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Mervyns Files Chapter 11

Department store group seeks to restructure operations.

The economy claimed another large retail victim Tuesday when the $2.5 billion Mervyns filed a voluntary Chapter 11 petition for bankruptcy court protection in Delaware.

The filing further dramatizes the treacherous nature of the current retail climate, and its close links to the health of the housing market and the price of gas. The 59-year-old Mervyns was once a star of the booming California market, and for years dominated the retail scene in many of the areas in which it operated. Mervyns currently has 177 stores in seven Southwestern states.

The California-based midtier department store chain said it will reorganize its business and continue to operate as the company moves through the restructuring process. Mervyns follows the likes of Steve & Barry’s, Goody’s Family Clothing Inc., Fortunoff, Linens-N-Things and Sharper Image into bankruptcy, although many industry executives predict there will be more retailers filing for Chapter 11 in the months ahead unless the economy makes an unexpected turnaround.

The Hayward, Calif.-based Mervyns said it has secured a $465 million debtor-in-possession financing facility from a lender group led by Wachovia Capital Finance Corp. The DIP ensures vendors that ship goods during the post-petition period will get paid. Those with outstanding balances with the retailer will have no such assurances.

“We have reached out to Mervyns’ management in an attempt to restore communications,” said Bob Carbonell, executive vice president and chief credit officer of Bernard Sands Credit Consultants, the credit-checking company. “When the court approves the DIP financing and we have adequate financial information, we will consider a change in our credit opinion.”

John Goodman, chief executive officer of Mervyns, said, “Mervyns needs to reorganize its finances and operations due to the state of the economy and difficult operating environment for our industry.

“After careful consideration of available alternatives, the company’s management board determined that a Chapter 11 filing was a necessary and prudent step that allows us to operate our business without interruption as we seek to restructure our debt and other obligations in a controlled, court-supervised environment. We are committed to serving our customers and maintaining regular operations as we undertake this reorganization.”

Mervyns said it will ask the court for permission to honor its current customer policies regarding merchandise returns and outstanding gift cards and customer loyalty programs.

Sun Capital Partners Inc., part of the consortium that acquired the retailer from Target Corp. for $1.65 billion in 2004, issued a statement noting that, at the time of the acquisition, “it was understood that it was a high-risk turnaround, which would involve a considerable amount of effort and significant merchandising initiatives to reestablish its brand identity. Prior to the acquisition, same-store comp sales had been negative for five consecutive years, and more than 25 percent of the 257-store portfolio was unprofitable (negative four-wall profit).

“The sponsor group worked collaboratively with management to develop and execute a focused strategic plan and road map,” Sun Capital continued. “Despite efforts to address Mervyns’ financial challenges, it was impossible to complete the turnaround outside of Chapter 11 due to, among other things, the impact of a sustained economic downturn in California, Mervyns’ key market.

“Under these circumstances, a bankruptcy filing was a difficult but necessary decision made by the board of directors,” Sun concluded.

The retailer’s bankruptcy court filing estimated assets and liabilities each between $10 million and $50 million.

Although questions about the company’s fiscal health have been circulating for some time, vendors, lenders and credit analysts earlier this month began feeling especially jittery about the future of the $2.5 billion regional chain when word seeped into the credit community that factors had pulled their support. As Mervyns has grown increasingly isolated and unwilling to communicate in recent weeks, industry speculation had begun to focus on the possibility of a bankruptcy filing.

Mervyns has been hurt by the housing implosion, worst in the very states that mean the most to the retailer, and its core working-class customers are being squeezed by rising gas and food prices, job cuts and tight credit.

The factoring arm of GMAC Commercial Finance earlier this month stopped approving orders of goods to the chain. In May, the factoring division of CIT stopped its approval of orders for Mervyns.

Buyers are said to be having a difficult time getting goods to the stores since factors stopped approving orders. Some vendors, especially larger ones who carry their own paper, are still waiting to get paid for shipments, having undertaken the risk themselves after the factors withdrew, sources said.

A reorganization of Mervyns will further complicate an already murky retail real estate picture. With several major retailers having filed Chapter 11 and solvent ones reluctant to expand, the inventory of vacant space could continue to climb.

Many have thought that the retailer might get some badly needed breathing room, or at least a cushion for the important back-to-school season, when Mervyns said in May that it planned to sell off five to 10 high-end store sites. However, the sale of those stores has yet to materialize.

The Mervyns stores that are up for sale are in desirable sites that are rapidly becoming upscale and more affluent than the retailer’s typical customer profile, credit and real estate sources said.

Mervyns hired DJM Realty LLC to sell the stores, and said the transactions were expected to generate “$25 million to $50 million in cash to fund operations and new growth initiatives.”

The chain, which takes pride in being a family-friendly department store, named former Levi Strauss & Co. executive Goodman as president and ceo in March. Goodman had been president and general manager of the Dockers brand. He replaced Rick Leto, who resigned in December after three years as ceo.

Among its top unsecured creditors, Goodman’s alma mater, Levi’s, is first with an owed claim of $12.8 million. Others holding trade debt claims include: Wicked Fashions in Fort Lee, N.J., $6.1 million; Nike USA Inc., Beaverton, Ore., $4.7 million; Vans Inc., Larkspur, Calif., $2.9 million; Fashion Resource, Los Angeles, $2.7 million; Hanes Brand-Hanes UW, Winston-Salem, N.C., $2.6 million; Lolly Togs, New York, $2.6 million; VF Jeanswear Inc., Greensboro, N.C., $2 million, and Jansport Inc.-VF Outerwear, San Leandro, Calif., $1.7 million.

The chain, founded early in the postwar West Coast boom by Mervin Morris as a single store in San Lorenzo, Calif., in 1949, went public in 1971 and was sold to Dayton Hudson Corp., later Target Corp., in 1978. In September 2004, the consortium including Sun Capital, Cerberus Capital Management LP and Lubert-Adler-Klaff acquired the chain. Cerberus since has sold its stake in the retail operation, although it still retains an interest in the retailer’s real estate holdings.

Mervyns filed its petition along with two affiliated firms.

“I want to thank our customers and vendors for their continued support during this process,” Goodman said Tuesday. “We are pleased that, as we seek to restructure, we can continue to satisfy our customers’ expectations by offering style, quality and excellent service, all at great prices. In addition, we are grateful to all of our associates for their hard work, loyalty and dedication. Our management team is committed to making this financial restructuring successful and leading Mervyns toward a bright future.”