PacSun’s Year and Quarter; Progress, but Work Left to Do

I want to start by focusing on some comments PacSun’s management made that are indicative, I think, of why this is a harder environment for most industry companies and especially for one that is working through a turnaround.

Strategies

Improving their merchandise assortment planning is not a new theme for PacSun. It’s something that CEO Gary Schoenfeld has been focused on since he joined the company. They use to send pretty much all the same inventory to all their stores at the same time. They say in their 10K (you can see the whole thing here):
 
“We are now grouping our stores into a number of store clusters based on customer segmentations, brand performance, differences in weather and demographics, among other characteristics. In conjunction with this clustering, we have changed our allocation strategies to distribute what we believe to be the right products to the right stores for the right customers.”
 
That’s a good thing. It’s important, they need to do it, and there’s a lot of benefit to be realized. Some years ago, it might have conferred a strategic advantage. Now, though some retailers no doubt do it better than others, it’s just the price of entry. It’s something you need to do well just to compete.
 
As you know, PacSun has been, and continues, to close stores; 38 in fiscal 2008, 40 in 2009, 44 in 2010, and 119 in 2011. That got them down to 733 stores at January 28th, the end of their fiscal year. In fiscal 2012, they expect to close an additional 100 to 120 stores. They expect the store closings this fiscal year to cost them $13 million, but to save $9 million a year annually after that. Pretty good return on investment.
 
Referring to the stores closed and being closed, they note, “The affected stores generate on average annual sales revenue of approximately $0.6 million as compared to our remaining stores, which generate approximately $1.1 million in average annual net sales. “
 
You can be a specialty retailer or a chain, but the days of low volume stores being profitable are mostly over and, as I wrote years ago, has been for a while. With distribution as broad as it is, you just can’t earn the margin you need to earn to keep a low volume store profitable. By the way, I’d love to hear from stores that are the exception to the rule. Tell me how you do it. Working for free doesn’t count.
 
Moving on, here’s who PacSun identifies as some of their competitors; “…Abercrombie & Fitch, Aéropostale, American Eagle Outfitters, The Buckle, Forever 21, H&M, Hollister, J.C. Penney, Kohl’s, Macy’s, Nordstrom, Old Navy, Target, Tilly’s, Urban Outfitters and Zumiez, as well as a wide variety of regional and local specialty stores.”
 
It’s not that I think they are wrong. In fact you might want to see the article I posted just yesterday which deals with this. But if in fact Penney and Target are serious competitors for PacSun, then what market are they in and how do they differentiate themselves? It’s not just PacSun that has this problem, but I’d say they have it worse than most right now. It’s a problem they are trying to solve. How?
Here’s what they say their mission is:
 
“Our mission is to be the favorite place for teens and young adults to shop in the mall. Our objective is to provide our customers with a compelling merchandise assortment and great shopping experience that together highlight a great mix of heritage brands, proprietary brands and emerging brands that speak to the action sports, fashion and music influences of the California lifestyle. We offer an assortment of apparel, accessories and footwear for young men and women designed to meet the fashion needs of our customers.”
 
Referring again to the article I published yesterday, the assortment strategy seems the same as Buckle or Kohl’s. Or Zumiez for that matter. What is the different thing you have to do (for any retailer) “…to be the favorite place for teens and young adults to shop in the mall.”?
 
Your Volcom product can’t be any better than the next retailer’s Volcom product can it? Does your strategy have to focus on making your proprietary brands better than the next retailer’s proprietary brands? CEO Schoenfeld said in their conference call that “…the biggest shift we are seeing in our business is growth in our emerging and proprietary brands, offset by declines in some of our key heritage brands.
 
Think of the implications of that, especially if you’re a brand other than a proprietary brand. Perhaps we see a reason here why so many brands are becoming retailers. Although I can also imagine that some of what PacSun calls heritage brands (brands they don’t own) might be a bit cautious in their relationship with PacSun right now as stores are closed and until their financial position begins to improve.
 
Numbers
 
Revenues for the fourth quarter ended January 28, 2012 were $234.2 million, down from $237.6 million in the same quarter the previous year. The loss in the quarter this year was $38.1 million compared to $35.2 million in the same quarter last year. The loss from continuing operations (ignoring stores being closed) was about the same in both quarters at $30.5 million.
 
For the year, sales of $834 million translated into a loss of $106.4 million. The previous year sales of $837 million produced a loss of $96.6 million. The loss from continuing operations also grew from $84.3 million to $90.6 million. Internet sales were 6% of sales in 2011 compared to 5% the two previous years.
 
The discontinued operations (stores closed or being closed) by themselves for the year had sales of $62.7 million and a gross profit margin of 17.6%. They generated a loss of $15.8 million.
 
49% of revenue was men’s apparel, 37% women’s and 14% accessories and footwear. Before 2007, non-apparel represented 30% of their revenues. But now they’ve reintroduced footwear into 425 of their stores, and they expect it to continue to grow.
 
Comparable store sales fell 0.6% compared to declines of 7.9%, 19.1%, and 4.7% in the three previous years.
Gross margin fell from 22.3% to 21.7% due in part to a fall in their merchandise margin from 46.9% to 46.7% and also due to deleveraging of occupancy costs. When your comparable store sales fall, but your costs for achieving those sales don’t, your gross margin goes down.
 
PacSun reduced their selling, general and administrative expenses from 32.2% of sales to 31.3% of sales, and are working to reduce them further in light of store closings. Since CEO Schoenfeld joined the company, consistent with the reduction in stores, they’ve eliminated three zone vice presidents, gone from 9 to 6 regional directions, and from 90+ to below 60 district managers.
 
The balance sheet is not as strong as it was a year ago. The current ratio has fallen from 2.11 to 1.58 and debt to total equity has risen from 0.87 times to 2.14 times. Much of the debt increase is the result of the money they raised last year in the form of long term debt.
 
Inventory was down about 7%, which you’d expect with store closings. It was flat on a comparable store basis, which you’d also expect as sales haven’t changed much. They note that there’s no liability from closed stores sitting in their inventory today. Their inventory reserve sat at $12.7 million at the end of the year, up from $5.7 million at the end of the previous year.
 
I had commented at the time of that long term debt transaction that they’d bought themselves some more time to implement their strategy, and I think that’s still a valid assessment. They expect their current sources of cash will be adequate “…to meet our operating and capital expenditure needs for the next twelve months,” as long as they don’t experience declines in same store sales like they had in 2009 or 2010 or further gross margin decline.
 
Let’s conclude with a conference call quote from CEO Schoenfeld. “I think we all believe that if we can execute it right, there’s a real future for PacSun. A lot of the branded business is done across department stores, and we think that as a specialty retailer, we have the opportunity to offer something different than what a department store offers.”
 
As indicated when we talked about strategies in the first part of this article, operating well, while critical, may not generate any kind of advantage. There are a lot of smart people running a lot of good businesses out there trying to do the same things to generate their own advantage. I also think that “offering something different” is a great idea, but I don’t know exactly what it’s going to be.
 
It will be tough to see how PacSun is going to do until after the dust settles from all the store closings, and I guess that takes us through this year and maybe a bit beyond. The question, I suppose, and not just for PacSun, is whether doing everything well is enough in the market and economy we’re in.