Can the Golden State of Mind Take Hold? PacSun’s First Quarter

Though PacSun still reported a loss in the quarter ended May 3, the income statement improved compared to the same quarter last year. Sales were up 2.9% from $166.4 to $171.1 million. The increase was the result of comparable store sales being up 3% compared to last year’s quarter. The average sales transaction was up 6%, though the number of transactions was down 3%. Ecommerce sales during the quarter grew 6% compared to last year’s quarter and represented 7% of total sales.

The store count was down to 618 from 638 a year ago. They expect to open four stores during the remainder of the year and close another 10 to 20.

 The gross profit margin rose from 25.1% to 26.1%. The merchandise margin rose 1.4% but increases in other costs left Pacsun with a net gain of 1%.
Selling, general and administrative expenses fell slightly from $52.8 to $52 million. As a percentage of sales they were down from 31.7% to 30.4%.
Higher sales and gross margin combined with unchanged SG&A expense meant that the operating loss fell 33% from $11 to $7.4 million. The net loss was $10.4 million, down from $24.2 million in last year’s quarter.
In between operating income and net income is the dreaded “(Gain) loss on derivative liability” which is related to the 1,000 shares of convertible series B preferred stock issued to Golden Gate Capital as part of a $60 million term loan they got a couple of years ago. In last year’s quarter, it was reported as a loss of $9.3 million. This year’s quarter showed a gain of $1.2 million. That’s a cumulative difference of $10.5 million before the impact on income taxes.
I imagine most of you will be both thrilled and relieved to learn that I am not going to spend time discussing how those numbers are calculated. Feel free to review footnote 10 of the 10Q here if you just can’t stand not to know.

What I like about the balance sheet is that inventory is down from $103.7 to $95.9 million even with increased sales. It was down 5% on a comparable store basis. I’m hoping that good inventory management has something to do with an increasing merchandise margin and the sales growth.
What I don’t like to see is that shareholders’ equity has fallen from $40.8 to $8.1 million. Even without much change on the liability side of the balance sheet from a year ago, that means the total liabilities to equity ratio has spiked from 6.1 times to 33.1 times. There is some good news on the cash flow, where we see that cash used in operating activities has fallen from $29.7 million to $4.7 million. That really needs to turn into a positive number.
In the conference call, CEO Gary Schoenfeld reminds us of Pacsun’s four “strategic imperatives.” They are:
“Creating a covenant brand portfolio with the best of the best brands, becoming a leader in anticipating and recognizing fashion trends, integrating the Golden State of Mind brand positioning in all customer test points and building a top talent organization across the country.”
Of those four, three are more or less what all their competitors would say. It’s the golden state of mind brand positioning that has my attention. I like the concept and how they are implementing it so far, but I need to clarify what I mean.
It doesn’t matter if it’s a compelling idea to me or not; I’m not the target customer. That’s too bad for me, but probably a big break for Pacsun.
I like it because it means somebody at Pacsun (I’ll hazard a guess- Gary and the management team he installed) said, “Okay, we need to operate smart, be efficient, and keep up with trends, but all that buys us is the chance to try. Given a tough economy and product that’s hard to differentiate from our competitors, what do we do?”
They came up with a specific answer in the golden state of mind campaign. We’ll all find out together if it’s the right concept. But it is an attempt to differentiate Pacsun as a brand and as a place to shop from its competitors, and that’s what they have to do.
Pacsun used to have some distinctiveness and a clearer market position, but it lost it for a variety of reasons, not least of which was growing to 900 stores. They’ve developed this market positioning concept to try and get it back. It’s specific and different from their competitors. I hope their balance sheet leaves them with the time and resources they need to pull it off.