PacSun’s Quarter Ended 7/29/06; Numbers and Industry Implications

I guess if you’re going to talk about a quarterly earnings release, you have to mention the numbers. Okay, fine. PacSun’s net income for the quarter ended July 29, 2006 was $0.14 a share compared to $0.28 a share for the same quarter the previous year. For the six months ended the same date, it was $0.30 a share compared to $0.51 for the same period the previous year. Those are drops of 50% and 41% respectively. Sales for the quarter grew only 1.3% from $309 million in the same quarter the previous year. Sales for the six month ended July 29, 2006 were up only 4.2% to $614 million.

 
What happened? Gross margin fell and expenses rose while sales were flat. That will put the kibosh on the old bottom line every time. On August 31st, PacSun announced that August sales were down 4.0% from August of last year and that same store sales for the period were down 9.4%.
 
If you’ve ever looked at PacSun’s stock chart, you maybe weren’t all that surprised by this. The stock fell about 10% the day after the announcement of the quarterly results, but the trend had been down for a while. The stock peaked at $29.05 way back on March 7, 2005. It fell as low as $20.33 on May 12, 2005, rallied back to almost $28 in November and has been mostly falling since. People who study this stuff tell me that a stock’s chart often shows weakness before the company’s fundamentals turn over. Speaking more generally, the stock market often leads the economy.
 
I hasten to add that PacSun’s chart doesn’t look much different from some other industry public companies, which is maybe a good way to move on to implications for our industry.
 
In its conference call on the quarterly results, PacSun acknowledged that business was tough, and that they were taking the usual and appropriate measures to respond. These included watching costs closely, controlling/reducing inventory and being cautious about their orders. Well, what would you expect them to do? They sounded like a competent management team in touch with reality. I imagine that’s because they are.
 
They also talked about meeting with the leading brands more often and earlier because of the challenging environment. They said they were trying to be “more responsive to their [the brand’s] insights around product.”
 
They talked about weakness in branded fashion denim sales, with the exception being Levis. They indicated they had added a specially designed selection of Levis for back to school in 200 stores and that the results had been “very positive.” They also talked in general about adding new brands for back to school.
 
This caused one analyst to ask whether PacSun was expecting to transition its business away from the core skate/surf brands. I seem to recall a reference to Volcom in the question.
 
PacSun’s answer was that the addition of new brands was a normal, ongoing, practice, that orders had been reduced consistent with the decline in business, and that they had no intention of transitioning the business away from the core brands.
 
But I think the analyst’s question went, or should have gone, deeper than that. What they were really asking was, “PacSun, what are you? Are you a skate/surf/lifestyle brand committed to the same market you’ve always focused on, or will a slowdown in that market’s growth and a saturation of its selling opportunities require that you expand your appeal? If so, how do you do that without losing your original, and very successful, franchise?
 
I think it was four years ago at the Surf Industry Conference where Bob McKnight warned us that the uptrend wouldn’t last forever. If the trend has stopped upping, is it a hiccup, or the beginning or a new kind of market? I don’t know. PacSun, and hopefully lots of other companies, are taking the appropriate tactical steps to manage it in the short term. But the longer term question is the one the analyst may have meant to ask but didn’t quite- What are you?