PacSun’s Quarter: The Transition Continues

I have been writing for a while now, without having a really good answer, about just what market we are in as action sports doesn’t, for most of our companies, adequately describe the customer base or competitive environment. Outdoor, youth culture, fashion are all words bandied about to describe it. It’s probably some of all of those. 

Pacific Sunwear has figured this out. It’s recognized that action sports isn’t a big enough market to support its plans. As a public company it has to seek some growth and it needs the broader market to find that. It’s choice of brands and positioning as a southern California lifestyle company is indicative of this. I think they’ve made the right choice (in fact the only choice they could make) even though it puts them in a position to have to compete against other fashion focused retailers like Forever 21 that Zumiez, for example, with its action sports positioning and focus doesn’t compete against quite so directly.
Reported sales for the quarter ended November 2nd fell 4% from $215.5 million to $206.6 million. However, due to the retail calendar shift, fiscal 2012 had an extra week in it. 
“Due to the inclusion of a 53rd week in fiscal 2012, there is a one-week calendar shift in the comparison of the third quarter of fiscal 2013 ended November 2, 2013, to the third quarter of fiscal 2012 ended October 27, 2012. The third quarter of fiscal 2012 included a higher volume back-to-school week as a result of the 53rd week retail calendar shift compared to the third quarter of fiscal 2013. This resulted in a decrease in net sales of approximately $11 million, a 1.9% decrease in gross margin…”
So there would have been higher margins and sales if not for the shift in the calendar. Gross margin fell from 28.1% during the quarter to 25% in the same quarter last year. It was basically all due to the calendar shift. 1.9% of the decline was due to lower merchandise margins. The rest of the gross margin decline was also due to the calendar shift because it caused an “Increase in occupancy, distribution costs and all other non-merchandise margin costs…”
In the conference call they tell us, “The decline in gross margin in the third quarter was the result of a challenging and competitive back-to-school landscape, leading to a higher promotional activity.” I wish somebody had asked them to compare what the 10Q says about gross margin with that statement from the conference call.
Selling, general and administrative expenses as a percentage of sales fell from 27.5% to 26.1%. Half the decline was due to a reduction in depreciation that resulted from store closings. The rest was from lower expenses. PacSun reported an operating loss of $2.24 million compared to an operating profit of $1.15 million in last year’s quarter. For the nine months ended November 2nd, the operating loss fell to $8.1 million compared to $22.8 million in the comparable nine months the previous year.
 Net income for the quarter rose from $948,000 to $17.2 million. Obviously, when you have an operating loss but a positive net income, there has to be something interesting going on between the middle of the income statement and the bottom- and there is.
There’s a gain on derivative liability of $23.4 million. In last year’s quarter the gain was $5.6 million. That is a non cash item associated with some of their financing activities that I’ve described before. You may read the footnotes in the 10Q if you have a compelling urge to know the details.
If we remove that non cash item from both quarters, we find that the loss in last year’s quarter before taxes and discontinued operations would have been $2.01 million. In this year’s quarter, it would have been $5.8 million.
In the cash flow, we see PacSun continues to use, rather than generate cash in operations. They used a bit over $21 million in both this fiscal year’s 9 months and last year’s. On the balance sheet, the current ratio has fallen from 1.38 to 1.21 and total liabilities to equity rose from 3.18 to 6.99 times compared to a year ago. Current liabilities in this quarter include a separate line item for derivative liability of $27.1 million. It was not broken out in last year’s quarter. I assume it was included in other current liabilities.
Merchandise inventories were almost constant at $137 million. They ended the quarter with 635 stores compared to 722 stores a year ago. They are, by the way, going to close another 15 to 20 stores during this quarter.
I might have expected a 12% decline in store count to result in some inventory reduction. They note in the conference call that “Adjusting for the timing of the 53rd week calendar shift, total inventory was down approximately 3% on a comparable store basis,” but I don’t think that takes closed stores into effect.
If I were running PacSun I think I’d have done basically what they’ve done. Because I don’t see a second viable choice. The balance sheet is still weakening. What PacSun (not to mention a host of other retailers) needs is some improvement in consumer spending.



6 replies
  1. Abercrombe Ian Fitch
    Abercrombe Ian Fitch says:

    But they threw a really kick-ass party with a performance by Snoop Dogg in a warehouse in downtown LA. So they got that going for them this year.

    Paradoxically, they picked a very interesting time to do their “Golden State of Mind” re-identification. In a year where everything cool was black & white, Brooklyn, Portland, street and anti-California, they said California was where it all was at. That may be so, but this was the year California couldn’t boast its usual “top of the heap” status in sportswear, with the big brands chasing moto, MMA, whatever sold goods, and losing sight of their roots at the beach.

    • jeff
      jeff says:

      Howdy Mr. Fitch,

      Wish I’d been to the party. Recognizing that the Golden State focus could be a problem if nobody else is focused that way, what choice did they have? I don’t think they could have pulled off a different focus. And everybody, I’m afraid, is chasing whatever sells goods. We are still way over retailed.

      Thanks for the comment,


  2. Rob Valerio
    Rob Valerio says:

    Hey Jeff-

    I’ve been spending quite a bit of time touring “action sports” retail lately. Pac Sun has done a great job re-merchandising their stores. Higher price points than Tillys and Zumiez on same/similiar merch and much better laid out for the shopper.

    Key take aways were Pac Sun is still concentrating deeper in fewer brands than its competitors. The “Golden” style is popular with the mall kids, and by that I mean Diamond, Neff, Huff, Stance (socks), etc.

    Interesting is the retailers saying Diamond Supply has peaked earlier in 2013. Some other brand will have to suck up all that shelf space Pac Sun is still giving it in this Holiday season.

    • jeff
      jeff says:

      Hi Rob,
      Thanks for the info. You’ve clearly looked more closely at the pricing of brands in different chains than I have. Deeper in fewer brands is great as long as you pick the right brands.


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