Z Gallerie faces tough decisions in Chapter 11 bankruptcy

Because of high brick-and-mortar operational costs, Home News Now 125 retailer says that it will likely need to close all stores and focus primarily on its online presence

GARDENA, Calif. — Retailer Z Gallerie, which filed for Chapter 11 bankruptcy protection on Monday, Oct. 16, said that it could be forced to close all its stores unless a buyer interested in its various assets comes forward.

As part of its declaration filed Monday in U.S. Bankruptcy Court for the District of New Jersey, the company said it has hired Charlotte, North Carolina-based Stump & Co. to help in a sale of its assets to maximize value for the debtor and its creditors. It also plans to initiate “soft” sales at its stores to begin selling off inventory.

“This dual path is necessary to maintain optionality, conserve liquidity and maximize the value of the debtor’s assets,” the declaration by Robert Fetterman, chief financial officer and interim CEO, stated.

“We think it’s an attractive asset that will have broad appeal to a wide variety of prospective buyers,” added Tim Stump, president of Stump & Co.

However, with e-commerce sales representing more than half of its estimated $126 million in revenues in fiscal 2022, the company faces a tough decision moving forward on whether it makes sense to continue operations at its 21 retail locations in nine states that employ a total of 250 full and part-time workers.

The outlook was grim: Unless a prospective purchaser shows interest in maintaining a physical store footprint, it intends to close all stores and its distribution center by the end of December.

“Based on the decline in retail store sales, the debtor believes that an online-only presence will maximize profitability, will substantially deleverage corporate overhead expenses and will curtail the significant operational costs of maintaining these stores,” the declaration stated, noting that these costs include substantial rent and payroll costs.

The company came to this conclusion following an in-depth analysis of store-by-store activity by a team of management and advisers that evaluated historical and recent store profitability, occupancy costs, the surrounding geographic market, the type of storefront of each store, and other specific operational factors related to each store’s performance.

Put another way, the declaration said, the cost of maintaining the stores outweighs any revenues that the stores now generate or are likely to generate in the future. Thus, the Home News Now 125 retailer has already begun closing several stores it acquired from Z Gallerie debtors in its prior March 2019 bankruptcy and has determined it needs to close several more by the end of November.

The filing Monday mirrors a challenging environment not just for Z Gallerie but for other retailers impacted by a slow housing market tied to high interest rates.

The company filed its voluntary petition in U.S. Bankruptcy Court for the District of New Jersey under the name of fellow subsidiary DirectBuy Home Improvement, which does business as Z Gallerie, a retailer with 21 stores in nine states. DirectBuy Home Improvement, part of the CSC Generation family of retail brands, acquired various assets of Z Gallerie in June 2019 as part of its last bankruptcy the previous March.

In its bankruptcy declaration, the company said that e-commerce accounted for more than half of sales in 2022, a figure that has remained proportionate to its brick-and-mortar business since the 2019 purchase.

However, it added that the stores have been less profitable than e-commerce as they cost more to operate based on payroll and rent. It also noted that the company has been operating under severe liquidity constraints because of underperforming retail stores and other headwinds including high interest rates combined with the lasting impact of Covid-19 supply chain disruptions and import costs on the retail sector.

“Specifically, supply chain and import costs significantly increased in 2021 and into 2022, severely impacting the brand’s profitability and cash position,” Fetterman noted in the declaration. “With interest rates increasing based on inflationary pressure, and mortgage rates increasing to some of the highest rates in approximately a decade or longer, new home purchases and the housing market have slowed significantly, which is a major driver of business for the brand.”

The company’s Chapter 11 filing was vague about the company’s assets and liabilities listing between $50 million and $100 million in estimated assets and the same amount of estimated liabilities. Its estimated number of creditors was equally vague, totaling between 200 and just under 1,000.

But the declaration indicates that a number of factors led to the company’s cash balance falling below $500,000 as of the petition date, compared to just under $2 million in cash balances as of its 2019 bankruptcy.

These factors include the following:

+ The company’s liquidity has been severely impacted by significant operating expenses including high rents, mounting accounts payable from past operations and its indebtedness to BRF Finance Co. under a second priority secured term loan agreement back from June 2019, the date that DirectBuy acquired the assets of Z Gallerie. The declaration said that the lack of available liquidity was further compounded by a reduction in sales and other relatively high SG&A costs.

+ Other macroeconomic trends, including the Covid-19 pandemic and the shift in the competitive retail landscape, specifically led to a decrease in sales. Inflationary pressures also led to higher inventory and operating costs, which in turn impacted revenues all the while contributing to its performance shortfalls.

+ Increasingly higher interest rates, in turn, impacted mortgage rates, which slowed housing sales and construction. “These macroeconomic trends have continued to have a negative impact on the business in the second half of 2023,” the declaration stated.

+ It further noted that as liquidity tightened, vendors began to place pressure on the supply chain cost structure. As a result, some vendors, it noted, are unwilling to release new product absent payment in full. “This in turn worsens the debtor’s ability to generate revenues from sales, creating a negative feedback loop decreasing liquidity. Without the flow of fresh inventory, the debtor’s retail business will effectively starve. Additionally, the debtor has no available liquidity under its prepetition credit facilities to resolve these challenges. The flow of fresh inventory is the lifeblood of retail sales and ensuring the uninterrupted flow of inventory to the debtor’s customers is of the utmost importance.”

+ While the company maintained a large store footprint and high operating expenses following the 2019 acquisition, sales and profits have lagged because of a negative cash flow at many of its stores. As a result, it has incurred what it described as substantial past-due rents, which have “resulted in landlords threatening or in some cases taking affirmative steps to remove the debtor from its locations.” Founded in 1979, the retailer had 75 locations by 1983. Today it has 21 stores. Its estimated sales in  fiscal 2022 were more than $126 million, the declaration noted.

+ The company also said in its declaration that it underestimated the impact its prior Chapter 11 case in March 2019 would have on customers’ perception of the brand. It believes this ultimately resulted in an overall decline in consumer confidence in the company, which it said resulted in lower foot traffic. Ultimately, the company said, its management team pursued a promotional strategy that it believes further deteriorated the company’s performance with a resulting decline in gross profit margins while fixed costs remained the same.

To counteract these challenges, the company said it expanded its e-commerce platform, “launching a significant number of digital initiatives to leverage its engagement and relevancy to consumers.” It also implemented various cost-cutting measures by closing certain underperforming stores and streamlining its workforce. It also lowered corporate overhead costs by reducing payroll, closing corporate offices, managing IT and marketing expenses and bringing on a new payment vendor to cut down on credit card fees. It also said it improved inventory management through more accurate estimates of landed costs and revamped its financial reporting system to “provide more helpful and readily available information for decision making.”

But this ultimately was not enough to stem its latest bankruptcy.

In addition to its efforts to sell off inventory in the coming weeks, the company said it also will consider hiring a liquidation professional for the potential wind-down of its operations and sale of all inventory at its retail stores, a process similar to steps other retailers have taken to wind down operations.

“To the extent necessary, the debtor believes that such procedures would result in an expedited and efficient wind-down process,” the declaration stated, adding that it also will continue to manage its inventory in the coming weeks, a process that could temporarily halt the closing of some stores involved in the sale of that inventory. “The debtor believes that this dual-path process will best maximize value for all stakeholders.”

Thomas Russell

Home News Now Editor-in-Chief Thomas Russell has covered the furniture industry for 25 years at various daily and weekly consumer and trade publications. He can be reached at tom@homenewsnow.com and at 336-508-4616.

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