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WHAT’S DRIVING THE WET SEAL’S MIRACULOUS TURNAROUND?

By Brad Berton

In only a year, The Wet Seal’s management appears to have brought the mall-based clothing chain back from the brink of insolvency. “From our perspective, Wet Seal’s turnaround has been nothing short of miraculous,” said Dane Smith, senior vice president of leasing at the Dallas office of The Macerich Co.

Same-store sales were up dramatically year on year at Wet Seal’s 400 apparel stores during the holiday shopping months and in January. The company’s Wet Seal brand targets fashion-forward juniors, while its Arden B. stores sell pricier apparel to older women. Analysts expect the Foothill Ranch, Calif.-based public company soon to book its first quarterly net profit in three years.

Having previously shut 153 Wet Seal shops, the company now plans to open 25 stores this year, mostly Wet Seal units, and perhaps 60 more next year, according to analyst Eric Beder of New York City-based Brean Murray, Carret & Co.

How have Wet Seal’s new CEO Joel Waller and turnaround consultant Michael Gold been able to revive the company so dramatically and quickly? One retail veteran points to downsizing measures and to a recapitalization in late 2004; others say it was merchandising. The latter may be on to it — Wet Seal will not discuss its strategies with the media these days, but its latest quarterly SEC filing does cite a new approach to merchandise, the elements of which are lower prices, a broader assortment of “fashion-right” apparel and more-frequent delivery of fresh product. Further, the company has improved store presentation by eliminating clutter, sources say. The result: Merchandise moved twice as fast last year as the year before, Beder says.

Initially, some had said the Arden B. division would be responsible for driving the company’s turnaround, but it seems the core Wet Seal division has in fact done more for the cause. In many respects the company’s revival represents a return to Wet Seal’s roots as a value-priced, high-turnover juniors’ retailer, says senior analyst Jeffrey Van Sinderen of B. Riley & Co., Los Angeles. Harking back to the chain’s earlier profitable years, the new managers “went back to buying product rather than trying to reinvent the wheel,” he said.

The previous management relied too heavily on in-house designers rather than suppliers’ creativity and know-how, Van Sinderen says. Furthermore, the company put too much focus on single seasonal lines. “That strategy failed,” he said. “They just missed the market.”

Indeed, Beder says Wet Seal expects to boost offshore merchandise sourcing from about 10 percent today to roughly 30 percent, with an emphasis on jeans and T-shirts. At that level, management can capitalize on fashion trends, Beder says.

The company is staying with mostly private-label apparel and moving fast, says Van Sinderen. “Now they’re constantly changing the merchandise,” he said.

Macerich’s Smith says the retooled mix is attracting more juniors. “We know kids are flocking to their stores today,” Smith said. “It’s every store in our portfolio — not just the West Coast or big cities, but the hinterlands as well.”

Wet Seal’s same-store sales gains for December were nearly double the consensus estimates, shooting up 38.5 percent. Companywide sales rose 10.6 percent to $69.9 million. Then in January comps soared 51.4 percent, on top of a 35.6 percent overall sales increase to $30.2 million.

For the four weeks ended Feb. 25, comps were up nearly 30 percent, with overall sales climbing to $36.1 million, up 21 percent from $29.9 million a year before.

It did not appear that Wet Seal would turn profitable again until the fourth quarter. (The quarter and year ended Jan. 26, but those figures were unavailable at press time.) For the quarter ended Oct. 29, meanwhile, the company continued to bleed, with a net loss of $6.45 million, or 14 cents a share. Consensus estimates call for a 2 cents per share profit for the fourth quarter and a net of 31 cents per share for the full year ending next January.

As of early March, the company operated 308 Wet Seal stores and 92 Arden B. units. The Arden B. chain has by all accounts remained a solid performer.

Yet some observers remain skeptical of the company’s long-term future. The financial restructuring and the subsequent closures of those unprofitable Wet Seal stores are the biggest factors in the company’s revival, says Howard Davidowitz, chairman of consulting and investment banking firm Davidowitz & Associates.

As the 2004 holiday season approached, Wet Seal seemed bound for bankruptcy court. Hedge fund director Steve Cohen’s S.A.C. Capital Management rode to the rescue, putting up $40 million in November to shore up Wet Seal’s finances and help shut cash-bleeding stores.

“The biggest step they were able to take was closing 153 Wet Seal stores without a bankruptcy,” Davidowitz said. Holding onto the stronger stores while dumping the unprofitable ones almost immediately improved pretty much all the company’s performance metrics, he says.

“Expenses went down, margins moved up, sales per foot improved,” said Davidowitz. “But these numbers always get distorted after a restructuring, so I’m not ready to attribute [the improvements] to management’s merchandising strategies.”

Wall Street, too, remains skeptical about the company’s ongoing profitability prospects. The share price had peaked north of $25 during the profitable days of 2002 but plummeted all the way to penny-stock status before the late-2004 recapitalization.

Nevertheless, management seems so confident about the company’s current momentum that it even cut a $15.2 million deal (plus assumption of $10 million in debtor-in-possession financing) in January to acquire a hugely troubled peer, G&G Retail. In the end, though, a rival bid from fashion retailer BCBG Max Azria won the court-supervised mid-February auction of G&G’s assets.

And that was a good stroke, says Davidowitz, calling it “the best thing that could happen” for the company. “Wet Seal just isn’t in a position to reach out and buy the Titanic,” he said. “They have to right their own ship.”

Rather than aggressively seeking large acquisitions like G&G, Beder says he expects the chain to pursue organic expansion of the Wet Seal and Arden B. chains. The company has already staffed up and invested in its store infrastructure in anticipation of further growth, which could lead to higher margins as sales rise faster than fixed costs, he says. Beder also argues that the company can continue generating comp growth in the mid-to-high single digits as well.

For his part, Smith thinks a 25-store expansion plan for this year is about right, as it is not “overly aggressive” and will allow strategists to “focus on getting the right locations.” Further, Wet Seal management is making savvy moves in negotiating for more store openings in 2007, he says. “They should be able,” Smith said, “to crank it up to that level by then.”