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PSUN > SEC Filings for PSUN > Form 10-Q on 8-Dec-2011All Recent SEC Filings

Show all filings for PACIFIC SUNWEAR OF CALIFORNIA INC

Form 10-Q for PACIFIC SUNWEAR OF CALIFORNIA INC


8-Dec-2011

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following management's discussion and analysis of financial condition and results of operations ("MD&A") should be read in conjunction with our Condensed Consolidated Financial Statements and notes thereto included elsewhere in this Report.

Cautionary Note Regarding Forward-Looking Statements

This Report contains "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and we intend that such forward-looking statements be subject to the safe harbors created thereby. In Item 1A, Risk Factors, in our Annual Report on Form 10-K for the year ended January 29, 2011 (the "2010 Annual Report"), we provide cautionary statements identifying important factors that could cause our actual results to differ materially from those projected in the forward-looking statements contained herein. Any statements that express, or involve discussions as to, expectations, beliefs, plans, objectives, assumptions, future events or performance (often, but not always, identifiable by the use of words or phrases such as "will result," "expects to," "will continue," "anticipates," "plans," "intends," "estimated," "projects" and "outlook") are not historical facts and may be forward-looking and, accordingly, such statements involve estimates, assumptions and uncertainties which could cause actual results to differ materially from those expressed in the forward-looking statements. Examples of forward-looking statements in this Report include, but are not limited to, the following categories of expectations about:

the sufficiency of operating cash flows, working capital and available credit to meet our operating and capital expenditure requirements,

our capital expenditure plans for fiscal 2011,

potential recording of noncash impairment charges for underperforming stores in future quarters,

increases in product sourcing costs,

forecasted net cash savings as a result of the amendment or termination of certain leases,

forecasts of future store closures, expansions, relocations and store refreshes during fiscal 2011, and

future increases in occupancy costs.

All forward-looking statements included in this Report are based on information available to us as of the date hereof, and are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. See Item 1A, Risk Factors, in the 2010 Annual Report, which are hereby incorporated by reference in this Report for a discussion of these risks and uncertainties. We assume no obligation to update or revise any such forward-looking statements to reflect events or circumstances that occur after such statements are made.

Executive Overview

We consider the following items to be key performance indicators in evaluating our performance:

Comparable (or "same-store") sales. Stores are deemed comparable stores on the first day of the fiscal month following the one-year anniversary of their opening or expansion/relocation. We consider same-store sales to be an important indicator of the Company's current performance. Same-store sales results are important in achieving operating leverage of certain expenses such as store payroll, store occupancy, depreciation, general and administrative expenses and other costs that are somewhat fixed. Positive same-store sales results usually generate greater operating leverage of expenses while negative same-store sales results generally have a negative impact on operating leverage. Same-store sales results also have a direct impact on our net sales, cash and working capital.


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Net merchandise margins. We analyze the components of net merchandise margins, specifically initial markups and markdowns as a percentage of net sales. Any inability to obtain acceptable levels of initial markups or any significant increase in our use of markdowns could have an adverse impact on our gross margin results and results of operations.

Operating margin. We view operating margin as a key indicator of our success. The key drivers of operating margins are comparable store net sales, net merchandise margins, and our ability to control operating expenses. For a discussion of the changes in the components comprising operating margins, see "Results of Operations" in this section.

Store sales trends. We evaluate store sales trends in assessing the operational performance of our stores. Important store sales trends include average net sales per store and average net sales per square foot.

Cash flow and liquidity (working capital). We evaluate cash flow from operations, liquidity and working capital to determine our short-term operational financing needs. Based on the availability under the New Credit Facility and the funds received upon closing of the Senior Secured Term Loan, the Company believes that it will be able to meet its operating and capital expenditure needs for the next twelve months. At October 29, 2011, we had no direct borrowings under the Former Credit Facility; however, we borrowed $20 million under the Facility subsequent to such date. The $20 million was re-paid at the closing of the Senior Secured Term Loan financing on December 7, 2011. For a discussion of the changes in operating cash flows and working capital, see "Liquidity and Capital Resources" in this section.

Critical Accounting Policies

There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in the 2010 Annual Report.

Results of Operations

The following table sets forth selected operating data expressed as a percentage
of net sales for the fiscal periods indicated. The discussion that follows
should be read in conjunction with the following table:



                                      For the Third Quarter Ended                   For the Three Quarters Ended
                                 October 29,              October 30,           October 29,              October 30,
                                     2011                     2010                  2011                     2010
Net sales                               100.0 %                  100.0 %               100.0 %                  100.0 %
Cost of goods sold,
including buying,
distribution and occupancy
costs                                    75.8                     75.0                  77.7                     76.4

Gross margin                             24.2                     25.0                  22.3                     23.6
Selling, general and
administrative expenses                  31.1                     27.6                  32.5                     32.7

Operating loss                           (6.9 )                   (2.6 )               (10.2 )                   (9.1 )
Other expense, net                        0.5                      0.2                   0.4                      0.1

Loss before income taxes                 (7.4 )                   (2.8 )               (10.6 )                   (9.2 )
Income tax (benefit)
expense                                  (0.1 )                   (0.1 )                  -                        -

Net loss                                 (7.3 )%                  (2.7 )%              (10.6 )%                  (9.2 )%

Number of stores open at
end of period                             820                      877
Total square footage (in
000s)                                   3,194                    3,400


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The third quarter (thirteen weeks) ended October 29, 2011 as compared to the third quarter (thirteen weeks) ended October 30, 2010

Net Sales

Net sales decreased to $242 million for the third quarter of fiscal 2011 from
$258 million for the third quarter of fiscal 2010. The components of this $16
million decrease in net sales are as follows:



$ millions                                   Attributable to
$        (13 )      Decrease in net sales due to store closures.
                    Increase in other non-comparable sales including sales from
                    expanded or relocated stores not yet included in the comparable
           4        store base, e-commerce and bulk sales.
                    3% decrease in comparable store net sales in the third quarter of
          (7 )      fiscal 2011 compared to the third quarter of fiscal 2010.

$        (16 )      Total

For the third quarter of fiscal 2011, comparable store net sales of Women's product decreased 5% and Men's product decreased 1%. Apparel represented 87% of total sales for the third quarter of fiscal 2011 and 2010. Accessories and footwear represented a combined 13% of total net sales for the third quarter of fiscal 2011 and 2010.

Gross Margin

Gross margin, after buying, distribution and occupancy costs, was $59 million for the third quarter of fiscal 2011 versus $64 million for the third quarter of fiscal 2010. As a percentage of net sales, gross margin was 24.2% for the third quarter of fiscal 2011 compared to 25.0% for the third quarter of fiscal 2010. The components of this 0.8% decrease in gross margin as a percentage of net sales were as follows:

  %                                     Attributable to
   0.1      Increase in merchandise margin as a percentage of sales.
            Decrease in occupancy costs to $45 million in the third quarter of

(0.5 ) fiscal 2011 compared to $47 million in the third quarter of fiscal 2010. Decrease in buying and distribution costs to $9 million in the third quarter of fiscal 2011 compared to $10 million in the third quarter of (0.2 ) fiscal 2010. (0.2 ) Increase in e-commerce shipping costs as a percentage of sales.

(0.8 ) Total


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Selling, General and Administrative Expenses

Selling, general and administrative expenses ("SG&A") increased to $75 million for the third quarter of fiscal 2011 from $71 million for the third quarter of fiscal 2010, an increase of $4 million, or 6%. These expenses increased to 31.1% as a percentage of net sales in the third quarter of fiscal 2011 from 27.6% in the third quarter of fiscal 2010. The components of this 3.5% increase in SG&A as a percentage of net sales were as follows:

  %                                     Attributable to
            Increase in payroll and payroll-related expenses as a percentage of
            sales. In dollars, payroll and payroll-related expenses were flat in the
            third quarter of fiscal 2011, as compared to the prior year, which
   0.9      includes a $2 million bonus accrual reversal.
            Decrease in depreciation expense to $10 million in the third quarter of
  (1.1 )    fiscal 2011 from $13 million in the third quarter of fiscal 2010.
            Increase in noncash asset impairment charges and store closure related
            charges to $9 million in the third quarter of fiscal 2011 from $2
   2.9      million in the third quarter of fiscal 2010.
            Increase in all other SG&A expenses. In dollars, all other SG&A expenses
            were $18 million in the third quarter of fiscal 2011 compared to $16
   0.8      million in the third quarter of fiscal 2010.

   3.5      Total

We evaluate the recoverability of the carrying amount of long-lived assets (primarily property and equipment at the store level) whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. For a discussion of impairment charges, see Note 4 to the Condensed Consolidated Financial Statements included in this Report. Should comparable store net sales and gross margin decline, we may record additional noncash impairment charges within selling, general and administrative expenses for underperforming stores in future periods.

Other Expense, Net

Other expense was $1.2 million and $0.4 million for the third fiscal quarter of 2011 and 2010, respectively, primarily related to interest expense associated with the mortgage debt described in Note 7 to the Condensed Consolidated Financial Statements included in this Report.

Income Taxes

We recognized an income tax benefit of $0.3 million and $0.2 million during the third quarters of fiscal 2011 and 2010, respectively. For fiscal 2011, we expect to continue to maintain a valuation allowance against deferred tax assets resulting in minimal income tax expense for the year. For further information, see Note 8 to the Condensed Consolidated Financial Statements included in this Report, which information is incorporated herein by reference.

Net Loss and Net Loss Per Share

Our net loss for the third quarter of fiscal 2011 was $17.6 million, or $(0.26) per share, versus a net loss of $7.0 million, or $(0.11) per share, for the third quarter of fiscal 2010. Amounts for the third quarter of fiscal 2011 and 2010 include store closure related charges and the continuing impact of a valuation allowance against our deferred tax assets.

The first three quarters (39 weeks) ended October 29, 2011 as compared to the first three quarters (39 weeks) ended October 30, 2010

Net Sales

Net sales decreased to $643 million for the first three quarters of fiscal 2011
from $667 million for the first three quarters of fiscal 2010. The components of
this $24 million decrease in net sales are as follows:



$ millions                                   Attributable to
$        (29 )      Decrease in sales due to store closures.
                    Increase in other non-comparable sales including sales from
                    expanded or relocated stores not yet included in the comparable
           9        store base, e-commerce sales and bulk sales.
                    1% decrease in comparable store net sales in the first three
                    quarters of fiscal 2011 compared to the first three quarters of
          (4 )      fiscal 2010.

$        (24 )      Total


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For the first three quarters of fiscal 2011, comparable store net sales of Women's product was flat and Men's product decreased 1%. Apparel represented 86% of total sales for the first three quarters of fiscal 2011 versus 87% for the first three quarters of fiscal 2010. Accessories and footwear represented a combined 14% of total net sales for the first three quarters of fiscal 2011 versus 13% in the first three quarters of fiscal 2010.

Gross Margin

Gross margin, after buying, distribution and occupancy costs, was $144 million for the first three quarters of fiscal 2011 versus $158 million for the first three quarters of fiscal 2010. As a percentage of net sales, gross margin was 22.3% for the first three quarters of fiscal 2011 compared to 23.6% for the first three quarters of fiscal 2010. The components of this 1.3% decrease in gross margin as a percentage of net sales were as follows:

  %                                     Attributable to
  (1.2 )    Decrease in merchandise margins as a percentage of sales.
            Decrease in occupancy costs to $138 million in the first three quarters
            of fiscal 2011 compared to $143 million for the first three quarters of
  (0.1 )    fiscal 2010.
            Decrease in buying and distribution costs to $26 million in the first
            three quarters of fiscal 2011 compared to $28 million for the first
   0.1      three quarters of fiscal 2010.
  (0.1 )    Increase in e-commerce shipping costs as a percentage of sales.

  (1.3 )    Total

Selling, General and Administrative Expenses

SG&A decreased to $209 million for the first three quarters of fiscal 2011 from $218 million for the first three quarters of fiscal 2010, a decrease of $9 million, or 4.0%. These expenses decreased to 32.6% as a percentage of net sales in the first three quarters of fiscal 2011 from 32.7% in the first three quarters of fiscal 2010. The components of this 0.1% decrease in SG&A as a percentage of net sales were as follows:

  %                                     Attributable to
            Decrease in payroll and payroll-related expenses as a percentage of
            sales. In dollars, payroll and payroll-related expenses were $116
            million in the first three quarters of fiscal 2011 compared to $124
  (0.5 )    million in the first three quarters of fiscal 2010.
            Decrease in depreciation expense to $31 million in the first three
            quarters of fiscal 2011 compared to $40 million in the first three
  (1.2 )    quarters of fiscal 2010.
            Increase in noncash asset impairment charges and store closure related
            charges to $15 million in the first three quarters of fiscal 2011 from
   0.9      $9 million in the first three quarters of fiscal 2010.
            Increase in all other SG&A expenses as a percentage of sales. In
            dollars, all other SG&A expenses were $48 million in the first three
            quarters of fiscal 2011 and $45 million in the first three quarters of
   0.7      2010.

  (0.1 )    Total

We evaluate the recoverability of the carrying amount of long-lived assets (primarily property and equipment at the store level) whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. For a discussion of impairment charges, see Note 4 to the Condensed Consolidated Financial Statements included in this Report. Should comparable store net sales and gross margin decline, we may record additional noncash impairment charges within selling, general and administrative expenses for underperforming stores in future periods.

Other Expense, Net

Other expense was $2.3 million and $0.5 million for the first three quarters of fiscal 2011 and 2010, respectively, primarily related to interest expense associated with the mortgage debt described in Note 7 to the Condensed Consolidated Financial Statements included in this Report.

Income Taxes

We recognized income tax expense of $0.3 million and $0.4 million during the first three quarters of fiscal 2011 and 2010, respectively. For fiscal 2011, we expect to continue to maintain a valuation allowance against deferred tax assets resulting in minimal income tax expense for the year. For further information, see Note 8 to the Condensed Consolidated Financial Statements included in this Report, which information is incorporated herein by reference.

Net Loss and Net Loss Per Share

Our net loss for the first three quarters of fiscal 2011 was $68.3 million, or $(1.03) per share, versus a net loss of $61.5 million, or $(0.93) per share, for the first three quarters of fiscal 2010. Amounts for the first three quarters of fiscal 2011 and 2010 include store closure related charges and the continuing impact of a valuation allowance against our deferred tax assets.

Liquidity and Capital Resources

We have typically financed our operations primarily from internally generated cash flow, with occasional short-term and long-term borrowings. Our primary cash requirements have been for the financing of inventories and construction of newly opened, remodeled, expanded or relocated stores.


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We evaluate cash flow from operations, liquidity and working capital to determine our short-term operational financing needs. Based on the availability under the New Credit Facility and the funds received upon closing of the Senior Secured Term Loan, the Company believes that it will be able to meet its operating and capital expenditure needs for the next twelve months. At October 29, 2011, we had no direct borrowings under the Former Credit Facility; however, we borrowed $20 million under the Facility subsequent to such date. The $20 million was re-paid at the closing of the Senior Secured Term Loan financing on December 7, 2011. For a discussion of the changes in operating cash flows and working capital, see "Liquidity and Capital Resources" in this section.

At October 29, 2011, we had no direct borrowings under our Former Credit Facility, however we borrowed $20 million under that credit facility subsequent to such date.

                                                      For the First Three Quarters Ended
                                                   October 29,                 October 30,
(In thousands)                                         2011                        2010
Net cash used in operating activities            $        (45,262 )          $        (62,199 )
Net cash used in investing activities                      (9,865 )                   (15,544 )
Net cash (used in) provided by financing
activities                                                   (303 )                    28,627

Net decrease in cash and cash equivalents        $        (55,430 )          $        (49,116 )

Operating Cash Flows

Net cash used in operating activities for the first three quarters of fiscal 2011 was $45 million. We used $20 million of cash in operations (net of noncash charges), before working capital changes. In addition, cash decreased $19 million from changes in working capital items primarily due to increases in merchandise inventories of $57 million, offset by increased accounts payable of $49 million due to the seasonal variation between the ramp up for the holiday season and the annual low point for inventories at the end of the fiscal year. The remaining decrease in cash from working capital items was attributable to an increase in other current assets of $7 million primarily due to an increase in prepaid expenses of $5 million. Additional decreases in operating cash flows were due to changes in other assets and liabilities of $7 million.

Net cash used in operating activities for the first three quarters of fiscal 2010 was $62 million. We used $8 million of cash in operations (net of noncash charges), before working capital changes. In addition, cash decreased $54 million from changes in working capital items primarily due to increases in merchandise inventories of $77 million, offset by increased accounts payable of $39 million due to the seasonal variation between the ramp up for the holiday season and the annual low point for inventories at the end of the fiscal year. Additional decreases in operating cash flows were due to changes in other assets and liabilities of $16 million.

Working Capital

Working capital at October 29, 2011 was $57 million compared to $93 million at
January 29, 2011, a decrease of $36 million. The changes in working capital were
as follows:



$ millions                                     Description
$         93        Working capital at January 29, 2011
         (55 )      Decrease in cash and cash equivalents.
           8        Increase in merchandise inventories, net of accounts payable, from
                    fiscal year end due to planned receipt flows.
           7        Increase in other assets, primarily prepaid expenses.
           4        Decrease in other current liabilities.

$         57        Working capital at October 29, 2011

Investing Cash Flows

Net cash used in investing activities in the first three quarters of fiscal 2011 was $10 million compared to $16 million for the first three quarters of fiscal 2010, a decrease in cash used of $6 million. Investing cash flows for the first three quarters of fiscal 2011 and 2010 were comprised primarily of capital expenditures at the store level. We expect total capital expenditures for fiscal 2011 to be approximately $13 to $15 million.

Financing Cash Flows

Net cash used in financing activities in the first three quarters of fiscal 2011 was $0.3 million compared to cash provided of $29 million for the first three quarters of fiscal 2010, an increase in cash used of approximately $30 million. The primary source of financing outflows in fiscal 2011 was principal payments under mortgage borrowings and capital leases offset by cash proceeds from the exercise of stock options. The primary source of financing inflows in fiscal 2010 was proceeds from mortgage borrowings, offset by payments for mortgage borrowing costs.

Credit Facility

Information regarding our Credit Facility is contained in Note 5 to the Condensed Consolidated Financial Statements and is incorporated herein by reference.

Mortgage Transactions

Information regarding our mortgage debt is contained in Note 7 to the Condensed Consolidated Financial Statements included in this Report and is incorporated herein by reference.

Contractual Obligations

We have minimum annual rental commitments under existing store leases as well as collateralized debt obligations related to our corporate headquarters and distribution center. In addition, at any given time, we are contingently liable for commercial letters of credit with foreign suppliers of merchandise. At October 29, 2011, our future financial commitments under all existing contractual obligations were as follows:

                                             Payments Due by Period (in $ millions)
                                                   Less                                 More
                                                  than 1         1-3        3-5        than 5
   Contractual Obligations         Total           year         years      years       years
   Operating lease obligations    $    443       $     84       $  149     $  108     $    102
   Mortgage debt                        29              1            1          1           26
   Letters of credit                    26             26           -          -            -
   Guaranteed minimum royalties          4              1            3         -            -

   Total                          $    502       $    112       $  153     $  109     $    128


Table of Contents

We review the operating performance of our stores on an ongoing basis to determine which stores, if any, to expand, relocate or close. We closed 32 stores in the first three quarters of fiscal 2011. We have an aggregate of nearly 400 lease expirations for reconsideration through 2013. These leases will either be renewed or extended, potentially at different rates, terminated early, or be allowed to expire. As a result, depending on market conditions, actual future rental commitments and the time frame of such commitments may differ significantly from those shown in the table above. Currently, we anticipate . . .

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