PacSun’s April 30 Quarter; How Long for the Strategy to Get Traction?

While CEO at Pacific Sunwear, Sally Frame Kasaks took some appropriate tactical actions. The problem, I conjectured at the time, was that she just didn’t “get it” when it came to the youth culture market/action sports market. Gary Schoenfeld, when he became CEO, knew that PacSun’s success ultimately depended on its ability to reconnect with its core customers and be relevant to them. No amount of tactical change and expense control, as important as those were, was going to change that. The customer had lost a reason to come into PacSun stores and had to be helped to rediscover it if PacSun was to have a future.

That implied a major organizational change that is long term, difficult, and a bit chaotic. Mr. Schoenfeld replaced almost the entire management team with the goal, I assume, of implementing a new way of thinking and approach to the business through the entire organization. He launched new marketing initiatives, closed (is closing) nonperforming stores, reintroduced the footwear that Ms. Kasaks had eliminated, localized the inventory assortment (an ongoing project), and revamped stores that needed new fixtures and merchandising (that initiative is constrained by cash flow issues).

PacSun undertook this not short term project at a time of economic weakness and reduced consumer spending. Now, with the economy possibly weakening again, and cost increases likely to show up in the second half of the year (not just for PacSun), there’s some additional urgency to see improvement.
 
And for the quarter ended April 30, they saw comparable store sales increase by 1%, which is improvement. Sales were down 2.39% from the same quarter the previous year to $185.8 million, but they ended the quarter with 827 stores versus 883 a year ago, so you’d expect some sales decline. Women’s comparable store net sales rose 4%. Men’s decreased 3%.
 
Their e-commerce business is about $50 million. They relaunched the web site in April. Their e-commerce sales were flat for the quarter. I haven’t heard many companies say that their e-commerce sales weren’t up, but they just relaunched so we’ll wait and see. My concern, of course, would be that flat e-commerce sales could be indicative of their marketing programs not getting traction. 
  
Gross margin, however, fell from 22.3% to 19.1%. Of that decline totaling 3.2%, 2.7%, or 84.4% of the total decline, came from a “Decrease in merchandise margin rate primarily due to increased markdowns as a percentage of sales.” I would expect that one indication that their new programs were having a positive impact would be an improving product gross margin. 
 
The remainder of the gross margin decline was due to deleveraging of costs because of fewer stores and a lower sales base.
I’m going to scurry right over to the balance sheet and point out that merchandise inventory on May 1, 2010 was $106.6 million. On April 30, 2011, it had actually risen it was $115.8 million. Now, an inventory number is as of single day, and there can be big timing issues (if you receive inventory on the last day of the month, it shows up in the quarter that day is in. If it’s received the next day, on the first of the month of a new quarter, it doesn’t show up in the quarter that just ended).
 
Still, with stores being closed, sales down, and additional markdown being taken, you might expect a drop in inventory levels. However, management indicated in the conference call that they were comfortable with inventory levels. As you think about inventories, there’s another issue impacting companies in our industry. As cost increases show up, the same number of units will appear in inventory with a higher value, increasing inventories to the extent of the price increase. No idea if that is involved here or not.
 
Sales, general and administrative expenses fell 9.7% to $66 million. As a percentage of sales they fell from 38.4% to 35.6%. The net loss for the quarter of $31.5 million was similar to the loss of $31 million for the same quarter last year.
 
Comparing the current balance sheet with the one from a year ago, we see that the current ratio has fallen from 2.25 to 1.80. Total debt to equity has risen from 0.59 to 1.03. Cash and cash equivalents fell from $56.6 million to $24.7 million, accounting for almost all the decline in current assets. Current liabilities rose slightly from $79.6 million to $88.6 million. Long term liabilities rose from $84.9 million to $101 million due to the mortgaging of certain of the company’s facilities to raise cash.
 
PacSun closed 25 stores during the first quarter, and anticipates closing a total of 40 to 50 during the whole fiscal year. They note in the 10Q that they have almost 400 lease expirations occurring through 2013. That will result in some additional closed stores, but I’d expect that some of the leases they keep will be renegotiated under more favorable terms.
 
I don’t have to come up with a conclusion for this article, because CEO Schoenfeld pretty much stated it for me during the conference call:
 
“There’s no question that the merchandising and execution in our stores has vastly improved, yet we know we still have a lot of work ahead of us. Customers have many choices. We still have real estate challenges to resolve. Consumer response to higher prices this fall is hard to predict, and having made so many organizational changes internally, it will still take some time for our team to consistently execute at the levels that I believe we are capable of.”
 
On the other hand, it’s my column, so I get the last word. It’s more or less what I said after their last report. Can PacSun’s new strategy get traction with the target consumer before the economy and cash flow issues get in the way?