Pacific Sunwear of California (PSUN)

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While many of its apparel competitors have been launching new store brands to expand its demographic reach (e.g., Aeropostale opened Jimmy'Z in 2006 and is planning on launching a new concept in 2009), Pacific Sunwear announced in October 2007 that it would be exiting its two ancillary businesses: One Thousand Steps (9 stores which sell trendy footwear) and demo (153 stores which sell urban and hip-hop merchandise).^[1] At the end of fiscal 2007, Pacific Sunwear had officially discontinued the One Thousand Steps segment and all 153 remaining demo stores were conducting liquidation sales to prepare for final shutdown of the business in the first quarter of 2008. The company will now focus on its core of 944 PacSun stores and outlets that cater to active teenagers and young adults interested in the extreme-sports lifestyles.

In fiscal 2007 Pacific Sunwear generated over $1.4 billion in net sales, while posting a $33 million operating loss, making it one of the smallest and least profitable competitors in the youth apparel retail market in terms of sales.^[2] The company posted a 0.7% increase in same store sales for 2007, however this figure is lowered by the 19.6% decrease in same store sales at demo for 2007 which will be irrelevant once the business is discontinued in the first quarter of 2008.^[3] The core PacSun stores and outlets recorded a 3.4% increase in same store sales for 2007, significant improvement from the 4.2% decrease in same store sales in 2006.^[4]

As the company restructures its business and focuses on the PacSun concept, Pacific Sunwear has looked to expand abroad in Canada, where many of its competitors such as American Eagle and Aeropostale already have established a presence. Merchandise mix is also a key issue for Pacific Sunwear, as private label products accounted for only 28% of net sales in FY06^[5] while its top two vendors of branded merchandise, Quiksilver and Billabong, generated 22% of revenue. Private label offerings typically have the dual benefit of being higher margin and establishing brand loyalty.

[edit] Business Financials

Pacific Sunwear sells surf and extreme sports styled clothing and accessories in its PacSun stores and outlets. Additionally, PacSun owns and operates the demo retail chain, which targets urban youth with hip-hop styled apparel and accessories. However, demo has been struggling for years and will be discontinued in the first quarter of FY08. Thus the company will return to its roots and operate only through its PacSun stores.

[edit] Trends and Forces

[edit] Shutting Down demo and One Thousand Steps

A large portion of Pacific Sunwear's financial woes since 2006 have come from the botched demo and One Thousand Steps chains, both of which posted operating losses for FY06. Both stores moved the company away from its core focus of extreme sports lifestyle clothing and accessories:

• demo was launched in an attempt to create a large scale retail chain targeting youth that identify with the urban and hip-hop lifestyle
• One Thousand Steps was created for 18 to 24 year olds that offers trendy designer footwear from brands such as Dolce Vita and Lacoste

Pacific Sunwear had hoped to leverage its experience retailing branded footwear in PacSun stores to One Thousand Steps but, as with demo, the company was reaching outside its traditional customer segment and both businesses failed. demo has been experiencing double-digit decreases in same store sales in fiscal 2007, with same store sales declining 31% in the fourth quarter of 2007, and the company's 9 One Thousand Steps floundered since its opening in 2006.^[8] The company discontinued the One Thousand Steps business in the fourth quarter of fiscal 2007 and is in the process of liquidating inventories in its 153 demo stores which will be discontinued in the first quarter of fiscal 2008. Although the costly shutdown of these two segments have already hurt Pacific Sunwear's profits, once discontinued the company will be able to re-focus on its core PacSun concept.

[edit] Seeking Opportunities in Canada and Abroad

From 2004 to 2006, some of Pacific Sunwear's main competitors had begun expanding their brands into Canada. At the end of the third quarter of FY07 there were 6 A&F stores^[9] and 75 AE stores^[10] in Canada. Aeropostale moved into the country in fiscal 2007 with 12 stores^[11] (through the first three fiscal quarters). Aeropostale hasn't yet released any sales figures for its Canadian stores, but during FY06 AE operated 72 Canadian stores which generated over $230 million in revenue^[12], selling more per store than their American counterparts while Abercrombie & Fitch has stated that its Canadian stores generate approximately three times the sales of their domestic stores^[13].

If this performance by its competitors can be seen as an indication of the demand for youth-targeted apparel in Canada, the market opportunity could be sizeable. Despite the large growth opportunity, it is uncertain how soon Pacific Sunwear will enter the Canadian market, as it deals restructuring from selling demo and closing One Thousand Steps.

[edit] Private Label in the Product Mix

Because Pacific Sunwear depends heavily upon the brands of its vendors for sales (22% of sold merchandise in FY06 were from brands by Quiksilver and Billabong (ASX:BBG))^[14], the company has a harder time turning as high of a profit margin compared to its private label based competitors like Abercrombie & Fitch and American Eagle.

Pacific Sunwear sells its own private label brands, but these high-margin products only represented approximately 28% of sales in FY06^[15]. The company is currently working to expand margins by growing sales of private label merchandise in PacSun stores, particularly within the Girls Apparel product category.

[edit] Surf Fashion

Fashion tastes are notoriously fickle, especially in the young demographic that Pacific Sunwear targets. The company focuses it merchandise on West Coast/California fashion (think surf and skate), which has been a popular trend category for retailers such as Abercrombie & Fitch's Hollister store brand, which was responsible for 41% of the company's $3.3 billion of sales in FY06.^[16]

[edit] Competition

Pacific Sunwear is one of the main competitors in the youth apparel retail market, generating over $1.4 billion in sales in fiscal 2007. However unlike other teen apparel retailers, such as Abercrombie & Fitch and American Eagle Outfitters which sell only their own private label products, Pacific Sunwear's sales rely heavily upon third-party branded merchandise. As private label goods have significantly higher profit margins than their branded counterparts, Pacific Sunwear's profit margins are considerably lower than its competitors. Also, Pacific Sunwear's extreme-sports culture based stores do not appeal to as wide of a range of customers as the more generic, "preppy" teen styled merchandise of some of the PacSun's competitors.

Pacific Sunwear's competitors include:

• Abercrombie & Fitch Company (ANF): Abercrombie & Fitch is the leader of the youth apparel retail market by nearly all measures. ANF is a larger company than PSUN in terms of sales and profits, although PSUN operates more stores than ANF. Abercrombie & Fitch also operates four brands: Abercrombie & Fitch, Hollister, abercrombie, and RUEHL; all of which target different subsets of the 8-30 age range. While Pacific Sunwear's namesake stores compete with A&F and Hollister stores, PSUN has no match for A&F's kids apparel or post-college merchandise concepts: abercrombie and RUEHL. Although ANF is one of PSUN's competitors, the two companies operate with different strategies: Abercrombie maintains a premium brand with high price points and private label products while Pacific Sunwear focuses on providing its customers with surf- and snowboard-inspired merchandise that is mostly sourced from branded manufacturers. Importantly, Abercrombie & Fitch's core fashion designs focus on classic and "preppy" apparel while PacSun provides its customers with extreme sports-inspired merchandise.
• American Eagle Outfitters (AEO): American Eagle competes for the same customers (young men and women between the ages of 15 and 25)^[17] with PacSun's namesake stores; however, PacSun does not have a direct match for AE's new aerie and Martin + OSA sub brands. AEO is larger than PacSun in terms of total sales and profits, and AEO has exhibited much stronger growth recently than PacSun.^[18] However, it is hard to directly compare the two retailers because of AEO only sells its own private label merchandise while PacSun relies heavily on branded apparel and accessories. Also, AEO's core fashion designs focus on classic and "preppy" apparel while PacSun provides its customers with extreme sports-inspired merchandise.
• Aeropostale (ARO): Aeropostale is a slightly smaller company than PSUN, with slightly less sales and a considerably smaller number of stores. Also the overwhelming majority of ARO's revenue comes from its namesake brand of stores that targets 14 to 17 year olds. Aeropostale's only sells private label merchandise, while PSUN relies heavily on branded apparel from third-party manufacturers. However, Aeropostale recently launched a sub-brand called Jimmy'Z which is designed to offer surf-inspired merchandise to 18 to 25 year olds, which places the new chain in direct competition with PacSun for young adults who embrace alternative sports lifestyle and culture. At this point Jimmy'Z is still a very young brand, with only 12 stores throughout the US as of the third fiscal quarter of 2007, but if the new chain takes off for Aeropostale (ARO) it could become a prime competitor of PacSun.
• Urban Outfitters (URBN): Urban Outfitters is a relatively young retailer that operates three different branded store chains, Urban Outfitters (18 to 30 year olds), Anthropologie (30 to 45 year old women), and Free People (16 to 35 year old women).^[19] Urban Outfitters is not as directly comparable to Pacific Sunwear due to its slight differentiation in targeted customer segments.
• Gap (GPS): Gap is a much larger company than ARO in terms of sales, stores and customer segments targeted. Through variations on Gap (Gap Kids, babyGap, Gap Maternity) the retailer serves a wide range of customers; also, Banana Republic and Old Navy stores serve different socio-economic segments.^[20] Because of the wider range of customers, Gap doesn't match up with PSUN as closely as some other competitors, however there is some overlap.
• Quiksilver (ZQK): Quiksilver is a conglomerate that has been formed through multiple acquisitions and mergers. The company not owns and manufactures apparel, accessories and footwear for surfers, skateboarders and snowboarders under the Quiksilver, Roxy and DC brands. Also, Quiksilver (ZQK) manufactures ski and snowboard equipment under the Rossignol, Dynastar and Lange brands. It is hard to make a direct comparison between Pacific Sunwear and Quiksilver on a competitive basis, particularly because Quiksilver's merchandise accounted for 11% of PacSun sales in 2006, because of Quiksilver's wide range of operating activities. However, it is important to note that Quiksilver owns nearly 280 retail stores through which the company sells its apparel and equipment and these stores directly compete with PacSun. Unfortunately the company does not break out financial figures for these stores so it is difficult to make an accurate comparison.
• Zumiez (ZUMZ) is a mall based specialty retailer of action sports related apparel, footwear, equipment and accessories operating under the Zumiez brand name. As of February 2, 2008 ZUMZ operated 285 stores primarily located in shopping malls, giving the company a presence in 27 states. ZUMZ stores cater to young men and women between the ages of 12 and 24 who seek popular brands representing a lifestyle centered on activities that include skateboarding, surfing, snowboarding, BMX and motocross. 10-K 2007, "Business",

Note: *:Much of Urban Outfitters' revenue is generated through wholesale and internet orders so sales per store is not reflective of store-only sales.

 Pacific Sunwear of California

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Company	Data From	Revenue	Comparable Sales Growth	Net Income	Website and Catalogue Sales	Sales per Store
Abercrombie & Fitch Company (ANF)	2007	$3.75B[27]	(1%)[27]	$476M[27]	$298M[28]	$3.47M[29]
Aeropostale (ARO)	2007	$1.59B[30]	3.3%[31]	$129M[30]	Add	$1.93M[30]
American Eagle Outfitters (AEO)	2007	$3.06B[32]	1%[32]	$400M[32]	Add	$3.1M[32]
Pacific Sunwear of California (PSUN)	2006	$1.45B[33]	(4.7%)[34]	$39.6M[33]	Add	$1.24B[35]
Zumiez (ZUMZ)	2007	$381M[36]	9.2%[37]	$25.3M[36]	Add	$1.43M[37]

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[edit] References

1. ↑ Pacific Sunwear of California (PSUN) Press Release, "Pacific Sunwear to Explore Strategic Alternatives..."
2. ↑ Pacific Sunwear of California (PSUN) Press Release, Fourth Quarter Earnings Release
3. ↑ Pacific Sunwear of California (PSUN) Press Release, Fourth Quarter Earnings Release
4. ↑ Pacific Sunwear of California (PSUN) Press Release, Fourth Quarter Earnings Release
5. ↑ Pacific Sunwear of California (PSUN) 10-K 2006, Merchandising, p. 4
6. ↑ Pacific Sunwear of California (PSUN) Press Release, Fourth Quarter Earnings Release
7. ↑ Pacific Sunwear of California (PSUN) 10-K 2006, Merchandising, p. 4
8. ↑ Pacific Sunwear of California (PSUN) Press Release, Third Quarter Earnings Release
9. ↑ Abercrombie & Fitch (ANF) Third Quarter Earnings Release
10. ↑ American Eagle Outfitters (AEO) Third Quarter Earnings Release
11. ↑ Aeropostale (ARO) Third Quarter Earnings Release 2007
12. ↑ American Eagle Outfitters (AEO) Annual Report 2006
13. ↑ Abercrombie & Fitch (ANF) Third Quarter Earnings Release
14. ↑ Pacific Sunwear of California (PSUN) 10-K 2006, Merchandising, p. 4
15. ↑ Pacific Sunwear of California (PSUN) 10-K 2006, Merchandising, p. 5
16. ↑ Abercrombie & Fitch (ANF) Annual Report 2006
17. ↑ American Eagle Outfitters (AEO) 10-K 2006, "Business", p. 1
18. ↑ American Eagle Outfitters (AEO) Annual Report 2006
19. ↑ Urban Outfitters (URBN) Corporate Website
20. ↑ Gap (GPS) Annual Report 2006
21. ↑ Pacific Sunwear of California (PSUN) Press Release, Fourth Quarter Earnings Release
22. ↑ Abercrombie & Fitch (ANF) Press Release, Fourth Quarter Earnings Release
23. ↑ Aeropostale (ARO) Press Release, Fourth Quarter Earnings Release
24. ↑ American Eagle Outfitters (AEO) Press Release Report, Fourth Quarter Earnings Release
25. ↑ Urban Outfitters (URBN) Press Release, Fourth Quarter Earnings Release
26. ↑ Gap (GPS) Press Release, Fourth Quarter Earnings Release
27. ↑ ^{27.0 27.1 27.2} Abercrombie & Fitch FY2007 10-K, 03/28/08, pg. 25, Item 6: Selected Financial Data
28. ↑ Abercrombie & Fitch FY2007 10-K, 03/28/08, pg. 4
29. ↑ Abercrombie & Fitch FY2007 10-K, 03/28/08, pg. 28, Item 7, Financial Summary
30. ↑ ^{30.0 30.1 30.2} Aeropostale, FY2007 10-K, 04/01/08, Item 6: Selected Financial Data, pg. 17
31. ↑ Aeropostale, FY2007 10-K, 04/01/08, Item 7: Key indicators, pg. 19
32. ↑ ^{32.0 32.1 32.2 32.3} AEO FY2007 10-K, 04/02/08, Item 6: Selected Consolidated Financial Data, pg. 16
33. ↑ ^{33.0 33.1} PSUN, 2006 10-K, Item 15, Pg F-4
34. ↑ PSUN, 2006 10-K, Item 15, Pg F-20
35. ↑ PSUN, 2006 10-K, Item 7, Pg 16
36. ↑ ^{36.0 36.1} ZUMZ FY2007 10-K, March 25, 2008, Item 6: Selected Financial Information, pg. 23
37. ↑ ^{37.0 37.1} ZUMZ FY2007 10-K, March 25, 2008, Item 6: Selected Financial Information, pg. 24