PacSun’s May 4th Quarter; A Couple of Items to Discuss

This, happily, won’t be like the short novel I had to write for Quiksilver. There are some interesting conference call comments and two income statement entries crying out for a brief discussion, but that’s pretty much it. Let’s get going. 

Sales rose 4.7% from $162.3 in the quarter last year ended April 28, 2012 to $169.8 million in the quarter ended May 4, 2013. Ecommerce sales were up 11%. Gross margin was up from $38.1 to $42.7 million. As a percent it rose from 23.5% to 25.1%. Selling, general and administrative expenses (SG&A) fell from $55.9 to $53.8 million. As a percentage of sales they fell from 34.5% to 31.6%. The operating loss fell from $17.8 to $11.1 million. They ended the quarter with 638 stores compared to 729 a year ago and expect to close 20 to 30 by the end of the fiscal year.
 
Okay here’s the first thing that needs to be discussed. The 2012 annual reporting period had an extra week in it. Here’s how Zumiez’s describes the impact:
 
“The first quarter of fiscal 2012 included a lower volume week and the first quarter of fiscal 2013 included a higher volume week as a result of the 53rd week retail calendar shift. This resulted in an approximately $6 million increase in net sales, 1.5% improvement in gross margin…”
 
Of the total sales increase of $7.5 million, $5.6 million, or 75%, resulted from the 53 week retail calendar. The reminder was the result of a 2.7% increase in comparable store sales offset by a 0.8% decline in non-comparable sales. The gross margin increased by 1.6% and you can see all that increase came from calendar shift. They also note that the merchandise margin rose from 51.4% to 53% and that 0.5% of that increase was from the calendar shift.
 
You can see you have to keep that shift in mind when comparing last year’s quarter with this year’s.
 
Right under the operating loss line is a $9.3 million loss on derivative liability. In last year’s quarter that was a gain of $6.3 million. That’s a $15.6 swing from one quarter to the next, so it requires a brief explanation. Here’s the link to the 10Q just in case you want to read a couple of footnotes with me.
 
Back in December 2011, PacSun got a $60 million term loan from Golden Gate Capital. The loan is due to be paid in December of 2016. As part of that deal, PacSun issued 1,000 shares of series B convertible preferred stock recorded as a derivative liability with a fair value of $15 million at the time it was issued. 
 
“The Series B Preferred shares are required to be measured at fair value each reporting period. The fair value of the Series B Preferred shares was estimated using an option pricing model that requires Level 3 inputs, which are highly subjective…”
 
Level three values are based on “unobservable inputs.” An amusing term, I’ve always thought. Anyway, this is noncash and goes up or down every quarter influencing the financial results as it does so.
 
The reported net loss for the quarter rose from $15.6 million to $24.2 million. Both the derivative liability and the calendar shift have significant impacts on how you look at PacSun’s results.
 
PacSun used about $30 million in cash for operating activities in the quarter. In last year’s quarter, it was $31 million. The current ratio has weakened from 1.53 to 1.21, and total debt to equity has jumped from 2.37 times to 6.13 times as losses have reduced equity from $98 million to $41 million. Long term liabilities are essentially unchanged.
 
On to the conference call. Let me start with a rather lengthy quote from CEO Gary Schoenfeld.
 
“We have spoken before about the decline in certain heritage brands that had become strongly associated with energy drink collaborations, which have largely gone away. Those brands will hopefully rebound over time, yet we continue to feel the effects of their decline, along with some of our other heritage brands as well. Within shorts and board shorts, Hurley continues to perform, as are our most — more basic Volcom and Modern Amusement shorts. Yet as our customer’s embracing more aggressive print and pattern trends in tops, it has been pretty much just the basic shorts that are selling and similarly, what we would consider to be the more fashion-forward board short ideas within our assortment, those are also underperforming compared to what we’ve seen in prior years.”
 
It isn’t just PacSun, of course, that’s reported some concern about heritage brands and that’s focusing on new and different brands. As I see it, it feels like they are favoring brands that are more fashion or youth culture and less action sports based. I also hypothesize that some of the older brands are aging up, and don’t hit PacSun’s target customers (17 to 24 in women’s) the way they used to.
 
Next, here’s a question that Berry Chen from Wedbush asked:
 
“…in terms of the Men’s heritage brands…is the team’s idea to continue to add some of these emerging brands that are doing well? And when do you expect some of that pressure from the heritage brands to kind of start to diminish?
 
Here’s Gary’s answer:
 
“…the shift to embracing the newer emerging brands and street wear as a trend has been critical. And if — had we not been successful in those efforts as well as expanding footwear and other accessory categories, our Men’s business would be in a much tougher position. There’s a lot of change happening within sort of the longer-standing brands. There have been significant executive changes at a number of key players. And so to answer your question, I can’t be specific in terms of exactly when that pressure lightens up. But obviously, we continue to focus on what we can control, which is continuing to work with the mix of brands that we have, both emerging and heritage, continuing to also bring the best that we can in terms of our proprietary design and in denim, in particular, to support changes in trends.”
 
Gary also noted “…the complete rethinking of design and development, as speed to market has become critical to sustainable performance.”
I’ve been reading that consumers are more willing to accept and trust new brands then they used to be. I’d expect this evolving consumer behavior coupled with the need to be quick to market to bias some retailers towards proprietary brands, and I think that’s happening.
 
It’s good to see the store closings finally tapering off. That’s a drain on resources PacSun could put to a better use. I agree with the market trends PacSun has identified and is focusing on. But as I asked back before Gary Schoenfeld even became CEO, can they make PacSun “cool” again and a place their target customers want to shop? There is certainly progress, but it’s still a work in progress and it needs to continue so the balance sheet doesn’t weaken further.

 

 

2 replies
  1. Rob Valerio
    Rob Valerio says:

    Great update on Pac Sun Jeff. I looked up Pac Sun’s heritage brands and they have it listed as “Fox Racing, DC Shoes, Roxy, Quicksilver, Hurley, Billabong, Element, O’Neill, Vans and Volcom”. My assumption is Quik and Billabong are not performing, but do you think any others in that list are strictly old man brands now?

    • jeff
      jeff says:

      Hi Rob,
      No, I don’t think they all are. Certainly PacSun is thrilled with Vans and even had a comment about how well their apparel program was going. And don’t necessarily lump the Quik brand in with Roxy, for example. I don’t really know who’s performing and who’s not. Walk in some stores and see which brands you see featured.

      Thanks,
      J.

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