UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington,
DC 20549
FORM 10-Q
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x
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Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
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For the quarterly period ended October 27,
2012
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¨
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Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
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For the transition period from
to
Commission File Number: 001-05893
FREDERICK’S OF HOLLYWOOD GROUP
INC.
(Exact name of Registrant as specified in
its charter)
New York
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13-5651322
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(State or other jurisdiction of
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(I.R.S. Employer
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incorporation or organization)
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Identification Number)
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6255 Sunset Boulevard, Hollywood, CA
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90028
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(Address of principal executive offices)
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(Zip Code)
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(323) 466-5151
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(Registrant’s telephone number, including area code)
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N/A
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(Former name, former address and former fiscal year, if changed since last report.)
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Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements
for the past 90 days.
Yes
x
No
¨
Indicate by check mark whether the registrant has submitted
electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant
to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit
and post such files).
Yes
x
No
¨
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated
filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer
¨
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Accelerated filer
¨
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Non-accelerated filer
¨
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Smaller reporting company
x
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(do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company
(as defined in Rule 12b-2 of the Exchange Act)
Yes
¨
No
x
The number of common shares outstanding on December 11, 2012
was 39,000,801.
FREDERICK’S
OF HOLLYWOOD GROUP INC.
QUARTERLY
REPORT ON FORM 10-Q
TABLE
OF CONTENTS
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Page
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PART I.
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Financial Information
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Item 1.
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Financial Statements
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3
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Consolidated Balance Sheets at October 27, 2012 (Unaudited) and July 28, 2012 (Audited)
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3
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Consolidated Statements of Operations (Unaudited) for the Three Months Ended October 27, 2012 and October 29, 2011
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4
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Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended October 27, 2012 and October 29, 2011
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5
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Notes to Consolidated Unaudited Financial Statements
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6 – 12
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Item 2.
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
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13 – 20
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Item 3.
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Quantitative and Qualitative Disclosures About Market Risk
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20
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Item 4.
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Controls and Procedures
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21
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PART II.
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Other Information
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Item 1.
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Legal Proceedings
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22
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Item 1A.
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Risk Factors
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22
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Item 6.
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Exhibits
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23
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Signatures
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24
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
FREDERICK’S OF HOLLYWOOD GROUP
INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
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October 27,
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July 28,
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2012
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2012
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(Unaudited)
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(Audited)
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ASSETS
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CURRENT ASSETS:
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Cash and cash equivalents
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$
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418
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$
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741
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Accounts receivable
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1,390
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997
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Merchandise inventories
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13,810
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12,915
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Prepaid expenses and other current assets
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1,575
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952
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Deferred income tax assets
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48
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48
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Total current assets
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17,241
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15,653
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PROPERTY AND EQUIPMENT, Net
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6,183
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6,806
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INTANGIBLE ASSETS
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18,259
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18,259
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OTHER ASSETS
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986
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756
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TOTAL ASSETS
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$
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42,669
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$
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41,474
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LIABILITIES AND SHAREHOLDERS’ DEFICIENCY
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CURRENT LIABILITIES:
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Revolving credit facility
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$
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7,554
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$
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7,356
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Accounts payable and other accrued expenses
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20,689
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14,623
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Total current liabilities
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28,243
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21,979
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DEFERRED RENT AND TENANT ALLOWANCES
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3,752
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3,887
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TERM LOAN
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9,097
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9,039
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DEFERRED INCOME TAX LIABILITIES
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7,352
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7,352
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TOTAL LIABILITIES
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48,444
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42,257
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COMMITMENTS AND CONTINGENCIES (Note 5)
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-
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-
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SHAREHOLDERS’ DEFICIENCY:
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Preferred stock, $.01 par value – authorized, 10,000,000 shares
at October 27, 2012 and July 28, 2012; issued and outstanding, 51,995 and 50,838 shares of Series A Convertible Preferred
Stock at October 27, 2012 and July 28, 2012, with a stated value of $100
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5,200
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5,084
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Common stock, $.01 par value – authorized, 200,000,000 shares at October 27, 2012 and July 28, 2012; issued and outstanding, 38,974,968 shares at October 27, 2012 and 38,964,891 shares at July 28, 2012
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390
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390
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Additional paid-in capital
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88,378
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88,283
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Accumulated deficit
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(99,743
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)
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(94,540
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)
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TOTAL SHAREHOLDERS’ DEFICIENCY
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(5,775
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)
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(783
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)
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TOTAL LIABILITIES AND SHAREHOLDERS’ DEFICIENCY
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$
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42,669
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$
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41,474
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See notes to consolidated unaudited financial
statements.
FREDERICK’S OF HOLLYWOOD GROUP
INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In Thousands, Except Per Share Amounts)
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Three Months Ended
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October 27,
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October 29,
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2012
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2011
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Net sales
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$
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22,455
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$
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28,363
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Cost of goods sold, buying and occupancy
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16,389
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18,803
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Gross profit
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6,066
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9,560
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Selling, general and administrative expenses
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10,076
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11,454
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Loss on abandonment
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521
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-
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Operating loss
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(4,531
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)
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(1,894
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)
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Interest expense, net
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531
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421
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Loss before income tax provision
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(5,062
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)
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(2,315
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)
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Income tax provision
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25
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17
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Net loss
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(5,087
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)
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(2,332
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)
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Less: Preferred stock dividends
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116
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-
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Net loss applicable to common shareholders
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$
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(5,203
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)
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$
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(2,332
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)
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Basic and diluted net loss per share applicable to common shareholders
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$
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(0.13
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)
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$
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(0.06
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)
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Weighted average shares outstanding – basic and diluted
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38,978
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38,693
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See notes to consolidated unaudited financial
statements.
FREDERICK’S OF HOLLYWOOD GROUP
INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In Thousands)
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Three Months Ended
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October 27,
2012
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October 29,
2011
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CASH FLOWS FROM OPERATING ACTIVITIES:
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Net loss
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$
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(5,087
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)
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$
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(2,332
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)
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Adjustments to reconcile net loss to net cash used in operating activities:
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Depreciation and amortization
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507
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665
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Issuance of common stock for directors’ fees
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8
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13
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Stock-based compensation expense
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86
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121
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Loss on abandonment
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521
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-
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Amortization of deferred financing costs
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68
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53
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Non-cash interest on term loan
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58
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113
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Amortization of deferred rent and tenant allowances
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(170
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)
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(114
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)
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Changes in operating assets and liabilities:
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Accounts receivable
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(393
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)
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(551
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)
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Merchandise inventories
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(895
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)
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(3,646
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)
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Prepaid expenses and other current assets
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(623
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)
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(321
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)
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Other assets
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(298
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)
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-
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Accounts payable and other accrued expenses
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5,710
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1,827
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Net cash used in operating activities
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(508
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)
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(4,172
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)
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CASH FLOWS FROM INVESTING ACTIVITIES:
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Purchases of property and equipment
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(3
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)
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(36
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)
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Net cash used in investing activities
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(3
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)
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(36
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)
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CASH FLOWS FROM FINANCING ACTIVITIES:
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Net borrowings under revolving credit facility
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198
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4,330
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Repayment of capital lease obligation
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(10
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)
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(14
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)
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Net cash provided by financing activities
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188
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4,316
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NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
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(323
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)
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108
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CASH AND CASH EQUIVALENTS:
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Beginning of period
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741
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448
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End of period
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$
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418
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$
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556
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SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
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Cash paid during period for:
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Interest
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$
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401
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$
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252
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Taxes
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$
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3
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$
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1
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See notes to consolidated unaudited financial
statements.
FREDERICK’S OF HOLLYWOOD GROUP
INC.
NOTES TO CONSOLIDATED UNAUDITED FINANCIAL
STATEMENTS
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1.
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ORGANIZATION AND BASIS OF PRESENTATION
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Description of Business
–Frederick’s
of Hollywood Group Inc. (the “Company”), through its subsidiaries, sells women’s apparel and related products
under its proprietary
Frederick’s of Hollywood
®
brand predominantly through U.S. mall-based specialty
stores, which are referred to as “Stores,” and through its catalog and website at
www.fredericks.com
, which
are referred to collectively as “Direct.”
Fiscal Year
– The Company’s fiscal
year is the 52- or 53-week period ending on the last Saturday in July. References to the three months ended October 27, 2012 and
October 29, 2011 refer to the 13-week periods then ended. References to fiscal years 2013 and 2012 refer to the 52-week period
ending July 27, 2013 and the 52-week period ended July 28, 2012, respectively.
Interim Financial Information
– In the opinion
of management, the accompanying consolidated unaudited financial statements contain all adjustments (consisting of normal recurring
accruals) necessary to present fairly the Company’s financial position as of October 27, 2012 and the results of operations
and cash flows for the three months ended October 27, 2012 and October 29, 2011.
The information set forth in these consolidated financial statements
is unaudited except for the July 28, 2012 consolidated balance sheet data. These statements have been prepared in accordance with
accounting principles generally accepted in the United States of America for interim financial information, the instructions to
Form 10-Q, and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete financial statements. The results of operations for
the three months ended October 27, 2012 are not necessarily indicative of the results to be expected for the full year. This Form
10-Q should be read in conjunction with the Company’s audited consolidated financial statements and accompanying notes for
the year ended July 28, 2012 included in the Company’s 2012 Annual Report on Form 10-K filed with the Securities and Exchange
Commission (“SEC”) on October 26, 2012 and amended on November 13, 2012.
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2.
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SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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Revenue
Recognition
–
The Company records revenue for Stores at the point at which the customer receives and pays for the
merchandise at the register. For Direct sales, goods are shipped to the customer when payment is made and the Company records the
revenue at the time the customer receives the merchandise. The Company estimates and defers revenue and the related product costs
for shipments that are in transit to the customer. Customers typically receive goods within a few days of shipment. Outbound shipping
charges billed to customers are included in net sales. The Company records an allowance for estimated returns from its customers
in the period of sale based on prior experience. At October 27, 2012
and July 28, 2012, the
allowance for estimated returns was $802,000 and $665,000, respectively. If actual returns are greater than expected, additional
sales returns may be recorded in the future. Sales are recorded net of sales taxes collected from customers at the time of the
transaction.
The Company records other revenue for shipping
revenue, commissions earned on direct sell-through programs on a net basis as the Company acts as an agent on behalf of the related
vendor, and product sales to its license partner in the Middle East. Product sales to the Company’s license partner are recognized
upon delivery to the partner’s freight forwarder. For the three months ended October 27, 2012 and October 29, 2011, total
other revenue recorded in net sales in the accompanying consolidated unaudited statements of operations were $798,000
and
$1,172,000,
respectively.
Revenue from licensing arrangements
is recognized when earned in accordance with the terms of the underlying agreements.
For
the three months ended October 27, 2012 and October 29, 2011, licensing revenue recorded in net sales in the accompanying consolidated
unaudited statements of operations was $5,000 and $17,000, respectively.
The Company recognizes the sales from gift
cards, gift certificates, and store credits (“Gift Cards and Credits”) as they are redeemed for merchandise. Prior
to redemption, the Company maintains a deferred revenue liability for Gift Cards and Credits until the Company is released from
such liability. The Company’s Gift Cards and Credits do not have expiration dates; however, over time, a percentage of them
are not redeemed or recovered (“breakage”). The Company began recording breakage in the fourth quarter of the year
ended July 30, 2011 following an initial evaluation using historical redemption trend data to determine that the likelihood of
the redemption of certain unredeemed Gift Cards and Credits is remote. Breakage of $16,000 and $4,000 was recorded for the three
months ended October 27, 2012 and October 29, 2011, respectively. The Company continues to evaluate its historical redemption trends.
If these trends ultimately differ from the assumptions underlying the Company’s breakage adjustments or the Company’s
future experience indicates the likelihood of redemption becomes remote at a different point in time after issuance, the Company
may recognize further adjustments to its accruals for such deferred revenue, which could have an effect on the Company’s
net sales and results of operations.
Costs of Goods Sold, Buying, and Occupancy
– The Company’s costs of goods sold, buying, and occupancy includes the cost of merchandise, freight from vendors,
shipping and handling, payroll and benefits for the design, buying, and merchandising personnel, warehouse and distribution, and
store occupancy costs. Store occupancy costs include rent, deferred rent, common area maintenance, utilities, real estate taxes,
and depreciation. Markdown allowances received from vendors are reflected as reductions to cost of sales in the period they are
received if these allowances are received after goods have been sold or marked down. When a markdown allowance is received prior
to the sale or mark down of the merchandise, the allowance will be recognized as a reduction in the cost basis of the inventory.
For the three months ended October 27, 2012 and October 29, 2011, markdown allowances received from vendors were $312,000 and $100,000.
Merchandise Inventories
–
Stores inventories are valued at the lower of cost or market using the retail inventory first-in, first-out (“FIFO”)
method, and Direct inventories are valued at the lower of cost or market, on an average cost basis that approximates the FIFO method.
Stores and Direct inventories consist entirely of finished goods. Freight costs are included in inventory and vendor promotional
allowances are recorded as a reduction in inventory cost.
These inventory methods inherently require
management judgments and estimates, such as the amount and timing of permanent markdowns to clear unproductive or slow-moving inventory,
which may impact the ending inventory valuations and gross margins. Markdowns are recorded when the sales value of the inventory
has diminished. Factors considered in the determination of permanent markdowns include current and anticipated demand, customer
preferences, age of the merchandise, and fashion trends. The Company reserves for the difference between the cost of inventory
and the estimated market value based upon assumptions about future demand, market conditions, and the age of the inventory. If
actual market conditions are less favorable than those projected by management, additional inventory reserves may be required.
Markdown allowances received from vendors are reflected as reductions to cost of sales in the period they are received if these
allowances are received after goods have been sold or marked down. When a markdown allowance is received prior to the sale or markdown,
the allowance will be recognized as a reduction in the cost basis of the inventory. Historically, management has found its inventory
reserves to be appropriate, and actual results generally do not differ materially from those determined using necessary estimates.
Inventory reserves were $534,000 at October 27, 2012 and $628,000 at July 28, 2012.
Deferred
Catalog Costs
– Deferred catalog costs represent direct-response advertising that is capitalized and
amortized over its expected period of future benefit. The capitalized costs of the advertising are amortized over the
expected revenue stream following the mailing of the respective catalog, which is generally less than three months. The
realizability of the deferred catalog costs are also evaluated as of each balance sheet date by comparing the capitalized
costs for each catalog, on a catalog by catalog basis, to the probable remaining future gross profit of the related revenue.
Direct-response
advertising costs included in prepaid expenses and other current assets in the accompanying
consolidated balance sheets at October 27, 2012
and July 28, 2012 were $1,197,000 and $564,000,
respectively. Management believes that they have appropriately determined the expected period of future benefit as of the
date of the Company’s consolidated financial statements. However, should actual sales results differ from expected
sales, deferred catalog costs may be written off on an accelerated basis. Direct-response advertising expense for the three
months ended October 27, 2012
and October 29, 2011 was $874,000 and $1,744,000,
respectively.
Property and Equipment
–
Property and equipment are stated at cost, less accumulated
depreciation.
The Company’s policy is to capitalize expenditures that materially increase asset lives and expense
ordinary repairs and maintenance as incurred. Depreciation is provided for on the straight-line method over the estimated useful
lives of the assets, which is generally three years for computer software, five years for computer equipment, three to seven years
for furniture and equipment, and the shorter of the remaining lease term or the estimated useful life for leasehold improvements.
Impairment of Long-Lived Assets
– The Company reviews long-lived assets, including property and equipment and its amortizable intangible assets, for impairment
whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on undiscounted
cash flows. If long-lived assets are impaired, an impairment loss is recognized and is measured as the amount by which the carrying
value exceeds the estimated fair value of the assets. The estimation of future undiscounted cash flows from operating activities
requires significant estimates of factors that include future sales growth and gross margin performance. Management believes they
have appropriately determined future cash flows and operating performance; however, should actual results differ from those expected,
additional impairment may be required. No impairment was recorded for the three months ended October 27, 2012 and October 29, 2011.
Abandonment
of leases
-
The Company recorded a charge of $259,000 related to a portion of its
Hollywood corporate office space that was vacated during the three months ended October 27, 2012 and subleased to a third party.
In addition, the Company recorded a charge of $262,000 related to a portion of its Phoenix facility that housed its customer contact
center. The customer contact center was outsourced to a third party during the quarter ended October 27, 2012.
Intangible Assets
– The
Company has certain indefinite lived intangible assets, principally the Frederick’s of Hollywood trade name and domain names.
The Company’s intangible assets are comprised of $18,090,000 attributable to its trademarks and $169,000 to its domain names
as of October 27, 2012 and July 28, 2012. Applicable accounting guidance requires the Company not to amortize indefinite life intangible
assets, but to test those intangible assets for impairment annually and between annual tests when circumstances or events have
occurred that may indicate a potential impairment has occurred. No impairment was present and no write-down was required when the
trademarks were reviewed for impairment in connection with the annual impairment test. The fair value of the trademarks was determined
using the relief-from-royalty method. The relief-from-royalty method estimates the royalty expense that could be avoided in the
operating business as a result of owning the respective asset or technology. The royalty savings are measured, tax-effected and,
thereafter, converted to present value with a discount rate that considers the risk associated with owning the intangible asset.
No impairment was recorded for the three months ended October 27, 2012 and October 29, 2011 related to these intangible assets.
Fair Value of Financial Instruments
– The Company’s management believes the carrying amounts of cash and cash equivalents, accounts receivable, and
accounts payable and accrued expenses approximate fair value due to their short maturity. The carrying amount of the revolving
line of credit approximates fair value, as these borrowings have variable rates that reflect currently available terms and conditions
for similar debt. The Company believes its long-term loan approximates fair value because the transaction contemplated by the financing
agreement relating to this debt was consummated on May 31, 2012.
Accounting for Stock-Based Compensation
– The Company measures and recognizes compensation expense for all share-based payment awards to employees and directors
based on estimated fair values on the grant date. The Company recognizes the expense on a straight-line basis over the requisite
service period, which is the vesting period. The value of each stock option is estimated on the date of grant using the Black-Scholes
option-pricing model. The fair value generated by the Black-Scholes model may not be indicative of the future benefit, if any,
that may be received by the option holder.
The following
assumptions were used for options granted during the three months ended
October 29, 2011
:
Risk-free interest rate
|
|
|
1.41
|
%
|
Expected life (years)
|
|
|
7
|
|
Expected volatility
|
|
|
74.43
|
%
|
Dividend yield
|
|
|
0.0
|
%
|
During the three months ended October 29, 2011, the Company
issued 80,000 shares of restricted stock and granted options to purchase 150,000 shares of common stock under the 2010 Long-Term
Equity Incentive Plan. The restricted shares and options vest in two equal annual installments on the first and second anniversaries
of the grant date. The options are exercisable at $0.62 per share.
There were no options granted during the three months ended
October 27, 2012.
Income Taxes
– Income
taxes are accounted for under an asset and liability approach that requires the recognition of deferred income tax assets and liabilities
for the expected future consequences of events that have been recognized in the Company’s financial statements and income
tax returns. The Company provides a valuation allowance for deferred income tax assets when it is considered more likely than not
that all or a portion of such deferred income tax assets will not be realized.
Applicable accounting guidance requires that
a position taken or expected to be taken in a tax return be recognized in the financial statements when it is more likely than
not that the position would be sustained upon examination by tax authorities. A recognized tax position is then measured at the
largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. Accounting provisions also
require that a change in judgment that results in subsequent recognition, derecognition, or change in a measurement of a tax position
taken in a prior annual period (including any related interest and penalties) be recognized as a discrete item in the period in
which the change occurs. The Company regularly evaluates
the likelihood
of recognizing the benefit for income tax positions taken in various federal and state filings by considering all relevant facts,
circumstances, and information available.
The Company classifies any interest and penalties
related to unrecognized tax benefits as a component of income tax expense.
Supplemental Disclosure of Cash Flow
Information
– The Company had outstanding accounts payable and accrued expenses of $33,000 and $29,000 at October
27, 2012 and July 28, 2012, respectively, related to purchases of property and equipment. The Company had outstanding accounts
payable and accrued expenses of $233,000 at October 27, 2012 related to deferred financing fees, which are classified as other
assets on the consolidated balance sheets.
During the three months ended October 27,
2012, the Company accrued dividends of $116,000 on its Series A Convertible Preferred Stock.
Recently Issued Accounting Updates
– In July 2012, the Financial Accounting Standards Board issued Accounting Standards Update No. 2012-02
,
Intangibles – Goodwill and Other: Testing Indefinite-Lived Intangible Assets for Impairment
(“ASU No.
2012-02”). ASU No. 2012-02 gives companies testing indefinite-lived intangible assets for impairment the option of
performing a qualitative assessment before calculating the fair value of the indefinite-lived intangible asset in a
quantitative impairment test. If companies determine, based on qualitative factors, that the fair value of the intangible
asset is more likely than not less than the carrying amount, the quantitative impairment test would be required. Otherwise,
further testing would not be needed. ASU No. 2012-02 is effective for annual and interim impairment tests performed for
fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment
tests performed as of a date before July 27, 2012 if the financial statements for the most recent or interim period have not
yet been issued. The Company adopted ASU No. 2012-02 in the fourth quarter of fiscal year 2012. The application of ASU
2012-02 did not have an impact on the Company’s consolidated financial statements.
|
3.
|
ACCOUNTS PAYABLE AND OTHER ACCRUED EXPENSES
|
Accounts payable and other accrued expenses
at October 27, 2012 and July 28, 2012 consist of the following (in thousands):
|
|
October 27,
2012
|
|
|
July 28,
2012
|
|
Accounts payable
|
|
$
|
12,225
|
|
|
$
|
6,875
|
|
Accrued payroll and benefits
|
|
|
582
|
|
|
|
1,182
|
|
Accrued vacation
|
|
|
901
|
|
|
|
914
|
|
Deferred revenue from gift cards, gift certificates, and store credits
|
|
|
1,392
|
|
|
|
1,428
|
|
Return reserves
|
|
|
802
|
|
|
|
665
|
|
Deferred revenue
|
|
|
329
|
|
|
|
328
|
|
Sales and other taxes payable
|
|
|
761
|
|
|
|
541
|
|
Lease abandonment – current
|
|
|
305
|
|
|
|
-
|
|
Miscellaneous accrued expense and other
|
|
|
3,392
|
|
|
|
2,690
|
|
Total
|
|
$
|
20,689
|
|
|
$
|
14,623
|
|
Salus Credit and Security Agreement
On May 31, 2012, the Company and its subsidiaries (collectively,
the “Borrowers”) entered into a Credit and Security Agreement (“Credit Agreement”) with Salus Capital Partners,
LLC (“Salus”), which provides the Borrowers with a $24,000,000 revolving line of credit through May 31, 2015 (the “Salus
Facility”).
The Salus Facility includes a “first in last out”
tranche (“FILO Advance”) of up to $9,000,000 that consists of the first advances made under the Salus Facility and
will be the last amounts repaid. The maximum amount of the FILO Advance and the total Salus Facility will be reduced by certain
mandatory and voluntary prepayments. The Borrowers may periodically borrow, repay in whole or in part, and reborrow under the Salus
Facility, except that amounts repaid on account of the FILO Advance may not be reborrowed. The actual amount of credit available
under the Salus Facility is determined using measurements based on the Borrowers’ receivables, inventory, intellectual property
and other measures.
The unpaid principal of the FILO Advance bears interest, payable
monthly, in arrears, at the 30-day LIBOR rate plus 11.5%, but not less than 12.0% regardless of fluctuations in the LIBOR rate
(12.0% at October 27, 2012). Up to 2.5% of the interest payable on the FILO Advance will be capitalized, compounded and added to
the unpaid amount of the obligations each month, will accrue interest at the rate applicable to the FILO Advance and will be due
and payable in cash upon the expiration or other termination of the Salus Facility. At October 27, 2012, $9,097,000 was outstanding
under the FILO Advance.
The unpaid principal of advances other than the FILO Advance
bears interest, payable monthly, in arrears, at the Prime rate plus 4.0%, but not less than 7.0%, regardless of fluctuations in
the Prime rate (7.25% at October 27, 2012). At October 27, 2012, $7,554,000 of advances other than the FILO Advance was outstanding.
The obligations of the Borrowers under the Credit Agreement
are secured by first priority security interests in all of the Borrowers’ tangible and intangible property, including intellectual
property such as trademarks and copyrights, as well as shares and membership interests of the Company’s subsidiaries.
The Credit Agreement provides for the Borrowers to pay Salus
an origination fee of $465,000, 50% of which was paid at the closing and 50% to be paid on the first anniversary of the closing.
The Credit Agreement also provides for certain customary fees to be paid to Salus, including: (i) a monthly fee on the unused portion
of the Salus Facility; (ii) a monthly collateral monitoring fee; and (iii) an annual FILO facility fee based on the then-outstanding
FILO Advance.
The Credit Agreement and other loan documents contain customary
representations and warranties, affirmative and negative covenants and events of default, including covenants that restrict the
Borrowers’ ability to create certain liens, make certain types of borrowings and investments, liquidate or dissolve, engage
in mergers, consolidations, significant asset sales and affiliate transactions, incur certain lease obligations, pay cash dividends,
redeem or repurchase outstanding equity and issue capital stock. In lieu of financial covenants, fixed charge coverage and overall
debt ratios, the Salus Facility has a $1.5 million minimum availability reserve requirement. At October 27, 2012, the Company was
in compliance with the Salus Facility’s affirmative and restrictive covenants and minimum availability reserve requirement.
|
5.
|
COMMITMENTS AND CONTINGENCIES
|
On February 2, 2012, a former California store employee filed
a purported class action lawsuit in the California Superior Court, County of San Francisco, naming Frederick’s of Hollywood,
Inc., one of the Company’s subsidiaries, as a defendant (Michelle Weber, on behalf of herself and all others similarly situated
v. Frederick’s of Hollywood, Inc., Case No. CGC-12-517909). The complaint alleges, among other things, violations of the
California Labor Code, failure to pay overtime, failure to provide meal and rest periods and termination compensation and violations
of California’s Unfair Competition Law. The complaint seeks, among other relief, collective and class certification of the
lawsuit (the class being defined as all California retail store hourly employees), unspecified damages, costs and expenses, including
attorneys’ fees, and such other relief as the Court might find just and proper. The Company contests these allegations and
denies any liability with respect to the lawsuit. The Company answered the Plaintiff’s first amended complaint on April 2,
2012. The parties agreed to stay discovery proceedings and have attended mediation, most recently on November 29, 2012, which has
not concluded. Therefore, the Company is unable to predict the likely outcome and whether such outcome may have a material adverse
effect on its results of operations or financial condition. Accordingly, no provision for a loss contingency has been accrued as
of October 27, 2012.
The Company also is involved from time to
time in litigation incidental to its business. The Company believes that the outcome of such litigation will not have a material
adverse effect on its results of operations or financial condition.
The Company’s calculations of basic
and diluted net loss per share applicable to common shareholders are as follows (in thousands, except per share amounts):
|
|
Three Months Ended
|
|
|
|
October 27,
|
|
|
October 29,
|
|
|
|
2012
|
|
|
2011
|
|
Total net loss applicable to common shareholders
|
|
$
|
(5,203
|
)(a)
|
|
$
|
(2,332
|
)
|
Basic and diluted weighted average number of shares outstanding
|
|
|
38,978
|
|
|
|
38,693
|
|
Total basic and diluted net loss per share applicable to common shareholders
|
|
$
|
(0.13
|
)
|
|
$
|
(0.06
|
)
|
|
(a)
|
Includes Preferred Stock dividend of $116.
|
There were 66,000 potentially dilutive
shares that were not included in the computation of diluted net loss per share for the three months ended October 29, 2011 since
their effect would be anti-dilutive.
For the three months ended October
27, 2012, there were 2,674,000 shares of common stock issuable upon exercise of stock options and 5,544,000 shares of common stock
issuable upon the exercise of warrants that also were not included in the computation of diluted net loss per share since the exercise
prices of these instruments exceeded the average market price of the common stock during the period.
For the three months ended October
29, 2011, there were 2,891,000 shares of common stock issuable upon exercise of stock options and 4,044,000 shares of common stock
issuable upon the exercise of warrants that also were not included in the computation of diluted net loss per share since the exercise
prices of these instruments exceeded the average market price of the common stock during the period.
Amendments to the Phoenix, Arizona Distribution Center Lease
On August 16, 2012 and November 8,
2012, the lease for the Company’s Phoenix facility was amended. Under the terms of the amendments, upon not less than 50
days’ prior notice from the current landlord, the Company agreed to surrender possession of approximately 94,000 out of
131,000 square feet of warehouse, office and data center space. The Company has received notice to surrender possession by December
29, 2012. In consideration of the current landlord agreeing to the surrender, the Company has agreed to pay approximately $1,150,000
in 24 equal monthly payments following the surrender date. The total lease obligation as of October 27, 2012 through the end of
the lease term in March 2018 was approximately $9,264,000, which will be reduced to approximately $2,291,000 (excluding the surrender
payment of $1,150,000) assuming the Company vacates the space as of December 29, 2012 and is not required to return as described
below. As a result of the foregoing, the Company expects that its rent and common area charges will be reduced from approximately
$1,700,000 annually to approximately $400,000. The Company recorded a loss on abandonment of $262,000 during the three months
ended October 27, 2012 and will record an additional loss on abandonment of approximately $192,000 during the three months ending
January 26, 2013. However, if the Company does not vacate the space on or before January 31, 2013, the terms of the amendments
will no longer be effective and the Company will be required to continue to perform its obligations under the lease through the
end of the term in March 2018.
In addition, the current
landlord has entered into an agreement to sell the building where the Company’s Phoenix facility is located to a third
party. Under the terms of the amendments, if the sale is not completed by March 31, 2013, then, notwithstanding the
Company’s agreement to surrender possession as described above, the current landlord has the right to reinstate the
terms of the lease that were in place prior to the amendments. In such event, if the Company has either vacated or is in the
process of vacating the space, the current landlord will be required to pay the Company $200,000.
Following
the surrender, the Company is planning to relocate its Stores distribution and data center operations to third parties and to
continue to handle Direct fulfillment in the Phoenix facility. If the Company experiences disruptions in relocating the
Stores distribution or data center, or the sale of the building is not completed in the timeframe provided and the Company is
required to return to the Phoenix facility, this could have a material adverse effect its ability to distribute products,
which in turn could have a material adverse effect on its business, financial condition and results of operations. See the
risks included in “Item 1A: Risk Factors” of the Company’s Form 10-K for the year ended July 28, 2012.
|
ITEM 2.
|
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
Forward-Looking Statements
When used in this Form 10-Q of Frederick’s
of Hollywood Group Inc.
(the “Company,” “we,” “us,” “our” or “Frederick’s”)
and in our future filings with the Securities and Exchange Commission (“SEC”), the words or phrases “will likely
result,” “management expects” or “we expect,” “will continue,” “is anticipated,”
“estimated” or similar expressions are intended to identify “forward-looking statements” within the meaning
of the Private Securities Litigation Reform Act of 1995. Readers are cautioned not to place undue reliance on any such forward-looking
statements, each of which speaks only as of the date made. We have no obligation to publicly release the result of any revisions
which may be made to any forward-looking statements to reflect anticipated or unanticipated events or circumstances occurring after
the date of such statements.
Such statements are subject to certain
risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated
or projected. These risks are included in “Item 1: Business,” “Item 1A: Risk Factors” and “Item 7:
Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Form 10-K for the year
ended July 28, 2012. In assessing forward-looking statements contained herein, readers are urged to carefully read those statements.
Among the factors that could cause actual results to differ materially are: competition; business conditions and industry growth;
rapidly changing consumer preferences and trends; general economic conditions; working capital needs; continued compliance with
government regulations; loss of key personnel; labor practices; product development; management of growth; increases of costs of
operations or inability to meet efficiency or cost reduction objectives; timing of orders and deliveries of products; risks of
doing business abroad; and our ability to protect our intellectual property.
Our History
We are a New York corporation incorporated
on April 10, 1935. On January 28, 2008, we consummated a merger with FOH Holdings, Inc., a privately-held Delaware corporation
(“FOH Holdings”), whereby FOH Holdings became our wholly-owned subsidiary. FOH Holdings is the parent company of Frederick’s
of Hollywood, Inc. Upon consummation of the merger, we changed our name from Movie Star, Inc. to Frederick’s of Hollywood
Group Inc.
Our Business
Frederick’s of Hollywood Group Inc.,
through its subsidiaries, sells women’s apparel and related products under its proprietary
Frederick’s of Hollywood
®
brand predominantly through its U.S. mall-based specialty retail stores, which are referred to as “Stores,”
and through its catalog and website at
www.fredericks.com
, which are referred to
collectively as “Direct.” As of October 27, 2012, we operated 118 Frederick’s of Hollywood stores in 29 states.
We also have a license agreement with a
subsidiary of Emirates Associated Business Group (“EABG”), which provides for EABG to build and operate Frederick’s
of Hollywood retail stores in the Middle East. As of October 27, 2012, EABG had opened three stores in the region. In addition,
we have selectively licensed the right to use the
Frederick’s of Hollywood
®
brand and logo on specified
categories of products manufactured and sold by other companies. Our licensed merchandise categories currently include Halloween
costumes, jewelry and accessories.
Operating Initiatives
While business continues to be softer
than anticipated, we are focused on executing the initiatives described below to improve sales and profitability and reduce
expenses. Together with these initiatives, we are working to maintain an efficient balance among inventory, promotional sales,
gross margins and overhead costs. We are also continuing to evaluate our long-term domestic and international store and
product licensing strategy. We believe some of these initiatives will have an immediate impact on our operating results while
others may be more gradual, although we cannot assure you that we will ultimately be successful. These initiatives are
as follows:
|
·
|
Relocate
Phoenix facility
.
During the second
quarter of fiscal
year 2013, we are
planning to surrender
approximately 94,000
out of 131,000 square
feet of warehouse,
office and data
center space at
our Phoenix facility,
and relocate our
Stores distribution
and data center
operations to third
parties. We plan
to continue to handle
Direct fulfillment
in the Phoenix facility.
The total lease
obligation as of
October 27, 2012
through the end
of the lease term
in March 2018 was
approximately $9,264,000,
which will be reduced
to approximately
$2,291,000 (excluding
a surrender payment
of $1,150,000) assuming
the Company vacates
the space as of
December 29, 2012.
As a result of the
foregoing, we expect
that our rent and
common area charges
will be reduced
from approximately
$1,700,000 annually
to approximately
$400,000. For a
more detailed discussion
of the relocation
and the related
risks, see Note
7 “
Subsequent
Event
,”
included in the
notes to the consolidated
unaudited financial
statements appearing
elsewhere in this
report and “
Item
1A: Risk Factors
”
included in our
Form 10-K for the
year ended July
28, 2012.
|
|
·
|
Expand product categories and product mix
. We have been expanding
the types of products we offer and have increased our branded product assortment.
|
|
·
|
Utilize innovative and cost-effective marketing strategies
. Due to the costs involved in producing a traditional
catalog, we have steadily reduced catalog circulation and have been reallocating resources to more innovative direct mail
pieces such as our “brandzine,” or branded magazine, which includes magazine-like content and third party
advertisements in a mail piece featuring our products, and to cost-effective digital marketing alternatives. We also are
increasing our digital marketing efforts to attract new customers through digital display advertising, email retargeting, and
increased search marketing.
|
|
·
|
Implement a three-tier branding and merchandising strategy to provide
customers with a full array of products across a broader assortment of merchandise and price points
. During the first quarter
of fiscal year 2013, we launched our new luxury label collection, Harriett, which is currently sold in our Hollywood flagship store
and online through
www.harriett.com
, and offers higher priced and more luxurious
goods. We also introduced The Find by Frederick’s, which serves as an online venue to purchase our discount and clearance
product offerings at
www.thefindbyfredericks.com
.
|
Critical Accounting Policies and Estimates
The preparation of financial statements
in conformity with accounting principles generally accepted in the United States of America requires the appropriate application
of certain accounting policies, many of which require estimates and assumptions about future events and their impact on amounts
reported in the financial statements and related notes. Since future events and their impact cannot be determined with certainty,
the actual results will inevitably differ from our estimates. Such differences could be material to the financial statements.
Management believes that the application
of accounting policies, and the estimates inherently required by the policies, are reasonable. These accounting policies and estimates
are constantly re-evaluated, and adjustments are made when facts and circumstances dictate a change. Historically, management has
found the application of accounting policies to be appropriate, and actual results generally do not differ materially from those
determined using necessary estimates.
Our accounting policies are more fully described
in Note 2 to the consolidated unaudited financial statements appearing elsewhere in this report. Management has identified certain
critical accounting policies that are described below.
Our most significant areas of estimation
and assumption are:
|
·
|
determination of the appropriate amount and timing of markdowns to clear unproductive or slow-moving retail inventory and overall
inventory obsolescence;
|
|
·
|
estimation of future cash flows used to assess the recoverability of long-lived assets, including trademarks;
|
|
·
|
estimation of expected customer merchandise returns;
|
|
·
|
estimation of the net deferred income tax asset valuation allowance; and
|
|
·
|
capitalization of deferred catalog costs and the estimated amount of future benefit to be derived from the catalogs.
|
Revenue Recognition –
We record revenue for Stores at the point at which the customer receives and pays for the merchandise at the register. For
Direct sales, goods are shipped to the customer when payment is made and we record the revenue at the time the customer receives
the merchandise. We estimate and defer revenue and the related product costs for shipments that are in transit to the customer.
Customers typically receive goods within a few days of shipment. Outbound shipping charges billed to customers are included in
net sales. We record an allowance for estimated returns from our customers in the period of sale based on prior experience. At
October 27, 2012 and July 28, 2012, the allowance for estimated returns was $802,000
and $665,000,
respectively. If actual returns are greater than expected, additional sales returns may be recorded in the future.
Historically, management has found its return reserve to
be appropriate, and actual results generally do not differ materially from those determined using necessary estimates.
Merchandise Inventories
– Stores
inventories are valued at the lower of cost or market using the retail inventory first-in, first-out (“FIFO”) method,
and Direct inventories are valued at the lower of cost or market, on an average cost basis that approximates the FIFO method. Stores
and Direct inventories consist entirely of finished goods. Freight costs are included in inventory and vendor promotional allowances
are recorded as a reduction in inventory cost.
These inventory methods inherently require
management judgments and estimates, such as the amount and timing of permanent markdowns to clear unproductive or slow-moving inventory,
which may impact the ending inventory valuations as well as gross margins. Markdowns are recorded when the sales value of the inventory
has diminished. Factors considered in the determination of permanent markdowns include current and anticipated demand, customer
preferences, age of the merchandise, and fashion trends. We reserve for the difference between the cost of inventory and the estimated
market value based upon assumptions about future demand, market conditions, and the age of the inventory. If actual market conditions
are less favorable than those projected by management, additional inventory reserves may be required. Markdown allowances received
from vendors are reflected as reductions to cost of sales in the period they are received if these allowances are received after
goods have been sold or marked down. When markdown allowances are received prior to the sale or markdown, the allowance will be
recognized as a reduction in the cost basis of the inventory. Historically, management has found its inventory reserves to be appropriate,
and actual results generally do not differ materially from those determined using necessary estimates. Inventory reserves were
$534,000 at October 27, 2012 and $628,000 at July 28, 2012.
Deferred
Catalog Costs
– Deferred catalog costs represent direct-response advertising that is capitalized and amortized over its
expected period of future benefit. The capitalized costs of the advertising are amortized over the expected revenue stream following
the mailing of the respective catalog, which is generally less than three months. The realizability of the deferred catalog costs
are also evaluated as of each balance sheet date by comparing the capitalized costs for each catalog, on a catalog by catalog basis,
to the probable remaining future gross profit of the related revenue. Direct-response
advertising costs of $1,197,000
and $564,000 are included in prepaid expenses and other current assets in the accompanying consolidated balance sheets at October
27, 2012 and July 28, 2012, respectively. Management believes that they have appropriately determined the expected period of future
benefit as of the date of its consolidated financial statements. However, should actual sales results differ from expected sales,
deferred catalog costs may be written off on an accelerated basis. Direct-response advertising expense for the three months ended
October 27, 2012
and October 29, 2011 was $ 874,000 and $1,744,000, respectively.
Impairment of Long-Lived Assets
–
We review long-lived assets, including property and equipment and our amortizable intangible assets, for impairment whenever events
or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on undiscounted cash flows.
If long-lived assets are impaired, an impairment loss is recognized and is measured as the amount by which the carrying value exceeds
the estimated fair value of the assets.
The estimation of future undiscounted cash
flows from operating activities requires significant estimates of factors that include future sales growth and gross margin performance.
Management believes they have appropriately determined future cash flows and operating performance; however, should actual results
differ from those expected, additional impairment may be required. No impairment was recorded for the three months ended October
27, 2012 and October 29, 2011.
Abandonment of leases
–
We recorded a charge of $259,000 related to a portion of our Hollywood corporate office space that was vacated during the three
months ended October 27, 2012 and subleased to a third party. In addition, we recorded a charge of $262,000 related to a portion
of our Phoenix facility that housed our customer contact center. The customer contact center was outsourced to a third party during
the quarter ended October 27, 2012.
Intangible
Assets
– We have certain indefinite lived intangible assets, principally the Frederick’s of Hollywood trade name
and domain names. Applicable accounting guidance requires us not to amortize indefinite life intangible assets, but to test those
intangible assets for impairment annually and between annual tests when circumstances or events have occurred that may indicate
a potential impairment has occurred. No impairment was present and no write-down was required when the trademarks were reviewed
for impairment in connection with the annual impairment test. The fair value of the trademarks was determined using the relief-from-royalty
method. The relief-from-royalty method estimates the royalty expense that could be avoided in the operating business as a result
of owning the respective asset or technology. The royalty savings are measured, tax-effected and, thereafter, converted to present
value with a discount rate that considers the risk associated with owning the intangible asset. No impairment was recorded for
the three months ended October 27, 2012 and October 29, 2011
related to these intangible assets.
Income Taxes
– Income taxes are
accounted for under an asset and liability approach that requires the recognition of deferred income tax assets and liabilities
for the expected future consequences of events that have been recognized in our financial statements and income tax returns. We
provide a valuation allowance for deferred income tax assets when it is considered more likely than not that all or a portion of
such deferred income tax assets will not be realized.
Results of Operations
Management considers certain key indicators
when reviewing our results of operations, liquidity and capital resources. One key operating metric is the performance of comparable
store sales, which are the net merchandise sales of stores that have been open at least one complete year. Because our results
of operations are subject to seasonal variations, retail sales are reviewed against comparable store sales for the similar period
in the prior year. A material factor that we consider when reviewing sales is the gross profit percentage. We also consider our
selling, general and administrative expenses as a key indicator in evaluating our financial performance. Inventory and our outstanding
borrowings are the main indicators we consider when we review our liquidity and capital resources, particularly the size and age
of the inventory. We review all of our key indicators against the prior year and our operating projections in order to evaluate
our operating performance and financial condition.
The following table sets forth each specified
item as a dollar amount and as a percentage of net sales in each fiscal period, and should be read in conjunction with the consolidated
unaudited financial statements included elsewhere in this report (in thousands, except for percentages, which percentages may not
add due to rounding):
|
|
Three Months Ended
|
|
|
|
October 27, 2012
|
|
|
October 29, 2011
|
|
Net sales
|
|
$
|
22,455
|
|
|
|
100.0
|
%
|
|
$
|
28,363
|
|
|
|
100.0
|
%
|
Cost of goods sold, buying and occupancy
|
|
|
16,389
|
|
|
|
73.0
|
%
|
|
|
18,803
|
|
|
|
66.3
|
%
|
Gross profit
|
|
|
6,066
|
|
|
|
27.0
|
%
|
|
|
9,560
|
|
|
|
33.7
|
%
|
Selling, general and administrative expenses
|
|
|
10,076
|
|
|
|
44.9
|
%
|
|
|
11,454
|
|
|
|
40.4
|
%
|
Loss on abandonment
|
|
|
521
|
|
|
|
2.3
|
%
|
|
|
-
|
|
|
|
0.0
|
%
|
Operating loss
|
|
|
(4,531
|
)
|
|
|
(20.2
|
)%
|
|
|
(1,894
|
)
|
|
|
(6.7
|
)%
|
Interest expense, net
|
|
|
531
|
|
|
|
2.4
|
%
|
|
|
421
|
|
|
|
1.5
|
%
|
Loss before income tax provision
|
|
|
(5,062
|
)
|
|
|
(22.5
|
)%
|
|
|
(2,315
|
)
|
|
|
(8.2
|
)%
|
Income tax provision
|
|
|
25
|
|
|
|
0.1
|
%
|
|
|
17
|
|
|
|
0.1
|
%
|
Net loss
|
|
|
(5,087
|
)
|
|
|
(22.7
|
)%
|
|
|
(2,332
|
)
|
|
|
(8.2
|
)%
|
Less: Preferred stock dividends
|
|
|
116
|
|
|
|
0.5
|
%
|
|
|
-
|
|
|
|
0.0
|
%
|
Net loss applicable to common shareholders
|
|
$
|
(5,203
|
)
|
|
|
(23.2
|
)%
|
|
$
|
(2,332
|
)
|
|
|
(8.2
|
)%
|
Net Sales
Net sales for the three months ended October
27, 2012 and October 29, 2011 were as follows (in thousands):
|
|
Three Months Ended
|
|
|
|
October 27,
2012
|
|
|
October 29,
2011
|
|
|
Decrease
|
|
Stores
|
|
$
|
15,159
|
|
|
$
|
19,145
|
|
|
$
|
(3,986
|
)
|
Direct
|
|
|
6,493
|
|
|
|
8,029
|
|
|
|
(1,536
|
)
|
Licensing revenue
|
|
|
5
|
|
|
|
17
|
|
|
|
(12
|
)
|
Other revenue
|
|
|
798
|
|
|
|
1,172
|
|
|
|
(374
|
)
|
Total net sales
|
|
$
|
22,455
|
|
|
$
|
28,363
|
|
|
$
|
(5,908
|
)
|
Total store sales for the three months ended
October 27, 2012 decreased by $3,986,000, or 20.8%, as compared to the three months ended October 29, 2011. Comparable store sales
for the three months ended October 27, 2012 decreased by $3,024,000, or 17.0%, as compared to the three months ended October 29,
2011. These decreases were primarily due to:
|
·
|
lower consumer traffic at our stores, which is primarily
attributable to lower promotional activity during the first half of the three months ended October 27, 2012 as
compared to
the same
period in
the prior
year;
|
|
·
|
a reduction in the number of stores from 123 at October 29, 2011 to
118 at October 27, 2012; and
|
|
·
|
a delay in the receipt of core product inventory, which
was transitioned to a new vendor in the fourth quarter of fiscal year 2012 for deliveries in the first quarter of fiscal year 2013.
|
Direct sales for the three months ended
October 27, 2012 decreased by $1,536,000, or 19.1%, as compared to the three months ended October 29, 2011. This decrease is primarily
attributable to mailing fewer catalogs during the three months ended October 27, 2012 as compared to the same period in the prior
year as part of our efforts to reduce catalog costs and reallocate resources to our digital marketing initiatives. We are continuing
to strategically review our Direct marketing strategy in order to find ways to drive more profitable sales.
Other revenue consists of shipping revenue,
commissions earned on direct sell-through programs and breakage on gift cards. Other revenue for the three months ended October
27, 2012 decreased by $374,000, or 31.9%, as compared to the three months ended October 29, 2011. This decrease is primarily attributable
to a decrease in shipping revenue due to an increase in promotional shipping offers to stimulate sales in a retail environment
with competitors frequently offering free shipping, and lower Direct sales.
Gross Profit
Gross margin (gross profit as a percentage
of net sales) for the three months ended October 27, 2012 was 27.0% as compared to 33.7% for the three months ended October 29,
2011. This decrease was due to the following:
|
·
|
Product costs as a percentage of sales increased by 3.4 percentage points for the three months ended October 27, 2012 as
compared to the three months ended October 29, 2011. This increase was due to an increase in product and shipping
promotional
offers during the second half of the three months ended October 27, 2012, partially offset by a $212,000 increase in
vendor
allowances
during the
three months
ended October
27, 2012
as compared to
the same
period in
the prior
year.
|
|
·
|
All other costs included in cost of sales, including buying costs, store occupancy, store depreciation, freight and distribution
center costs, decreased by $940,000 for the three months ended October 27, 2012 as compared to the three months ended October 29,
2011. This decrease was primarily attributable to lower occupancy and depreciation costs as a result of fewer stores, headcount
reductions resulting from streamlining the buying and merchandising departments and lower distribution center costs due to lower
sales and lower rent in the three months ended October 27, 2012 as compared to the same period in the prior year. As a percentage
of sales, these costs increased by 3.1 percentage points for the three months ended October 27, 2012 as compared to the same period
in the prior year. This percentage increase was due to lower sales during the three months ended October 27, 2012 as compared to
the same period in the prior year.
|
|
·
|
Other revenue decreased by $374,000 as described above, which had a negative impact on our gross margin.
|
Selling, General and Administrative Expenses
Selling, general and administrative expenses
for the three months ended October 27, 2012 decreased by $1,378,000 to $10,076,000, or 44.9% of sales, from $11,454,000, or 40.4%
of sales, for the three months ended October 29, 2011. This decrease is primarily attributable to the following:
|
·
|
Expenses related to corporate overhead decreased by $487,000 to $2,431,000 for the three months ended October 27, 2012 from
$2,918,000 for the same period in the prior year. This decrease was primarily due to lower salary and salary related expenses.
|
|
·
|
Store selling, general and administrative expenses decreased by $381,000 to $4,707,000 for the three months ended October 27,
2012 from $5,088,000 for the same period in the prior year. This decrease was primarily due to having fewer stores for the three
months ended October 27, 2012 as compared to the prior year and lower credit card fees of $91,000 resulting from reduced sales and interchange rates.
|
|
·
|
Direct selling, general and administrative expenses decreased by $687,000 to $2,721,000 for the three months ended October
27, 2012 from $3,408,000 for the same period in the prior year. This decrease was primarily due to a $888,000 decrease in catalog
and related expenses because fewer catalogs were mailed and lower credit card
fees of $70,000 resulting from reduced sales and interchange rates. This decrease was partially offset by a $306,000
increase in marketing expenses related to our strategy to increase our digital marketing initiatives.
|
These decreases were partially offset by
a $177,000 increase in brand marketing expenses to $217,000 for the three months ended October 27, 2012 as compared to $40,000
for the same period in the prior year. The increase was primarily due to an increase in public promotional events and complimentary
customer offerings.
Loss
on Abandonment
We
recorded a charge of $259,000 related to a portion of our Hollywood corporate office space that was vacated during the three months
ended October 27, 2012 and subleased to a third party. In addition, we recorded a charge of $262,000 related to a portion of our
Phoenix facility that housed our customer contact center. The customer contact center was outsourced to a third party during the
three months ended October 27, 2012.
Interest Expense, Net
For the three months ended October 27, 2012,
net interest expense was $531,000 as compared to $421,000 for the three months ended October 29, 2011. This increase resulted primarily
from higher borrowings under the Salus Facility (described below under “
Salus Credit and Security Agreement
”).
Income
Tax Provision
Our income tax provision for the three months
ended October 27, 2012 and October 29, 2011 primarily represents minimum and net worth taxes due in various states. Due to the
uncertainty of realization in future periods, no tax benefit has been recognized on the net losses for these periods. Accordingly,
a full valuation allowance has been established on the current loss and all net deferred tax assets existing at the end of the
period, excluding the deferred tax liability related to intangible assets, which have an indefinite life.
Liquidity and Capital Resources
Cash Used in Operations
Net cash used in operating activities for
the three months ended October 27, 2012 was $508,000, resulting primarily from the following:
|
·
|
net losses for the three months ended October 27, 2012
of
$5,087,000;
|
|
·
|
an increase in inventory of 895,000, which resulted from normal seasonal inventory fluctuations; and
|
|
·
|
an increase in prepaid expenses and other current assets of $623,000, which was primarily due to an increase in deferred catalog
costs in connection with our holiday brandzine.
|
These decreases in cash flow were partially
offset by the following:
|
·
|
an increase in accounts payable and other accrued expenses of $5,710,000, which resulted from higher inventory levels and slower
payments to vendors;
|
|
·
|
non-cash expenses of $507,000 for depreciation and amortization; and
|
|
·
|
a charge for the abandonment of leases
of $521,000.
|
Cash Used in Investing Activities
Net cash used
in investing activities for the three months ended
October 27, 2012
was $3,000.
Cash Provided by Financing Activities
Net cash provided by financing activities
for the three months ended October 27, 2012 was $188,000, which resulted primarily from net borrowings under the Salus Facility
of $198,000.
Salus Credit and Security Agreement
On May 31, 2012, we and our subsidiaries
(collectively, the “Borrowers”) entered into a Credit and Security Agreement (“Credit Agreement”) with
Salus Capital Partners, LLC (“Salus”), which provides the Borrowers with a $24,000,000 revolving line of credit through
May 31, 2015 (the “Salus Facility”).
The Salus Facility includes a “first
in last out” tranche (“FILO Advance”) of up to $9,000,000 that consists of the first advances made under the
Salus Facility and will be the last amounts repaid. The maximum amount of the FILO Advance and the total Salus Facility will be
reduced by certain mandatory and voluntary prepayments. The Borrowers may periodically borrow, repay in whole or in part, and reborrow
under the Salus Facility, except that amounts repaid on account of the FILO Advance may not be reborrowed. The actual amount of
credit available under the Salus Facility is determined using measurements based on the Borrowers’ receivables, inventory,
intellectual property and other measures.
The unpaid principal
of the FILO Advance bears interest, payable monthly, in arrears, at the 30-day LIBOR rate plus 11.5%, but not less than 12.0% regardless
of fluctuations in the LIBOR rate (12.0% at October 27, 2012). Up to 2.5% of the interest payable on the FILO Advance will be capitalized,
compounded and added to the unpaid amount of the obligations each month, will accrue interest at the rate applicable to the FILO
Advance and will be due and payable in cash upon the expiration or other termination of the Salus Facility.
At
October 27, 2012, $9,097,000 was outstanding under the FILO Advance.
The unpaid principal of advances other than
the FILO Advance bears interest, payable monthly, in arrears, at the Prime rate plus 4.0%, but not less than 7.0%, regardless of
fluctuations in the Prime rate (7.25% at October 27, 2012). At October 27, 2012, $7,554,000 of advances other than the FILO Advance
was outstanding.
The obligations of the Borrowers under the
Credit Agreement are secured by first priority security interests in all of the Borrowers’ tangible and intangible property,
including intellectual property such as trademarks and copyrights, as well as shares and membership interests of our subsidiaries.
The Credit Agreement provides for the Borrowers
to pay Salus an origination fee of $465,000, 50% of which was paid at the closing and 50% to be paid on the first anniversary of
the closing. The Credit Agreement also provides for certain customary fees to be paid to Salus, including: (i) a monthly fee on
the unused portion of the Salus Facility; (ii) a monthly collateral monitoring fee; and (iii) an annual FILO facility fee based
on the then-outstanding FILO Advance.
The Credit Agreement and other loan documents
contain customary representations and warranties, affirmative and negative covenants and events of default, including covenants
that restrict the Borrowers’ ability to create certain liens, make certain types of borrowings and investments, liquidate
or dissolve, engage in mergers, consolidations, significant asset sales and affiliate transactions, incur certain lease obligations,
pay cash dividends, redeem or repurchase outstanding equity and issue capital stock. In lieu of financial covenants, fixed charge
coverage and overall debt ratios, the Salus Facility has a $1.5 million minimum availability reserve requirement. At October 27,
2012, we were in compliance with the Salus Facility’s affirmative and restrictive covenants and minimum availability reserve
requirement.
Future Financing Requirements
As of October 27, 2012, our working capital
deficiency increased by $4,676,000 to $11,002,000 from $6,326,000 at July 28, 2012. As our business continues to be effected by
limited working capital, management plans to carefully manage working capital and believes that our projected operating cash flows,
together with the Salus Facility, will allow us to maintain sufficient working capital through fiscal year 2013. However, our ability
to achieve our fiscal year 2013 business plan is critical to maintaining adequate liquidity, and there can be no assurance that
we will be successful in our efforts. We are actively seeking to raise additional capital through public or private financings,
strategic relationships or other arrangements. There can be no assurance that we will be able to obtain additional financing on
acceptable terms, or at all. Our failure to achieve our fiscal year 2013 business plan or to raise sufficient capital could have
a material adverse effect on our business, results of operations and financial condition. We expect our capital expenditures for
fiscal year 2013 to be less than $1,000,000, primarily for improvements to our information technology systems, expenditures to
support our digital marketing initiatives, store refurbishment costs, and other general corporate expenditures.
Off Balance Sheet Arrangements
We are not a party to any material off-balance
sheet financing arrangements.
Effect
of New Accounting Standards
See Note 2, “
Summary of Significant
Accounting Policies
,” included in the notes to the consolidated unaudited financial statements appearing elsewhere in
this report for a discussion of recent accounting developments and their impact on our consolidated unaudited financial statements.
There has been no recently issued accounting updates that had a material impact on our consolidated unaudited financial statements
for the three months ended October 27, 2012 or are expected to have an impact in the future.
Seasonality
and Inflation
Our business experiences seasonal sales
patterns. Sales and earnings typically peak during the second and third fiscal quarters (November through April), primarily during
the holiday season in November and December, as well as the Valentine’s Day holiday in the month of February. As a result,
we maintain higher inventory levels during these peak selling periods.
Inflationary factors such as increases in
the cost of our products and overhead costs may adversely affect our operating results. Although we do not believe that inflation
has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may
have an adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expenses
as a percentage of net revenue if the selling prices of our products do not increase with these increased costs.
ITEM 3.
– QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest
Rate Risks
We are exposed to interest rate risk associated
with the Salus Facility.
Interest accrues on the outstanding borrowings under the Salus Facility
at rates per annum equal to (A) with respect to unpaid principal of advances other than the FILO Advance, (i) the Prime Rate plus
(ii) an applicable margin of 4.0%, but not less than 7.0% per annum regardless of fluctuations in the Prime Rate and (B) with respect
to unpaid principal of the FILO Advance, (i) the LIBOR Rate plus (ii) an applicable margin of 11.5%, but not less than 12.0% per
annum regardless of fluctuations in the LIBOR Rate.
Borrowings under the Salus Facility (excluding
the FILO advance) for the three months ended October 27, 2012 peaked at $8,959,000 and the average borrowing during the period
was approximately $8,255,000. As of October 27, 2012, the total amount outstanding under the Salus Facility (excluding the
FILO advance) was $7,554,000. An increase or decrease in the interest rate by 100 basis points from the total loan balance
of the Salus Facility (excluding the FILO advance) at October 27, 2012 would have increased or decreased annual interest expenses
by approximately $76,000. Borrowings under the FILO Advance for the three months ended October 27, 2012 peaked at $9,097,000
and the average borrowing during the period was approximately $9,077,000. As of October 27, 2012, the total amount outstanding
under the FILO Advance was $9,097,000. An increase or decrease in the interest rate by 100 basis points from the total loan
balance of the FILO Advance at October 27, 2012 would have increased or decreased annual interest expenses by approximately $91,000.
Foreign Currency Risks
We buy products from a significant number
of domestic vendors who enter into purchase obligations outside of the U.S. All of our product purchase orders are negotiated and
settled in U.S. dollars. Therefore, we have no exposure to foreign currency exchange risks. However, fluctuations in foreign currency
rates could have an impact on our future purchases.
ITEM 4. – CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls
and Procedures
Disclosure controls
and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in company
reports filed or submitted under the Securities Exchange Act of 1934 (“Exchange Act”) is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls
and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed
in company reports filed or submitted under the Exchange Act is accumulated and communicated to management, including our chief
executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.
As required by
Rules 13a-15 and 15d-15 under the Exchange Act, our chief executive officer and chief financial officer performed an evaluation
of the effectiveness of the design and operation of our disclosure controls and procedures as of October 27, 2012. Based upon their
evaluation, they concluded that our disclosure controls and procedures were effective.
Internal Control Over Financial
Reporting
Our internal control
over financial reporting is a process designed by, or under the supervision of, our chief executive officer and chief financial
officer and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability
of our financial reporting and the preparation of our financial statements for external purposes in accordance with generally accepted
accounting principles in the United States. Internal control over financial reporting includes policies and procedures that pertain
to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our
assets; provide reasonable assurance that transactions are recorded as necessary to permit preparation of our financial statements
in accordance with generally accepted accounting principles in the United States, and that our receipts and expenditures are being
made only in accordance with the authorization of our board of directors and management; and provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect
on our financial statements.
Changes in Internal Control Over
Financial Reporting
During the three
months ended October 27, 2012, there were no changes made in our internal control over financial reporting (as such term is defined
in Rule 13a-15(f) under the Exchange Act) that have materially effected, or are reasonably likely to materially effect, our internal
control over financial reporting.
|
PART II
|
OTHER INFORMATION
|
ITEM 1 – LEGAL PROCEEDINGS
On February 2, 2012, a former California
store employee filed a purported class action lawsuit in the California Superior Court, County of San Francisco, naming Frederick’s
of Hollywood, Inc., one of our subsidiaries, as a defendant (Michelle Weber, on behalf of herself and all others similarly situated
v. Frederick’s of Hollywood, Inc., Case No. CGC-12-517909). The complaint alleges, among other things, violations of the
California Labor Code, failure to pay overtime, failure to provide meal and rest periods and termination compensation and violations
of California’s Unfair Competition Law. The complaint seeks, among other relief, collective and class certification of the
lawsuit (the class being defined as all California retail store hourly employees), unspecified damages, costs and expenses, including
attorneys’ fees, and such other relief as the Court might find just and proper. We contest these allegations and deny any
liability with respect to the lawsuit. We answered the Plaintiff’s first amended complaint on April 2, 2012. The parties
agreed to stay discovery proceedings and have attended mediation, most recently on November 29, 2012, which has not concluded.
Therefore, we are unable to predict the likely outcome and whether such outcome may have a material adverse effect on our results
of operations or financial condition. Accordingly, no provision for a loss contingency has been accrued as of October 27, 2012.
We also are involved from time to time in
litigation incidental to our business. We believe that the outcome of such litigation will not have a material adverse effect on
our results of operations or financial condition.
ITEM 1A – RISK FACTORS
There are no material changes from the risk
factors set forth in the “Risk Factors” section of our Annual Report on Form 10-K filed with the SEC on October 26,
2012. Please refer to this section for disclosures regarding the risks and uncertainties in our business.
ITEM 6 – EXHIBITS
Exhibit No.
|
|
Description
|
|
|
|
31.1
|
|
Certification by Chief Executive Officer and Principal Executive Officer
|
|
|
|
31.2
|
|
Certification by Chief Financial Officer and Principal Accounting Officer
|
|
|
|
32
|
|
Section 1350 Certification
|
|
|
|
101
|
|
Financial statements from the Quarterly Report on Form 10-Q of the Company for the three months ended October 27, 2012, formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations (Unaudited), (iii) Consolidated Statements of Cash Flows (Unaudited) and (v) Notes to Consolidated Unaudited Financial Statements, as blocks of text and in detail.*
|
|
|
|
101.INS
|
|
XBRL Instance Document*
|
|
|
|
101.SCH
|
|
XBRL Taxonomy Extension Schema Document *
|
|
|
|
101.CAL
|
|
XBRL Taxonomy Extension Calculation Linkbase Document *
|
|
|
|
101.DEF
|
|
XBRL Taxonomy Extension Definition Linkbase Document *
|
|
|
|
101.LAB
|
|
XBRL Taxonomy Extension Label Linkbase Document*
|
|
|
|
101.PRE
|
|
XBRL Taxonomy Extension Presentation Linkbase Document *
|
|
*
|
As provided in Rule 406T of Regulation S-T, this information shall not be deemed “filed” for purposes of Section
11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934 or otherwise subject to liability
under those sections.
|
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 hereunto duly authorized.
|
FREDERICK’S OF HOLLYWOOD GROUP INC.
|
|
|
|
|
|
Date: December 11, 2012
|
By:
|
/s/ Thomas J. Lynch
|
|
|
|
THOMAS J. LYNCH
|
|
|
|
Chief Executive Officer and
|
|
|
|
Principal Executive Officer
|
|
|
|
|
|
Date: December 11, 2012
|
By:
|
/s/ Thomas Rende
|
|
|
|
THOMAS RENDE
|
|
|
|
Chief Financial Officer and
|
|
|
|
Principal Accounting Officer
|
|
Fredericks of Hollywood Grp. (AMEX:FOH)
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Fredericks of Hollywood Grp. (AMEX:FOH)
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