Wet Seal (NASDAQ:WTSLA) finished off a solid quarter in which it achieved top-line growth of 20.5%, fueled by an increase of 20% in comparable same-store sales. Additionally, gross margins increased to 37.4%, as it benefited from a 70-plus basis point improvement in merchandise margins. Looking ahead, the picture gets a little fuzzier. Bodhi Zappa and Hank Schofield join me once again as we dive into the company's latest conference call. Our goal is to get a better grasp on its comps for the remainder of the year, and what variables may be impacting this metric.
Hank: The bear that I am, back in the day of sagging comps, this retailer used to be a favorite of mine. It rids itself of poorly performing units, comps move back into positive territory, and all of a sudden it becomes a front runner for a feel-good turnaround story. But there's still plenty to be critical of. I'll start with the month of May, in which comps declined 8.3%, which was well below expectations. And now we find out that June comps will also turn negative. In the conference call, management explained that the shortfalls were a result of inventory being light on key hot items, including fashion tops and dresses. Inventory levels should be back at full strength in June, but it appears to be too little too late. Now, management is projecting comps for the full year to increase only in the mid-single-digit range, a far cry from the high-double-digit rates it achieved last year.
Bodhi: It's a bummer that May and June comps will end up in negative territory, but it should be noted that the company's leadership was on top of the fashion curve, identifying the tops and dresses that would be strong sellers this season. Unfortunately, order delays impeded its ability to fully capitalize on these categories. To characterize it as "too little too late" is ill-stated in my opinion -- CEO Joel Waller clearly believes the current fashion trend will be there in the coming months, as it has been "growing" week by week. He adds, "As we build our inventories, we're actually selling more each week, the demand is gaining each week."
Jeremy: It's a positive sign that Wet Seal is on top of the fashion curve, but falling short on inventory levels is a bit of a concern. We saw earlier this year, when Pacific Sunwear (NASDAQ:PSUN) came up shy on key merchandise categories, that the effects were rather dismal. Given this inventory glitch, we have to assume that its full-year estimates for a single-digit increase in comps is a combination of a couple factors. First, the retailer is facing difficult year-ago comparisons in which comps in the months of May, June, and July were 57%, 59%, and 51%, respectively. Comps of this nature place the bar at a much higher level, making it difficult to duplicate. The second factor has to be attributed to its inventory situation. Coming up short on key fashion items when a particular trend is hot will do little to help drive sales.
Hank: Ordering delays do not quite tell the whole inventory story. This suggests that it might be more a fault of the supplier, but later remarks by Wet Seal's management might indicate that something else is amiss. Wet Seal just hired a new chief merchant in Dyan Jozwick, and it may be that this transitioning to a new merchant has had a trickle-down effect on getting the right products to the stores. One analyst questioned whether the company is preparing for the upcoming back-to-school season and how it is insuring that there will be no further inventory shortages. Waller responded by saying that Jozwick has only been on board a few weeks and her most pressing concern is dealing with the current shortage, but she will also be "focusing on back-to-school to make sure the right product is at the right place at the right time." This suggests to me the inventory problems are of an internal nature as the company transitions to new leadership.
Jeremy: Management did admit that it's a mixture of both external and internal factors. When asked whether the problems were planning-related or rather delays from suppliers, Waller indicated that both were at play. In his view, however, the greatest challenge was delivery delays from vendors. To catch up, the company had to add more vendors just to meet the demand.
Bodhi: I don't get the sense the current inventory shortage has all that much to do with internal factors. In fact, one analyst asked for further elaboration on this point to make sure there's nothing structural involved at the company that caused the delays. Waller's response was clear and simple, "No, none whatsoever." The company placed a certain percentage of merchandise in the basic category and the remaining in fashion, with the assumption that if the fashion items began flying off store shelves, it would be able to meet demand from domestic manufacturers. However, the "deliveries just weren't able to deliver."
Hank: Structurally, everything may be sound, but that doesn't mean there were no planning hiccups. Waller practically gave what may be likened to a religious confession when he admitted that "against my better judgment," the company tried a new promotion in May -- 25% off for Seal Deal members -- and it failed. The promotion wasn't tested beforehand, and "it didn't work." When asked why it didn't work, Waller stated, "It was sort of like we gave a party and nobody came." Similar style promotions have worked well at Arden B., the company's other concept, and similar high-end retailers, but the younger customers that Wet Seal accommodates weren't sold on the idea. The net result is that Waller believes "it had a negative effect on our sales."
Foolish conclusions
Jeremy: Poor planning and delivery delays from vendors -- in combination with tough year-ago comparisons -- will challenge the company's same-store sales this year. But the turnaround story may still be in place when you consider that management believes it has the operational foundation in place to increase square footage by 15% annually. Additionally, by leveraging fixed costs in the years to come, improving margins will help it achieve greater operating and net income growth rates than sales. Inventory glitches aside, there are enough positives here to warrant further investigation.
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Fool contributor Jeremy MacNealy has no financial interest in any company mentioned.
