My Farewell to PacSun as a Public Company

It was a couple of weeks ago that PacSun finally released its year end financials for January 30, 2016.  Arguably, nobody cares given the time that’s passed, the bankruptcy filing and the fact that they’ve now emerged from bankruptcy.

But a brief review of the numbers tells us something about how the company deteriorated to the point where a bankruptcy filing was the only real choice.  It’s also good information to have as we take a look at how they came out of bankruptcy.

The Deal

To remind you, the bankruptcy plan was confirmed on September 6th.  The common stock holders got zero.  The unsecured creditors got their pro rata share of a $400,000 pool.  There was a pool of “Qualified Unsecured Trade Claims” that are getting paid in full- half at plan confirmation and half on December 16th.  These are the claims “…directly relating to and arising solely from the receipt of goods and services by the Debtors arising with, and held by, Entities with whom the Debtors are conducting, and with whom the Reorganized Debtors elect to continue to conduct, business as of the Effective Date.”

The lawyers, consultants, bankers and tax authorities all get paid in full- standard and appropriate operating procedure even though you can’t help but wish the bankruptcy process wasn’t so expensive.

Golden Gate, the lender to whom PacSun owned the big chunk of debt due at the end of this year that they couldn’t pay, ends up owning all the equity of this now private company, having converted 65% of its term debt into equity.

The Year End Numbers

This filing isn’t the standard 10-K where they discuss and explain results, and of course there was no conference call.  Here are the year-end numbers in brief.

Revenue fell 3.3% from $827 million in the previous year to $801 million.  The gross profit margin was down a bit from 27% to 26.7%.   SG&A expenses were reduced 7.1% from $238.4 to $221.6 million.  There was an operating loss of $18 million, up from a loss of $15.1 million the prior year.  The net loss actually improved from $29.4 million last year to $8.5 million BUT that includes a non-cash gain of $27.7 million on their derivative liability, up from a gain of $2.3 million last year.

If we ignore that, we’ve got an operating loss before taxes that rose from $26.4 million last year to $35.3 million.

On the balance sheet, we see that cash fell from $22.6 to $6.2 million.  Inventory rose from $81.7 to $96.5 million.  Current assets were constant at $120 million.  However, current liabilities rose from $113 to $179 million, as the debt owed to Golden Gate became due within a year.  They also borrowed $18 million on their line of credit which had been zero at the end of the prior year.  These changes caused the current ratio to decline from 1.07 to 0.67.

Meanwhile, long term debt had fallen as the Golden Gate debt transitioned from long term to current because it was due within a year.  Equity declined from a negative $9.4 million to negative $15.5 million.

So not a pretty picture.  There was no possibility PacSun could pay the Golden Gate debt when it became due and the bankruptcy filing on April 7 was the response.

The Bigger Issue

The restructuring is mostly done.  There’s equity on the balance sheet, cash flow has improved, and all the creditors have been dealt with.  We finance guys like that.  Now what?

Regular readers know that I’ve been a supporter of what CEO Gary Schoenfeld has been doing since the day he took over.  But I also raised the key strategic issue of how you make PacSun “cool” again.  That is, having lost your target customers, how do you make them want to return to PacSun?  However you do it, they couldn’t get it to happen in time to avoid a bankruptcy.

Partly, you make the PacSun brand a little less ubiquitous.  Gary famously noted in his first conference call that nobody needed 900 plus PacSun Stores.  At January 30, 2016 they were down to 601 stores.  At September 7th, they were down to 583.

They announced as part of the bankruptcy that they were closing 100 stores and I guess that process continues.  I’m a bit surprised they didn’t close more.  I suppose that was a function of the deals they could make with their landlords since under bankruptcy law they can reject any contract they don’t want to live up to.  But those deals tend to be negotiations- they aren’t as cut and dried as “Give us what we want or we’re gone.”

No doubt landlords made concessions, but I imagine they also got some concessions that gives them some flexibility in the future.  Somebody also reminded me that if you’re a brand that had any kind of exclusive deal with PacSun, your contract almost certainly had an out in case of a bankruptcy filing.  I wonder if any of those brands extracted any kind of pound of flesh from PacSun so that they’d stay.

As we’ve seen with a number of industry companies, financial distress leads you to make selling, distribution, and discount decisions you might not normally make.  PacSun emphasized house brands and got known for its discounting as things got harder.  That may have been the correct short term financial decision, but it’s not a market position that lets you be “cool” again.  And it’s probably not one PacSun can afford in the long term given the cost of the mall space they are in.

As a private company, PacSun will have a great deal more flexibility in approaching the market.  The restructuring that resulted from the bankruptcy gives them more time to become attractive to their target customers.  But think of the bankruptcy as a necessary action that’s now completed.  They’ve won (if you want to call it that) a battle- not the war.