June 6, 2019, Torrid Holding LLC issued a $20.0 million promissory note to us in exchange for cash, due on or before June 6, 2025 (“$20 M Related Party Promissory Note Receivable”). The $20 M Related Party Promissory Note Receivable accrued interest at an annual compounding rate of 2.78 % upon its maturity. As of the end of fiscal year 2020, there was a $20.0 million lump sum principal payment due to us upon the June 6, 2025 maturity date. The total amount of interest Torrid Holding LLC owed us as of the end of fiscal year 2020 was $0.9 million.
On June 14, 2019, Torrid Holding LLC issued a $10.0 million promissory note to us in exchange for cash, due on or before June 14, 2025 (“$10 M Related Party Promissory Note Receivable”). The $10 M Related Party Promissory Note Receivable accrued interest at an annual compounding rate of 2.78 % upon its maturity. As of the end of fiscal year 2020, there was a $10.0 million lump sum principal payment due to us upon the June 14, 2025 maturity date. The total amount of interest Torrid Holding LLC owed us as of the end of fiscal year 2020 was $0.5 million.
On July 31, 2019, Torrid Holding LLC issued a $214.6 million promissory note to us, due on or before July 31, 2025 (“$214.6 M Related Party Promissory Note Receivable”). The $214.6 M Related Party Promissory Note Receivable was issued to us in exchange for the $213.2 million investment we made in HTI (as defined below) on June 14, 2019 plus the associated $1.4 million interest due to us through July 31, 2019. The $214.6 M Related Party Note Receivable accrued interest at an annual compounding rate of 1.87 % upon its maturity. As of the end of fiscal year 2020, there was a $214.6 million lump sum principal payment due to us upon the July 31, 2025 maturity date. The total amount of interest Torrid Holding LLC owed us as of the end of fiscal year 2020 was $6.1 million.
On August 1, 2019, Torrid Holding LLC issued a $1.2 million promissory note to us in exchange for cash, due on or before August 1, 2025 (“$1.2 M Related Party Promissory Note Receivable”). The $1.2 M Related Party Promissory Note Receivable was issued to us in exchange for purchasing $1.2 million of senior participating preferred stock from HTI (as defined below) on behalf of Torrid Holding LLC. The $1.2 M Related Party Promissory Note Receivable accrued interest at an annual compounding rate of 1.87 % upon its maturity. As of the end of fiscal year 2020, there was a $1.2 million lump sum principal payment due to us upon the August 1, 2025 maturity date. The total amount of interest Torrid Holding LLC owed us as of the end of fiscal year 2020 was not material.
On November 26, 2019, Torrid Holding LLC issued a $12.0 million promissory note to us in exchange for cash, due on or before November 26, 2025 (“$12 M Related Party Promissory Note Receivable”). The $12 M Related Party Promissory Note Receivable accrued interest at an annual compounding rate of 1.59 % upon its maturity. As of the end of fiscal year 2020, there was a $12.0 million lump sum principal payment due to us upon the November 26, 2025 maturity date. The total amount of interest Torrid Holding LLC owed us as of the end of fiscal year 2020 was $0.2 million.
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On June 14, 2021, Torrid Holding LLC issued a $300.0 million promissory note to us in exchange for cash, due on or before June 14, 2027 (“$300 M Related Party Promissory Note Receivable”). The $300 M Related Party Promissory Note Receivable accrued interest at an annual compounding rate of 1.02 % upon its maturity.
Sponsor Advisory Services Agreement
On May 1, 2015, we entered into an advisory services agreement with Sycamore, pursuant to which Sycamore agreed to provide strategic planning and other related services to us. We are obligated to reimburse Sycamore for its expenses incurred in connection with providing such advisory services to us. As of the end of fiscal year 2020 and as of the end of the third quarter of fiscal year 2021, there were no no
From time to time, we reimburse Sycamore for certain management expenses it pays on our behalf. During the three- and nine-month periods ended October 31, 2020, we did no no amount due, and as of the end of the third quarter of fiscal year 2021, the amount due was $0.7 million.
Other Related Party Transactions
On June 14, 2019, we used funds obtained from the Term Loan Credit Agreement (as defined in “Note 12—Debt Financing Arrangements”) to purchase $213.2 million of senior participating preferred stock from Hot Topic’s parent, HT Intermediate Holdings Corp. (“HTI”). We accounted for the purchase under the cost method in accordance with ASC 325, Investments—Other. On July 31, 2019, Torrid Holding LLC issued the $214.6 M Related Party Promissory Note Receivable to us in exchange for our $213.2 million investment in HTI’s senior participating preferred stock, including $1.4 million of accrued interest. Due to the nature of this $214.6 M Related Party Promissory Note Receivable, we considered it to be an in-substance distribution to Torrid Holding LLC and accounted for it as contra-equity. Pursuant to the Reorganization, we assumed the obligations of Torrid Holding LLC under the $214.6 M Related Party Promissory Note Receivable.
MGF Sourcing US, LLC, an entity indirectly controlled by affiliates of Sycamore, is one of our suppliers. During the three- and nine-month periods ended October 31, 2020, purchases from this supplier were $10.9 million and $29.5 million, respectively. During the three- and nine-month periods ended October 30, 2021, purchases from this supplier were $12.4 million and $44.5 million, respectively. As of the end of fiscal year 2020 and as of the end of the third quarter of fiscal year 2021, the net amounts we owed MGF for these purchases were $8.0 million and $5.5 million, respectively. This liability is included in due to related parties in our condensed consolidated balance sheets.
HU Merchandising, LLC, a subsidiary of Hot Topic, is one of our suppliers. During the three- and nine-month periods ended October 31, 2020, purchases from this supplier were $0.1 million and $0.3 million, respectively. During the three- and nine-month periods ended October 30, 2021, purchases from this supplier were $0.2 million and $0.7 million, respectively. As of the end of fiscal year 2020 and as of the end of the third quarter of fiscal year 2021, the amounts due to HU Merchandising, LLC were $0.1 million and $0.2 million, respectively. This liability is included in due to related parties in our condensed consolidated balance sheets.
Staples, Inc., an entity indirectly controlled by affiliates of Sycamore, is one of our suppliers. During the three- and nine-month periods ended October 31, 2020 and October 30, 2021, purchases from this supplier were not material. As of the end of fiscal year 2020 and as of the end of the third quarter of fiscal year 2021, the amounts due to Staples, Inc. were not material.
In April 2020, we received a letter of support from Sycamore for up to $20.0 million of additional equity funding, which, if necessary and sufficient, would be provided to further prevent noncompliance with the financial covenants in the Amended Term Loan Credit Agreement (as defined in “Note 12—Debt Financing Arrangements”) through May 2021. In September 2020, we received an updated letter of support from Sycamore extending the equity funding commitment of up to $20.0 million, if necessary and sufficient, through January 2022. The letter of support was terminated as of May 6, 2021.
In March 2021, Hot Topic entered into a consulting services agreement with our Chief Financial Officer, George Wehlitz, Jr. (“CFO”), pursuant to which Hot Topic agreed to pay our CFO a consulting fee of $10,000 per month. The agreement was effective from January 3, 2021 and terminated on May 31, 2021.
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Note 12. Debt Financing Arrangements
Our debt financing arrangements consist of the following (in thousands):
| January 30, 2021 | October 30, 2021 | ||||||||||
| Existing ABL Facility, as amended | $ | $ | |||||||||
| Term loan | |||||||||||
| Amended Term Loan Credit Agreement | |||||||||||
| New Term Loan Credit Agreement | |||||||||||
| Less: current portion of unamortized original issue discount and debt financing costs | ( | ( | |||||||||
| Less: noncurrent portion of unamortized original issue discount and debt financing costs | ( | ( | |||||||||
| Total term loan outstanding, net of unamortized original issue discount and debt financing costs | |||||||||||
| Less: current portion of term loan, net of unamortized original issue discount and debt financing costs | ( | ( | |||||||||
| Total term loan, net of current portion and unamortized original issue discount and debt financing costs | $ | $ | |||||||||
Fixed mandatory principal repayments due on the outstanding term loan are as follows as of the end of the third quarter of fiscal year 2021 (in thousands):
| 2021 | |||||
| 2022 | |||||
| 2023 | |||||
| 2024 | |||||
| 2025 | |||||
| 2026 | |||||
| 2027 | |||||
| 2028 | |||||
| $ | |||||
New Term Loan Credit Agreement
On June 14, 2021, we entered into a term loan credit agreement (“New Term Loan Credit Agreement”) among Bank of America, N.A., as agent, and the lenders party thereto.
The New Term Loan Credit Agreement provides for term loans in an initial aggregate amount of $350.0 million (“Principal”), which is recorded net of an original issue discount (“OID”) of $3.5 million and has a maturity date of June 14, 2028. In connection with the New Term Loan Credit Agreement, we paid financing costs of approximately $6.0 million.
The $346.5 million proceeds of the New Term Loan Credit Agreement, net of OID, were used to (i) repay and terminate the Amended Term Loan Credit Agreement (as defined below); (ii) make a $131.7 million distribution to the direct and indirect holders of our equity interests; and (iii) pay for financing costs associated with the New Term Loan Credit Agreement.
Loans made pursuant to the New Term Loan Credit Agreement bear interest at an annual rate equal to, at our option, either (a) a base rate determined by reference to the highest of (1) the prime rate quoted by The Wall Street Journal, (2) the federal funds effective rate plus 0.50 % and (3) a LIBOR rate for an interest period of one month, plus 1.00 % (in each case, subject to a floor of 1.75 0.75 5.50 % for LIBOR borrowings and 4.50 % for base rate borrowings.
If we elect the LIBOR rate, interest is due and payable on the last day of each interest period, unless an interest period exceeds three months, then the respective dates that fall every three months after the beginning of the interest period shall also be interest payment dates. If we elect the Base rate loan, interest is due and payable the last day of each calendar quarter. The elected interest rate on October 30, 2021 was approximately 6 %.
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In addition to paying interest on the outstanding Principal under the New Term Loan Credit Agreement, we are required to make fixed mandatory repayments of the Principal on the last business day of each fiscal quarter until maturity commencing with the second full fiscal quarter following the closing date (“Repayment”). For each of the fiscal quarters until the maturity date and starting with the fourth fiscal quarter of 2021, Repayments represent 1.25 % of the Principal, reduced as a result of the application of prior Prepayments, as defined below.
Under the New Term Loan Credit Agreement, we are also required to make variable mandatory prepayments of the Principal, under certain conditions as described below, approximately 102 days after the end of each fiscal year (each, a “Prepayment”). Prepayments, if applicable, commence at the end of fiscal year 2022 and represent between 0 % and 50 % (depending on our first lien net leverage ratio) of Excess Cash Flow (as defined in the New Term Loan Credit Agreement) in excess of $10.0 million, minus prepayments of Principal, the Existing ABL Facility, as amended (to the extent accompanied by a permanent reduction in the commitments thereunder) and certain other specified indebtedness and amounts in connection with certain other enumerated items.
In addition to mandatory Repayment and Prepayment obligations, we may at our option, prepay a portion of the outstanding Principal (“Optional Prepayment”). If we make Optional Prepayments before June 14, 2023, we will be subject to penalties ranging from 1.00 % to 2.00 % of the aggregate principal amount.
All of Torrid LLC’s existing domestic subsidiaries and Torrid Intermediate LLC unconditionally guarantee all obligations under the New Term Loan Credit Agreement. Substantially all of the assets of Torrid LLC, Torrid LLC’s existing subsidiaries and Torrid Intermediate LLC will secure all such obligations and the guarantees of those obligations, subject to certain exceptions.
The New Term Loan Credit Agreement also contains a number of covenants that, among other things and subject to certain exceptions, will restrict our ability and the ability of our subsidiaries to: create, incur or assume liens on our assets or property; incur additional indebtedness; issue preferred or disqualified stock; consolidate or merge; sell assets; pay dividends or make distributions, make investments, or engage in transactions with our affiliates.
As of the end of the third quarter of fiscal year 2021, we were compliant with our debt covenants under the New Term Loan Credit Agreement.
We consider the carrying amount of the term loan to approximate fair value because of the variable interest rate of the term loan.
As of the end of the third quarter of fiscal year 2021, total borrowings, net of OID and financing costs, of $341.0 million remain outstanding under the New Term Loan Credit Agreement. During the three- and nine-month periods ended October 30, 2021, we recognized $5.5 million and $8.4 million of interest expense, respectively. During the three- and nine-month periods ended October 30, 2021, we recognized $0.3 million and $0.5 million of OID and financing costs related to the New Term Loan Credit Agreement. The OID and financing costs are amortized over the New Term Loan Credit Agreement’s seven-year term and are reflected as a direct deduction of the face amount of the term loan in our condensed consolidated balance sheets. We recognize interest payments, together with amortization of the OID and financing costs, in interest expense in our condensed consolidated statements of operations and comprehensive income (loss).
Term Loan Credit Agreement
On June 14, 2019, we entered into a term loan credit agreement (“Term Loan Credit Agreement”) with Cortland Capital Market Services LLC, as agent, KKR Credit Advisors (US) LLC, as structuring advisor, and the lenders party thereto (the “Lenders”). On September 17, 2020, we entered into an amended term loan credit agreement (“Amended Term Loan Credit Agreement”) with the Lenders, pursuant to which the definition of total debt used in the calculation of Total Net Leverage Ratio (as defined below) was amended. All other material terms of the Term Loan Credit Agreement remained substantially the same. In September 2020, in conjunction with the Amended Term Loan Credit Agreement, we prepaid $35.0 million of the outstanding Amended Term Loan Credit Agreement Principal (as defined below), associated accrued interest of $0.2 million and an amendment fee of $0.5 million. On June 14, 2021, we utilized the proceeds from the New Term Loan Credit Agreement to pay the remaining outstanding Amended Term Loan Credit Agreement Principal (as defined below) of $207.5 million, associated accrued interest of $1.2 million and a prepayment penalty of $2.1 million.
The Amended Term Loan Credit Agreement provided for term loans in an initial aggregate amount of $260.0 million (“Amended Term Loan Credit Agreement Principal”), which was recorded net of an original issue discount (“OID”) of
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$2.9 million and had a maturity date of December 14, 2024. In connection with the Term Loan Credit Agreement, we paid financing costs of approximately $3.6 million.
The $257.1 million proceeds of the Term Loan Credit Agreement, net of OID, were used to i) purchase $213.2 million of senior participating preferred stock from Hot Topic’s parent, HT Intermediate Holdings Corp., for which we subsequently received a promissory note receivable in exchange from Torrid Holding LLC; ii) purchase certain information technology assets from Hot Topic for $29.5 million; iii) make a $10.0 million distribution to Torrid Holding LLC; and iv) pay for financing costs associated with the Term Loan Credit Agreement.
Loans made pursuant to the Amended Term Loan Credit Agreement bore interest at an annual rate equal to, at our option, either (a) a base rate determined by reference to the highest of (1) the prime rate quoted by The Wall Street Journal, (2) the federal funds effective rate plus 0.50 % and (3) a LIBOR rate for an interest period of one month, plus 1.00 % or (b) at a LIBOR rate for the interest period relevant to such borrowing, in each case plus an applicable margin of either 6.75 % or 7.00 % for LIBOR borrowings and either 5.75 % or 6.00 % for base rate borrowings, in each case, based upon our total net leverage ratio as of the relevant testing date.
If we elected the LIBOR rate, interest was due and payable on the last day of each interest period, unless an interest period exceeded three months, then the respective dates that fell every three months after the beginning of the interest period should also be interest payment dates. If we elected the Base rate loan, interest was due and payable the last day of each fiscal quarter.
In addition to paying interest on the outstanding Principal under the Amended Term Loan Credit Agreement, we were required to make fixed mandatory repayments of the Principal on the last business day of each fiscal quarter until maturity (“Amended Term Loan Credit Agreement Repayment”). Amended Term Loan Credit Agreement Repayments for the first four fiscal quarters, starting in the third quarter of fiscal year 2018, represented 0.75 % of the Amended Term Loan Credit Agreement Principal, reduced as a result of the application of prior Amended Term Loan Credit Agreement Prepayments (as defined below). For each of the eight fiscal quarters thereafter, Amended Term Loan Credit Agreement Repayments represented 1.25 % of the Amended Term Loan Credit Agreement Principal, reduced as a result of the application of prior Amended Term Loan Credit Agreement Prepayments (as defined below). For each of the 10 fiscal quarters thereafter until the maturity date, Amended Term Loan Credit Agreement Repayments represented 1.875 % of the Amended Term Loan Credit Agreement Principal, reduced as a result of the application of prior Amended Term Loan Credit Agreement Prepayments (as defined below).
Under the Amended Term Loan Credit Agreement, we are also required to make variable mandatory prepayments of the Amended Term Loan Credit Agreement Principal, under certain conditions as described below, approximately 102 days after the end of each fiscal year (each, an “Amended Term Loan Credit Agreement Prepayment”). Amended Term Loan Credit Agreement Prepayments, if applicable, commenced at the end of fiscal year 2018 and represented between 25 % and 75 % (depending on our first lien net leverage ratio) of Excess Cash Flow (as defined in the Amended Term Loan Credit Agreement) in excess of $2.0 million, minus prepayments of Amended Term Loan Credit Agreement Principal, the Existing ABL Facility, as amended (as defined below), (to the extent accompanied by a permanent reduction in the commitments thereunder) and certain other specified indebtedness and amounts in connection with certain other enumerated items. As of the end of fiscal year 2020, our Excess Cash Flow amount was $2.0 million, which did not meet the Excess Cash Flow threshold to require an Amended Term Loan Credit Agreement Prepayment.
All of Torrid LLC’s existing domestic subsidiaries and Torrid Intermediate LLC unconditionally guaranteed all obligations under the Amended Term Loan Credit Agreement. Substantially all of the assets of Torrid LLC, Torrid LLC’s existing subsidiaries and Torrid Intermediate LLC secured all such obligations and the guarantees of those obligations, subject to certain exceptions.
Our borrowings under the Amended Term Loan Credit Agreement were subject to a financial covenant that required us to maintain a maximum ratio of our total debt to Adjusted EBITDA (as defined in the Amended Term Loan Credit Agreement) (“Total Net Leverage Ratio”). The maximum ratio was 3.60 for the quarter ended November 2, 2019, 3.35 3.10 for the quarter ended October 31, 2020, 2.50 for the quarter ended January 30, 2021, 2.35 for the quarter ended May 1, 2021, 2.10 1.85 for all quarters thereafter. The Amended Term Loan Credit Agreement amended the definition of total debt used in the Total Net Leverage Ratio calculation for the quarters ended October 31, 2020, January 30, 2021, May 1, 2021 and July 31, 2021. The amended definition of total debt permitted us to exclude indebtedness associated with our Existing ABL Facility, as amended, through the quarter ended October 31, 2020, removed the $20.0 million cap from the amount of cash and cash equivalents on-hand that we were permitted to net against our total debt for purposes of the ratio calculation through the quarter
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ended January 30, 2021, and raised the $20.0 million cap to $40.0 million and $30.0 million for the quarters ended May 1, 2021 and July 31, 2021, respectively, before reverting to $20.0 million for all quarters thereafter.
The Amended Term Loan Credit Agreement contained a limitation on our capital expenditures paid in cash in any fiscal year and such expenditures could not exceed 37.5 % of prior year Adjusted EBITDA (as defined by the Amended Term Loan Credit Agreement). If the amount of our capital expenditures paid in cash in any fiscal year was less than the 37.5 % threshold, 50 % of the difference was to be automatically applied to increase the maximum threshold in the next fiscal year. The Amended Term Loan Credit Agreement also contained a number of other covenants that, among other things and subject to certain exceptions, would restrict our ability and the ability of our subsidiaries to: create, incur or assume liens on our assets or property; incur additional indebtedness; make capital expenditures; issue preferred or disqualified stock; incur hedging obligations; consolidate or merge; sell assets; pay dividends or make distributions, make investments or engage in transactions with our affiliates.
During the three- and nine-month periods ended October 31, 2020, we recognized $4.2 million and $15.0 million of interest expense, respectively. During the three- and nine-month periods ended October 31, 2020, we recognized $0.4 million and $1.0 million of OID and financing costs related to the Amended Term Loan Credit Agreement, respectively. During the nine-month period ended October 30, 2021, we recognized $11.0 million of interest expense. During the nine-month period ended October 30, 2021, prior to the repayment of the Amended Term Loan Credit Agreement, we recognized $0.4 million of OID and financing costs. The OID and financing costs were amortized over the Amended Term Loan Credit Agreement’s contractual term and were reflected as a direct deduction of the face amount of the term loan in our condensed consolidated balance sheets. On June 14, 2021, upon repayment of the outstanding borrowings under the Amended Term Loan Credit Agreement, we wrote off $5.2 million of unamortized OID and financing costs and incurred a $2.1 million prepayment penalty. We recognize interest payments, OID and financing costs and the prepayment penalty in interest expense in our condensed consolidated statements of operations and comprehensive income (loss).
Senior Secured Asset-Based Revolving Credit Facility
In May 2015, we entered into a credit agreement for a senior secured asset-based revolving credit facility (“Original ABL Facility”) of $50.0 million (subject to a borrowing base), with Bank of America, N.A. On October 23, 2017, we entered into an amended and restated credit agreement (“Existing ABL Facility”), which amended our Original ABL Facility. The Existing ABL Facility increased the aggregate commitments available under the Original ABL Facility from $50.0 million to $100.0 million (subject to a borrowing base); and increased our right to request additional commitments from up to $30.0 million to up to $30.0 million plus the aggregate principal amount of any permanent principal reductions we may take (subject to customary conditions precedent). On June 14, 2019, in conjunction with the Term Loan Credit Agreement, we entered into an amendment to the Existing ABL Facility (the “1st Amendment”). The 1st Amendment decreased the aggregate commitments available under the Existing ABL Facility from $100.0 million to $70.0 million (subject to a borrowing base), permitted indebtedness incurred pursuant to the Term Loan Credit Agreement and made certain other modifications. On September 4, 2019, we entered into another amendment to the Existing ABL Facility (the “2nd Amendment”). The 2nd Amendment permitted parent company financial statements to be used to satisfy reporting requirements and made certain other modifications. On June 14, 2021, in conjunction with the New Term Loan Credit Agreement, we entered into a third amendment to the amended and restated credit agreement (the “3rd Amendment”), which amended our Existing ABL Facility, as amended. The 3rd Amendment increased the aggregate commitments available under the Existing ABL facility, as amended, from $70.0 million to $150.0 million (subject to a borrowing base) and extended the date upon which the principal amount outstanding of the loans would be due and payable in full from October 23, 2022 to June 14, 2026. All other material terms of the Existing ABL Facility, as amended, remain substantially the same as the previous agreements it replaced.
The borrowing base for the Existing ABL Facility, as amended, at any time equals the sum of 90 % of eligible credit card receivables, plus 90 % of the appraised net orderly liquidation value of eligible inventory and eligible in-transit inventory multiplied by the cost of such eligible inventory and eligible in-transit inventory (to be increased to 92.5 % during the period beginning on September 1 of each year and ending on December 31 of each year). The Existing ABL Facility, as amended, includes borrowing capacity for letters of credit and for borrowings on same-day notice, referred to as Swing Line Loans, and is available in U.S. dollars.
Under the Existing ABL Facility, as amended, we have the right to request up to $50.0 million of additional commitments plus the aggregate principal amount of any permanent principal reductions we may take plus the amount by which the borrowing base exceeds the aggregate commitments (subject to customary conditions precedent). The lenders under this facility are not under any obligation to provide any such additional commitments, and any increase in commitments is subject to customary conditions precedent. If we were to request any such additional commitments and the existing lenders or new lenders
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were to agree to provide such commitments, the size of the Existing ABL Facility, as amended, could increase to up to $200.0 million, but our ability to borrow under this facility would still be limited by the amount of the borrowing base.
Borrowings under the Existing ABL Facility, as amended, bear interest at an annual rate equal to, at our option, either (a) a base rate determined by reference to the highest of (1) the prime rate of Bank of America, N.A., (2) the federal funds effective rate plus 0.50 % and (3) a LIBOR rate for an interest period of one month adjusted for certain costs, plus 1.00 % or (b) at a LIBOR rate for the interest period relevant to such borrowing adjusted for certain costs (“Adjusted LIBOR”), in each case plus an applicable margin that ranges from 1.25 % to 1.75 % for LIBOR borrowings and 0.25 % to 0.75 % for base rate borrowings, in each case, based on average daily availability. As of the end of the third quarter of fiscal year 2021, the applicable interest rate for borrowings under the Existing ABL Facility was approximately 4 % per annum.
If we elect the LIBOR rate, interest is due and payable on the last day of each interest period, unless an interest period exceeds three months, then the respective dates that fall every three months after the beginning of the interest period shall also be interest payment dates. If we opt for the base rate (including a Swing Line Loan), interest is due and payable on the first business day of each month and on the maturity date.
In addition to paying interest on outstanding principal under the Existing ABL Facility, as amended, we are required to pay a commitment fee in respect of unutilized commitments. The commitment fee ranges between 0.25 % and 0.375 % per annum of unutilized commitments and will be subject to adjustment each fiscal quarter based on the amount of unutilized commitments during the immediately preceding fiscal quarter. We must also pay customary letter of credit fees and agent fees.
If at any time the aggregate amount of outstanding loans, unreimbursed letter of credit drawings and undrawn letters of credit under the Existing ABL Facility, as amended, exceeds the lesser of (a) the commitment amount and (b) the borrowing base, we will be required to repay outstanding loans and/or cash collateralize letters of credit in an aggregate amount equal to such excess, with no reduction of the commitment amount.
We may voluntarily reduce the unused portion of the commitment amount and repay outstanding loans at any time. Prepayment of the loans may be made without premium or penalty other than customary “breakage” costs with respect to LIBOR loans.
All obligations under the Existing ABL Facility, as amended, are unconditionally guaranteed by substantially all of Torrid Intermediate LLC’s existing majority-owned domestic subsidiaries and will be required to be guaranteed by certain of Torrid Intermediate LLC’s future domestic majority-owned subsidiaries. All obligations under the Existing ABL Facility, as amended, and the guarantees of those obligations, will be secured, subject to certain exceptions, by substantially all of Torrid Intermediate LLC’s assets.
The Existing ABL Facility, as amended, requires us to maintain a fixed charge coverage ratio of at least 1.00 to 1.00 if we fail to maintain Specified Availability (as defined by the Existing ABL Facility, as amended) of at least the greater of 10 % of the Loan Cap, as defined by the Existing ABL Facility, as amended, and $7.0 million. The Existing ABL Facility, as amended, contains a number of other covenants that, among other things and subject to certain exceptions, will restrict our ability and the ability of our subsidiaries to: incur additional indebtedness; pay dividends on our capital stock or redeem, repurchase or retire our capital stock or our other indebtedness; make investments, loans and acquisitions; engage in transactions with our affiliates; sell assets, including capital stock of our subsidiaries; alter the business we conduct; consolidate or merge; and incur liens. As of the end of the third quarter of fiscal year 2021, we were compliant with our debt covenants under the Existing ABL Facility, as amended.
The Existing ABL Facility, as amended, specifically restricts dividends and distributions, aside from amounts to cover ordinary operating expenses and taxes, between our subsidiaries and to us. However, dividends and distributions are permitted at any time that either (1) availability under the Existing ABL Facility, as amended, is equal to or greater than 15 % of the maximum borrowing amount on a pro forma basis and we are pro forma compliant with a 1.00 to 1.00 fixed charge coverage ratio or (2) availability under the Existing ABL Facility, as amended, is equal to or greater than 20 % of the maximum borrowing amount on a pro forma basis. As of the end of the third quarter of fiscal year 2021, the maximum restricted payment utilizing the Existing ABL Facility, as amended, that our subsidiaries could make from its net assets was $105.7 million.
We consider the carrying amounts of the Existing ABL Facility, as amended, to approximate fair value because of the variable interest rate of this facility.
Availability under the Existing ABL Facility, as amended, at the end of fiscal year 2020 and as of the end of the third quarter of fiscal year 2021 was $65.5 million and $119.0 million, respectively, which reflects no borrowings. In March 2020,
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Note 13. Income Taxes
Effective Tax Rate
During the three- and nine-month periods ended October 31, 2020, the provision for income taxes were $5.8 million and $4.4 million, respectively. During the three- and nine-month periods ended October 30, 2021, the provision for income taxes were $96.5 million and $13.0 million, respectively. The effective tax rates for the three- and nine-month periods ended October 31, 2020, were 57.8 % and 11.8 %, respectively. The effective tax rates for the three- and nine-month periods ended October 30, 2021, were 256.5 % and 222.9 %, respectively. These unconventional effective tax rates are primarily due to the increase in the amount of non-deductible items associated with share-based compensation, relative to income before provision for income taxes for the three- and nine-month periods ended October 30, 2021. The increase in the amount of non-taxable items associated with share-based compensation during the three- and nine-month periods ended October 30, 2021 was driven by the $111.4 million remeasurement adjustment related to the increase in the value of the incentive units as indicated by the Torrid Holding LLC equity value as of June 30, 2021, following the pricing of our IPO. Please refer to “Note 14—Share-Based Compensation” for further discussion regarding the $111.4 million remeasurement adjustment.
On March 27, 2020, December 27, 2020 and March 11, 2021 the CARES Act, CAA and ARPA, respectively, were signed into law and have resulted in significant changes to the U.S. federal corporate tax law as described in “Note 1—Basis of Presentation and Description of the Business.” We have considered the applicable CARES Act, CAA and ARPA tax law changes in our tax provision for the period ended October 30, 2021 and continue to evaluate the impact of these tax law changes on future periods.
Uncertain Tax Positions
The amount of income taxes we pay is subject to ongoing audits by taxing authorities. Our estimate of the potential outcome of any uncertain tax issue is subject to our assessment of the relevant risks, facts and circumstances existing at the time. We believe that we have adequately provided for reasonably foreseeable outcomes related to these matters. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved, which may impact our effective tax rate. As of the end of fiscal year 2020, the total liability for income tax associated with unrecognized tax benefits, including interest and penalties, was $2.4 million ($2.0 million, net of federal benefit). As of the end of the third quarter of fiscal year 2021, the total liability for income tax associated with unrecognized tax benefits, including interest and penalties, was $2.9 million ($2.3 million, net of federal benefit). Our effective tax rate will be affected by any portion of this liability we may recognize.
We believe that it is reasonably possible that $0.2 million ($0.2 million net of federal benefit) of our liability for unrecognized tax benefits, of which the associated interest and penalties are not material, may be recognized in the next 12 months due to the expiration of statutes of limitations.
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IT Asset Purchase Agreement with Hot Topic
In connection with the IT Asset Purchase Agreement, we generated a tax amortizable basis of the $29.5 million purchase price, amortizable over three years commencing in fiscal year 2019. We recorded the $26.0 million variance between the $3.5 million net book value and $29.5 million tax amortizable basis of the information technology assets in equity, net of $6.7 million deferred tax.
Note 14. Share-Based Compensation
Our share-based compensation expense, by award type, consists of the following (in thousands):
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| October 31, 2020 | October 30, 2021 | October 31, 2020 | October 30, 2021 | ||||||||||||||||||||
| Restricted stock units | $ | $ | $ | $ | |||||||||||||||||||
| Restricted stock awards | |||||||||||||||||||||||
| Stock options | |||||||||||||||||||||||
| Employee stock purchase plan | |||||||||||||||||||||||
| Remeasurement adjustments for incentive units | ( | ||||||||||||||||||||||
| Total share-based compensation expense | $ | $ | $ | ( | $ | ||||||||||||||||||
On June 22, 2021, in connection with our IPO, the board of directors (“Board”) adopted the Torrid Holdings Inc. 2021 Long-Term Incentive Plan (the “2021 LTIP”), for employees, consultants and directors. The 2021 LTIP provides for the grant of non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units (“RSUs”), stock awards, dividend equivalents, other stock-based awards, cash awards and substitute awards intended to align the interests of service providers, with those of our shareholders. As of the end of the third quarter of fiscal year 2021, 10,687,500 shares were authorized for issuance under the 2021 LTIP.
On June 22, 2021, in connection with our IPO, the Board adopted the Torrid Holdings Inc. 2021 Employee Stock Purchase Plan (the “ESPP”), intended to qualify under Section 423 of the U.S. Internal Revenue Code of 1986, as amended, in order to provide all of our eligible employees with a further incentive towards ensuring our success and accomplishing our corporate goals. The ESPP allows eligible employees to contribute up to 15 % of their base earnings towards purchases of common stock, subject to an annual maximum. The purchase price is 85 % of the lower of (i) the fair market value of the stock on the date of enrollment and (ii) the fair market value of the stock on the last day of the related purchase period. As of the end of the third quarter of fiscal year 2021, 3,650,000 shares were authorized for issuance under the ESPP.
Incentive Units
Prior to the IPO, Torrid Holding LLC issued 13,660,000 Class A, Class B, Class C, Class D, Class E, Class F, Class G, Class H and Class J Torrid incentive units, in the aggregate, net of forfeitures, to certain members of our management.
We recognized the impact of share-based compensation associated with incentive units issued by Torrid Holding LLC in selling, general and administrative expenses in the condensed consolidated statements of operations and comprehensive income (loss). The share-based compensation expense and related capital contribution are reflected in our condensed consolidated financial statements as these awards were deemed to be for our benefit. The intent of the incentive units was to provide profit-sharing opportunities to management rather than equity ownership in our then parent, Torrid Holding LLC. The incentive units did not have any voting or distribution rights and contained a repurchase feature, whereby upon termination, Torrid Holding LLC had the right to purchase from former employees any or all of the vested incentive units at fair value. In addition, although the fair value of the incentive units was determined through an option pricing methodology that utilized the possible equity values of Torrid Holding LLC, the settlement amounts and method of settlement of the incentive units were at the discretion of the Board. Based on these aforementioned features and characteristics, we determined that the incentive units were in-substance liabilities accounted for as liability instruments in accordance with ASC 710, Compensation. The incentive units were remeasured based on the fair value of the awards at the end of each reporting period. We recorded the expense associated with changes in the fair value of these incentive units as a capital contribution from our former parent, Torrid Holding LLC, as our former parent is the legal obligor for the incentive units.
The incentive units were valued utilizing a contingent claims analysis (“CCA”) methodology based on a Black-Scholes option pricing model (“OPM”). Under the OPM, each class of incentive units was modeled as a call option with a unique claim on the assets of Torrid Holding LLC. The characteristics of each class of incentive units determined the uniqueness of the claim
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on the assets of Torrid Holding LLC. The OPM used to value the incentive units incorporated various assumptions, including the time to liquidity event, equity volatility and risk-free interest rate of return. Equity volatility was based on the historical volatilities of comparable publicly traded companies for the time horizon equal to the time to the anticipated liquidity event; and the risk-free interest rate was for a term corresponding to the time to liquidity event. The assumptions underlying the valuation of the incentive units represented our best estimates, which involved inherent uncertainties and the application of our judgement. The most recent remeasurement of the fair value of the incentive units utilizing the CCA methodology was performed as of May 1, 2021.
During the second quarter of fiscal year 2021, we recorded a share-based compensation expense remeasurement adjustment of $111.4 million related to the increase in the value of the incentive units as indicated by the Torrid Holding LLC equity value as of June 30, 2021, following the pricing of our IPO. The vested portion of the incentive units was exchanged for 13,353,122 shares of our common stock of an equivalent fair value as the vested incentive units and the unvested portion was cancelled. As such, the fair value of these incentive units is no longer recognized in our condensed consolidated statement of operations.
During the three-month period ended October 31, 2020, we recognized share-based compensation expense of $7.1 million and during the nine-month period ended October 31, 2020, we recorded a reduction of $25.6 million to share-based compensation expense, primarily due to a decline in the Torrid Holding LLC equity value. During the nine-month period ended October 30, 2021, we recognized share-based compensation expense associated with incentive units of $151.2 million, primarily due to an increase in the Torrid Holding LLC equity value.
IPO Awards
Pursuant to the agreements we entered into with certain members of our management, upon completion of the IPO, such employees received one-time grants of RSUs (“IPO Awards”) in an aggregate amount equal to $5.7 million. 50 % of the IPO Awards were fully vested on the date of grant, and the remaining 50 % will vest in equal installments on the first, second and third anniversaries of the date of our IPO. These members of our management must remain employed by us through each vesting date in order to vest in the applicable portions of their IPO Awards. Consequently, we recognized $2.8 million of share-based compensation expense related to these IPO Awards upon the consummation of our IPO with the remainder recognized over the three-year vesting period.
RSUs
RSUs are awarded to certain employees, non-employee directors and consultants and entitle the grantee to receive shares of common stock at the end of a vesting period, subject to the employee's continued employment or service as a director or consultant. 50 % of the RSUs granted as IPO Awards fully vested on the date of grant, and the remaining 50 % will vest in equal installments on the first, second and third anniversaries of the date of grant. In general, the remaining RSUs vest in equal installments each year over 4 years.
RSU activity under the 2021 LTIP consists of the following (in thousands except per share and contractual life amounts):
| Shares | Weighted average grant date fair value per share | Weighted average remaining contractual life (years) | |||||||||||||||
| Nonvested, January 30, 2021 | |||||||||||||||||
| Granted | $ | ||||||||||||||||
| Vested | ( | $ | |||||||||||||||
| Forfeited | $ | ||||||||||||||||
| Nonvested, October 30, 2021 | $ | ||||||||||||||||
As of the end of the third quarter of fiscal year 2021, unrecognized compensation expense related to unvested RSUs was $6.7 million, which is expected to be recognized over a weighted average period of approximately 3.3 years. The total vesting date fair value of RSUs which vested during the nine-month period ended October 30, 2021 was $2.6 million.
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Restricted Stock Awards
Restricted stock awards are awarded to certain employees, non-employee directors and consultants, subject to the employee's continued employment or service as a director or consultant. Restricted stock awards vest over periods ranging from 2 to 4 years, subject to the employee's continued employment or service as an employee, non-employee director or consultant, as applicable, on each vesting date.
Restricted stock award activity under the 2021 LTIP consists of the following (in thousands except per share and contractual life amounts):
| Shares | Weighted average grant date fair value per share | Weighted average remaining contractual life (years) | |||||||||||||||
| Nonvested, January 30, 2021 | |||||||||||||||||
| Granted | $ | ||||||||||||||||
| Vested | ( | $ | |||||||||||||||
| Forfeited | $ | ||||||||||||||||
| Nonvested, October 30, 2021 | $ | ||||||||||||||||
As of the end of the third quarter of fiscal year 2021, unrecognized compensation expense related to unvested restricted stock awards was $15.4 million, which is expected to be recognized over a weighted average period of approximately 2.5 years.
Stock Options
Stock options generally vest in equal installments each year over 4 years and generally expire 10 years from the grant date.
Stock option activity under the 2021 LTIP consists of the following (in thousands except per share and contractual life amounts):
| Shares | Weighted average exercise price per share | Weighted average remaining contractual life (years) | Aggregate intrinsic value | ||||||||||||||||||||
| Outstanding, January 30, 2021 | |||||||||||||||||||||||
| Granted | $ | ||||||||||||||||||||||
| Exercised | |||||||||||||||||||||||
| Expired / forfeited | |||||||||||||||||||||||
| Outstanding, October 30, 2021 | $ | $ | |||||||||||||||||||||
| Exercisable, October 30, 2021 | |||||||||||||||||||||||
The weighted average grant date fair value of stock option awards granted during the three- and nine-month periods ended October 30, 2021 was $11.22
| Dividend yield | % | ||||
Expected volatility(1) | % | ||||
Risk-free interest rate(2) | % | ||||
Expected term(3) | |||||
| Grant date fair value per share | $ | ||||
(1) The expected volatility is estimated based on the historical volatility of a select peer group of similar publicly traded companies for a term that is consistent with the expected term of the stock options.
(2) The risk-free interest rates are based on the U.S. Treasury constant maturity interest rate whose term is consistent with the expected term of the stock options.
(3) The expected term of the stock options represents the estimated period of time until exercise and is calculated using the simplified method.
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Note 15. Commitments and Contingencies
Litigation
From time to time, we are involved in matters of litigation that arise in the ordinary course of business. Though significant litigation or awards against us could seriously harm our business and financial results, we do not at this time expect any of our pending matters of litigation to have a material adverse effect on our overall financial condition.
Indemnities, Commitments and Guarantees
During the ordinary course of business, we have made certain indemnities, commitments and guarantees under which we may be required to make payments in relation to certain transactions. These indemnities include those given to various lessors in connection with facility leases for certain claims arising from such facility or lease and indemnities to our board of directors and officers to the maximum extent permitted. Commitments include those given to various merchandise vendors and suppliers. From time to time, we have issued guarantees in the form of standby letters of credit as security for workers’ compensation claims (our letters of credit are discussed in more detail in “Note 12—Debt Financing Arrangements”). The durations of these indemnities, commitments and guarantees vary. Some of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments we could be obligated to make. We have not recorded any liability for these indemnities, commitments and guarantees in the accompanying condensed consolidated financial statements as no demands have been made upon us to provide indemnification under such agreements and there are no claims that we are aware of that could have a material effect on our condensed consolidated financial statements.
Note 16. Stockholders' Deficit
Torrid was formed on October 29, 2019 and capitalized on February 20, 2020. Torrid is authorized to issue 1.0 billion shares of common stock at $0.01 par value, and 5.0 million shares of preferred stock at $0.01 par value. Torrid had 110,091,816 no
On June 22, 2021, Torrid's stockholder approved an amendment to Torrid's certificate of incorporation to (i) effect a 110,000 -for-1 stock split of all shares of the issued and outstanding common stock, which was effected on June 22, 2021 and (ii) authorize 5.0 million shares of preferred stock. All share and per-share data in the financial statements and notes to the financial statements has been retroactively adjusted to reflect the stock split for all periods presented. The par value of the common stock was not adjusted as a result of the stock split.
Note 17. Earnings Per Share
Note 18. Fair Value Measurements
We carry certain of our assets and liabilities at fair value in accordance with GAAP. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
Valuation techniques used to measure fair value require us to maximize the use of observable inputs and minimize the use of unobservable inputs. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Financial
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assets and liabilities carried at fair value are to be classified and disclosed in one of the following three levels of the fair value hierarchy, of which the first two are considered observable and the last is considered unobservable:
Level 1: Quoted prices in active markets for identical assets or liabilities.
Level 2: Observable inputs, other than Level 1 prices, such as quoted prices for similar assets or liabilities in active markets; quoted prices for similar assets or liabilities in markets that are not active; or other inputs other than quoted prices that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities, including interest rates and yield curves, and market corroborated inputs.
Level 3: Unobservable inputs for the asset or liability that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. These are valued based on our estimates and assumptions that market participants would use in pricing the asset or liability.
Financial assets and liabilities measured at fair value on a recurring basis as of the end of fiscal year 2020 consisted of the following (in thousands):
| January 30, 2021 | Quoted Prices in Active Markets for Identical Items (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3 | ||||||||||||||||||||
| Assets: | |||||||||||||||||||||||
| Money market funds (cash equivalent) | $ | $ | $ | $ | |||||||||||||||||||
| Total assets | $ | $ | $ | $ | |||||||||||||||||||
| Liabilities: | |||||||||||||||||||||||
| Deferred compensation plan liability | $ | $ | $ | $ | |||||||||||||||||||
| Total liabilities | $ | $ | $ | $ | |||||||||||||||||||
Financial assets and liabilities measured at fair value on a recurring basis as of the end of the third quarter of fiscal year 2021 consisted of the following (in thousands):
| October 30, 2021 | Quoted Prices in Active Markets for Identical Items (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||||||||||
| Assets: | |||||||||||||||||||||||
| Money market funds (cash equivalent) | $ | $ | |||||||||||||||||||||
| Total assets | $ | $ | $ | $ | |||||||||||||||||||
| Liabilities: | |||||||||||||||||||||||
| Deferred compensation plan liability | $ | $ | $ | $ | |||||||||||||||||||
| Total liabilities | $ | $ | $ | $ | |||||||||||||||||||
Note 19. Private Label Credit Card
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Note 20. Deferred Compensation Plan
Note 21. Employee Benefit Plan
Note 22. Subsequent Events
Subsequent events were evaluated through December 8, 2021, the date these financial statements were available to be issued.
On December 6, 2021, the Board authorized a new share repurchase program under which we may purchase up to $100 million of our outstanding common stock. Repurchases may be made from time to time, depending upon a variety of factors, including share price, corporate and regulatory requirements, and other market and business conditions, as determined by us. We may purchase shares of our common stock in the open market at current market prices at the time of purchase, in privately negotiated transactions, or by other means. The authorization does not, however, obligate us to acquire any particular amount of shares, and the share repurchase program may be suspended or terminated at any time at our discretion.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion summarizes the significant factors affecting the consolidated operating results, financial condition, liquidity and cash flows of our Company as of and for the periods presented below. The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements that are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. Actual results could differ materially from those discussed in or implied by forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Quarterly Report on Form 10-Q, particularly in the section entitled “Risk Factors.”
Overview
Torrid is a direct-to-consumer brand of apparel, intimates and accessories in North America, targeting the 25- to 40-year old woman who is curvy and wears sizes 10 to 30. Torrid is focused on fit and offers high quality products across a broad assortment that includes tops, bottoms, denim, dresses, intimates, activewear, footwear and accessories. Our proprietary product offering delivers a superior fit for the curvy woman that makes her love the way she looks and feels. We offer a broad assortment of high quality products including tops, denim, dresses, intimates, activewear, footwear and accessories. Our style is unapologetically youthful and sexy. We believe our customer values the appeal and versatility of our curated product assortment that helps her look her best for any occasion, including weekend, casual, work and dressy, all at accessible price points. We specifically design for stylish curvy women and are maniacally focused on fit. Through our product and brand experience we connect with customers in a way that other brands, many of which treat plus-size customers as an after-thought, have not.
Key Financial and Operating Metrics
We use the following metrics to assess the progress of our business, inform how we allocate our time and capital, and assess the near-term and longer-term performance of our business.
| October 31, 2020 | October 30, 2021 | ||||||||||
| Number of stores (as of end of period) | 608 | 619 | |||||||||
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| (in thousands, except percentages) | |||||||||||||||||||||||
| October 31, 2020 | October 30, 2021 | October 31, 2020 | October 30, 2021 | ||||||||||||||||||||
Comparable sales(A) | 4 | % | 14 | % | (12) | % | 42 | % | |||||||||||||||
| Net income (loss) | $ | 4,251 | $ | (58,902) | $ | 33,297 | $ | (7,190) | |||||||||||||||
Adjusted EBITDA(B) | $ | 30,768 | $ | 55,178 | $ | 56,815 | $ | 217,406 | |||||||||||||||
Adjusted EBITDA margin(B) | 11 | % | 18 | % | 8 | % | 23 | % | |||||||||||||||
(A)The computation of comparable sales includes results from stores that were temporarily closed due to COVID-19.
(B)Please refer to "Results of Operations" for a reconciliation of net income to Adjusted EBITDA.
Comparable Sales. We define comparable sales for any given period as the sales of our e-Commerce operations and stores that we have included in our comparable sales base during that period. We include a store in our comparable sales base after it has been open for 15 full fiscal months. If a store is closed during a fiscal year, it is only included in the computation of comparable sales for the full fiscal months in which it was open. The computation of comparable sales includes results from stores that were temporarily closed due to COVID-19. Partial fiscal months are excluded from the computation of comparable sales. Comparable sales allow us to evaluate how our unified commerce business is performing exclusive of the effects of new store openings. We apply current year foreign currency exchange rates to both current year and prior year comparable sales to remove the impact of foreign currency fluctuation and achieve a consistent basis for comparison. Comparable sales allow us to evaluate how our unified commerce business is performing exclusive of the effects of non-comparable sales.
Number of Stores. Store count reflects all stores open at the end of a reporting period. In connection with opening new stores, we incur pre-opening costs, which primarily consist of payroll, travel, training, marketing, initial opening supplies, costs of transporting initial inventory and fixtures to store locations, and occupancy costs incurred from the time of possession of a store site to the opening of that store. These pre-opening costs are included in our selling, general and administrative expenses and are expensed as incurred.
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Adjusted EBITDA and Adjusted EBITDA Margin. Adjusted EBITDA and Adjusted EBITDA margin are supplemental measures of our operating performance that are neither required by, nor presented in accordance with GAAP and our calculations thereof may not be comparable to similarly titled measures reported by other companies. Adjusted EBITDA represents GAAP net income (loss) plus interest expense less interest income, net of other (income) expense, plus provision for less (benefit from) income taxes, depreciation and amortization (“EBITDA”), and share-based compensation, non-cash deductions and charges and other expenses. Adjusted EBITDA margin represents Adjusted EBITDA as a percentage of our total net sales. We believe Adjusted EBITDA and Adjusted EBITDA margin facilitate operating performance comparisons from period to period by isolating the effects of certain items that vary from period to period without any correlation to ongoing operating performance. We also use Adjusted EBITDA and Adjusted EBITDA margin as two of the primary methods for planning and forecasting the overall expected performance of our business and for evaluating on a quarterly and annual basis actual results against such expectations. Further, we recognize Adjusted EBITDA and Adjusted EBITDA margin as commonly used measures in determining business value and, as such, use them internally to report and analyze our results and we additionally use Adjusted EBITDA as a benchmark to determine certain non-equity incentive payments made to executives.
Adjusted EBITDA and Adjusted EBITDA margin have limitations as analytical tools. These measures are not measurements of our financial performance under GAAP and should not be considered in isolation or as alternatives to or substitutes for net income (loss), income (loss) from operations or any other performance measures determined in accordance with GAAP or as alternatives to cash flows from operating activities as a measure of our liquidity. Our presentation of Adjusted EBITDA and Adjusted EBITDA margin should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. Among other limitations, Adjusted EBITDA does not reflect:
•interest expense;
•interest income, net of other (income) expense;
•provision for income taxes;
•depreciation and amortization;
•share-based compensation;
•non-cash deductions and charges; and
•other expenses.
Factors Affecting Our Performance
We believe that our performance and future success depend on a number of factors that present significant opportunities for us but also pose risks and challenges, including those discussed below and elsewhere in this Quarterly Report on Form 10-Q in the section titled “Risk Factors.”
Customer Acquisition and Retention. Our success is impacted not only by efficient and profitable customer acquisition, but also by our ability to retain customers and encourage repeat purchases. It is important to maintain reasonable costs for these marketing efforts relative to the net sales and profit we expect to derive from customers. Failure to effectively attract customers on a cost-efficient basis would adversely impact our profitability and operating results. New requirements for consumer disclosures regarding privacy practices, and new application tracking transparency framework that requires opt-in consent for certain types of tracking were implemented by third party providers in 2021 which has increased the difficulty and cost of acquiring and retaining customers. These changes may adversely affect our results of operations.
Customer Migration from Single to Omni-channel. We have a history of converting customers from single-channel customers to omni-channel customers, defined as active customers who shopped both online and in-store within the last twelve months. Customers that shop across multiple channels purchase from us more frequently and, spent approximately 3.2 times more per year than our single-channel customer.
Overall Economic Trends. Consumer purchases of clothing generally remain constant or may increase during stable economic periods and decline during recessionary periods and other periods when disposable income is adversely affected. Consequently, our results of operations during any given period are often impacted by the overall economic conditions in the markets which we operate. Additionally, the COVID-19 pandemic may continue to have a materially adverse impact on the macroeconomic environment in the United States as well as our results of operations.
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Demographic Changes. Our business has experienced growth over recent periods due, in part, to an increase in the plus-size population. Slower or negative growth in this demographic, in particular among women ages 25 to 40, specific to certain geographic markets, income levels or overall, could adversely affect our results of operations.
Growth in Brand Awareness. We intend to continue investing in our brand, with a specific focus on growing brand awareness, customer engagement, and conversion through targeted investments in performance and brand marketing. We have made significant historical investments to strengthen the Torrid brand through our marketing efforts, brand partnerships, events and expansion of our social media presence. If we fail to cost-effectively promote our brand or convert impressions into new customers, our net sales growth and profitability may be adversely affected.
Inventory Management. Our strategy is built around a base of core products that provide our customer with year round style. At the same time, we introduce new lines of merchandise approximately 16 times per year, thus providing a consistent flow of fresh merchandise to keep our customer engaged, encourage repeat business and attract new customers. We employ a data-driven approach to design and product development, proactively and quickly incorporating sales and operational performance information alongside customer feedback from thousands of product reviews. We engage in ongoing dialogue with customers through social media and customer surveys. Shifts in inventory levels may result in fluctuations in the amount of regular price sales, markdowns, and merchandise mix, as well as gross margin.
Impact of COVID-19. The COVID-19 pandemic has caused general business disruption worldwide. The full extent to which the COVID-19 pandemic will directly or indirectly impact our business, results of operations, cash flows, and financial condition will depend on future developments that are uncertain. As a result of the COVID-19 pandemic, we temporarily closed our headquarters, distribution center and retail stores, required our employees and contractors to work remotely, and implemented travel restrictions. The operations of our suppliers and manufacturers and behaviors of customers have likewise been altered. Concurrently with the vaccine rollout, business restrictions and stay-at-home orders have eased out (although we remain subject to the risk of future restrictions). Consumer spending has also increased with additional U.S. government stimulus payments. Consequently, our operating results improved significantly in the first three quarters of fiscal year 2021. However, the impact of the COVID-19 pandemic remains highly uncertain and depends on future developments that cannot be accurately predicted at this time, such as the extent and effectiveness of the vaccine rollout and containment actions taken in relation to new variants of COVID-19. As a result, recent favorable trends may not continue and our results of operations may continue to be adversely affected by the COVID-19 pandemic.
Investments. We have invested significantly to strengthen our business, including augmenting leadership across our organization and enhancing our infrastructure and technology, and have delivered significant growth as a result. In order to realize such growth, we anticipate that our operating expenses will grow as we continue to increase our spending on advertising and marketing and hire additional personnel primarily in marketing, product design and development, merchandising, technology, operations, customer service and general and administrative functions. We will also continue to selectively expand our store footprint and make investments to improve the customer experience both in-store and online. We believe that such investments will increase the number and loyalty of our customers and, as a result, yield positive financial performance in the long term.
Seasonality. While seasonality frequently impacts businesses in the retail sector, our business is generally not seasonal. Accordingly, our net sales do not fluctuate as significantly as those of other brands and retailers from quarter to quarter and any modest seasonal effect does not significantly change the underlying trends in our business. Additionally, we do not generate an outsized share of our net sales or Adjusted EBITDA during the holiday season. Typically, our Adjusted EBITDA generation is strongest in the first half of the year as we benefit from more favorable merchandise margins, lower advertising and lower shipping expenses relative to the second half of the year. The lack of net sales seasonality provides structural cost advantages relative to peers, including reduced staffing cyclicality and seasonal distribution capacity needs.
Components of Our Results of Operations
Net Sales. Net sales reflects our revenues from the sale of our merchandise, shipping and handling revenue received from e-Commerce sales and gift card breakage income, less returns, discounts and loyalty points/awards. Revenue from our stores is recognized at the time of sale and revenue from our e-Commerce channel is recognized upon shipment of the merchandise to the home of the customer; except in cases where the merchandise is shipped to a store and revenue is recognized when the customer retrieves the merchandise from the store. Net sales are impacted by the size of our active customer base, product assortment and availability, marketing and promotional activities and the spending habits of our customers. Net sales are also impacted by the migration of single-channel customers (i.e., customers shopping only in-store or online) to omni-channel customers (i.e., customers shopping both in-store and online), who on average spend significantly more than single-channel customers in a given year.
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Gross Profit. Gross profit is equal to our net sales less cost of goods sold. Our cost of goods sold includes merchandise costs, freight, inventory shrinkage, payroll expenses associated with the merchandising department, distribution center expenses and store occupancy expenses, including rent, common area maintenance charges, real estate taxes and depreciation. Merchandising payroll costs and store occupancy costs included within cost of goods sold are largely fixed and do not necessarily increase as volume increases. We review our inventory levels on an ongoing basis in order to identify slow-moving merchandise and generally use markdowns to clear that merchandise. The timing and level of markdowns are driven primarily by customer acceptance of our merchandise. The primary drivers of our merchandise costs include the raw materials, labor in the countries where we source our merchandise, customs duties, and logistics costs.
Selling, General and Administrative Expenses. Selling, general and administrative expenses include all operating costs not included in cost of goods sold or marketing expenses. Our historical revenue growth has been accompanied by increased selling, general and administrative expenses. For instance, we continue to make payroll investments to support our growth.
Marketing Expenses. We continue to make investments in marketing in an effort to grow and retain our active customer base and increase our brand awareness. Marketing expenses consist primarily of (i) targeted online performance marketing costs, such as retargeting, paid search/product listing advertising, and social media advertisements, (ii) store and brand marketing, public relations and photographic production designed to acquire, retain and remain connected to customers, (iii) direct mail marketing costs and (iv) payroll and benefits expenses associated with our marketing team.
Interest Expense. Interest expense consists primarily of interest expense and other fees associated with our Existing ABL Facility, as amended, Amended Term Loan Credit Agreement and New Term Loan Credit Agreement. On June 14, 2021, we repaid and terminated the Amended Term Loan Credit Agreement with borrowings under the New Term Loan Credit Agreement and amended our Existing ABL Facility.
Provision for (Benefit from) Income Taxes. Our provision for (benefit from) income taxes primarily consists of an estimate of federal and state income taxes based on enacted federal and state tax rates, as adjusted for allowable credits, deductions and uncertain tax positions.
Results of Operations
Three-Months Ended October 30, 2021 Compared to Three-Months Ended October 31, 2020
The following table summarizes our consolidated results of operations for the periods indicated (dollars in thousands):
| Three Months Ended | |||||||||||||||||||||||
| October 31, 2020 | % of Net Sales | October 30, 2021 | % of Net Sales | ||||||||||||||||||||
| Net sales | $ | 270,129 | 100.0 | % | $ | 306,241 | 100.0 | % | |||||||||||||||
| Cost of goods sold | 174,601 | 64.6 | % | 181,094 | 59.1 | % | |||||||||||||||||
| Gross profit | 95,528 | 35.4 | % | 125,147 | 40.9 | % | |||||||||||||||||
| Selling, general and administrative expenses | 66,706 | 24.7 | % | 66,399 | 21.7 | % | |||||||||||||||||
| Marketing expenses | 14,091 | 5.2 | % | 15,023 | 4.9 | % | |||||||||||||||||
| Income from operations | 14,731 | 5.5 | % | 43,725 | 14.3 | % | |||||||||||||||||
| Interest expense | 4,666 | 1.7 | % | 6,104 | 2.0 | % | |||||||||||||||||
| Interest income, net of other income | (12) | 0.0 | % | (12) | 0.0 | % | |||||||||||||||||
| Income before provision for income taxes | 10,077 | 3.8 | % | 37,633 | 12.3 | % | |||||||||||||||||
| Provision for income taxes | 5,826 | 2.2 | % | 96,535 | 31.5 | % | |||||||||||||||||
| Net income (loss) | $ | 4,251 | 1.6 | % | $ | (58,902) | (19.2) | % | |||||||||||||||
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The following table provides a reconciliation of net income to Adjusted EBITDA for the periods presented (dollars in thousands):
| Three Months Ended | |||||||||||
| October 31, 2020 | October 30, 2021 | ||||||||||
| Net income (loss) | $ | 4,251 | $ | (58,902) | |||||||
| Interest expense | 4,666 | 6,104 | |||||||||
| Interest income, net of other income | (12) | (12) | |||||||||
| Provision for income taxes | 5,826 | 96,535 | |||||||||
Depreciation and amortization(A) | 8,477 | 8,482 | |||||||||
Share-based compensation(B) | 7,124 | 2,450 | |||||||||
Non-cash deductions and charges(C) | 424 | 306 | |||||||||
Other expenses(D) | 12 | 215 | |||||||||
| Adjusted EBITDA | $ | 30,768 | $ | 55,178 | |||||||
(A)Depreciation and amortization excludes amortization of debt issuance costs and original issue discount that are reflected in interest expense.
(B)Prior to the consummation of our IPO on July 6, 2021, share-based compensation was determined based on the remeasurement of our liability-classified incentive units.
(C)Non-cash deductions and charges includes losses on property and equipment disposals and the net impact of non-cash rent expense.
(D)Other expenses include IPO-related transaction fees and the reimbursement of certain management expenses, primarily for travel, incurred by Sycamore on our behalf, which are not considered to be part of our core business.
Net Sales
Net sales increased $36.1 million, or 13.4%, to $306.2 million for the three months ended October 30, 2021, from $270.1 million for the three months ended October 31, 2020. This increase was primarily driven by an increase in orders placed and an increase in average order value relative to the three months ended October 31, 2020, which were impacted by disruption caused by the COVID-19 pandemic. The total number of stores we operate increased by 11 stores, or 1.8%, to 619 stores as of October 30, 2021, from 608 stores as of October 31, 2020.
Gross Profit
Gross profit for the three months ended October 30, 2021 increased $29.6 million, or 31.0%, to $125.1 million, from $95.5 million for the three months ended October 31, 2020. This increase was primarily due to higher net sales volumes that drove a $34.6 million increase in merchandise margin. Gross profit as a percentage of net sales increased 5.5% to 40.9% for the three months ended October 30, 2021 from 35.4% for the three months ended October 31, 2020. This increase was primarily driven by higher merchandise margin rate and leverage of lower distribution costs, merchandising payroll costs and store depreciation expense as a result of higher net sales volume, partially offset by increased store occupancy costs. The higher merchandise margin rate was primarily driven by decreased promotional activity and lower inventory reserve levels, partially offset by increased e-Commerce shipping costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the three months ended October 30, 2021 decreased $0.3 million, or 0.5%, to $66.4 million, from $66.7 million for the three months ended October 31, 2020. The decrease was primarily due to a $4.7 million decrease in share-based compensation expense and a $1.1 million decrease in performance bonuses, partially offset by increases in headquarters general and administrative expenses of $2.4 million primarily due to additional costs associated with being a publicly traded company, store payroll costs of $2.1 million, other store operating costs of $0.5 million and store preopening costs of $0.5 million. Selling, general and administrative expenses as a percentage of net sales decreased by 3.0% to 21.7% for the three months ended October 30, 2021 from 24.7% for the three months ended October 31, 2020. This decrease was driven by decreased share-based compensation and performance bonuses and leverage of store payroll costs and other store operating costs as a result of higher net sales volume, partially offset by increased store preopening costs and additional costs associated with being a publicly traded company.
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Marketing Expenses
Marketing expenses for the three months ended October 30, 2021 increased $0.9 million, or 6.6%, to $15.0 million, from $14.1 million for the three months ended October 31, 2020. This increase was primarily due to increased digital, store and brand marketing, partially offset by decreased direct mail program spend. Marketing expenses as a percentage of net sales decreased by 0.3% to 4.9% during the three months ended October 30, 2021 from 5.2% during the three months ended October 31, 2020. This decrease was driven by leverage of our marketing expenses as a result of higher net sales volume.
Interest Expense
Interest expense was $6.1 million for the three months ended October 30, 2021, compared to $4.7 million for the three months ended October 31, 2020. The increase was primarily due to an increase in the total borrowings outstanding related to the New Term Loan Credit Agreement as of October 30, 2021 compared to the total borrowings outstanding related to the Amended Term Loan Credit Agreement as of October 31, 2020.
Provision for Income Taxes
The provision for income taxes for the three months ended October 30, 2021 increased by $90.7 million to $96.5 million, from $5.8 million for the three months ended October 31, 2020. Our effective tax rate was 256.5% for the three months ended October 30, 2021 and 57.8% for the three months ended October 31, 2020. The unconventional effective tax rate for the three months ended October 30, 2021 is primarily due to the increase in the amount of non-deductible items associated with share-based compensation, relative to income before provision for income taxes for the three months ended October 30, 2021. The increase in the amount of non-deductible items associated with share-based compensation during the three months ended October 30, 2021 was driven by a $111.4 million remeasurement adjustment related to the increase in the value of the incentive units as indicated by the Torrid Holding LLC equity value as of June 30, 2021, following the pricing of our IPO.
Nine-Months Ended October 30, 2021 Compared to Nine-Months Ended October 31, 2020
The following table summarizes our consolidated results of operations for the periods indicated (dollars in thousands):
| Nine Months Ended | |||||||||||||||||||||||
| October 31, 2020 | % of Net Sales | October 30, 2021 | % of Net Sales | ||||||||||||||||||||
| Net sales | $ | 675,832 | 100.0 | % | $ | 964,858 | 100.0 | % | |||||||||||||||
| Cost of goods sold | 459,381 | 68.0 | % | 545,059 | 56.5 | % | |||||||||||||||||
| Gross profit | 216,451 | 32.0 | % | 419,799 | 43.5 | % | |||||||||||||||||
| Selling, general and administrative expenses | 124,057 | 18.4 | % | 355,353 | 36.9 | % | |||||||||||||||||
| Marketing expenses | 37,946 | 5.6 | % | 35,276 | 3.6 | % | |||||||||||||||||
| Income from operations | 54,448 | 8.1 | % | 29,170 | 3.0 | % | |||||||||||||||||
| Interest expense | 16,645 | 2.5 | % | 23,390 | 2.4 | % | |||||||||||||||||
| Interest income, net of other expense (income) | 71 | 0.0 | % | (72) | 0.0 | % | |||||||||||||||||
| Income before provision for income taxes | 37,732 | 5.6 | % | 5,852 | 0.6 | % | |||||||||||||||||
| Provision for income taxes | 4,435 | 0.7 | % | 13,042 | 1.3 | % | |||||||||||||||||
| Net income (loss) | $ | 33,297 | 4.9 | % | $ | (7,190) | (0.7) | % | |||||||||||||||
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The following table provides a reconciliation of net income to Adjusted EBITDA for the periods presented (dollars in thousands):
| Nine Months Ended | |||||||||||
| October 31, 2020 | October 30, 2021 | ||||||||||
| Net income (loss) | $ | 33,297 | $ | (7,190) | |||||||
| Interest expense | 16,645 | 23,390 | |||||||||
| Interest income, net of other expense (income) | 71 | (72) | |||||||||
| Provision for income taxes | 4,435 | 13,042 | |||||||||
Depreciation and amortization(A) | 25,162 | 25,626 | |||||||||
Share-based compensation(B) | (25,581) | 157,238 | |||||||||
Non-cash deductions and charges(C) | 1,755 | 376 | |||||||||
Other expenses(D) | 1,031 | 4,996 | |||||||||
| Adjusted EBITDA | $ | 56,815 | $ | 217,406 | |||||||
(A)Depreciation and amortization excludes amortization of debt issuance costs and original issue discount that are reflected in interest expense.
(B)Prior to the consummation of our IPO on July 6, 2021, share-based compensation was determined based on the revaluation of our liability-classified incentive units.
(C)Non-cash deductions and charges includes losses on property and equipment disposals and the net impact of non-cash rent expense.
(D)Other expenses include IPO-related transaction fees and the reimbursement of certain management expenses, primarily for travel, incurred by Sycamore on our behalf, which are not considered to be part of our core business.
Net Sales
Net sales increased $289.0 million, or 42.8%, to $964.9 million for the nine months ended October 30, 2021, from $675.8 million for the nine months ended October 31, 2020. This increase was primarily driven by an increase in orders placed and an increase in average order value relative to the nine months ended October 31, 2020, which were impacted by disruption caused by the COVID-19 pandemic. The increase in net sales was also as a result of temporary store closures due to the COVID-19 pandemic during the nine months ended October 31, 2020. The total number of stores we operate increased by 11 stores, or 1.8%, to 619 stores as of October 30, 2021, from 608 stores as of October 31, 2020.
Gross Profit
Gross profit for the nine months ended October 30, 2021 increased $203.3 million, or 93.9%, to $419.8 million, from $216.5 million for the nine months ended October 31, 2020. This increase was primarily due to higher net sales volumes that drove a $209.5 million increase in merchandise margin. Gross profit as a percentage of net sales increased 11.5% to 43.5% for the nine months ended October 30, 2021 from 32.0% for the nine months ended October 31, 2020. This increase was primarily driven by higher merchandise margin rate, lower distribution costs and leverage of our store occupancy costs, store depreciation expense and merchandising payroll costs as a result of higher net sales volume. The higher merchandise margin rate was primarily driven by decreased promotional activity, lower inventory reserve levels and leverage of freight expense as a result of higher net sales volume.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the nine months ended October 30, 2021 increased $231.3 million, or 186.4%, to $355.4 million, from $124.1 million for the nine months ended October 31, 2020. The increase was primarily due to a $182.8 million increase in share-based compensation expense, increased store payroll costs of $21.1 million, increased performance bonuses of $16.5 million, increased other store operating costs of $5.7 million and $5.3 million increase in headquarters general and administrative expenses. Selling, general and administrative expenses as a percentage of net sales increased by 18.5% to 36.9% for the nine months ended October 30, 2021 from 18.4% for the nine months ended October 31, 2020. This increase was driven by increased share-based compensation and performance bonuses, partially offset by leverage of store payroll costs and headquarters general and administrative expenses and other store operating costs as a result of higher net sales volume.
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Marketing Expenses
Marketing expenses for the nine months ended October 30, 2021 decreased $2.7 million, or 7.0%, to $35.3 million, from $37.9 million for the nine months ended October 31, 2020. This decrease was primarily due to decreased spending on direct mail program, partially offset by increased digital, store and brand marketing. Marketing expenses as a percentage of net sales decreased by 2.0% to 3.6% during the nine months ended October 30, 2021 from 5.6% during the nine months ended October 31, 2020. This decrease was driven by decreased spending on direct mail program, and leverage of digital, store and brand marketing spend as a result of higher net sales volume.
Interest Expense
Interest expense was $23.4 million for the nine months ended October 30, 2021, compared to $16.6 million for the nine months ended October 31, 2020. The increase was primarily due to the write-off of $5.2 million of unamortized deferred financing costs and OID when we repaid the Amended Term Loan Credit Agreement, and the $2.1 million prepayment penalty. The increase in interest expense was partially offset by a decrease in the variable interest rate related to the New Term Loan Credit Agreement compared to the Amended Term Loan Credit Agreement.
Provision for Income Taxes
The provision for income taxes for the nine months ended October 30, 2021 increased by $8.6 million to $13.0 million, from $4.4 million for the nine months ended October 31, 2020. Our effective tax rate was 222.9% for the nine months ended October 30, 2021 and 11.8% for the nine months ended October 31, 2020. The unconventional effective tax rate for the nine months ended October 30, 2021 is primarily due to the increase in the amount of non-deductible items associated with share-based compensation, relative to income before provision for income taxes for the nine months ended October 30, 2021. The increase in the amount of non-deductible items associated with share-based compensation during the nine months ended October 30, 2021 was driven by a $111.4 million remeasurement adjustment related to the increase in the value of the incentive units as indicated by the Torrid Holding LLC equity value as of June 30, 2021, following the pricing of our IPO.
Liquidity and Capital Resources
General
Our business relies on cash flows from operations as our primary source of liquidity. We do, however, have access to additional liquidity, if needed, through borrowings under our Existing ABL Facility, as amended. Our primary cash needs are for merchandise inventories, payroll, rent for our stores, headquarters and distribution center, capital expenditures associated with opening new stores and updating existing stores, logistics and information technology. We also need cash to fund our interest and principal payments on the New Term Loan Credit Agreement. Additional future liquidity needs will include funding the costs of operating as a public company. The most significant components of our working capital are cash and cash equivalents, merchandise inventories, prepaid expenses and other current assets, accounts payable and accrued and other current liabilities. We believe that cash generated from operations and the availability of borrowings under our Existing ABL Facility, as amended, or other financing arrangements will be sufficient to meet working capital requirements and anticipated capital expenditures for at least the next 12 months. There can be no assurance, however, that our business will generate sufficient cash flows from operations or that future borrowings will be available under our Existing ABL Facility, as amended, or otherwise to enable us to service our indebtedness, or to make capital expenditures in the future. Our future operating performance and our ability to service or extend our indebtedness will be subject to future economic conditions and to financial, business and other factors, many of which are beyond our control.
Cash Flow Analysis
A summary of operating, investing and financing activities are shown in the following table (dollars in thousands):
| Nine Months Ended | |||||||||||
| October 31, 2020 | October 30, 2021 | ||||||||||
| Net cash provided by operating activities | $ | 120,438 | $ | 125,253 | |||||||
| Net cash used in investing activities | (9,505) | (11,342) | |||||||||
| Net cash used in financing activities | (42,675) | (174,414) | |||||||||
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Net Cash Provided By Operating Activities
Operating activities consist primarily of net income adjusted for non-cash items, including depreciation and amortization and share-based compensation, the effect of working capital changes, taxes paid and lease incentives received from landlords.
Net cash provided by operating activities during the nine months ended October 30, 2021 was $125.3 million compared to $120.4 million during the nine months ended October 31, 2020. The increase in cash provided by operating activities during the nine months ended October 30, 2021 was primarily as a result of the add back of $157.2 million of share-based compensation expense to net cash provided by operating activities as a non-cash adjustment, compared to the nine months ended October 31, 2020 in which $25.6 million of share-based compensation expense was deducted from net cash provided by operating activities. The increase in share-based compensation expense during the nine months ended October 30, 2021, was due to an increase in Torrid Holding LLC’s equity value combined with share-based compensation pursuant to the 2021 LTIP adopted on June 22, 2021. The increase in cash provided by operating activities during the nine months ended October 30, 2021 compared to the nine months ended October 31, 2020 was also as a result of an increase in accrued and other current liabilities related to increases in accrued payroll and related expenses and accrued inventory in-transit. The increase in cash provided by operating activities was partially offset by an increase in prepaid income taxes due to the increase in the amount of non-deductible items associated with share-based compensation relative to income before provision for income taxes for the nine months ended October 30, 2021, an increase in inventory purchases, and decreases in net income, accounts payable and operating lease liabilities.
Net Cash Used In Investing Activities
Typical investing activities consist primarily of capital expenditures for growth (new store openings, relocations and major remodels), store maintenance (minor store remodels and investments in store fixtures), and infrastructure to support the business related primarily to information technology, our headquarters facility and our West Jefferson, Ohio distribution center.
Net cash flows used in investing activities during the nine months ended October 30, 2021 was $11.3 million compared to $9.5 million during the nine months ended October 31, 2020. The increase in cash used in investing activities was primarily as a result of an increase in capital expenditures related to the opening of new stores and store relocations and investments in our West Jefferson, Ohio distribution center during the nine months ended October 30, 2021 compared to the nine months ended October 31, 2020.
Net Cash Used In Financing Activities
Financing activities consist primarily of borrowings and repayments related to our Existing ABL Facility, as amended, borrowings and repayments related to the Amended Term Loan Credit Agreement and New Term Loan Credit Agreement and fees and expenses paid in connection with entry into our Existing ABL Facility, as amended, and New Term Loan Credit Agreement and from the repayment and termination of the Amended Term Loan Credit Agreement.
Net cash used in financing activities during the nine months ended October 30, 2021 was $174.4 million compared to $42.7 million during the nine months ended October 31, 2020. The increase in net cash used in financing activities is primarily as a result of the following activities during the nine months ended October 30, 2021: (i) $300.0 million distribution to Torrid Holding LLC, (ii) principal payments on the Amended Term Loan Credit agreement of $210.7 million, (iii) $2.1 million prepayment penalty related to the Amended Term Loan Credit Agreement, (iv) tax payments of $1.7 million made on behalf of our employees related to the vesting of restricted stock awards and RSUs, and (v) $0.7 million of deferred financing costs related to the 3rd Amendment to the Existing ABL Facility, as amended, partially offset by proceeds from the New Term Loan Credit Agreement of $340.5 million, net of OID and deferred financing costs.
Debt Financing Arrangements
As of October 30, 2021, we had $341.0 million of outstanding indebtedness, net of unamortized original issue discount and debt financing costs, consisting of term loans under the New Term Loan Credit Agreement. On June 14, 2021, we entered into a term loan credit agreement which provided for a new $350.0 million senior secured seven-year term loan facility in an initial aggregate amount of $350.0 million and used borrowings thereunder to, among other things, repay and terminate the Amended Term Loan Credit Agreement. Please refer to "Note 12—Debt Financing Arrangements" for further discussion regarding our indebtedness.
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Critical Accounting Policies and Significant Estimates
Our discussion of results of operations and financial condition is based upon the condensed consolidated financial statements included elsewhere in this Form 10-Q, which have been prepared in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and certain assumptions about future events that affect the classification and amounts reported in our condensed consolidated financial statements and accompanying notes, including revenue and expenses, assets and liabilities, and the disclosure of contingent assets and liabilities. These estimates and assumptions are based on our historical results as well as management’s judgment. Although management believes the judgment applied in preparing estimates is reasonable based on circumstances and information known at the time, actual results could vary materially from estimates based on assumptions used in the preparation of our condensed consolidated financial statements.
The most significant accounting estimates involve a high degree of judgment or complexity. Management believes the estimates and judgments most critical to the preparation of our condensed consolidated financial statements and to the understanding of our reported financial results include those made in connection with revenue recognition, including accounting for gift card breakage, estimated merchandise returns and loyalty program expenses; estimating the value of inventory; determining operating lease liabilities; and estimating share-based compensation expense. Management evaluates its policies and assumptions on an ongoing basis. Our significant accounting policies related to these accounts in the preparation of our condensed consolidated financial statements are described below (see Note 2 to our audited consolidated financial statements included in our Registration Statement on Form S-1/A filed with the SEC on June 30, 2021 for additional information regarding our critical accounting policies).
Revenue Recognition
Under ASU 2014-09, Revenue from Contracts with Customers, and related amendments (“ASC 606”), we recognize revenue when our performance obligations under the terms of a contract or an implied arrangement with a customer are satisfied, which is when the merchandise is transferred to the customer and the customer obtains control of it. The amount of revenue we recognize reflects the total consideration we expect to receive for the merchandise, which is the transaction price. For arrangements that contain multiple performance obligations, we allocate the transaction price to each performance obligation on a relative stand-alone selling price basis.
At our retail store locations, we satisfy our performance obligation and recognize revenue at the point in time when a customer takes possession of the merchandise and tenders payment at the point-of-sale register. For e-Commerce sales shipped to a customer from our distribution center, or from a retail store location (ship from store), we satisfy our performance obligation and recognize revenue upon shipment, which is the point in time we believe the customer obtains control of the merchandise after payment has been tendered. Income we receive from customers for shipping and handling is recognized as a component of revenue upon shipment of merchandise to the customer. We satisfy our performance obligation and recognize revenue from e-Commerce sales shipped to a retail store location from our distribution center, or fulfilled from merchandise already located at a retail store location (buy-online-pickup-in-store), at the point in time when the customer retrieves the merchandise from within the retail store location or at a retail store curbside.
We are required to estimate certain amounts included in a contract or an implied arrangement with a customer which add variability to the transaction price. Under certain conditions, we are obligated to accept customer returns for most of our merchandise. Sales returns reduce the revenue we expect to receive for merchandise and therefore add variability to the transaction price. Based on historical return pattern experience, we reasonably estimate the amount of merchandise expected to be returned and exclude it from revenue. We record a reserve for merchandise returns at the time revenue is recognized based on prior returns experience and expected future returns in accordance with our return policy and discretionary returns practices. We monitor our returns experience and resulting reserves on an ongoing basis and we believe our estimates are reasonable. We do not believe there is a reasonable likelihood that there will be a material change in the assumptions used to calculate the allowance for sales returns. However, if actual sales returns are significantly different than the estimated allowance, our results of operations could be materially affected.
We satisfy our performance obligation and recognize revenue from gift cards and store merchandise credits at the point in time when the customer presents the gift cards and store merchandise credits for redemption. Gift card breakage is income recognized due to the non-redemption of a portion of gift cards sold by us for which a liability was recorded in prior periods. We recognize estimated gift card breakage over time as a component of net sales in proportion to the pattern of rights exercised by the customer as reflected in actual gift card redemption patterns over the period. Based upon historical experience, we estimate the value of outstanding gift cards that will ultimately not be redeemed (breakage) nor escheated under statutory unclaimed property laws. This amount is recognized as revenue over the time pattern established by our historical gift card
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redemption experience. We monitor our gift card redemption experience and associated accounting on an ongoing basis. Our historical experience has not varied significantly from amounts historically recorded and we believe our assumptions are reasonable. While customer redemption patterns result in estimated gift card breakage, changes in our customers’ behavior could impact the amount that ultimately is unused and could affect the amount recognized as a component of net sales.
If a customer earns loyalty program points in connection with the sales transactions described above, then we have a remaining performance obligation and cannot recognize all the revenue. A portion of the revenue is allocated to the loyalty program points earned during the transaction. We satisfy our performance obligation and recognize revenue allocated to these loyalty program points and the resulting awards at the point in time when the awards are redeemed for merchandise, when we determine that they will not be redeemed, or when the awards and points expire. Under our loyalty program, customers accumulate points based on purchase activity and qualifying non-purchase activity. Upon reaching a certain point level, customers can earn awards that may only be redeemed for merchandise. Unredeemed points typically expire after 13 months without additional purchase activity and qualifying non-purchase activity. Unredeemed awards typically expire 45 days after issuance. We use historical redemption rates to estimate the value of future award redemptions and we recognize the estimated value of these future awards as a reduction of revenue in the condensed consolidated statements of operations and comprehensive income (loss) in the period the points are earned by the customer.
Inventory
Inventory consists of finished goods merchandise held for sale to our customers. Inventory is valued at the lower of moving average cost or net realizable value.
In the normal course of business, we record inventory reserves based on past and projected sales performance, as well as the inventory on hand. We make certain assumptions regarding net realizable value in order to assess whether our inventory is recorded properly at the lower of cost or net realizable value. These assumptions are based on both historical average selling price experience, current selling price information and estimated future selling price information. The carrying value of inventory is reduced to estimated net realizable value when factors indicate that merchandise will not be sold on terms sufficient to recover its cost.
We monitor inventory levels, sales trends and sales forecasts to estimate and record reserves for excess, slow-moving and obsolete inventory. Accordingly, estimates of future sales prices requires management judgment based on historical experience, assessment of current conditions and assumptions about future transactions. In addition, we conduct physical inventory counts to determine and record actual shrinkage. Estimates for shrinkage are recorded between physical counts, based on actual shrinkage experience. Actual shrinkage can vary from these estimates. We believe our assumptions are reasonable, and we monitor actual results to adjust estimates and inventory balances on an ongoing basis.
Leases
We consider an agreement to be or contain a lease if it conveys us with the right to control the use of an identified asset for a period of time in exchange for consideration. Based on these criteria, we have operating lease agreements for our retail stores, distribution center and headquarter office space; and vehicles and equipment; under primarily non-cancelable leases with terms ranging from approximately two to seventeen years.
Certain of our operating lease agreements contain one or more options to extend the leases at our sole discretion. However, the periods covered by the options to extend the leases of our retail stores, vehicles and equipment are not recognized as part of the associated ROU assets and lease liabilities, as we are not reasonably certain to exercise the options. The periods covered by the options to extend the leases of our distribution center and headquarter office space are recognized as part of the associated ROU assets and lease liabilities, as we are reasonably certain to exercise the options. Some of our operating lease agreements contain options to terminate the lease under certain conditions.
The retail space leases provide for rents based upon the greater of the minimum annual rental amounts or a percentage of annual store net sales volume. Certain leases provide for increasing minimum annual rental amounts. We consider rents based upon a percentage of annual store net sales volume, and other rent-related payments that generally vary because of changes in facts and circumstances (other than due to the passage of time), to be variable lease payments. Variable lease payments associated with retail space leases are recognized as occupancy costs within cost of goods sold in the condensed consolidated statements of operations and comprehensive income (loss) in the period in which the obligation for those payments is incurred. We generally consider all other lease payments to be fixed in nature and the sum of all the discounted remaining fixed payments in the lease terms make up the lease liabilities in our condensed consolidated balance sheet (if the lease terms are longer than 12 months).
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We discount the fixed lease payments that make up the lease liabilities using an incremental borrowing rate (“IBR”), as the rates implicit in our leases are not readily determinable. The IBR is the rate of interest that we would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. The determination of the incremental borrowing rate incorporates various assumptions including the financial scale, leverage and coverage measures that indicate our financial flexibility and long-term viability. These measures utilize credit ratings that are assigned scores which, when weighted based on certain quantitative factors, indicate overall credit score. An IBR for each lease term is determined based on the credit score. All scores, credit ratings and corresponding IBRs are highly subjective.
We choose not to separate nonlease components (such as common area maintenance charges and heating, ventilation and air conditioning charges), from lease components (such as fixed minimum rent payments), and instead account for each separate lease component and the nonlease components associated with that lease component as a single lease component. We do not apply ASU 2016-02, Leases, and all related guidance (“ASC 842”) requirements to leases that have lease terms of 12 months or less upon commencement, and instead recognize short-term lease payments, if applicable, in the condensed consolidated statements of operations and comprehensive income (loss) on a straight-line basis over the lease term.
In response to the COVID-19 pandemic, the FASB issued interpretive guidance in April 2020, which provides entities the option to elect to account for lease concessions as though the enforceable rights and obligations existed in the original lease terms. We elected this option; accordingly, we do not remeasure the lease liabilities or record a change to the ROU assets for any concessions we receive for our retail store leases. Rather, deferred lease payments are recorded to operating lease liabilities until paid and lease concessions are recorded in the period they are negotiated or when the lower lease expense is paid.
Share-Based Compensation
Prior to the IPO, Torrid Holding LLC issued 13,660,000 Class A, Class B, Class C, Class D, Class E, Class F, Class G, Class H and Class J Torrid incentive units, in the aggregate, net of forfeitures, to certain members of our management. These incentive units were intended to constitute profits interests.
We recognized the impact of share-based compensation associated with incentive units issued by Torrid Holding LLC in selling, general and administrative expenses in the condensed consolidated statements of operations and comprehensive income (loss). The share-based compensation expense and related capital contribution are reflected in our condensed consolidated financial statements as these awards were deemed to be for our benefit. The intent of the incentive units was to provide profit-sharing opportunities to management rather than equity ownership in our then parent, Torrid Holding LLC. The incentive units did not have any voting or distribution rights and contained a repurchase feature, whereby upon termination, Torrid Holding LLC had the right to purchase from former employees any or all of the vested incentive units at fair value. In addition, although the fair value of the incentive units was determined through an option pricing methodology that utilized the possible equity values of Torrid Holding LLC, the settlement amounts and method of settlement of the incentive units were at the discretion of the Board. Based on these aforementioned features and characteristics, we determined that the incentive units were in-substance liabilities accounted for as liability instruments in accordance with ASC 710, Compensation. The incentive units were remeasured based on the fair value of the awards at the end of each reporting period. We recorded the expense associated with changes in the fair value of these incentive units as a capital contribution from our former parent, Torrid Holding LLC, as our former parent is the legal obligor for the incentive units.
The incentive units were valued utilizing a CCA methodology based on a Black-Scholes OPM. Under the OPM, each class of incentive units was modeled as a call option with a unique claim on the assets of Torrid Holding LLC. The characteristics of each class of incentive units determined the uniqueness of the claim on the assets of Torrid Holding LLC. The OPM used to value the incentive units incorporated various assumptions, including the time to liquidity event, equity volatility and risk-free interest rate of return. Equity volatility was based on the historical volatilities of comparable publicly traded companies for the time horizon equal to the time to the anticipated liquidity event; and the risk-free interest rate was for a term corresponding to the time to liquidity event. The assumptions underlying the valuation of the incentive units represented our best estimates, which involved inherent uncertainties and the application of our judgement. The most recent remeasurement of the fair value of the incentive units utilizing the CCA methodology was performed as of May 1, 2021.
Stock options are valued utilizing a Black-Scholes OPM. The OPM used to value the stock options incorporates various assumptions, including dividend yield, expected volatility, risk-free interest rate and expected term of the stock options. The expected volatility is estimated based on the historical volatility of a select peer group of similar publicly traded companies for a term that is consistent with the expected term of the stock options. The risk-free interest rates are based on the U.S. Treasury constant maturity interest rate whose term is consistent with the expected term of the stock options. The expected term of the stock options represents the estimated period of time until exercise and is calculated using the simplified method.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
We are subject to interest rate risk in connection with borrowings under our Existing ABL Facility, as amended, and New Term Loan Credit Agreement, which bear interest at a variable rate equal to LIBOR plus an applicable margin. On June 14, 2021, we entered into the New Term Loan Credit Agreement and used borrowings thereunder to, among other things, repay and terminate the Amended Term Loan Credit Agreement. Prior to June 14, 2021 we were subject to interest rate risk in connection with borrowings under the Amended Term Loan Credit Agreement, which bore interest at a variable rate equal to LIBOR plus an applicable margin. As of October 30, 2021, we had $341.0 million of outstanding variable rate loans under the New Term Loan Credit Agreement and no outstanding variable rate borrowings under the Existing ABL Facility, as amended. An increase or decrease of 1% in the variable rates on the amount outstanding under the New Term Loan Credit Agreement will increase or decrease our annual interest expense by approximately $3.5 million.
Foreign Exchange Risk
The reporting currency for our condensed consolidated financial statements is U.S. dollars. To date, net sales generated outside of the United States have not been significant. As a result, we have not been impacted materially by changes in exchange rates and do not expect to be impacted materially for the foreseeable future. However, as our net sales generated outside of the United States increase, our results of operations could be adversely impacted by changes in exchange rates. For example, if we recognize international sales in local foreign currencies (as we currently do in Canada), as the U.S. dollar strengthens it would have a negative impact on our international results upon translation of those results into U.S. dollars during consolidation. We also purchase a significant quantity of merchandise from foreign countries. However, these purchases are made in U.S. dollar-denominated purchase contracts. We do not currently hedge foreign currency fluctuations and do not intend to do so for the foreseeable future.
Internal Control Over Financial Reporting
In connection with the audits of our consolidated financial statements as of and for the years ended January 30, 2016, January 28, 2017 and February 3, 2018, we identified material weaknesses in our internal control over financial reporting, one of which remains unremediated as of October 30, 2021. See the section titled “Risk Factors—Risks Related to Ownership of Our Common Stock—If we are unable to design, implement and maintain effective internal controls in accordance with Section 404 of Sarbanes-Oxley, we may not be able to report our financial results in a timely and reliable manner, which could have a material adverse effect on our business and stock price. We have identified material weaknesses in our internal control over financial reporting.”
Item 4. Controls and Procedures
Management’s Evaluation of Disclosure Controls and Procedures
We, under the supervision of and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based on that evaluation, as a result of the previously identified material weakness in internal control over financial reporting described below, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of October 30, 2021, to ensure that information required to be disclosed in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure.
Previously Identified Material Weakness in Internal Control Over Financial Reporting
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis.
We previously disclosed in our Form S-1 registration statement, as amended, the following material weakness, which still existed as of October 30, 2021. We did not design and maintain controls related to the accuracy and presentation of our share-based compensation expense and the corresponding capital contribution from Torrid Holding LLC. The material weakness
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relates to share-based compensation associated with incentive units that were accounted for as liability instruments and remeasured at the end of each reporting period. Upon completion of the IPO, these incentive units were replaced with restricted stock, RSUs and stock options that do not typically require remeasurement at the end of each reporting period. This material weakness resulted in a revision and restatement of previously issued annual and interim consolidated financial statements for the years ended January 30, 2016 and February 3, 2018 and could have resulted in misstatements to our consolidated financial statements or disclosures that would have resulted in a material misstatement to our annual or interim consolidated financial statements that would not have been prevented or detected on a timely basis.
Notwithstanding such material weakness, our Chief Executive Officer and Chief Financial Officer have concluded that our condensed consolidated financial statements in this Quarterly Report on Form 10-Q present fairly, and in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with U.S. generally accepted accounting principles.
Remediation Plan for Material Weakness
To remediate this material weakness, we will continue to design and implement new and enhance existing share-based compensation controls to specifically address the accuracy and disclosure of share-based compensation expense recorded for awards granted under our 2021 LTIP.
Actions Taken During the Current Quarter
During the three-months ended October 30, 2021, we designed and implemented new and enhanced existing share-based compensation controls that specifically address the accuracy and presentation of our share-based compensation expense. We operated these controls as part of our quarterly close process for the third quarter of fiscal year 2021.
Status of Remediation Efforts
We believe the measures described above will facilitate the remediation of the material weakness we have identified and strengthen our internal control over financial reporting. We are committed to continuing to improve our internal control processes and will continue to review, optimize and enhance our financial reporting controls and procedures. This material weakness will not be considered remediated until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively.
Changes in Internal Control Over Financial Reporting
As described above in the "Remediation Plan for Material Weakness" section, there were changes during the three months ended October 30, 2021 in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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Part II - Other Information
Item 1. Legal Proceedings
From time to time, we are subject to certain legal proceedings and claims in the ordinary course of business. We are not presently party to any legal proceedings the resolution of which we believe would have a material adverse effect on our business, financial condition, operating results or cash flows. We establish reserves for specific legal matters when we determine that the likelihood of an unfavorable outcome is probable and the loss is reasonably estimable.
Item 1A. Risk Factors
There have been no material changes to the risk factors disclosed in our Quarterly Report on Form 10-Q filed with the SEC on September 8, 2021.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
None.
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Item 6. Exhibits
EXHIBIT INDEX
| Exhibit Number | Description | Incorporated by Reference | ||||||||||||
Form | Filing Date | Exhibit | ||||||||||||
| 3.1 | 8-K | July 6, 2021 | 3.1 | |||||||||||
| 3.2 | 8-K | July 6, 2021 | 3.2 | |||||||||||
| 31.1** | ||||||||||||||
| 31.2** | ||||||||||||||
| 32.1** | ||||||||||||||
| 32.2** | ||||||||||||||
| 101* | Interactive Data Files (formatted in Inline XBRL) | |||||||||||||
| 104* | Cover Page Interactive Data Files (Embedded within the Inline XBRL document and included in Exhibit 101) | |||||||||||||
+ | Indicates a management contract or compensatory plan or arrangement. | ||||
* | Filed herewith | ||||
** | Furnished herewith | ||||
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in City of Industry, California on December 8, 2021.
| Torrid Holdings Inc. | |||||
| By: | /s/ Elizabeth Muñoz | ||||
| Name: | Elizabeth Muñoz | ||||
| Title: | Chief Executive Officer and Director | ||||
| (Principal Executive Officer) | |||||
| By: | /s/ George Wehlitz | ||||
| Name: | George Wehlitz | ||||
| Title: | Chief Financial Officer | ||||
| (Principal Financial and Accounting Officer) | |||||
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