More Declines in Department Store Locations?

The Wall Street Journal had an article this morning on how many locations certain department stores needed to close if they wanted to get their sales per square foot back to 2006 levels.  While they may not (mostly) be the retailers we (hopefully) expect to sell to, the discussion of the dynamics leading to the closings that have already occurred and the possible need for more is interesting.

“Sales at the nation’s department stores averaged $165 a square foot last year, a 24% drop since 2006, according to company disclosures and Green Street estimates. Over the same period, the stores reduced their physical footprint by 7% in aggregate.”

The article notes, to nobody’s surprise, that internet sales are partly responsible for all the store closing to dates.  But we’ve got the spokesperson for JC Penney saying that when they close, especially in a smaller market, internet sales go down.

Will the first person who figures out exactly how exactly how brick and mortar and online influence each other please let me know?

I’m pretty sure that even without the internet, there would be ongoing store closings, but I’m sure not as extensive as it has been and will continue to be.  The impact on malls will also be pronounced.

Before I give you the link, be aware that only the first couple of the lines will be available on the page.  You have to copy the headline into your search window, do a search, and click on the first result that comes up.  Then the whole article will be visible.  No idea why that works.

Here’s the link.

Skullcandy’s Strategic Positioning and Annual Results

Somehow, I didn’t see Skull’s 10-K with their results for the December 31, 2015 year when it came out and then I found myself busy with a couple of clients.  But it’s not so much that I want to give you a deep dive on the financials, but that I want to talk about their strategic balancing act a bit. There are some things we can all learn.

Let’s take a brief look at the numbers and then move on to that.

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Some Numbers on Online Retail and Perspective on the Teen Market

Moss-Adams Capital is the mergers and acquisitions, capital raising, strategic advising arm of Moss-Adams LLC, which does accounting, wealth management and taxes.  As you may be aware, they’ve been pretty active in our industry, whatever industry we’re now in.  For some time, they’ve published a report that provides information on which deals have been recently completed at what prices.  I’ve always reviewed it, but never highlighted it.

Now, it seems that they’ve expanded that report to include some good information on the size of and trends in the online market.  This is definitely worth your time as it’s pretty short and includes some ideas and data you may find interesting.  Thought provoking?  Call to action? Downright scary?

Some of the ideas, hopefully, won’t be new to you, but it’s succinct enough that I bet it find its way into some of your planning and strategy discussions.

As we all struggle to figure just what the hell “omnichannel” means and what, exactly, we need to do about it, I’ve seen some companies find themselves in an uncomfortable defensive position.  What I mean by that is that they spend a bunch of money on their online presence but the additional gross profit they generate doesn’t cover those costs.

Moss-Adams notes that online (including mobile) sales accounted for 7.3% of total U.S. retail sales in 2015 and two thirds of total retail sales growth that year.  Obviously, if your brick and mortar sales should be down 7.3% but you’re up 7.3% in online sales but have all the additional costs associated with online (depending on the comparative gross margins) you’re in a bad place.

This, essentially, is why your engagement with the omni channel has to be the place where the whole is greater than the sum of its parts.  You have to be online, but spending money to cannibalize your brick and mortar sales is completely defensive and maybe destructive.

Here’s the link to their report.

Meanwhile, I came across a chart with some information on the evolution of the teen retail market between 2003 and 2014.  I imagine you’ll want to think about what it means.  Though maybe it doesn’t have any deep meaning and is just good information.  I got it from a free publication I get five days a week called The Daily Shot.

Online and Teen Market 4-16









The PacSun Bankruptcy

Nobody who’s followed PacSun or my analysis of it was very surprised by yesterday morning’s filing of a Chapter 11 bankruptcy.  We’ve had a number of retail bankruptcies and I expect more.

Somebody suggested to me that the filing might occur around this time because their 10-K with audited financials would be due to be published, and their auditor would have to give them a “qualified” opinion as part of the audit.  That is, they’d say they had concerns about PacSun’s ability to continue as a “going concern.”   That tends to make lenders and suppliers uneasy.

Looks like the person who suggested that was right on.

If you’ve read the press release from PacSun, you know that the filing is being done as part of a plan negotiated with their debt holder, Golden Gate Capital and Wells Fargo who has a line of credit to PacSun.  This is optional, but here’s a link to the article I wrote on PacSun back on December 20 after their published their last 10-Q.  I said in that article:

“As I’ve reminded you before, they also have a $75.6 million payment to make for a term loan and some “payment in kind” interest due December 7th 2016. The line of credit from Wells Fargo matures the same day.  It’s pretty clear they won’t be able to make that payment from their own cash flow. They are talking with the lender (Golden Gate) about how that might be managed.”

The writing was on the wall at least back then.  I’d say sooner, but obviously it’s nice to get through the holiday season before you take this kind of step.

Let’s take a look at the proposed plan as described in the press release and then move on to the numbers for the last quarter and the fiscal year.

What’s the Plan?

Golden State Capital is going to end up owning PacSun as a private company.  Shades of how the Quiksilver bankruptcy ended up.  Regular readers already know, and are probably tired of my saying it ad nauseum, that there’s a conflict between being a successful brand and a public company in our current and projected economic environment.  That’s especially true in our industry.

“Golden State Capital will be converting more than 65% of its term loan debt into the equity of the reorganized company and providing a minimum of $20 million in additional capital to the reorganized Company upon its emergence from Chapter 11 to support its long-term growth objectives.”

Literally as I write this, PacSun has just filed the 8K describing the bankruptcy filing in more detail.  Golden State will end up owning 100% of PacSun’s equity.  So if you are a common stockholder from before the filing, sorry, because “…on the effective date of the Plan, all previously outstanding equity securities of the Company shall be cancelled and discharged.”

The term loan is about $77 million.  65% of that is $50 million.  At the end of the fiscal year, on January 30, the line of credit outstanding was $18 million.  Wells Fargo was providing the line of credit.  As part of the bankruptcy filing and restructuring plan, Wells Fargo will provide a $100 million debtor in possession (DIP) line of credit.  “Wells Fargo has also committed to provide a five-year $100 million revolving line of credit effective upon the Company’s emergence from Chapter 11 and subject to certain conditions.”   DIP financing has a priority over certain debt of the company prior to the bankruptcy filing, so it’s more secure than you might expect lending to a company in bankruptcy to be.

I still think PacSun President and CEO Gary Schoenfeld has pretty much done all the right things since he took over some years ago.  He inherited a chain that had lost relevance to its target market.  Reclaiming that was a hard, long term project under any circumstances.  Here’s how he described it in his last conference call.

“Without a doubt, the bar keeps getting raised in terms of what it takes to be successful, given overall headwinds in retail and apparel and the battles for consumer discretionary spending. Clear merchandising strategies, consistent in-store execution across our entire chain and further penetration into the digital world of our customers, are all essential.”

He goes on to say, ““Our liquidity has been adversely impacted by our negative operating results and we cannot assure you that we will have sufficient liquidity going forward if certain negative trends continue, or if we are not able to refinance the Term Loan in light of the upcoming maturity of the Wells Credit Facility and the Term Loan.”

PacSun ran out of cash and, as a result, time.  CEO Schoenfeld explains in the press release that the bankruptcy is meant to solve two “…structural issues that operationally we could not fix on our own.  First is a very high occupancy cost of approximately $140 million per year, and second is nearly $90 million of long-term debt coming due later this year.”

The debt issue and associated interest expense is resolved by conversion of 65% of the Golden Gate debt to equity.  The occupancy cost (store lease) issue will be managed “…either through landlord negotiations or lease rejections…” as part of the bankruptcy process.”   I expect to see some further store closings and I consider those necessary and appropriate.

What this doesn’t address, obviously, is the strategic issue of PacSun’s market position and its relevancy to its target customers.  Have they made progress?  I think so.  Are they there yet?  Apparently Golden State thinks they are or can be with a lower cost financial structure that allows them to pursue their strategy.  We’ll see.

Financial Results

The quarter and year ended January 31, 2016.  Know that I’m doing this based on the financials in the press release, rather than the 10-K which isn’t out yet.

For the quarter, net sales were more or less constant at $232 million.  The gross margin fell from 26.1% to 24.3%.  The operating loss declined from $7.42 to $5.49 million, largely due to expenses that fell from $67.8 to $62.1 million.  The net loss declined from $26.0 to $10.0 million, but the decline is almost entirely the result of having a loss of $14.3 million loss on the derivative liability in last year’s quarter compared to a gain of $192,000 in this year’s quarter.

For the year, sales were down 3.13% from $826.8 to $800.9 million.  The gross profit margin fell from 27% to 25.4%.  They reduced expenses from $238.4 to $221.6 million, but the operating loss rose from $15.1 to $18.0 million.  Interest expense, by the way, was $17.3 million, and much of that cost goes away in the conversion of debt to equity.  The reported gain on that derivative liability was $2.3 million last year and $27.7 million this year.  Take that into account as I tell you the net loss improved from $29.4 to $8.5 million.

The expenses include the $140 million in occupancy costs Gary Schoenfeld refers to in the press release, and that will be reduced as PacSun works its way through bankruptcy, but we don’t know by how much.  You can see that between some reduction there and the decline in interest expense, all other things being equal, the year just ended probably would have been profitable.

PacSun ended the year with 601 stores compared to 605 at the end of last year.  126 were outlet stores, up from 120.

The balance sheet is, well, kind of irrelevant since it’s about to change dramatically.  However there are a few telltale signs worth highlighting.  First, cash and cash equivalents fell from $22.6 to $6.2 million.  I’d note that net cash provided by operations went from a positive $10.7 million last year to a negative $15.1 million in the year just ended.

Inventory, interestingly, rose 18.2% from $81.7 to $96.5 million.  Wouldn’t necessarily expect that with cash constraints and constant sales.  Hard to imagine them buying in anticipation of a bankruptcy in this industry where what’s selling changes so quickly.  Hard to imagine brands not being cautious in selling to them as I’m hardly the only one who saw this coming.

Speaking of inventory, I guess I should remind anybody who has product at PacSun on consignment and thinks that they either can get paid or get their inventory back what happened with the Sports Authority bankruptcy.  Here’s the link to the article I wrote about the litigation over this issue on my site.  Don’t know if this will be an issue with PacSun or not.

One of the headlines in the press release says, “ALL KEY SUPPLIERS TO BE PAID.”  I have a couple of comments.  First, I wonder what “key” means.  Second, I wonder when.  Under the bankruptcy law, no old debt can be paid except as part of the plan when the company comes out of bankruptcy.  However, bankruptcy judges have wide discretion and you probably remember Quiksilver getting the court’s permission to pay some important suppliers.  Wonder if they called them “key?”

Third, I wonder if paid mean paid in full and, if so, why they didn’t say that.  Fourth and finally, I wonder how much, if anything, suppliers who aren’t “key” will get paid.

On the liability side of the balance sheet, accounts payable rose 17.8% from $36.8 to $43.3 million.  The line of credit was $0 last year and $18 million at this year’s end.  PacSun had told us they expected to borrow up to $35 million for inventory and to pay “most” of the advance back by year end.

Current portion of long term debt went from $541,000 to $77.4 million at January 31 as the note to Golden Gate came to within a year of being due.  Long term saw a similar drop, from $94.4 to $26.8 million.  PacSun also has long term debt for a mortgage on a facility they own.

Equity is a negative $15.5 million compared to negative $9.4 million at the end of last year.

Though I can’t quantify them, I see the significant financial benefits that will accrue to PacSun under the proposed plan.  But retail conditions remain somewhere between difficult and brutal and I’m still waiting to be completely convinced that PacSun can again become a destination store for its target customers.

Zumiez’s Year and Quarter; What Are They Preparing For?

Like most industry retailers, Zumiez has been impacted by a slow growth economy, reduced and redirected spending on the part of its primary customer group, and the internet’s ability to make consumers powerful, product differentiation harder, and the brand cycle shorter.  There’s no news there and nothing unique as far as its impact on Zumiez goes.

However, two issues came up in the report I want to spend a little time on.  The first is Zumiez’s discussion of product cycles and their response to analysts’ questions on the subject.  The second is the announcement that came out of the conference call that Zumiez would be opening fewer stores.  They are related, and both represent the tip of the iceberg in terms of what Zumiez is trying to accomplish.

Let’s look at both of them, explore their interdependence, and figure out what I think Zumiez’s management is saying without exactly saying it.  First, I’ll review the numbers just so you have them in mind as we get to the more interesting stuff.

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Consignments to Sports Authority; Well, This is Awkward

Just for fun, let’s say you’re a brand that has some product at The Sports Authority (TSA) on consignment.  When TSA filed for bankruptcy, your finance and credit people probably high fived each other out of the sheer joy of knowing that they could expect to be paid for that product when it was sold or at least get the product back- which would not be the case if you had sold the product to TSA and made yourself an unsecured creditor.

Uh, well, maybe not.

Sports Executive Weekly as well as the Wall Street Journal and other publications are reporting that TSA is suing a bunch of its suppliers who have consignment product at TSA.  TSA wants to be able to keep the product and I guess the money from selling the product.  Apparently, there are 160 suppliers who have consigned product to TSA (Doesn’t anybody just sell product to retailers anymore?) and we’re talking about $85 million of merchandise.

The bankruptcy judge has told TSA that they have to return the consigned goods to the consigning brand if requested and pay them the money they already owe vendors for consigned product that’s been sold.  Apparently there have been a number of such requests.  But TSA, which has until April 28th to come up with a buyer or another form or reorganization that will let it survive, doesn’t want to do that because they need these brands and their products, not to mention the cash, to continue operating.

So we’ll see.  If the lawsuit is successful, I guess these consignors end up as unsecured creditors.

Globe’s Half Year Results- Serious Improvement, But It’s Hard to Figure Out Just What They Did Better

This is going to be a short article. On February 23rd, Globe reported solid improvement for the half year ended December 31, 2015. But I don’t have much to tell you in terms of what they did better or how because it wasn’t in the public information. Let’s go with what we’ve got. The numbers are in Australian dollars.

Revenue rose 19.5% to $78.8 million from $66.0 million in last year’s six months (the prior calendar period- PCP). There’s no cost of goods sold provided as there would be in the U.S.

Okay, I think maybe I’ve figured it out with a little help from people who understand the presentation of Australian financial statements better than I do.

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The Sports Authority Bankruptcy: Symptom of a Perfect Storm and How You Can Benefit

TSA’s filing for bankruptcy on March 2nd wasn’t a surprise. It had missed a $20 million bond interest payment in mid-January. It reached an agreement with the bond holder to file and try to sell assets to pay down debt. We’ll see how that works out and if they can avoid liquidation.

A couple of people asked me when I was going to write about it, so I sat down and started working through some of the bankruptcy court documents. Here’s the link to the court documents should you be inclined to plod through any them yourself.

But then I noticed that some other people had undertaken the task of plodding through them.  Between all those articles and court filings, your need for details of the filing should be well and truly sated.

Now let’s get to what I’m calling the strategic background. In an operational sense, you probably only care about TSA’s bankruptcy if you’re an unsecured creditor. Like most unsecured creditors in most bankruptcies, you shouldn’t expect to see a lot of your money.

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3D Printing the Mattel Way

On several occasions, I’ve discussed 3D printing or directed you to some discussion of it. I’m here to do it again. I’ve gotten some feedback that it wasn’t practical or wasn’t going to happen quickly, but as far as I can tell it’s moving forward.

Mattel has announced a $300 3D printer that will allow kids to make toys. Yes, yes, I’m sure it’s limited in what it can do, etc., but it’s better than what was available before and not as good as what will be available tomorrow. And tomorrow’s will be even cheaper of course.

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Good and Bad- Billabong’s Six Month Results

Billabong presented its results on February 26th, which is a day before I took off for a week in Scottsdale to golf and have a drink or two with old friends. As usual, a lot seems to have happened while I was gone, and I’m working to catch up.

I agree with Billabong CEO Neil Fiske who said, “There are important positives to report among a mixed overall result this half.”

Let’s right get to the numbers as reported and then as adjusted. In this discussion, I’ll rely mostly on the formal financial report with the audited financials. All the numbers are in Australian dollars.

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