The retail industry appears to be reaching the crossroads of complete transformation due to a significant shift in consumer sentiment. Those companies that can embrace the change quickly enough will likely survive. Those that cannot may simply become legends. Indeed, we have seen well-known companies such as RadioShack, Brookstone, Frederick’s of Hollywood, dELiA*s, Cache, ALCO Stores, Deb Shops and others file for bankruptcy protection within the last year and, in many instances, ended up selling all of their assets for much less than market value.
On September 9, 2015, Quiksilver, Inc. and certain of its affiliated domestic companies (collectively “Quiksilver” or “Company”) joined the group of retailers needing special relief, when it filed for bankruptcy in Delaware. See In re Quiksilver, Inc., et al., Case No. 15-11880 (Bankr. D. Del. Sept. 9, 2015). However, the difference between Quiksilver and some of the other faltering retailers is that Quiksilver is not attempting to liquidate its assets in a piecemeal fashion. It is not calling it quits. Rather, through its chapter 11 bankruptcy, it is proposing to reorganize its global operations in a manner that more readily addresses the new challenges in the retail industry.
Changes in the Retail Industry
As demonstrated by the number of recent bankruptcy filings of notable companies, competing in the retail sector as of late has never been harder. Among the many challenges that retailers currently face include:
- Consumer shifts to online shopping and a corresponding decline in visits to brick-and-mortar stores;
- Retailer’s reluctance to reduce the number and size of brick-and-mortar stores;
- Increased advertising and staffing budgets;
- A lack of broad-based training programs for merchandising executives; and
- A general lack of tech savvy management.
See Peter N. Schaeffer, Old School Merchants’ Survival Threatened by Consumer Realities, Journal of Corporate Renewal, Vol. 28, No. 4, at pgs. 7, 8 and 11 (Turnaround Management Association May 2015.)
A study of sales performance between 2012 and 2013 by major retailers, like Sears, Macy’s, GAP, Kohl’s, Nordstrom’s and JC Penny, shows that (a) web sales have increased, on average, by approximately 21%, (b) store sales (without the web) have declined, on average, by 6.2% and (c) total sales (including both web and store) have declined approximately 3%. See id. At some of these retailers, like Sears, JC Penny and Abercrombie & Fitch, sales without the web declined by as much as approximately 10% or more during this period. See id. The results lead to the inevitable conclusion that web sales are comprising an increasing percentage of a retailer’s total sales, and some analysts believe that, as Baby Boomers retire and Generations X, Y and Z become a greater influence in the marketplace, this upward trajectory will invariably continue. See id. at 11.
Given the current consumer trends, one would expect that, in order to regain profitability, most national retailers have considered reducing the amount of their retail space as well as corresponding staffing, advertising, and other store related expenses. Some well-known retailers, like Sears, Aeropostale, JC Penny, Children’s Place and others, have done just that to try to stay afloat amidst these challenging times. See Antony Karabus, Consumer Polarization Squeezes Retailers in the Middle, Journal of Corporate Renewal, Vol. 28, No. 4, at p. 13 (Turnaround Management Association May 2015.)
As discussed below, Quiksilver, itself, commenced reducing its brick-and-mortar stores in 2013. However, few retailers, including Quiksilver, have been able to achieve the full benefit of these cost cutting initiatives outside of bankruptcy. (For a discussion regarding a debtor’s ability to restructure lease obligations in bankruptcy, please see the following articles: Buffets, Inc. Emerges from Bankruptcy; Ritz Camera Files Second Bankruptcy; and Cap On Landlords’ Rejection Damages Claim.)
Headquartered in Huntington Beach, California, Quiksilver is one of the world’s leading manufacturers and retailers of outdoor sports apparel. The Company was founded in 1976 as a California company making boardshorts for surfers in the U.S. Today, the Company provides apparel and accessories all around the world that cater to a casual outdoor lifestyle associated with various outdoor activities, including surfing, skateboarding and motocross.
The Company has over 1500 employees and generates sales in over 115 countries through several distribution channels, including wholesale customers (i.e., outside retail stores), traditional Company-owned stores, and e-commerce. At the end of 2014, the Company had approximately 266 full-price core brand stores, 75 of which were located in the U.S, and 147 factory outlet stores, 47 of which were located in the U.S. In papers filed with the Delaware bankruptcy court, the Company disclosed that 67% of its net revenues in 2014 came from wholesale customers, 28% came from Company-owned stores and 5% came from e-commerce.
Quiksilver has four operating centers consisting of the Americas (the United States, Mexico, Brazil and Canada), EMEA (Europe, the Middle East, and Africa), APAC (Australia, New Zealand and the Pacific Rim) and corporate operations. According to documents filed in the bankruptcy case, Quiksilver’s U.S. operations generate approximately 34% of the Company’s revenues, while 66% is generated by non-debtor affiliates located outside of the U.S.
As of 2014, the Company and its non-debtor affiliates had approximately $850 million in long-term debt, consisting primarily of asset-based borrowing facilities and several secured and unsecured notes (in excess of $700 million).
The Company disclosed that it was forced to file bankruptcy because of a lack of adequate liquidity, exacerbated by underperforming retail stores and substandard delivery of product to wholesale customers. The situation apparently was so fragile that, for example, Quiksilver disclosed that it suffered a major setback when one of its major distribution centers was slowed down by a labor dispute in a Los Angeles port. The Company’s weakened performance further caused a contraction of trade liquidity, which caused the Company to hasten its prepetition turnaround efforts, as discussed below.
Prior to filing bankruptcy, Quiksilver looked at a range of strategic alternatives to find additional liquidity but no alternatives came to fruition. Part of the alternatives that it pursued involved entering into new credit facilities with more borrowing capacity. However, because most of Quiksilver’s and its non-debtor affiliate’s assets had already been pledged, new financing was difficult to obtain outside of a in-court restructuring process (which allows the restructuring of prepetition debt instruments).
Prepetition Turnaround Plan
Quiksilver has been attempting to implement a turnaround plan since 2013. The turnaround plan is aimed at strengthening its core brands, growing sales and improving operational efficiencies. Among other things, Quiksilver plans to focus on 3 flagship brands and divest noncore brands and product lines; re-prioritize its current marketing strategies and continue to invest in emerging markets and e-commerce; improve sales execution; optimize the Company’s supply chain; lower G&A expenses; centralize global responsibility for key functions; and close underperforming retail stores.
The Company disclosed that it had already closed several underperforming stores prior to the bankruptcy filing, whenever leases came due or they struck a deal with landlords. In addition to cost cutting, the Company raised additional revenue by (a) divesting itself of approximately $100 million of noncore business lines in 2014 and (b) engaging two well-known liquidation companies, Hilco Merchant Resources, LLC and Gordon Brothers Retail Partners, LLC, to sell certain excess inventory through special store closing sales at various leased locations, including temporary “pop-up” stores. Despite these initiatives, Quiksilver still could not generate enough revenues to maintain its global operations, while attempting to turn around its business.
Bankruptcy Reorganization Plan
Because Quiksilver’s strategic alternatives were limited outside of bankruptcy, it eventually struck a deal with Oaktree Capital Management, L.P., a private equity firm that owns 73% of the secured notes ($279 million) issued by the Company and a portion of the unsecured European notes ($221 million) issued by a non-debtor foreign affiliate, Boardriders S.A. The basic game plan is to (a) provide Quiksilver with enough runway (i.e., liquidity) to implement its prepetition turnaround plan through its domestic operations and (b) leave Quiksilver’s foreign operations unaffected by the bankruptcy filing.
Specifically, the deal with Oaktree (a) involves a bankruptcy filing by Quiksilver and not its foreign affiliates and (b) requires Quiksilver to support a plan of reorganization that accomplishes, among other things:
- converting the Company’s secured notes into equity;
- replacing Quiksilver’s secured borrowing facility ($92 million) with an exit facility upon emergence from bankruptcy;
- reinstating Quiksilver’s guaranties on certain foreign debt owed by its non-debtor affiliates;
- eliminating existing equity in Quiksilver; and
- raising additional capital upon Quiksilver’s emergence from bankruptcy through a rights offering to secured noteholders.
There is a fundamental reason that Quiksilver’s foreign affiliates are not in bankruptcy. According to Quiksilver, the Delaware bankruptcy court could not directly exercise jurisdiction over these foreign entities, and Quiksilver’s restructuring efforts could easily become frustrated if its foreign affiliates filed elsewhere, because the governing insolvency laws in other jurisdictions vary and are not as flexible as U.S. bankruptcy laws.
As an important part of the deal with Oaktree, the Company obtained $115 million in post-petition financing from Oaktree, plus an additional $60 million in financing from one of its prepetition secured lenders, Bank of America. The post petition financing should provide Quiksilver with sufficient working capital and funding to restructure and maintain its global operations. In addition, in order to leave Quiksilver’s foreign affiliates undisturbed, the Company obtained a waiver of certain defaults (i.e., those triggered by the bankruptcy filing) under the European notes issued by Boardriders S.A.
There is much hope that Quiksilver’s turnaround plan will ultimately work. It already has a unique customer value proposition for its products, which complements its wholesale business that generates 67% of its revenues. It is focusing on its core brands (which historically have been popular) and optimizing its supply chain to deploy its most popular products timely. It is re-prioritizing its marketing efforts and continues to invest in emerging markets and e-commerce, which appears to align with recent consumer sentiment. It also is attempting to manage its operating costs by centralizing global responsibility for key functions, lowering G&A expenses and eliminating its underperforming retail stores. According to Antony Karabus, CEO of HRC Advisors, these are some of the primary areas that retailers in Quiksilver’s position must take in order to remain competitive and weather the current storm. See Karabus, supra, Journal of Corporate Renewal, at p. 14. Now all Quiksilver needs is a little more time to see its plan implemented, and bankruptcy affords it such relief.
The retail industry appears to be undergoing a huge transformation due to growing changes in the way consumers like to shop. And while many retailers have been slow to confront this transformation—for one reason or another—there is still optimism that others have been learning from recent retail bankruptcies. Quiksilver is a good example of a retailer that began planning many years ago, but just needed a little more time to execute a turnaround plan.
Other retailers have also started to change the way they operate. As mentioned, several of them have been cutting their retail space, and associated costs, nationwide.
Another interesting dynamic that we will soon see play out is the fact that a number of CEO positions have turned over within the past 2 years at major retailers, like The GAP, Things Remembered, Sur La Table, Hollister, American Apparel, Yankee Candle, Footlocker, Justice, Christopher & Banks, Bebe, New York & Company, Body Central, Abercrombie & Fitch, Gymboree, Office Depot, Michaels, Hot Topic, American Eagle and Aeropostale, to name a few. See, supra, Karabus, Journal of Corporate Renewal, at p. 14. Typically, when a retailer makes such a change, it also results in a change in direction, including internal changes in leadership, strategy, initiatives and focus. See id. For example, Target’s announcement in January 2015, that it was closing its Canadian business (133 stores) and taking a $5 billion write-down came 5 months after the arrival of its new CEO, Brian Cornwell, who was able to take a fresh look at that investment. See http://www.bloomberg.com/news/articles/2015-01-22/why-target-is-closing-up-shop-in-canada.
The new retail leadership no doubt understands that their businesses must adapt to the recent changes in the retail industry. Now, they are just charged with the enormous task of crafting a turnaround plan that can work fast enough, while navigating their companies through the storm of less liquidity. Whether these retail leaders can implement a strategy in time to save their companies will be no easy task, as illustrated by several of the recent retail bankruptcies filed within the last year. Quiksilver’s case serves as a good example, however, that, with some creativity and adequate planning, bankruptcy relief can help a retailer buy some extra time to properly shift gears.