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PSUN > SEC Filings for PSUN > Form 10-Q on 7-Jun-2013All Recent SEC Filings

Show all filings for PACIFIC SUNWEAR OF CALIFORNIA INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for PACIFIC SUNWEAR OF CALIFORNIA INC


7-Jun-2013

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 February 2, 2013 (our "2012 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 2013; and

potential recording of non-cash impairment charges for underperforming stores in future quarters.

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 our 2012 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 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 current Company 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.

Net merchandise margin

We analyze the components of net merchandise margins, specifically initial markups, discounts 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 discounts or 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.


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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, average net sales per square foot and number of transactions.

Cash flow and liquidity (working capital)

We evaluate cash flow from operations, liquidity and working capital to determine our short-term operational financing needs. Although we made progress with respect to our comparable store net sales and gross margins in fiscal 2012, if we were to experience a substantial decline in same-store sales and gross margins in the future, we may be required to access most, if not all, of the Wells Credit Facility and would potentially require other sources of financing to fund our operations, which sources might not be available. Based on current forecasts, we believe that cash flows from operations and working capital will be sufficient to meet our operating and capital expenditure needs for the next twelve months.

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 our 2012 Annual Report.

Results of Operations

Continuing Operations

The following table sets forth selected income statement data from our
continuing operations expressed as a percentage of net sales for the fiscal
years indicated. The table excludes discontinued operations and the discussion
that follows should be read in conjunction with the table:



                                                           For the First Quarter Ended
                                                   May 4, 2013                 April 28, 2012
Net sales                                                 100.0 %                        100.0 %
Cost of goods sold, including buying,
distribution and occupancy costs                           74.9                           76.5

Gross margin                                               25.1                           23.5
Selling, general and administrative
expenses                                                   31.6                           34.5

Operating loss                                             (6.5 )                        (11.0 )
Loss (gain) on derivative liability                         5.5                           (3.9 )
Interest expense, net                                       2.1                            2.0

Income (loss) before income taxes                         (14.1 )                         (9.1 )
Income tax expense                                          0.1                            0.2

Income (loss) from continuing operations                  (14.2 )%                        (9.3 )%

53rd Week Calendar Shift

Our fiscal 2012 annual reporting period included a 53rd week. Due to the inclusion of a 53rd week in fiscal 2012, there is

a one-week calendar shift in the comparison of the first quarter of fiscal 2013 ended May 4, 2013, to the first quarter of fiscal

2012 ended April 28, 2012. The first quarter of fiscal 2012 included a lower volume week and the first quarter of fiscal 2013 included a higher volume week as a result of the 53rd week retail calendar shift. This resulted in an approximately $6 million increase in net sales, 1.5% improvement in gross margin, and $0.03 per share improvement to our first quarter of fiscal 2013, compared to the first quarter of fiscal 2012 .

The first quarter (13 weeks) ended May 4, 2013 as compared to the first quarter (13 weeks) ended April 28, 2012

Net Sales

Net sales increased to $169.8 million for the first quarter of fiscal 2013 from
$162.3 million for the first quarter of fiscal 2012. The components of this $7.5
million increase in net sales are as follows:



$ millions                                   Attributable to
$       5.6         The 53rd week retail calendar shift which resulted in the
                    inclusion of a higher volume week at the end of our first quarter
                    of fiscal 2013 versus a lower volume week at the beginning of our
                    first quarter of fiscal 2012.
        2.7         An increase in comparable store sales.
       (0.8 )       Decrease in non-comparable sales.

$       7.5         Total


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For the first quarter of fiscal 2013, comparable store net sales of Women's increased by 7% while Men's decreased by 2%. The increase in Women's was driven by tops, bottoms and accessories. The decrease in Men's was driven by primarily shorts, board shorts and graphic tees, partially offset by increases in footwear and accessories. Apparel represented 81% of total Men's sales for the first quarter of fiscal 2013 versus 84% in fiscal 2012, while Women's apparel was flat at 86% of total Women's sales for the first quarters of fiscal 2013 and fiscal 2012. Total accessories and footwear represented a combined 17% of total sales for the first quarter of fiscal 2013 versus 15% in the first quarter of fiscal 2012.

Gross Margin

Gross margin, after buying, distribution and occupancy costs, was $42.7 million for the first quarter of fiscal 2013 versus $38.1 million for the first quarter of fiscal 2012. As a percentage of net sales, gross margin was 25.1% for the first quarter of fiscal 2013 compared to 23.4% for the first quarter of fiscal 2012. The components of this 1.7% increase in gross margin as a percentage of net sales were as follows:

  %                                     Attributable to
  1.6       Increase in merchandise margin to 53.0% in the first quarter of fiscal
            2013 from 51.4% in the first quarter of fiscal 2012. Approximately 0.5%
            of this increase was due to the 53rd week retail calendar shift.
  0.1       Occupancy, distribution costs and all other non-merchandise margin costs
            which were relatively flat as compared to the first quarter of fiscal
            2012. However, adjusting for the 53rd week retail calendar shift, there
            was deleveraging of buying and occupancy costs of 0.9% primarily due to
            prior year rent relief that did not anniversary in the first quarter of
            2013.

  1.7       Total

Selling, General and Administrative Expenses

Selling, general and administrative expenses ("SG&A") were $53.8 million for the first quarter of fiscal 2013 compared to $55.9 million for the first quarter of fiscal 2012. As a percentage of net sales, these expenses decreased to 31.7% in the first quarter of fiscal 2013 from 34.5% in the first quarter of fiscal 2012. The components of this 2.8% decrease in SG&A as a percentage of net sales were as follows:

  %                                       Attributable to
  (1.1 )      Decrease in depreciation expense to $6 million in the first quarter of
              fiscal 2013 from $8 million in the first quarter of fiscal 2012 due
              primarily to recent store closures.
  (1.0 )      Decrease in store payroll and payroll-related expenses as a percentage
              of net sales due primarily to a decrease in employee benefits.
  (0.1 )      Decrease in non-cash asset impairment charges and store closure related
              charges to $1.1 million in the first quarter of fiscal 2013 from $1.2
              million in the first quarter of fiscal 2012.
  (0.6 )      Decrease in all other SG&A expenses as a percentage of sales. Other
              SG&A expenses decreased $1 million to $12 million in the first quarter
              of fiscal 2013 from $13 million in the first quarter of fiscal 2012.

  (2.8 )      Total

We assess long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of such assets (or asset group) may not be recoverable. Based on management's review of the historical operating performance, including sales trends, gross margin rates, current cash flows from operations and the projected outlook for each of our stores, we determined that certain stores would not be able to generate sufficient cash flows over the remaining term of the related leases to recover our investment in the respective stores. As a result, we recorded non-cash impairment charges from continuing operations of approximately $1 million during each of the first quarters of fiscal 2013 and 2012, respectively, to write-down the carrying value of certain long-lived store assets to their estimated fair values.

Loss on Derivative Liability

We recorded a fair market adjustment of approximately $9 million related to the derivative liability in the first quarter of fiscal 2013. See Note 9 to the Condensed Consolidated Financial Statements "Fair Value Measurements - Recurring Fair Value Measurements-Derivative Liability" for further discussion on the derivative liability.

Interest Expense, Net

Interest expense, net, was approximately $4 million and $3 million for the first quarters of fiscal 2013 and 2012, respectively. The increase in interest expense, net, from fiscal 2012 to fiscal 2013 was primarily related to interest expense associated with the Term Loan described in Note 6 to the Condensed Consolidated Financial Statements.


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Income Taxes

We recognized income tax expense of $0.2 million and $0.4 million for the first quarters of fiscal 2013 and 2012, respectively. For fiscal 2013, we expect to continue to maintain a valuation allowance against deferred tax assets resulting in minimal income tax expense for the year. Information regarding the realizability of our deferred tax assets and our assessment of a need for a valuation allowance is contained in Note 7 to the Condensed Consolidated Financial Statements.

Loss from Continuing Operations

Our loss from continuing operations for the first quarter of fiscal 2013 was approximately $24 million, or $(0.35) per diluted share, versus a loss from continuing operations of approximately $15 million, or $(0.22) per diluted share, for the first quarter of fiscal 2012. Our loss for the first quarter of fiscal 2013 included a loss on our derivative liability of approximately $9 million, or $(0.13) per diluted share, as discussed in Note 9 to the Condensed Consolidated Financial Statements. The 53rd week retail calendar shift resulted in a $0.03 improvement in loss per diluted share in the first quarter of fiscal 2013.

Liquidity and Capital Resources

We have historically financed our operations primarily from internally generated cash flow and with 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. Although we made progress with respect to our comparable store net sales and gross margins in fiscal 2012, if we were to experience a substantial decline in same-store sales and gross margins in the future, we may be required to access most, if not all, of the Wells Credit Facility and would potentially require other sources of financing to fund our operations, which sources might not be available. Based on current forecasts, we believe that cash flows from operations and working capital will be sufficient to meet our operating and capital expenditure needs for the next twelve months.

                                                              For the First Quarters Ended
                                                          May 4, 2013            April 28, 2012
                                                                     (In thousands)
Net cash used in operating activities                    $      (29,704 )        $       (31,357 )
Net cash (used in) provided by investing activities              (1,114 )                  4,228
Net cash used in financing activities                              (257 )                 (1,582 )

Net decrease in cash and cash equivalents                $      (31,075 )        $       (28,711 )

Operating Cash Flows

Net cash used in operating activities in the first quarter of fiscal 2013 was $29.7 million, compared to $31.4 million for the first quarter of fiscal 2012. This increase of $1.7 million was due primarily to higher sales and improved gross margins in the first quarter of fiscal 2013, and was partially offset by increases in accounts payable and other current liabilities. Our primary use of cash in the first quarters of fiscal 2013 and 2012 was to purchase merchandise inventories. Non-cash adjustments to reconcile our net loss to net cash used in operating activities were approximately $18 million in the first quarter of fiscal 2013 and $5 million in the first quarter of fiscal 2012, respectively, and were primarily related to depreciation expense, asset impairment charges and loss (gain) on derivative liability in both periods.

Working Capital

Working capital at May 4, 2013, was $24 million compared to $42 million at
February 2, 2013, a decrease of $18 million. The changes in working capital were
as follows:



 $ millions                                      Description
$         42            Working capital at February 2, 2013.
         (31 )          Decrease in cash and cash equivalents.
          16            Increase in inventories, net of accounts payable.
          (3 )          Increase in other current liabilities, net of other current
                        assets.

$         24            Working capital at May 4, 2013.


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Investing Cash Flows

Net cash used in investing activities in the first quarter of fiscal 2013 was $1.1 million compared to $4.2 million provided by investing activities for the first quarter of fiscal 2012, a decrease in cash outflow of $5.3 million. Investing cash outflows in the first quarters of fiscal 2013 and 2012 were comprised primarily of capital expenditures for refreshing existing stores and information technology investments at the store level. We expect total capital expenditures for fiscal 2013 to be approximately $10 million to $15 million which is consistent with fiscal 2012. Investing cash inflows of $8 million in the first quarter of fiscal 2012 were primarily related to the receipt of restricted cash that was used as collateral to fund letters of credit outstanding under the Former Credit Facility.

Financing Cash Flows

Net cash used in financing activities in the first quarter of fiscal 2013 was $0.3 million compared to $1.6 million for the first quarter of fiscal 2012. The primary use of cash for financing activities in the first quarter of fiscal 2013 was principal payments under our mortgage borrowings and under capital lease obligations. The primary use of cash for financing activities in the first quarter of fiscal 2012 was principal payments under the Wells Credit Facility.

Wells Credit Facility

Information regarding the Wells Credit Facility is contained in Note 6 to the Condensed Consolidated Financial Statements and is incorporated herein by reference.

Term Loan

Information regarding the Term Loan is contained in Note 6 to the Condensed Consolidated Financial Statements and is incorporated herein by reference.

Mortgage Transactions

Information regarding our mortgage debt is contained in Note 6 to the Condensed Consolidated Financial Statements and is incorporated herein by reference.

Contractual Obligations

We have minimum annual rental commitments under existing store leases as well as a minor amount of capital leases for computer equipment. We lease all of our retail store locations under operating leases. We lease equipment, from time to time, under both capital and operating leases. In addition, at any time, we are contingently liable for commercial letters of credit with foreign suppliers of merchandise. At May 4, 2013, our future financial commitments under all existing contractual obligations were as follows:

                                                     Payments Due by Period
                                                  Less                              More
                                                 than 1       1-3        3-5       than 5
                                      Total       year       years      years       years
                                                         (In millions)
       Operating lease obligations    $  345     $    76     $  125     $   82     $    62
       Term loan                         101           4          8         89          -
       Mortgage debt                      36           2          5         29          -
       Letters of credit                  11          11         -          -           -
       Guaranteed minimum royalties        3           2          1         -           -
       Capital lease obligations           1           1         -          -           -

       Total                          $  497     $    96     $  139     $  200     $    62

Operating lease obligations consist primarily of future minimum lease commitments related to store operating leases. The contractual obligations table above does not include common area maintenance ("CAM") charges, insurance, or tax obligations, which are also required contractual obligations under our store operating leases. In many of our leases, CAM charges are not fixed and can fluctuate significantly from year to year for any particular store. Total store rental expenses, including CAM, for the first quarters of fiscal 2013 and fiscal 2012 were approximately $33 million and $32 million, respectively. Total CAM expenses may continue to fluctuate significantly from year-to-year as long-term leases come up for renewal at current market rates in excess of original lease terms and as we continue to close stores. Additional information regarding operating leases can be found below under the caption "Operating Leases."


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Obligations under our Executive Deferred Compensation Plan are equal to approximately $2 million as of May 4, 2013 and have been excluded from the contractual obligations table above as we are unable to reasonably determine the amount or the timing of the future payments.

Operating Leases

We lease our retail stores and certain equipment under operating lease agreements expiring at various dates through January 2024. Many of our retail store leases require us to pay CAM charges, insurance and property taxes. In addition, many of our retail store leases require us to pay percentage rent ranging from 2% to 20% when sales volumes exceed certain minimum sales levels. The initial terms of such leases are typically 8 to 10 years, some of which contain renewal options exercisable at our discretion. Most leases also contain rent escalation clauses that come into effect at various times throughout the lease term. Rent expense is recorded under the straight-line method over the life of the lease (see "Straight-Line Rent" in Note 1 to the Consolidated Financial Statements). Other rent escalation clauses can take effect based on changes in primary mall tenants throughout the term of a given lease. Many leases also contain cancellation or kick-out clauses in our favor that relieve us of any future obligation under a lease if specified criteria are met. These cancellation provisions typically apply if annual store sales levels do not exceed $1 million or mall occupancy targets are not achieved within the first 36 months of the lease. Generally, we are not required to make payments to our landlords in order to exercise our cancellation rights under these provisions. The Wells Credit Facility and Term Loan do not preclude the transfer or disposal of assets related to the stores we are projecting to close by the end of fiscal 2013. None of our retail store leases contain purchase options.

Indemnifications

In the ordinary course of business, we may provide indemnifications of varying scope and terms to customers, vendors, lessors, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of our breach of such agreements, services to be provided by us, or intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors and certain of our officers that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. We maintain director and officer insurance, which may cover certain liabilities arising from our obligation to indemnify our directors and officers in certain circumstances.

It is not possible to determine our maximum potential liability under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Such indemnification agreements may not be subject to maximum loss clauses. Historically, we have not incurred material costs as a result of obligations under these agreements.

Off-Balance Sheet Arrangements

We have not entered into any transactions with unconsolidated entities whereby we have financial guarantees, subordinated retained interests, derivative instruments, or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to us.

Recent Accounting Pronouncements

Information regarding recent accounting pronouncements is contained in Note 3 to the Condensed Consolidated Financial Statements and is incorporated herein by reference.

Inflation

We do not believe that inflation has had a material effect on our results of operations in the recent past, including the first quarter of fiscal 2013.

Seasonality and Quarterly Results

Our business is seasonal by nature. Our first quarter historically accounts for the smallest percentage of annual net sales with each successive quarter contributing a greater percentage than the last. In recent years, approximately 45% of our net sales have occurred in the first half of the fiscal year and 55% have occurred in the second half. The six to seven week selling periods for each of the back-to-school and holiday seasons together account for approximately 35% to 40% of our annual net sales and a higher percentage of our operating results on a combined basis. Our quarterly results of operations may also fluctuate significantly as a result of a variety of factors, including changes in consumer buying patterns, fashion trends, the timing and level of markdowns, the timing . . .

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