Forever 21, Inc. – Fashion Retailer Files Chapter 11 and Plans Significant U.S. Store Closings and Lines Up $350mn in DIP Financing in Effort to Right Size Through Restructuring

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September 29, 2019 − Privately-held Forever 21, Inc. and seven affiliated Debtors (“Forever 21” or the “Debtors”) filed for Chapter 11 protection with the U.S. Bankruptcy Court in the District of Delaware, lead case number 19-12122 . The Debtors, a global "a fast fashion" retailer, are represented by Laura Davis Jones of Pachulski Stang Ziehl & Jones LLP. Further board-authorized engagements include (i) Alvarez & Marsal  North America, LLC (“A&M,” who also supply Jonathan Goulding as Chief Restructuring Officer), (ii) Kirkland & Ellis LLP as bankruptcy counsel, (iii) Lazard & Co., as financial advisor and investment banker, (iv) SSA & Company (“SSA”) to provide management services and (v) Prime Clerk as claims agent. The Company also announced that its Canadian subsidiary filed for and was granted protection under the Companies’ Creditors Arrangement Act by the Ontario Superior Court of Justice (Commercial List) in Toronto.

The Debtors’ lead petition notes more than 100,000 creditors; estimated assets between $1.0bn and $10.0bn; and estimated liabilities between $1.0bn and $10.0bn. Documents filed with the Court list the Debtors’ five largest unsecured creditors as (i) KNF International CO., Ltd ($13.4mn trade debt), (ii) Praxton Commercial Corp. ($13.2mn loan), (iii) C&C Nantong Cathay Clothing Co Ltd ($12.9mn trade payable), (iv) INTEC Ltd ($10.4mn trade payable) and (v) CRS Denim Garments Egypt SAE ($9.8mn trade payable). In a staggering display of trade debt, all 50 of the Debtors' top 50 unsecured creditors (48 or 49 are trade creditors) have claims in excess of $2.0mn (15 in excess of $7.0mn). 

In documents filed with the Court, the Debtors "estimate that they owe approximately $350 million to their vendors as of the Petition Date" which matches the amount being provided in the Debtors' debtor-in-possession ("DIP") financing. The Debtors are insistent that they will honor their trade debt (and the DIP financing tends to back up that commitment in the short-term) in their pursuit of "keeping the American dream alive," but that $350.0mn of jettisonable unsecured debt will certainly be scrutinized by secured pre-petition (now DIP) lenders who will have their own dreams, theirs being slightly higher up the dream waterfall. The right-sizing will not come at their expense, so it will have to come at the expense of the founding Chang family, the unsecured creditors (vendors and landlords) or a mixture of both. How much of the Chang's American dream will be lelt to them upon emergence of the restructured Debtors?

In a press release announcing the filing, the Debtors advised that “Forever 21 intends to use these proceedings to facilitate a global restructuring that will allow the Company to focus on a profitable core part of its operations. As part of its restructuring strategy, the Company plans to exit most of its international locations in Asia and Europe, but will continue operations in Mexico and Latin America….Forever 21 will use these proceedings to right size its store base and return to basics that allowed the Company to thrive and grow into the fast fashion leader. 

Linda Chang, the Debtors' Executive Vice President and daughter of founders Do Won and Jin Sook Chang, added: “With support from our key landlord and vendor constituents, we are confident we will emerge as a stronger, more competitive enterprise that is better positioned to prosper for years to come, and we remain committed to delivering the fast fashion trends that our customers have come to expect from Forever 21.”

Objectives of the Chapter 11 Filing

In a declaration in support of the Chapter 11 filing (the “Goulding Declaration”), Jonathan Goulding, the Debtors’ Chief Restructuring Officer, stated: "Forever 21 is a story about family and the 'American Dream.' In an age when retail, as most Americans know it, is under assault, Forever 21 intends to use these proceedings to remain viable and write a different ending from so many retail companies before it. The goal of these chapter 11 cases is clear: emerge with a viable and feasible standalone business and keep the dream alive.

Strong relationships with its vendors and landlords, that in many instances stretch close to 30 years, have served as a foundation for success. These relationships—carefully cultivated over the course of two plus decades—have been the backbone of Forever 21’s success since its inception. And it is these relationships that allowed Forever 21 to operate with very little funded debt, supported Forever 21 during its recent difficulties, resulting in virtually no cash-on-delivery demands or actions to “lock” Forever 21 out of its stores, and will be critical sources of support for Forever 21’s successful restructuring. Vendor relationships together with support from Forever 21’s longstanding landlord community will ensure the fresh start necessary to keep the dream alive—not only for the Changs and Forever 21, but for hundreds of vendors and thousands of employees who also have realized their dreams through Forever 21’s meteoric rise."

DIP Financing

Forever 21 announced that has obtained $275.0mn in financing from its existing lenders with JPMorgan Chase Bank, N.A. as agent, as well as $75.0mn in new capital from TPG Sixth Street Partners. Debtor-in-possession ("DIP") financing documents have not yet been filed.

Pre-Petition Debt

Funded Debt

Maturity

Interest Rates

Principal Amount Outstanding

ABL Facility

March 2022

LIBOR + 1.25–1.75%

$194.5mn

Term Loan Agreements

December 2019

2.00%

$20.0mn

Praxton Note

October 2020

2.75%

$13.2mn

TOTAL

$227.7mn

…and yes that $350.0mn in unsecured trade debt.

Store Closings

The Debtors' press release indicates the Debtors intend to "right size" their store base and clearly that will involve store closings. As of writing, the Debtors have yet to file their motion "Seeking Entry of an Order (I) Authorizing the Debtors to Enter Into the Consulting Agreement, (II) Approving Procedures for Store Closing
Sales, and (III) Granting Related Relief," although they have indicated their intent to do so "contemporaneously" with the Petition. It has been widely reported that
the Debtors intend to close up to 178 stores in the U.S. and that “the decisions as to which domestic stores will be closing are ongoing, pending the outcome of continued conversations with landlords…We do, however, expect a significant number of these stores will remain open and operate as usual, and we do not expect to exit any major markets in the U.S.”

Events Leading to the Chapter 11 Filings

The Goulding Declaration does its best to cast the Debtors’ decline in terms of macro-economic factors (ie, the decline of the mall), but clearly there are some very significant Debtor-specific issues that have served as accelerators and one would imagine that a lot of attention will be given to the fact that Debtors continue to be run as a family business; a fact that may explain why retail consultant SSA has been brought prominently into the equation at the beginning of the Debtors' reorganization efforts. These Debtor-specific factors include “merchandising miscalculations;” rapid international expansion based on a failed “hub” flagship store concept; inability to match fashion trends in international markets; and an obligation to keep aged inventory in order to comply with provisions in its ABL facility. All of these factors, as compounded by the retail apocalypse, led to a $1.0bn drop in annual global sales ($4.1bn in 2014 to $3.1bn in 2019) and losses of $10.0mn a month at its non-U.S. stores. Forever 21 management has made a number of mistakes and will now be required to grow up.

The Goulding Declaration states: “A number of factors, both macro and micro contributed to the need to commence these chapter 11 cases. Most significantly is the decrease in mall traffic. Many Forever 21 storefronts are located in malls. As its neighbors have closed, the number of customers walking past Forever 21 has declined. This has led to a decrease in sales through what has traditionally been Forever 21’s predominant retail channel, its brick and mortar stores. Despite Forever 21’s continued efforts to adjust its sales strategy to one capitalizing on its online store, it remains saddled with excessive floor space from leases entered almost a decade ago or more in unprofitable markets. Over time, Forever 21’s liquidity has become strained and its vendor relations have been tested. Its vendor relationships have passed those tests. Despite continued vendor and landlord support, the following factors culminated with dwindling cash flows and the inability to access incremental liquidity under its prepetition debt facilities.

Additionally, Forever 21 suffered from recent merchandising miscalculations that have contributed to the decline in EBITDA. Historically, merchandising decisions largely were in reaction to the previous year’s performance, resulting in a ‘pendulum’ phenomenon whereby Forever 21 underspent one year and overspent the next. Specifically, Forever 21 materially under-purchased inventory in 2017 due to excess 2016 inventory levels. Following this under-purchase, Forever 21 materially over purchased in 2018. 

In 2008, Forever 21 began expanding into international markets. The initial strategy was to create a hub within a city, with a flagship store surrounded by more affordable rent locations spread throughout a metro area. Forever 21, however, was generally unable to accumulate sufficient storefronts in lower-rent areas and were left with several high-rent locations without the necessary surrounding support. Therefore, Forever 21 entered lease agreements for store footprints which were too large and required more products to fill the available space.

Compounding the risk of high-rent locations, Forever 21’s focus on rapid expansion left Forever 21 without the operational capabilities to scale effectively. By 2015, there were 262 international stores. The majority of the international stores were unprofitable due to variances in local fashion trends and elevated labor costs. As a result, Forever 21 was unable to account for geographical differences in taste and climate, ultimately leading to operational scaling inefficiencies

Despite relatively strong domestic sales, international sales have remained depressed and have counter-balanced the strong performance of the stateside stores. Global sales dropped from $4.1 billion in 2014 to $3.1 billion in the latest twelve months as of July 31, 2019. Specifically, Forever 21’s storefronts in Canada, Europe, and Asia are losing approximately $10 million per month on average over the past 12 months. These losses from international operations, compounded with the foregoing factors, have rendered Forever 21 unable to service its outstanding debt. 

As is typical in the apparel industry, inventory levels form a substantial portion of the ABL Facility borrowing base. When new inventory failed to resonate with customers, the ABL made it difficult to clear inventory at lower margin rates as this would depress the borrowing base and, therefore, liquidity. As a result, Forever 21 continued to carry aged inventory which crowded out new product and low liquidity made it challenging to procure new product. Forever 21 has continued to sell through older inventory rather than bringing in new product. The lack of fresh inventory has a negative impact on sales which tightens liquidity (including by reducing the borrowing base under the ABL Facility), creating a negative feedback loop. Without the flow of fresh inventory, Forever 21’s business will effectively starve."

Significant Shareholders

  • Do Won and Jin Sook Chang Family Trust: 56.48%
  • Jin Sook Chang 2014 Grantor Retained Annuity Trust: 10.37%
  • Too Capital, LLC: 10.00%
  • Jin Sook Chang 2009 Grantor Retained Annuity Trust: 6.39% 
  • Do Won Chang 2009 Grantor Retained Annuity Trust:  6.39%

All of the above have an address of: 3880 N. Mission Road, Los Angeles, California 90031

About the Debtors

Founded in 1984, Forever 21, Inc., headquartered in Los Angeles, California, is a fast fashion retailer of women’s, men’s and kids clothing and accessories and is known for offering the hottest, most current fashion trends at a great value to consumers. Forever 21 delivers a curated assortment of new merchandise brought in daily. 

As of the Petition Date, the Debtors operate 549 stores across the United States, and 251 stores are operated internationally by non-Debtor affiliates. Of the 251 international stores, 181 are owned and operated exclusively by the non-Debtor affiliates, 54 are franchises, and 16 are operated as joint ventures. The Debtors also maintain a substantial online presence, with their e-commerce platform accounting for approximately 16 percent of all sales. In addition to the 534 stores operated under the Forever 21 brand, the Debtors formed a beauty and wellness brand, Riley Rose, in 2017, which operates 15 stores in the United States.

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