💥Shade of the Week— “We Believe Real Models Will Become Wildly Popular in the Post WeWork Era”💥

Restoration Hardware Inc. ($RH) reported earnings this week and blew it out of the water in every possible way. Not all retail is a hot mess, apparently. When you crush it like they did — 6+% revenue increase and doubled profits — we suppose that gives you some license to sh*t on LITERALLY EVERYONE UNDER THE SUN. This is savage:

DAAAAAAAAAMMMMN. DTC DNVBS and standard brick-and-mortar retailers just got run over by the Restoration Hardware bus. And rightfully so:

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💊How's GNC Doing (Long Online Supplements, Short Fitness Stores)?💊

A quick recap of PETITION’s coverage of everyone’s (cough, no one’s) favorite supplements slinger.

In August 2017 in “GNC Holdings Inc. Needs Some Protein Powder,” we wrote:

GNC Holdings Inc. ($GNC) remains in focus as it reported its Q2 numbers this past Thursday. In summary, decreased consolidated revenue, decreased domestic (company-owned and franchised) same-store sales, decreased net income and operating income, decreased manufacturing/wholesale business...basically a hot mess. Limited bright spots included China sales and the new GNC storefront on Amazon. You read that right: the storefront on Amazon. Ugh. The company has $52mm of cash, $163.1mm available under its revolver and a robust $1.5b of long-term debt on its balance sheet. The stock traded down 7% after the announcement (but was up on the week).

In February 2018 in “GNC Makes Moves (Long Brand Equity, Meatheads & Chinese Cash),” we introduced the great strides GNC was undertaking to avoid a bankruptcy filing. These actions included (a) paying down its revolving credit facility, (b) moving towards an amend-and-extend transaction vis-a-vis its term loan, (c) obtaining a $300mm capital infusion by way of issuance of a perpetual preferred security to CITIC Capital, a Chinese investment fund and controlling shareholder of Harbin Pharmaceutical Group, and (d) the formation of a JV in China whereby it would slap its brand on Harbin’s product.

The following month in “GNC Holdings Inc. & the Rise of Supplements,” we highlighted that the amend-and-extend got done. And this:

Concurrently, the company entered into a new $100 million asset-backed loan due August 2022 and engaged in certain other capital structure machinations to obtain $275 million of asset-backed “first in, last out” term loans due December 2022. Textbook. Kicking. The. Can. Which, of course, helped the company avoid Vitamin World’s bankrupt fate.  Goldman Sachs!

We also noted a number of DTC supplements companies that were juiced by financings or acquisitions, citing them as headwinds to GNC and GNC’s nascent DTC business. The stock traded at $3.97/share back then. And we wrote:

Perhaps those restructuring professionals disappointed by Goldman Sachs’ success in securing the refinancing should just put that GNC file in a box labeled “2021.”

We revisited GNC in May 2018 in “GNC Holdings Inc. Isn’t Out of the Woods Yet.” At that time, the stock hovered around $3.53/share and the company reported more bad news including (i) 200 store closures, and (ii) declining revenue, same store sales at domestic franchise locations, and net income. We wrote:

Clearly GNC’s future — now that it has some balance sheet breathing room — will depend on its ability to capture new international markets, e-commerce growth primarily through its private label, innovation around product to combat DTC supplements brands, and continued cost controls. It will also need to execute on its goal of translating e-commerce sales to foot traffic. To accomplish this Herculean task, GNC may just need some supplements.

Last July, we noted that revenue continued its downward trend but earnings generally beat (uber-low) expectations. In August, we highlighted how Goldman Sachs was acting very “Goldman-y,” given that Goldman Sachs Investment Partners was a major investor in DTC vitamins and supplements startup Care/of, which had just raised a $29mm Series B round. We’ve slacked on our coverage since.

So, like, what’s up with GNC now?

It reported earnings back in July and continued to show weakness. Quarterly consolidated revenue and adjusted EBITDA declined meaningfully — the latter down 3% YOY. Same store sales were down 4.6%. E-commerce was down 0.2%. Revenue from franchise locations decreased 1.8%.

The company blamed promotional offers it implemented at the beginning of the quarter for the lousy same-store sales results.

Early in the second quarter, we made some adjustments to some of our promotional offers and our marketing vehicles, and we saw a direct negative impact to the top line. We quickly course corrected and saw sales strengthen throughout the remainder of the quarter.

PETITION Note: somebody must have gotten fired. Hard. Nothing like dropping an idea that is so horrifically bad that it immediately resulted in a “direct negative impact to the top line.” YIKES.

Speaking of yikes, mall performance is, like, YIIIIIIIIIIIKES:

In addition, the negative trends in traffic that we've seen in mall stores over the past several years has accelerated during the past few quarters putting additional pressure on comps. As part of our work to optimize our store footprint, we're increasing our focus on mall locations. And as you know, we have a great deal of flexibility to take further action here due to the short lease terms we have across our store portfolio.

It's important to note that our strip center locations are relatively stable from a comparable sales perspective. As a reminder, 61% of our existing store base is located in strip centers while only 28% reside in malls.

As a result of the current mall traffic trends, it's likely that we will end up closer to the top end of our original optimization estimate of 700 to 900 store closures.

Mall landlords everywhere were like:

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💊Pushed Pills Pressure Purdue Pharma💊

Long time PETITION readers should be, if they’re paying attention, identifying recurring themes confronting the various sectors of distress we cover. In retail bankruptcy, for instance, the stories generally contain the same elements: some combination of too much leverage (especially if PE-backed), too large an uneconomical brick-and-mortar footprint, slow adoption of e-commerce, poor supply chain management, awful off-trend product assortment, and disruptors (i.e., Amazon Inc., resale, DTC, etc.). In oil and gas, too much leverage backing capital intensive exploration and production initiatives, an unfavorable commodity environment, bloated SG&A, and too much money chasing outsized returns. In biopharma, new drugs are expensive and time-intensive to produce and often, despite potentially valuable IP and viable use cases, companies run out of money (and/or bust convertible debt) and are unable to continue paying to push their products through the regulatory framework absent a chapter 11. In healthcare, rollups of behavioral health, CCRC, rehab centers, etc., layer on too much debt on top of questionable business models in the face of an uncertain regulatory atmosphere.

And then there is another category: companies with little to no funded debt, minimal trade debt, an ability to fend off competition, and a viable product. What’s their problem? As we’ve seen in recent cases, i.e., Takata Corporation, Imerys Talc America Inc. (also discussed here), Insys Therapeutics Inc., The Diocese of Rochester, those companies tend to get sued into oblivion on the basis of shady-as-sh*t business practices or other general degenerative scumbaggery.

And so it should come as absolutely no surprise to anyone* that Oxycontin manufacturer, Purdue Pharma, has joined the fray, filing for bankruptcy this past week in the Southern District of New York (before the same judge administering the Sears sh*t show). Hold on to your butts people, this one ought to be interesting.

Unless you’re a total ignoramus, you know by now that the country has been ravaged by an opioid epidemic. Here is 60 Minutes doing a deep dive into the issue. Here is the White House talking about “[e]nding America’s Opioid Crisis.” And here is John Oliver doing the John Oliver thing while talking about opioids.

We mean, you have to be willfully unaware or just plain stupid if you don’t know that this is a big problem. While numerous companies are implicated in this ever-visible scandal, Purdue Pharma is the biggest fish to fall to date (query how long that lasts). But, as noted above, Purdue Pharma generates a ton of money, has no funded debt, etc. So what it needs — and what it gets from a chapter 11 bankruptcy filing — is a break from the deluge of lawsuits against it. All 2,625 of them.

For the uninitiated, a bankruptcy filing triggers an automatic stay pursuant to section 362 of the bankruptcy code. This is an injunction, of sorts, that draws a line in the sand and prevents creditors from rushing to enforce their claims against a debtor. The idea is that by halting this rush and providing the debtor a “breathing spell,” the debtor will have a better opportunity to configure a go-forward strategy that is not only to its benefit, but also treats similarly situated claimants fairly. As you might imagine in a litigation scenario where there are literally thousands of potential judgement creditors scattered across various state and federal courts across the country, this is a powerful tool. It prevents Mia Wallace, plaintiff #1, from winning a huge judgement and collecting against that judgement to the point of siphoning away all of the debtors’ asset value before Vincent Vega, plaintiff #2, has had his day in court.** It also helps the debtors triage the outrageous expense involved with defending heaps of lawsuits all across the country; indeed, the Purdue Pharma debtors note that they spend $5mm/week — A WEEK! — defending themselves against litigation. They project to spend approximately $263mm on legal and related professional costs in 2019. That’s no typo, folks. Biglaw lawyers charge mint.

Here’s the thing about that “automatic stay” thing, though: there are exceptions to it — including, most relevant here, one that’s commonly referred to as the “police and regulatory power exception” (section 362(b)(4)). To preempt the applicability of this section, the debtors have already filed a “preliminary injunction motion,” seeking to enjoin continued prosecution of active governmental litigation against them (and a long slate of related parties, i.e., the entire Sackler family tree).***

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Retail: DTC Disrupting DTC (Short the Notion of Long-Lasting Iconic Brands)

First, as we've harped on time and time again, enough with the "iconic" nonsense. Charlotte Russe is NOT an iconic brand. Read "Shoe Dog" by Phil Knight and then you'll get a sense of a truly iconic brand. 

But speaking of brands, here is a feature by Noah Brier and Colin Nagy about Tracksmith, an upstart fitness apparel brand geared towards serious-but-still-amateur runners. They take the general view that other players in the space have watered down running apparel with the hope of appealing more broadly to the masses; these folks are more old school, a bit snobby about running, and unapologetic about it. 

We found this bit particularly interesting (check links — 100% spot on):

With the gold rush of direct-to-consumer brands, you get the sense that everyone is trying to quickly slap something together using the same agencies, the same colors, and the same paid Instagram strategy. But building strong core muscles and doing something that can stand for a long period of time requires taking some deliberately contrarian positions.

It's true. The ease with which one can start a business today with virtually no infrastructure (PETITION Note: yes, we get that this comment is mildly meta), has created a deluge of purported “brands” all seeking to leech hard-earned dollars out of your pockets as you have a fleeting moment of insecurity-inducing scroll-based FOMO upon the umpteenth picture of your ex-boyfriend with his goddess new girlfriend tanning on a yacht off the coast of Costa Rica clanking bottles with f*cking Jennifer Lawrence as you dive into the misplaced hope that retail therapy will help you feel better(!) about how you're "living the dream" -- but, like, not, really -- because your existence is literally accounted for in six minute increments while you're red-lining changes to the memo that you submitted when it was due two weeks ago and the partner only just now got around to reviewing it despite it being oh-such-an-emergency when it forced you to miss your bestie's birthday party, all the while wondering “what’s the f*cking point” considering you have no clue how you’re possibly going to compete to make partner against that trust-fund broheim who rowed crew at Princeton, with whom the Department Head (who is on his fifth wife) isn’t #MeToo-afraid to go out to drinks and dinner with, who needn’t worry, five years from now, about going through IVF while also working bone-crushing hours or, if successful, ducking off into a dark dank closet to pump while on a conference call leaning up against a bucket and mop set with a stronger personality than the junior partner who is still single, still living in his one bedroom West Village apartment he had in law school, and has an empathy quotient on par with a bowling ball, all while it's 75 degrees outside, there's not a cloud in the sky, and there are people far worse-paid-but-far-happier enjoying their life out in Madison Square Park. Damn Instagram feeds with those damn shiny photos of DTC brands. There goes $4,279. 🖕🖕🖕🖕🖕🖕

But we digress.

Back to DTC...

The first wave of DTC were disruptive and interesting. The Caspers and Warbys of the world. The second wave were perhaps a bit more opportunistic, chasing the gold rush of capital and seemingly less interested in the intangible magic that makes a long-standing and iconic brand. (See: the inherent contradiction with things like Brandless.) But perhaps a third wave of these types of brands can balance a heartbeat with the spirit that goes into a category disruptor.

And as more and more of these zombie, grown-in-a-lab DTC brands pile up (and subsequently drive up the CPMs of social advertising even more), those companies that actually have a vision will be the ones around to be handed down.

We have no crystal ball and cannot predict what will be handed down but the "drive up the CPMs of social advertising even more" bit is on point and potentially devastating to all of those retailers out there whose stated strategy is to deploy more resources to social marketing. The cover charge for that is getting far more onerous as Facebook Inc. ($FB) limits supply amidst fervent demand. Indeed, the over-saturation of social is leading to a dramatic shift in customer-acquistion-strategies, with DTCs spentding $3.8b on TV ads last year — an increase of 60% over 2017. It's gotten so hard to stick out……..

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