Summary of Significant Accounting Policies

ANN INC. (the “Company”) is a leading national specialty retailer of women’s apparel, shoes and accessories sold primarily under the “Ann Taylor” and “LOFT” brands. Its principal markets consist of the United States and Canada. The Company sells its products through traditional retail stores and on the Internet at www.anntaylor.com and www.LOFT.com (together, the “Websites”) or by phone at 1-800-DIAL-ANN and 1-888-LOFT-444.

Basis of Presentation

The Consolidated Financial Statements include the accounts of the Company and its subsidiaries, including its wholly-owned subsidiary, AnnTaylor, Inc. The Company has no material assets other than the common stock of AnnTaylor, Inc. and conducts no business other than the management of AnnTaylor, Inc. All intercompany accounts have been eliminated in consolidation.

Fiscal Year

The Company follows the standard fiscal year of the retail industry, which is a 52- or 53-week period ending on the Saturday closest to January 31. All fiscal years presented in these Consolidated Financial Statements include 52 weeks, except the fiscal year ended February 2, 2013, which includes 53 weeks.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to use estimates and assumptions that affect the reported amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting period. The significant estimates and assumptions used by management affect: revenue related to the Company’s credit card and gift card and merchandise credit programs; expense associated with stock-based compensation; the reserve for sales returns; the valuation of inventories; the expense associated with short- and long-term performance-based compensation; the carrying value of long-lived assets and the valuation of deferred income taxes. Actual results could differ from these estimates.

Revenue Recognition

The Company records revenue as merchandise is sold to clients. Sales from the Company’s Websites are recorded as merchandise is shipped to clients based on the date clients are expected to receive the merchandise. Amounts related to shipping and handling billed to clients in a sales transaction are classified as revenue and the costs related to shipping product to clients (billed and accrued) are classified as Cost of sales. A reserve for estimated returns is established when sales are recorded based upon an analysis of actual historical returns and current sales and gross margin rate performance. The Company excludes sales taxes collected from clients from “Net sales” in its Consolidated Statements of Operations.

The following table sets forth certain product-level sales information for the past three fiscal years:



	Fiscal Year Ended
	February 1, 2014				February 2, 2013				January 28, 2012
	Sales		% of Sales		Sales		% of Sales		Sales		% of Sales
	($ in thousands)
Apparel	$	2,244,618	90	%	$	2,146,173	90	%	$	2,000,875	90	%
Accessories	164,897		7	%	157,852		7	%	153,088		7	%
Shoes	44,536		2	%	44,331		2	%	39,894		2	%
Other	39,440		1	%	27,153		1	%	18,636		1	%
Total	$	2,493,491	100	%	$	2,375,509	100	%	$	2,212,493	100	%

Gift cards and merchandise credits issued by the Company do not have expiration dates and the Company honors all gift cards and merchandise credits presented by clients, regardless of the length of time that passes from issuance to redemption. The Company records a liability for unredeemed gift cards and merchandise credits at the time gift cards are sold or merchandise credits are issued. The Company recognizes revenue and relieves the corresponding gift card and/or merchandise credit liability when the cards are redeemed by clients.

1. Summary of Significant Accounting Policies (Continued)

Revenue Recognition (continued)

In cases where the Company has determined that it has a legal obligation to remit the value of unredeemed gift cards and merchandise credits to any state, the value of these cards is escheated to the appropriate state in accordance with that state’s unclaimed property laws. In certain jurisdictions, the Company is permitted to retain a portion of the escheated value of unredeemed gift cards and merchandise credits, which is immaterial and is recorded in “Net sales” in the Company’s Consolidated Statements of Operations.

The Company recognized $2.1 million and $6.6 million in revenue during Fiscal 2013 and Fiscal 2012, respectively, for a portion of the unredeemed value of gift cards and merchandise credits where the Company has determined that, under applicable state unclaimed property laws, there is no legal obligation to escheat these amounts to such states and the likelihood of redemption is considered remote. Fiscal 2012 was the first period during which the Company recognized gift card and merchandise credit “breakage,” and therefore included the breakage income related to gift cards sold and merchandise credits issued since inception of these programs. Such gift card and merchandise credit “breakage” is estimated based upon an analysis of actual historical redemption patterns and is included in Net sales.

The Company has a credit card program that offers eligible clients in the United States the choice of a private label or co-branded credit card. All cardholders are automatically enrolled in the exclusive rewards program, which is designed to recognize and promote client loyalty. The Company provides the sponsoring bank with marketing support of the program, and uses our sales force to process credit card applications for both the private label and co-branded credit cards. On December 2, 2013, the Company entered into an eight-year agreement with the sponsoring bank, which amended and restated the original agreement that began in October 2008. As with the original agreement, the Company received an upfront signing bonus from the sponsoring bank and also receives ongoing payments for new accounts activated as well as a share of finance charges collected by the sponsoring bank. These revenue streams are accounted for as a single unit of accounting and accordingly, are recognized as revenue ratably based on the total projected revenues over the term of the agreement.

Certain judgments and estimates underlie the Company’s projected revenues and related expenses under the credit card program, including projected future store counts, the number of applications processed, the Company’s projected sales growth and points breakage, among other things. During Fiscal 2013, Fiscal 2012 and Fiscal 2011, the Company recognized approximately $18.8 million, $17.8 million, and $16.5 million of revenue related to the credit card program, respectively. Partially offsetting this credit card program revenue are costs, net of points breakage, related to the client loyalty program. These costs are included in either “Cost of sales” or in “Net sales” as a sales discount, as appropriate. The cost of sales impact, net of points breakage, was approximately $5.2 million, $5.7 million and $3.8 million and the sales discount impact was approximately $6.8 million, $6.8 million and $5.5 million in Fiscal 2013, Fiscal 2012 and Fiscal 2011, respectively.

1. Summary of Significant Accounting Policies (Continued)

Cost of Sales and Selling, General and Administrative Expenses

The following table illustrates the primary costs classified in each major expense category:



	Cost of Sales		Selling, General and Administrative Expenses
Ÿ	Cost of merchandise sold;	Ÿ	Payroll, bonus and benefit costs for retail and corporate associates;
Ÿ	Costs associated with the Company’s sourcing operations;	Ÿ	Design and merchandising costs;
Ÿ	Freight costs associated with moving merchandise from suppliers to the Company’s distribution center;	Ÿ	Occupancy costs for retail and corporate facilities;
Ÿ	Costs associated with the movement of merchandise through customs;	Ÿ	Depreciation related to retail and corporate assets;
Ÿ	Costs associated with the fulfillment and shipment of client orders from the Company’s Websites, including omni-channel sales;	Ÿ	Advertising and marketing costs;
Ÿ	Depreciation related to merchandise management systems;	Ÿ	Occupancy and other costs associated with operating the Company’s distribution center;
Ÿ	Sample development costs;	Ÿ	Freight expenses associated with moving merchandise from the Company’s distribution center to its retail stores or from store to store; and
Ÿ	Direct costs of the credit card client loyalty program;	Ÿ	Legal, finance, information systems and other corporate overhead costs.
Ÿ	Merchandise shortage; and
Ÿ	Client shipping costs for store merchandise shipments.

Cash and Cash Equivalents

Cash and short-term highly liquid investments with original maturity dates of three months or less at time of purchase and no redemption restrictions are considered cash and cash equivalents. The Company has significant amounts of cash and cash equivalents invested in deposit accounts at FDIC-insured financial institutions that are currently in excess of federally insured limits. The Company continually evaluates its deposit investment options in accordance with its corporate investment policy and certain restrictions on permitted investments in the revolving credit facility.

Merchandise Inventories

Merchandise inventories are valued at the lower of average cost or market, at the individual item level. A reserve is established when the current selling price or future estimated selling price is less than cost. Physical inventory counts are performed annually in January, and estimates are made for shortage between the date of the physical inventory count and the balance sheet date.

Property and Equipment

Property and equipment are presented at cost less accumulated depreciation and amortization. Depreciation and amortization are computed on a straight-line basis over the following estimated useful lives:



Building	40 years
Leasehold improvements	10 years or term of lease, if shorter
Furniture, fixtures and equipment	2-10 years
Software	5 years

1. Summary of Significant Accounting Policies (Continued)

Property and Equipment (continued)

When assets are sold or retired, the related cost and accumulated depreciation are removed from their respective accounts and any resulting gain or loss is recorded to “Selling, general and administrative expenses” in the Company’s Consolidated Statements of Operations. Expenditures for maintenance and repairs which do not improve or extend the useful lives of the respective assets are expensed as incurred.

Store Pre-Opening Costs

Non-capital expenditures, such as rent, advertising and payroll costs incurred prior to the opening of a new store are charged to expense in the period they are incurred.

Internal-Use Software Development Costs

The Company capitalizes certain external and internal computer software and software development costs incurred during the application development stage. The application development stage generally includes software design and configuration, coding, testing and installation activities. Capitalized costs include only external direct cost of materials and services consumed in developing or obtaining internal-use software, and payroll and payroll-related costs for employees who are directly associated with and devote time to the internal-use software project. Capitalization of such costs ceases no later than the point at which the project is substantially complete and ready for its intended use. Training and maintenance costs are expensed as incurred, while upgrades and enhancements are capitalized if it is probable that such expenditures will result in additional functionality. Capitalized software costs are depreciated on a straight-line basis over five years.

Deferred Rent Obligations

Rent expense under non-cancelable operating leases with scheduled rent increases or free rent periods is accounted for on a straight-line basis over the initial lease term beginning on the date of initial possession, which is generally when the Company has access to the space and begins construction build-out. Any reasonably assured renewals are considered. The amount of the excess of straight-line rent expense over scheduled payments is recorded as a deferred liability. Construction allowances and other such lease incentives are recorded as deferred credits and are amortized on a straight-line basis as a reduction of rent expense beginning in the period they are deemed to be earned, which often is subsequent to the date of initial possession and generally coincides with the store opening date. The current portion of unamortized deferred lease costs and construction allowances is included in “Accrued tenancy” and the long-term portion is included in “Deferred lease costs” on the Company’s Consolidated Balance Sheets.

Lease Termination Costs

The Company recognizes contractual penalties associated with lease terminations on an undiscounted basis at the time notification to terminate the lease is provided to the lessor.

Long-Lived Assets

Long-lived assets are reviewed periodically for impairment or when events or changes in circumstances indicate that full recoverability of net asset balances through future cash flows is in question. Assessment for possible impairment is based on the Company’s ability to recover the carrying value of the long-lived asset from the expected future pre-tax cash flows at a store level (undiscounted and without interest charges). The expected future pre-tax cash flows are estimated based on historical experience, knowledge and market data. Estimates of future cash flows require the Company to make assumptions and to apply judgment, including forecasting future sales and expenses and estimating the useful lives of assets. These estimates can be affected by factors such as, but not necessarily limited to, future store results, real estate demand, and economic conditions that can be difficult to predict. If the expected future cash flows related to the long-lived assets are less than the assets’ carrying value, an impairment charge is recognized for the difference between estimated fair value and carrying value. There were no material impairment charges in Fiscal 2013, Fiscal 2012 or Fiscal 2011.

1. Summary of Significant Accounting Policies (Continued)

Advertising

Costs associated with the production of advertising, such as print and other costs, as well as costs associated with communicating advertising that has been produced, such as magazine ads, are expensed when the advertising first appears in public. Costs of direct mail catalogs and postcards are fully expensed when the advertising is scheduled to first arrive in clients’ homes. Advertising costs were approximately $110.2 million, $96.2 million and $88.4 million in Fiscal 2013, Fiscal 2012 and Fiscal 2011, respectively.

Stock-based Awards

The Company estimates the fair value of non-qualified stock options on the date of grant using the Black-Scholes option pricing model. The fair value of restricted stock awards is determined using the closing price of the Company’s common stock on the date of grant. Performance-based awards are generally subject to annual vesting based on the achievement of seasonal performance targets. The Company recognizes stock-based compensation expense over the requisite service period, which is generally the vesting period, adjusted for estimated forfeitures, and for performance-based awards, based on the estimated achievement of seasonal performance targets. The Company estimates forfeitures based on an analysis of historical stock-based forfeiture rates, as well as current and future trends of expected behavior.

Long-Term Performance Compensation Expense

The Company recognizes the compensation cost associated with its Restricted Cash Program (“RCP”) over the mandatory service period, adjusted for estimated forfeitures. The service period includes the fiscal year in which amounts earned under the program are banked, plus a mandatory three-year deferral period. The calculation of long-term performance compensation expense related to the RCP requires the input of subjective assumptions, including the expected forfeiture of earned and banked awards and forecasts of the Company’s future income growth. The Company estimates forfeitures based on historical RCP forfeiture patterns, as well as current and future trends of expected behavior, and estimates future income growth based on past performance, future business trends and new business initiatives.

Income Taxes

The Company accounts for income taxes in accordance with the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized based on the differences between the financial statement carrying value of existing assets and liabilities and their respective tax bases. A valuation allowance is established for deferred tax assets when management anticipates that it is more likely than not that all, or a portion of these assets would not be realized. In determining the need for a valuation allowance, management is required to make assumptions and to apply judgment, including forecasting future earnings, taxable income, and the mix of earnings in the jurisdictions in which the Company operates.

The tax effects of uncertain tax positions taken or expected to be taken in income tax returns are recognized only if they are “more likely-than-not” to be sustained on examination by the taxing authorities, based on the technical merits as of the reporting date. The tax benefits recognized in the financial statements from such positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. The Company recognizes estimated accrued interest and penalties related to uncertain tax positions in income tax expense.

The Company and its domestic subsidiaries file a consolidated Federal income tax return, while the Company’s foreign subsidiaries file in their respective local jurisdictions.

Segments

The Company has determined that it has four operating segments: Ann Taylor, LOFT, Ann Taylor Factory and LOFT Outlet. The Company evaluates whether two or more operating segments may be aggregated into a single operating segment based on whether or not the segments have similar economic characteristics, similar product, similar production processes, similar clients and similar methods of distribution.

1. Summary of Significant Accounting Policies (Continued)

Segments (continued)

The Company’s four operating segments are similar in nature of product, as they all operate in the women’s specialty retail sector, offering women’s apparel, shoes and accessories sold primarily under the Ann Taylor and LOFT brand names. The Company’s four operating segments have similar clients with a significant percentage of clients cross-shopping the Company’s other operating segments. The merchandise offered at each operating segment is also sourced from the same countries and many of the same vendors, using similar production processes. Merchandise for the Company’s operating segments is distributed to retail stores in a similar manner, primarily through the Company’s Louisville Distribution Center, and is subsequently distributed to clients in a similar manner, through its retail and outlet stores. The Company’s Ann Taylor and LOFT operating segments also sell merchandise through the Company’s Websites.

As such, the Company has concluded that its operating segments have similar economic characteristics and meet the criteria for aggregation into a single reportable segment.

Fair Value of Financial Instruments

The Company determines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company uses a hierarchical structure to prioritize the inputs used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1), then to quoted market prices for similar assets or liabilities in active or inactive markets (Level 2) and gives the lowest priority to unobservable inputs (Level 3).

The Company did not have any non-financial assets or non-financial liabilities recognized at fair value on a recurring basis at February 1, 2014 or February 2, 2013.

Self-Insurance

The Company is self-insured for certain losses related to its employee point of service medical plan, its workers’ compensation plan, general liability and for short-term and long-term disability, up to certain thresholds. Costs for self-insurance claims filed, as well as claims incurred but not reported, are accrued based on estimates using information received from plan administrators, third-party actuaries, historical analysis and other relevant data. Management believes that it has adequately reserved for its self-insurance liability, which is capped through the use of stop loss contracts with insurance companies. Any significant variation from historical trends in claims incurred but not paid could cause actual expense to differ from the accrued liability.

Foreign Currency Translation

Balance Sheet accounts of the Company’s Canadian operations are translated at the exchange rate in effect at the end of each period. Statement of Operations accounts are translated using the weighted average of the prevailing exchange rates during each period. Gains or losses resulting from foreign currency transactions are included in the Company’s Consolidated Statements of Operations under the caption “Other non-operating expense, net” whereas, translation adjustments are reflected in the Consolidated Statements of Comprehensive Income under the caption “Foreign currency translation adjustment.”

Immaterial Correction of Statements of Cash Flows

As previously discussed in Revenue Recognition, the Company recognized $6.6 million in revenue for a portion of the unredeemed value of gift cards and merchandise credits during Fiscal 2012. Subsequent to the issuance of its Fiscal 2012 consolidated financial statements, the Company determined that this amount was incorrectly reported as an increase, rather than a reduction, in the reconciliation of Net income to Net cash provided by operating activities. This correction also impacted the line item “Accounts payable, accrued expenses and other current liabilities” in the changes in assets and liabilities section of net cash provided by operating activities, but had no impact on total Net cash provided by operating activities. The Company has restated the previously presented Consolidated Statement of Cash Flows for Fiscal 2012 to present “Recognition of gift card and merchandise credit breakage” as a reduction to reconcile net income to net cash provided by operating activities and properly state the change in “Accounts payable, accrued expenses and other current liabilities” as an increase of $5.6 million (previously reported as a reduction of $7.6 million).

Recent Accounting Pronouncements

There were no new accounting pronouncements that the Company expects to have a material impact on its financial condition or results of operations in future periods.