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<DAILY TROUBLE>
Friday, November 20, 1998
Gadzooks
<% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GADZ)") else Response.Write("(Nasdaq: GADZ)") end if %>
Phone: 972-307-5555
Website: www.gadzooks.com
Price (11/19/98): $7 3/4
HOW DID IT FIND TROUBLE?
Gadzooks is right! Shares of this specialty retailer of teen apparel have slipped as low as a pair of baggy jeans due to a weak merchandise mix and fears of recession that have hit other specialty retailers. Shareowners have been uttering more than mild oaths.
Business was booming in the first quarter aside from weak juniors swimsuit sales caused by a lack of new fashions and poor weather. Same-store sales fell 7.1% for March and 0.5% for the quarter. Yet, backing out swimwear, comp-store sales rose 6.6% for the quarter and 9.4% for April, with same-store sales of young women's apparel the strongest in over a year. Total sales soared 32.2%, bringing EPS in on target at $0.16.
May was another good month, with same-store sales up by 5.3% and overall sales growing by 40.6% as the warmer weather and price-cutting cleared out the swimwear inventory and allowed Gadzooks to focus on back-to-school items. The stock was flying high at around $30.
The bad news struck July 22, when the company admitted that the baggy denims and retro colors in the back-to-school collection weren't flying off the shelves as expected. Gadzooks said it was reevaluating its wardrobe and would reduce the number of pre-Christmas store openings from 20 to just 6.
The stock plunged 40% to $11 1/4 on the news. With Q2 earnings then coming in at the low end of guidance at $0.07 per share, Gadzooks has played fashion victim to a tee.
BUSINESS DESCRIPTION
Gadzooks is a fast-growing specialty retailer of casual apparel and accessories for young women and men ages 13 to 19.
In FY97, juniors (young women) apparel accounted for 29% of sales while young men's apparel accounted for 26%. The rest came from accessories (17%), unisex apparel (17%), and footwear (11%). The company sells brands such as JNCO, Dr. Marten, Kikwear, Adidas, and BC Ethic.
The company operates 311 mall-based stores in 22 states east of the Rocky Mountains, mainly in metropolitan and middle markets. It opened 67 new stores in 1997 and has opened 61 new stores this year. Five years ago it had just 65 locations.
Insiders own 4.3% of the stock.
FINANCIAL FACTS
Income Statement
12-month sales: $203.4 million
12-month income: $6.2 million
12-month EPS: $0.68
Profit Margins: 3.0 %
Market Cap: $69 million
Balance Sheet:
Cash: $7.0 million
Current Assets: $54.1 million
Current Liabilities: $22.1 million
Long-term Debt: $2.1 million
Ratios
Price-to-earnings: 11.4
Price-to-sales: 0.34
HOW COULD YOU HAVE SEEN IT COMING?
Specialty apparel retailers depend on having the latest fashions. When they're wrong, look out!
While the same-store sales picture had some notable blemishes around the bikini line, it really didn't look so bad in this case, though it foretold markdowns. The May 13 departure of general merchandise manager Loretta Falkner to "pursue other opportunities" also should have been cause for concern since the head buyer has a huge impact on the product mix. That's why investors like to see continuity in this area.
Also figuring into the equation was the Gap's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GPS)") else Response.Write("(NYSE: GPS)") end if %> omnipresent and obviously successful khaki campaign, which managed to make basics seem cool even to the part of the skateboard set that thinks wide-legged pants can't be wide enough. That left Gadzooks flaunting a retro-'70s look that didn't have mass appeal.
WHERE TO FROM HERE?
Gadzooks sports trailing 12-month sales of $203.4 million and EPS of $0.68. Yet analysts have been marking down estimates, with the lowball numbers now at $0.55 per share for FY98 ending in January and $0.80 for FY99. So there's a reason for the low P/E ratio despite Wall Street's previous projections for mid 20% long-term growth.
The company's third quarter will look ugly, with markdowns on accessories, unisex T-shirts, and back-to-school items destroying profits. Gadzooks also cancelled orders for delivery in September and October, accounting for the relatively lame 22.8% overall revenue growth for the period.
Getting the merchandise mix right for America's fickle teens can be harder than predicting whether Dawson and Joey will end the season together or apart. New Gadzooks merchandising head David Mangini, former president at the Limited's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LTD)") else Response.Write("(NYSE: LTD)") end if %> Structure unit, has already got the company narrowing its product line and increasing in-stock volume for high-demand items. That's a move torn from the Gap's successful playbook.
Also, Claire's Stores <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CLE)") else Response.Write("(NYSE: CLE)") end if %> announced on September 4 that it had acquired a 11.8% stake in the company as a prelude to a potential buyout. Gadzooks' board has said it isn't interested and has implemented a poison pill to block an unwanted takeover. Even so, Claire's interest will pressure management to do better.
It's also important to remember that Gadzooks has been quite a success story, with compound annual revenue growth of 45.6% and EPS growth of 39.5% between FY93 and FY97. Sure, earnings will actually dip this year, which they haven't done during this growth spurt. But the stock has been no stranger to choppy periods. As Kurt Cobain discovered, playing to teenage angst can pay off well, but it can sometimes leave you hankering for some pennyroyal tea.
At least some insiders have been buying in the $7 to $10 range. With a solid balance sheet, Gadzooks looks like a viable turnaround candidate, though when is the question. Time to head for the mall for research.
-- Louis Corrigan
([email protected])
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