PacSun’s Quarter. Can the Strategy Work in this Economy?

PacSun’s 10Q was filed two days ago. I’ve been through it and it offers a few tidbits of interesting information. But mostly, PacSun CEO Gary Schoenfeld said a lot of what needs to be said, at least strategically, in the conference call. Here are his most relevant comments:

“The economy is not getting better and competition remains fierce for a limited amount of discretionary spending. As a team, we remain committed to our turnaround strategy that includes a long-term focus on delivering trend-right products and creating a distinctive PacSun brand identity and experience tied to our unique California heritage.”

“But we also know our store gets shopped, but we’ve got to move up higher. There’s 8, 10, 12 good choices for her in the mall. And where you sit in that pecking order is pretty important.”
 
It’s hard to argue with the strategy, though it isn’t very distinctive and has elements of what most brands want to do. If a strategy lacks uniqueness, it can be expensive to implement. The question in my mind, which hasn’t changed much since the last time I took a look at PacSun, is whether there’s enough uniqueness so they can afford to implement it given the economy and the company’s financial circumstances.
 
Oh damn, I seem to have written the conclusion first. I guess I’ll just ignore that and move on to the numbers.
 
Sales for the quarter ended July 30 fell 1.6% to $214.9 million compared to the same quarter last year. I should point out they closed 31 stores during the first six months and expect to close 50 to 60 for the whole fiscal year.  Closing stores reduced sales by $8 million in the quarter. But stores not yet included in the comparable store calculation and a slight increase in comparable store sales increased sales $5 million, resulting in the net decline of $3 million. Women’s comparable store sales rose by 1%. Men’s were flat.
 
The gross margin fell from 23.2% to 23.0%. Merchandise margins fell by 1.3% but occupancy and buying and distribution costs fell so the decline in the gross margin was minimal.
 
Sales, general and administrative expenses fell 8% from $74 million to $68 million. As a percentage of sales it was down fro0m 33.9% to 31.6%. Most of the decline was payroll expense ($5 million) and depreciation ($4 million). You kind of wonder if their strategy doesn’t call for increasing certain of these expenses, but there’s that conflict between financial capability and the requirements of the strategy.
 
Inventory on the balance sheet fell from $174.8 million a year ago to $163.3 million at July 30, 2011. They have 59 less stores than they had a year ago. Total store count is now 821, down 59 from a year ago. Reported inventory is down 7%, but management indicated it would have been down 10% if they hadn’t taken some back to school deliveries early. There’s no discussion of the impact of any higher costs on inventory levels.
 
Cash was down from $25 million to $13.3 million. The current ratio fell from 1.61 to 1.44 over the year. Total debt to equity rose from 0.85 to 1.43. At least according to this cursory evaluation, the balance sheet has weakened a bit. They have nothing drawn on their line of credit, but indicate they might have to use it if current trends continue.
 
After the quarter ended, PacSun completed negotiations with some landlords. They are making payments of $1.3 million to buy out the leases on five stores which will be closed by the end of the year. They also made deals with 95 stores to reduce rents and extend leases at more favorable terms. They indicate this will save them $9.5 million over the lives of these leases (through most of fiscal 2012). They also issued 900,000 shares of stock (to the landlords I assume) as partial compensation for these lease changes.
One cool thing they did was to roll out Apple iPads in 300 stores. I’ve had the experience of shopping where clerks are equipped with them, and I like it a lot.
 
Along with other companies, PacSun has found the start of back to school difficult. As they describe it, “…the primary drivers included declining consumer confidence and a higher competitive promotional environment.” As a result, they are anticipating that same store sales “…will be in the mid to high negative single digits for the third quarter…”
 
I really miss the good, old fashioned reliable kind of recession where supply gets ahead of demand, companies pull back, we have a recession, then move forward as demand catches up. These debt excessive leverage recessions (of which this is my first one) are hard and very, very long because people paying down debt don’t buy stuff. It sucks to be a company- any company- trying to sell product to consumers that they can easily put off buying.
 
Okay, I’m done.  Like I said, I wrote the conclusion first so if you’re looking for closure, please read it again.

 

4 replies
  1. Jay Wilson
    Jay Wilson says:

    Hi Jeff, I believe that PacSun has done everything they could do to turnaround given their footprint.
    Their store is divided into 1/2 girls and 1/2 boys and the girls market has left for Forever 21 and H&M
    fashion retailers. So I don’t believe that they can solve their problems. If you look at Zumiez, The Core shop in the mall, it has a clear strategy and executes it well closing out PacSun in that space. No where to go!

    • jeff
      jeff says:

      Hi Jay,
      I hope you’re wrong, but think you might be right. There’s just no room for what they want to be and no time to get there.

      thanks,
      J.

  2. Rob Valerio
    Rob Valerio says:

    Nice job again on the analysis, Jeff. I think we all like Gary Schoenfeld and we want to see his strategy work. It appears that the game in the mall has significantly changed because of this recession, and textbook strategy may not have the expected outcome, no matter how well it’s executed.

    Pac Sun is showcasing youth culture brands to get people in the store, then selling a lot of private label to fill in the basics. They are competing against mall brands that draw customers to the house brand (some more popular than action sports brands) at the full vertical margin.

    Jeff, your summary rings true that Pac Sun’s unique selling position is not unique enough to draw dollars away from the vertical mall brands. The question now becomes whether one of the action sports or youth culture brands they carry will become extremely popular to drive foot traffic, yet remain available at the mall only via Pac Sun.

    • jeff
      jeff says:

      Hi Rob,
      If consumers are buying less, and continue to buy less, than some retailer somewhere becomes unnecessary. Generally, in my experience, the one with the least distinctive market position and value proposition.

      Thanks,
      J.

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