Summary of Significant Accounting Policies

Basis of Presentation

The information set forth in these condensed consolidated financial statements as of and for the 13 and 39 weeks ended November 1, 2014, and November 2, 2013 (collectively, the “Interim Financial Statements”), is unaudited. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information. Certain information and footnote disclosures normally included in The Wet Seal, Inc. (the “Company”) annual consolidated financial statements have been condensed or omitted, as permitted under applicable rules and regulations. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended February 1, 2014. All references in this Quarterly Report on Form 10-Q to “fiscal 2013” and “fiscal 2014” mean the fiscal years ended February 1, 2014 and ending January 31, 2015, respectively.

In the opinion of management, the Interim Financial Statements reflect all adjustments that are of a normal and recurring nature necessary to fairly present the Company’s financial position and results of operations and cash flows in all material respects as of the dates and for the periods presented. The results of operations presented in the Interim Financial Statements are not necessarily indicative of the results that may be expected for the fiscal year ending January 31, 2015.

On April 24, 2014, the Company committed to a plan to wind down the operations of its Arden B brand due to the long-term financial under-performance of the business. The Company evaluated the applicable accounting guidance for discontinued operations due to the wind down of the Arden B operations and concluded that the Arden B segment should be reported as discontinued operations. Arden B cash flows have ceased as of November 1, 2014, the end of the third quarter. The Company will not have any significant continuing involvement with the Arden B segment, and therefore, the Arden B segment has met the conditions to be reported as a discontinued operation beginning in the third quarter of fiscal 2014. Refer to Note 2, "Discontinued Operations."

In fiscal 2013 and the 39 weeks ended November 1, 2014, the Company incurred net losses of $38.4 million and $79.7 million and negative cash flow from operations of $17.6 million and $40.0 million, respectively. As of November 1, 2014, the Company had cash and cash equivalents of $19.1 million compared to cash and cash equivalents of $38.8 million at February 1, 2014. For the three fiscal quarters ended November 1, 2014, the Company has experienced comparable store sales and gross margin performance that were worse than expected entering fiscal 2014, and a number of factors continue to negatively impact the Company and the retail fashion apparel industry in which it does business. The Company expects to report net losses and negative cash flow from operations through at least the fourth quarter of fiscal 2014, and may also incur significant net losses and negative cash flows beyond the fourth quarter. The Company’s negative cash flows from operations have adversely impacted the Company’s cash and liquidity reserves. Concerns about the Company’s financial condition have adversely impacted the terms the Company can obtain from some of its vendors, and some of its vendors and their factors are unwilling to continue to extend credit to the Company or otherwise now require that the Company obtain letters of credit or other forms of credit support. The Company has issued letters of credit as collateral to certain vendors and factors that provide financial support to certain vendors and may issue additional letters of credit, and these letters of credit have utilized, and may further utilize, a significant amount of the borrowing capacity under the Company’s senior revolving credit facility and reduce the amount of available borrowing capacity for general corporate and other purposes. As of the date of this filing, the total amount of our outstanding letters of credit has more than doubled since the end of our second fiscal quarter, increasing by approximately $6.9 million. The Company has also received notice from The NASDAQ OMX Group ("Nasdaq") indicating that the bid price of its common stock for the 30 consecutive business days ended August 15, 2014 had closed below the minimum $1.00 per share required for continued listing under Nasdaq listing rules, which could result in Nasdaq de-listing the Company’s common stock if not cured within a 180-day period, subject to additional applicable grace periods for which the Company may be eligible. If the Company’s common stock is not listed on the Nasdaq Global Select Market, the Nasdaq Global Market, the Nasdaq Capital Market or other eligible market, it would result in an event of default under the Company’s senior convertible note, which event of default would also result in a default under our senior revolving credit facility, whereupon the holder under the Company’s senior convertible note and the lender under the Company’s senior revolving credit facility could accelerate the indebtedness under such note and facility.

In an effort to address the Company’s immediate liquidity needs, the Company is, with the assistance of its strategic advisors, exploring various potential strategic and financial alternatives and is engaged in discussions with third parties, as well as key financial stakeholders, including lenders, stockholders, landlords and others. Such strategic and financial alternatives include, among other things, consideration of out-of-court restructurings as well as bankruptcy court proceedings to recapitalize or restructure the Company’s indebtedness and other obligations. With the assistance of its advisors, the Company is attempting to raise new additional capital in the very near term to address its immediate liquidity needs. As of the date of this filing, the Company is evaluating its ability to successfully raise equity capital pursuant to its previously announced contemplated private placement and rights offering in light of its financial condition and immediate liquidity needs, the terms and conditions of such contemplated transactions and the related risks and uncertainties concerning such transactions. As a result of this evaluation, such transactions have been delayed and even if completed, we expect that such transactions will not close in the current fiscal year. Additionally, a number of factors may cause delays or difficulties with such transactions and the closings of such transactions are subject to conditions, some of which are outside of the Company’s control. Accordingly, no assurances can be given that these contemplated transactions will close. Furthermore, in order to address its immediate liquidity needs, the Company believes it needs to raise new additional capital in the form of equity and/or debt in the very near term.

The Company has taken steps to reduce its costs, including reducing overhead costs. In this regard, in October 2014 the Company announced a workforce reduction resulting in the elimination of 78 filled and open positions and continues to evaluate how it can further rationalize the total number of its employees given its anticipated revenues, number of stores and organizational structure. Further, the Company is seeking ways it can reduce the number of its stores and is engaging in discussions with landlords seeking concessions from such landlords in the form of reduced monthly rent or suspended rental payments in an effort to reduce its rental obligations. In addition to these actions, the Company anticipates that it will critically evaluate any leases which by their terms expire in the near term and it anticipates not renewing the vast majority of such leases.

In November 2014, the Company entered into a commitment letter with the agent and the lender under its existing senior secured revolving credit facility which would, subject to the conditions set forth therein, among other things, extend the maturity date of the facility to the fifth anniversary of the closing date of the amendment and increase certain advance rates used to determine the borrowing base under the revolving credit facility. In addition, the Company entered into a commitment letter with a third party lender, pursuant to which the potential lender, subject to the conditions set forth therein, committed to provide the Company with a $10.0 million term loan secured by all of its assets, which loan would constitute a use of the incremental facility included in the Company’s senior revolving credit facility.

As of the date of this filing, the discussions and efforts described above have not resulted in a strategic or financial transaction, a recapitalization, a restructuring or the raising of new additional capital, and no assurances can be given that such discussions and efforts will successfully result in a transaction, recapitalization, restructuring or the raising of new additional capital, or if a transaction, recapitalization or restructuring is undertaken, or if new capital is raised, as to its terms or timing. Uncertainty exists as to the outcome of the efforts and discussions described above and a number of factors could impact the outcome of such efforts and discussions and cause the Company’s actual results to differ from its expectations. Concerns of vendors, landlords, employees, potential financing sources and others about the Company’s financial condition may make it more difficult for the Company to succeed in its efforts to address its immediate liquidity needs in the very near term. If the Company continues to experience negative cash flows from operations, the Company would deplete its cash reserves and working capital in the very near term and require other sources of financing to fund its operations, which sources might not be available, or if available, may not be on terms acceptable to the Company. If the Company is unsuccessful in the very near term in its efforts to address its immediate liquidity needs or otherwise experiences delays and difficulties in such efforts, the Company’s business, liquidity and financial condition would be materially and adversely affected and the Company may deem it advisable to seek a restructuring or other relief under the provisions of the U.S. Bankruptcy Code, which could lead to a significant and possibly total loss of investment for holders of the Company’s Class A common stock.

Each of the above factors, or a combination thereof, reflect risks and uncertainties that raise substantial doubt about the Company’s ability to continue as a going concern.

Significant Accounting Policies

Long-Lived Assets

The Company evaluates the carrying value of long-lived assets for impairment quarterly or whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Factors that are considered important that could result in the necessity to perform an impairment review include a current-period operating or cash flow loss combined with a history of operating or cash flow losses and a projection or forecast that indicates continuing losses or insufficient income associated with the realization of a long-lived asset or asset group. Other factors include a significant change in the manner of the use of the asset or a significant negative industry or economic trend. This evaluation is performed based on estimated undiscounted future cash flows from operating activities compared with the carrying value of the related assets. If the estimated undiscounted future cash flows are less than the carrying value, an impairment loss is recognized, measured by the difference between the carrying value and the estimated fair value of the assets, based on discounted estimated future cash flows using the Company’s weighted average cost of capital. With regard to store assets, which are comprised of leasehold improvements, fixtures and computer hardware and software, the Company considers the assets at each individual store to represent an asset group. In addition, the Company has considered the relevant valuation techniques that could be applied without undue cost and effort and has determined that the discounted estimated future cash flow approach provides the most relevant and reliable means by which to determine fair value in this circumstance.

The Company conducts its quarterly impairment evaluation at the individual store level using the guidance under applicable accounting standards. The quarterly analysis includes the Company's estimates of future cash flows using only the cash inflows and outflows that are directly related to each store over the remaining lease term. Key assumptions made by the Company and included within the cash flow estimates are future sales and gross margin projections. The Company determines the future sales and gross margin projections by considering each store's recent and historical performance, the Company's overall performance trends and projections and the potential impact of strategic initiatives on future performance.

The Company's evaluations during the 13 and 39 weeks ended November 1, 2014, and November 2, 2013 included impairment testing of 67, 147, 38 and 55 stores and resulted in 53, 133, 22 and 28 stores being impaired, respectively, as their projected future cash flows were not sufficient to recover the net carrying value of their assets. Due to the Company's wind down of the Arden B brand, during the quarter ended May 3, 2014, it tested all Arden B stores with carrying value and the corporate assets associated with the Arden B website, which was also impaired as of May 3, 2014.

The Company recorded the following non-cash charges within asset impairment in the condensed consolidated statements of operations to write down the carrying values of impaired stores' long-lived assets to their estimated fair values (in thousands except for number of stores):



	13 Weeks Ended				39 Weeks Ended
	November 1, 2014		November 2, 2013		November 1, 2014		November 2, 2013
Aggregate carrying value of all long-lived assets impaired	$	12,586	$	5,418	$	29,738	$	7,054
Less: Impairment charges - stores	12,586		4,761		29,324		6,156
Aggregate fair value of all long-lived assets impaired	$	—	$	657	$	414	$	898
Number of stores with asset impairment	53		22		133		28

Of the 14 stores that were tested and determined not to be impaired during the 13 weeks ended November 1, 2014, 10 could be deemed to be at risk of future impairment. When making this determination, the Company considered the potential impact that reasonably possible changes to sales and gross margin performance versus the Company's current projections for these stores could have on their current estimated cash flows.

As noted above, the Company considers the potential impact expected from its strategic initiatives when determining the key assumptions to use within the projected cash flows for each store during its quarterly analysis. If the Company is not able to achieve its projected key financial metrics, and the strategic initiatives being implemented do not result in significant improvements in the Company's current financial performance trend, the Company may incur additional impairment in the future for those stores and corporate assets tested and not deemed to be impaired in its most recent quarterly analysis, as well as for additional stores not tested in its most recent quarterly analysis. In addition, we evaluated the corporate assets for 13 weeks ended November 1, 2014, noting no corporate asset impairments were required. Refer to Note 2, "Discontinued Operations."

Capitalized interest included in equipment and leasehold improvements, net, totaled less than $0.1 million during the 13 and 39 weeks ended November 1, 2014.

Discontinued Operations

The Company evaluated the applicable accounting guidance for discontinued operations due to the wind down of the Arden B operations and concluded that the Arden B segment should be reported as discontinued operations. Refer to Note 2, "Discontinued Operations."

Warrants for Common Stock and Embedded Derivatives

The Company’s common stock warrants and embedded derivatives have been bifurcated from the debt host and are classified as liabilities on the condensed consolidated balance sheet. The Company records the warrants and embedded derivatives liabilities at fair value and adjusts the carrying values to their estimated fair value at each reporting date, with the increases or decreases in the fair values at each reporting date recorded as a gain or (loss) in the condensed consolidated statements of operations. Refer to Note 5, "Senior Convertible Note and Warrants" and Note 6, "Fair Value Measurements and Disclosures."

Income Taxes

The Company accounts for income taxes in accordance with applicable accounting standards which require that the Company recognize deferred tax assets, which include net operating loss carryforwards (NOLs) and tax credits, and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities, using enacted tax rates in effect in the years the differences are expected to reverse. Deferred income tax expense or benefit results from the change in net deferred tax assets or deferred tax liabilities. Such guidance requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. Due to the Company's three-year cumulative operating losses, the Company established a valuation allowance against all of its deferred tax assets in fiscal 2012. In addition, the Company discontinued recording income tax benefits in the condensed consolidated statements of operations. The Company will not record income tax benefits until it is determined that it is more likely than not that the Company will generate sufficient taxable income to realize the deferred income tax assets. The Company remains in a cumulative three-year operating loss position and realization of its deferred income tax assets is not deemed to be more likely than not. Prospectively, as the Company continues to evaluate available evidence, it is possible that the Company may deem some or all of its deferred income tax assets to be realizable.

The Company has approximately $165.6 million of federal NOLs available to offset taxable income in fiscal 2014 and thereafter, subject to certain annual limitations based on the provisions of Section 382 of the Internal Revenue Code. It is possible that future financings, if completed, may result in additional ownership changes for purposes of Section 382, which could significantly impair the Company's ability to utilize the NOL. The Company's effective tax rates from continuing operations for the 13 and 39 weeks ended November 1, 2014, were approximately negative 0.2% and negative 0.3%, respectively, despite its net loss. These effective rates are due to certain state income taxes for fiscal 2014 that are not based on consolidated net income. The Company expects a negative 0.3% effective income tax rate for fiscal 2014, although a number of factors could cause its actual effective tax rate for fiscal 2014 to differ.

Other Comprehensive Income

Other comprehensive income refers to gains and losses that are recorded as an element of stockholders' equity but are excluded from net loss. Employers are required to recognize the over or under funded status of defined benefit plans and other postretirement plans in the statement of financial position and to recognize changes in the funded status in the year in which the changes occur through comprehensive (loss) income. Accumulated other comprehensive (loss) income in the condensed consolidated balance sheets as of November 1, 2014 is zero, due to the settlement of the Company’s supplemental employee retirement plan liability. Refer to Note 3, Stock-Based Compensation and Supplemental Employee Retirement Plan.

Business Segment

GAAP has established guidance for reporting information about a company's operating segments, including disclosures related to a company's products and services, geographic areas and major customers. As of November 1, 2014, the Company has a single operating and reportable segment, which includes net sales generated from its retail stores and e-commerce website.

Recent Accounting Pronouncements

In April 2014, the Financial Accounting Standards Board ("FASB") issued amended guidance on the presentation of financial statements and reporting discontinued operations and disclosures of disposals of components of an entity within property, plant and equipment. This guidance amends the definition of a discontinued operation and requires entities to disclose additional information about disposal transactions that do not meet the discontinued-operations criteria. The effective date is for disposals that occur in annual periods (and interim periods therein) beginning on or after December 15, 2014. Early adoption is permitted. As discussed under "Basis of Presentation" above, the Company evaluated its wind down of the Arden B brand under the existing discontinued operations guidance and did not elect early adoption of this amended guidance.

In May 2014, the FASB issued a new accounting standard which amends the existing accounting standards for revenue recognition. This new standard is based on principles that govern the recognition of revenue at an amount to which an entity expects to be entitled when products are transferred to customers. The Company is required to adopt this new standard for annual and interim periods beginning after December 15, 2016. Early adoption is not permitted. The new revenue accounting standard may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption. Based on the Company’s evaluation of this standard, adoption is not expected to have a material impact on the Company’s consolidated financial statements.

In June 2014, the FASB issued a new stock compensation accounting standard, which requires an entity to treat a performance target that affects vesting and that could be achieved after the requisite service period as a performance condition. Under this new standard, the performance target should not be reflected in estimating the grant-date fair value of the award, and compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved, and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered; if the performance target becomes probable of being achieved before the end of the requisite service period, then the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest, and should be adjusted to reflect those awards that ultimately vest. The Company is required to adopt this new standard for annual and interim periods beginning after December 15, 2015. The Company does not expect the adoption of this new standard to have a material impact on its consolidated financial statements.

In August 2014, the FASB issued a new accounting standard which requires management to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern for each annual and interim reporting period. If substantial doubt exists, additional disclosure is required. This new standard will be effective for the Company for annual and interim periods beginning after December 15, 2016. Early adoption is permitted. The Company expects to adopt this new standard for the fiscal year ending February 3, 2018 and the Company will continue to assess the impact on its consolidated financial statements.

In November 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update 2014-16, Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity (a consensus of the FASB Emerging Issues Task Force). This update does not change the current criteria in GAAP for determining when separation of certain embedded derivative features in a hybrid financial instrument is required, but clarifies how current GAAP should be interpreted in the evaluation of the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share, reducing existing diversity in practice. The Company is evaluating this update to determine if this guidance will have a material impact on the Company’s condensed consolidated financial statements.