Pacific Sunwear’s Quarter; Look! It’s a Profit!

PacSun earned $948,000 in the quarter ended October 27 compared to a loss of $17.6 million in the same quarter last year. Their comparable store sales rose 1%. It’s the first time that’s happened since the third quarter of 2007. Their loss for nine months is $32.2 million compared to a loss of $68.3 million in nine months in the previous year. 

Okay, progress though not the end of the turnaround road. They did it by increasing their gross margin from 24.4% in last year’s quarter to 26.6% this year and by cutting selling, general and administrative expenses (SG& A) from 30.2% of sales to 27.2% of sales. Sales increased only slightly from $226.8 million to $228.4 million.
 
Remember, this is a company that’s still closing stores. They closed a net of five during the quarter and ended it with 722 stores compared to 820 a year ago. They expect to have closed an additional 75 stores by the end of the fourth quarter in January. I would guess that those closings will largely happen after the holiday shopping season.
 
Most of the gross margin increase came from the improvement in the merchandise margin from 47.2% to 49%. Of the 3% decline in SG& A, 1.80% came from a decline in non-cash impairment charges for long lived assets. These assets are mostly furniture, fixtures, equipment and leasehold improvements for stores being closed. In last year’s quarter, the charge was a bit over $7 million. This year, it was only $533,000.
 
They’ve now written those assets down to $6 million and, as of the end of the quarter, think they can recover it all. Is so, we shouldn’t see any future write downs for store closings.
 
There was also a 0.8% decrease in depreciation (which you’d expect as stores get closed and there are fewer assets to depreciate). There was also a 1.1% decrease in other SG& A expenses “…primarily due to the timing of advertising expenses and a decrease in consulting fees.” To the extent the decline was due to timing, I assume it just moved to the next quarter. Finally, there was an offsetting 0.7% increase in compensation due to an increase in employee benefits.
 
I also want to point out that net income includes a $5.6 million “Gain on derivative liability.” This has to do with their estimate of the fair value of the Series B Preferred shares using “highly subjective” inputs. Now I’m guessing that nobody really wants to get into those details, but should I be wrong, you can check out footnote nine in their 10Q. My holiday gift to you.
 
Over on the balance sheet, we see that cash has risen from $8.3 million a year ago to $23.9 million. Cash is good. Inventories are down from $152 million to $137 million as you’d expect with stores being closed. The inventory decline on a comparable store basis was about 4%. Current assets at $182 million are down just $3 million with cash basically replacing inventory on the balance sheet.
 
Net property and equipment has declined from $158 million to $131 million with the store closures and asset write offs we’ve discussed. Total assets are down $28 million to $348 million.
 
Current liabilities are up slightly from $129 million to $132 million, which is a bit of a surprise. Accounts payable are down $22 million which again makes sense with stores closing, but other current liabilities have jumped from $39 million to $65 million over a year. Oh- that’s mostly the derivative liability thing and a $6 million increase in accrued compensation and benefits.
 
Long term liabilities have risen 37% from $96.4 million to $132.2 million. Deferred lease incentives and rent are down (again, it’s the store closings). But other long term debt and liabilities have risen in a year from $55.2 million to $100.5 million. Shareholder equity is down 45% from $150.4 million to $83.3 million.
 
Okay, well those balance sheet numbers make me scurry to the cash flow for nine months. I see that net cash used in operating activities has fallen from $45 million to $22 million. And cash used in investing activities has fallen from $9.8 million to $3.1 million. That’s an improvement, but we’re still a long way from a positive operating cash flow.
 
CEO Gary Schoenfeld told the analysts that PacSun continues to be “…focused on 3 main tenets of our strategy: authentic brands, trend-right merchandising and reestablishing a distinctive customer connection that once again makes PacSun synonymous with the creativity, optimism and diversity that is uniquely California.”
 
He left it to poor Mike Kaplan, the CFO, to provide the guidance for the fourth quarter. Excluding the stores to be close by the end of the quarter, they expect comparable store sales to be down 1% to 3%. They project a “…non-GAAP net loss per share from continuing operations of $0.09 to $0.17 for the quarter…” I imagine that will translate into a loss at the net income line.
 
They reasonably pointed out that this year’s fourth quarter includes an extra week, which incurs expenses at the usual rate, but has weak revenue because of the time of the year.
 
I was all excited when I saw the profit and positive comp for the quarter, but less excited after I’d been through the numbers. There’s no doubt there’s been a tremendous amount of progress. Lots of battles won, but the war goes on. The company is still cash negative, and to some extent the positive comp (and it was only 1%) is the inevitable result of closing enough stores that aren’t performing. But when you get down to your good stores, you need to be doing better than 1%.
 
It’s not easy for me to evaluate PacSun while they are still closing bunches of stores. Apparently, that will mostly be over at the end of January. It’s interesting that yesterday I was reading and writing about Zumiez, and wrote that they had a solid market niche that they had to continually validate but also break out of as the action sports lifestyle market changed. That’s both their challenge and their opportunity.
 
PacSun’s challenge, on the other hand, is to figure out and establish to the satisfaction of their customers what their market niche is. They lost their “distinctive customer connection” and are working to get it back. But that means they aren’t gated, at least compared to Zumiez, by their historical market positioning. And that might be a good situation to be in right now.

 

 

2 replies
  1. april mcintosh
    april mcintosh says:

    Jeff, I just wanted to tell you that your ability to be decipher the financial mumbo jumbo and give me a concise, easy to read analysis is truly awe inspiring. I walk away being, not just more informed, but a little bit more intelligent! Thank you for contributing to the free flow of information that allows each of us to take a moment to be better educated about the companies in our industry.

    • jeff
      jeff says:

      Thank you April,

      Now I’m going to feel really guilty if I ever try and make this a pay site. The goal is always to identify and get you to think about issues that might help you run your business better. Even, or maybe especially, the unpleasant ones that everybody wishes would just go away.

      J.

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