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Perfumania's 10-K Reinforces Our Short Thesis

|Includes:Perfumania Holdings, Inc (PERF)

Perfumania's (NASDAQ:PERF) 10-K was released on Friday.

I feel the need to start by saying that we have nothing personal against the company. In fact, almost every PERF employee I have encountered has been kind and friendly (which is commendable considering my bearish stance). That being said, stock investing is about cold hard facts, so I have to provide a cold hard analysis.

As for the 10-K, in my opinion it was an ugly read. It came as no surprise to see the stock fall on Monday and Tuesday, even as the broader market hit new all-time highs. Here are some of the key quotes, along with my commentary in italics:

They saved the best for first…

"In April 2012, the Company acquired Parlux, further enhancing its position as a manufacturer, wholesale distributor and specialty retailer of fragrances and related products. The Company has merged some of Parlux's operations, including sales, marketing, finance and human resources, with its New York offices. Management will continue integrating the operations of Parlux over the next twelve months and expects to realize greater margins on fragrances licensed by Parlux and sold through the QFG, Perfumania and SOW divisions. Management also expects that the increased size of the Company will help obtain more and higher profile fragrance licenses, which will broaden the Company's product offerings and enhance revenue and gross margins. Management also anticipates that the Company will continue to realize operating synergies, resulting in reduced aggregate costs in distribution, promotional activities, administration and operations."

Nice sentiments, but the 2012 results paint a completely different picture…

"Net sales increased 8.4% from $493.5 million in fiscal 2011 to $534.8 million in fiscal 2012. Of the $41.3 million increase in net sales, $7.5 is attributable to the fifty-third week in fiscal 2012."

Also, $39.9 million was due to the Parlux acquisition, part of which overlaps with the 53rd week data. Netting that out, organic (real) revenue growth was just $1.4 million or one-third of one percent (0.3%).

Similarly, "total gross profit increased 11.8% from $191.1 million in fiscal 2011 to $213.6 million in fiscal 2012, largely due to the Parlux acquisition."

In addition to its anemic growth, Perfumania incurred "store asset impairment charges of approximately $2.8 million and $0.3 million for fiscal 2012 and 2011, respectively, and impairment charges on a building under a capital lease of approximately $5.3 million and $0.8 million for fiscal 2012 and 2011, respectively, are included in asset impairment on the accompanying consolidated statements of operations."

So, PERF took impairment charges of $8.1 million (a $7.0 million annual increase) against organic growth of just $1.4 million.

"The average number of stores operated was 344 in fiscal 2012 compared with 347 in fiscal 2011. Perfumania's comparable store sales increased by 0.6% during fiscal 2012." However, they "exclude stores that are closed for renovation from comparable store sales from the month during which renovation commences until the first full month after reopening."

With a number of underperforming stores being renovated, I suspect that their monthly same-store sales (SSS) figures are painting a deceptive picture of what they will report for April-quarter sales and earnings. April's monthly SSS should be out on Thursday.

After publishing a photo of an empty and ragged-looking store, the company was kind enough to reach out and let me know that the store was under renovation at the time. They also sent photos of what their renovated stores look like. While the upgrades are better than the old look, our retail analyst had this to say:

"you know, it's funny....those are nice pictures-very clean and modern. but i just don't believe in their concept in terms of how the average person likes to shop. especially when trying to find a scent. people like to try things without needing help or being watched over...they want to touch the bottles and have a hand's on experience. perf's format simply does not optimize that this is how the average person likes to shop. it isn't even that the stores are so awful looking-the one at the aventura mall was nice. nothing really bad to say about it."

Pursuant to this discussion, we took to the road and visited at least five Perfumania stores in southern Florida. In general, the stores were clean and the upgraded stores did look better than the rest. However, that didn't change the fact that store traffic was miniscule. In fact, there were more workers than customers at every store we visited.

For me, this calls into question the value of these upgrades. To be fair, I need to ask the company what kind of SSS improvements they have experienced in upgraded stores. However, I'm still waiting for a response my last questions regarding how many stores they plan to upgrade and how much each upgrade costs.

"The average retail price per unit sold during fiscal 2012 increased by 6.2% from fiscal 2011 primarily due to increases in selling prices of some products, and the total number of units sold increased by 1.7%." However, "the increase in the number of units sold was due primarily to the additional week included in fiscal 2012 compared with fiscal 2011, as discussed earlier, which resulted in $3.0 million of additional sales."

"SOW's consignment sales increased from $71.7 million in fiscal 2011 to $73.7 million in fiscal 2012. The increase in SOW's net sales is due primarily to an increase in sales by SOW's largest customer offset by the loss of two consignment customers during fiscal 2012."

"Excluding the results of Parlux, the decrease in wholesale sales of $8.6 million is the result of less product availability for QFG and less customer demand during fiscal 2012 compared with the prior year."

Just to top things off, share-based compensation expense was up more than 3,000% to $4.5 million.

Bottom Line: Considering the contents of PERF's 10-K, the slow store traffic, and the company's pending removal from the Russell 2000, we feel comfortable with our short position and plan to hold it until the official Russell removal in late-June.

Disclosure: I am short PERF.

Stocks: PERF