New York — The Wet Seal Inc. will be sweating out the back-to-school selling season.

After seven consecutive quarters of same-store sales declines, the specialty retailer is under pressure to show signs of a turnaround. In its quarterly filing with the Securities and Exchange Commission earlier this month, the firm said it couldn’t rule out the possibility of a “potential reorganization under Chapter 11 of the U.S. bankruptcy code.”

This story first appeared in the June 29, 2004 issue of WWD.  Subscribe Today.

Joseph Teklits, an analyst at Wachovia Securities, on Friday, raised the possibility that the “company will never return to profitability.” He noted that the “odds of a Chapter 11 filing over the next 12 months appear to be greater than 50 percent.”

According to executives at Wet Seal, the SEC filing language about a possible Chapter 11 is part of its legal disclosure. “I would say it’s routine for a company in the situation that we are in,” said Helen Rotherham, a spokeswoman for the Foothill Ranch, Calif., retailer. “We are required by law to do that. But we have no plans whatsoever to file.”

Rotherham said the company is looking for additional capital and “working in total accordance” with the company’s turnaround plans. “We definitely have big plans for the future,” she said.

Katherine Rose Galligan, an analyst at Aperion Group Inc., which has a hold rating on the stock, said, “While the risk of a Chapter 11 is standard language, the truth of the matter is that this company is teetering on the fence. If it is not successful with its back-to-school season, the feasibility of a bankruptcy is more likely than it might have seemed six months ago or even one month ago.”

Wet Seal also disclosed in its regulatory filing, “Due to our financial results over the past 22 months, we have begun to experience a tightening of credit extended to us by vendors, factors and others for merchandise and services. The initial impact of this credit tightening has required us to issue letters of credit outside of the ordinary course of business, or, in some instances, shorten vendor credit terms.”

Wet Seal’s same-store sales have been negative for the past 22 months with declines as high as 32 percent. It’s important to note that the retailer’s sales fell along with the entire specialty teen sector. But as the sector recovered, Wet Seal did not. Over the past several months, competitors such as PacSun and Hot Topic have delivered stronger comps. PacSun, for example, has posted same-store sales gains of 12.4, 11.4 and 7.8 for March, April and May, respectively.

Wet Seal emphasized that it hasn’t experienced any significant delay or disruption of merchandise flow. The retailer noted in the filing that the b-t-s season represents a “pivotal point in our turnaround strategy.”

As reported in WWD, the Wet Seal previewed its b-t-s line to analysts, scheduled to hit stores on July 12 on both coasts. Designed by the company’s new creative director, Victor Alfaro, there are high hopes for looks called “vintage angels” and “granny chic.”

“A lot is riding on fall,” said Liz Pierce, an analyst with Sanders Morris Harris in Los Angeles. “Is it a make-or-break situation? It’s too early to say. Some of the [fall] product is coming [in stores] on an item-by-item basis. That’s not merchandised like they told us it was going to be. They said it’s going to be a compelling selling presentation.”

Wachovia analyst Teklits, wrote in his research note, “We have learned from industry contacts that Wet Seal’s woes are deepening on all fronts.” Those fronts, according to the analyst, include inventory issues and the exodus of internal talent. He also wrote that the company might be an acquisition candidate, but that buyers who see value to the Arden b. concept might think twice about undertaking the task of turning around the Wet Seal division.

Members of the financial community are trying to remain optimistic regarding Wet Seal, but emphasized the retailer is heading into a critical juncture as to the state of its financial well-being.

Jim Rice, credit analyst at Bernard Sands, said, “We’re watching them very closely. They do need a good fall season and back-to-school, as well. The company sources overseas, and the problem and risk are that if there is a fashion mistake, it can’t really be corrected because there will be too much product already in the pipeline.”

One factoring executive on the West Coast, who requested anonymity, acknowledged he’s heard of Wet Seal’s request for capital, but said it may not be easy for the company to secure funding. “There has got to be some very special arrangements when it gets down to granting them credit,” he said. “It’s something that the credit community is very concerned about.”

However, Wet Seal has the advantage of having no debt on its balance sheet, which may give the retailer additional breathing room beyond for a few quarters as it tweaks it merchandise mix.

Howard Tubin, an analyst at Cathay Financial, observed, “We have a neutral rating on the stock. Based on the back-to-school preview I saw, the line’s got potential. It offers some fashion newness and some differentiation that was lacking in the spring line. If back-to-school doesn’t work, and the fall and holiday seasons are a miss, then it will be another story.”

Compromised Comps

Y axis: Same-Store Sales(%) X axis: Trailing 24 Months

Sagging Sales

Y axis: Sales (millions) X axis: Trailing Eight Quarters

Bottoming Out

Y axis: Profit/Loss (millions) X axis: Trailing Eight Quarters

SOURCE: COMPANY REPORTS AND SEC FILINGS FO THE MOST RECENT QUARTER.

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