Service searches for answers

Discount Store News, May 19, 1997 by Dawn Wilensky

BRENTWOOD, TENN. -- Call it a mid-life crisis.

At 37, Service Merchandise has been struggling to find itself and reclaim not just the glory of its youth but also that of its not-too-distant past.

Just 12 years ago, the catalog showroom chain was flying high, posting sales of approximately $10 billion in 1985. Today, Service is a $4 billion chain and the sole national survivor in an industry segment many have dismissed as passe. But Service's niche in the market grows ever more perilous as big box retailers such as Circuit City, Wal-Mart, Kmart and Target continue to gnaw away at many of its core competencies with better execution.

"Today, we have the Big Three, which offer low prices, better customer service, a more pleasant shopping environment and a much wider assortment of both hard lines and soft lines," said Kenneth Gassman Jr., an analyst with Davenport & Co. "It is anybody's guess as to whether the catalog concept can exist in its current state."

These realities have not been lost on Service president and coo Gary Witkin who is trying to give consumers a new reason to visit the 343-unit chain much as Sears did successfully following its own fall from grace a few years ago.

Service has tightened its merchandising and is paying special attention to higher-end branded goods across the board where the chain "can maintain dominant category selections which provide returns that exceed the company's cost of capital," according to Witkin. Steps have been taken to make better use of its 24 million-customer database, to speed up its notoriously slow checkout and product pickup and to streamline its catalog and sales flyers and circulars. The company also exited the highly competitive, low margin computer business early this month, a move that was judged "a good idea" by many industry watchers.

"Service Merchandise did itself a great service by getting out of computers--a horrible business where inventory loses value if you make the wrong decision," said an analyst with Salomon Brothers. "There's not much money to be made even when you make the right decision."

But the initiatives of the past few months have had minimal impact on the chain's balance sheet, which ended 1996 with sales declines of 1.6% to $3.96 billion from $4.02 billion the prior year. Comp store sales slipped 1.9% in 1996 on top of a 3.3% decline in 1995.

More recently, the chain reported a significant 1Q loss of $107.2 million, or $1.07 per share. The loss included a $129.5 million restructuring charge related to the closing of 60 underperforming stores last month. Excluding the restructuring charge, the loss was $26.3 million, compared to a $24.7 million loss for the first quarter a year ago. Per share, the loss was 26 cents, down from a 24 cents loss a year earlier.

The continued deterioration of its financials prompted Standard & Poor's to put Service on credit watch March 27, the same day the chain announced it would close 60 stores. Shortly thereafter, Moody's did the same. Duff & Phelps downgraded its debt citing negative sales trends, declining earnings and a decline in debt protection measures.

Despite the negative news, analysts feel the chain has strong management and some fight left--primarily from a cash standpoint. Service ended its fiscal year, Dec. 29, 1996, with $285.4 million in cash on hand, an increase from $177.3 million during the year-earlier period. It also owed nothing on its $525 million revolving credit line.

"I think Gary Witkin has great ideas that are rational and well thought out," said J. Gary Dennis, an analyst with J.C. Bradford. "The stores that I saw looked better than ever, so I'm baffled as to why the chain didn't see some improvements last Christmas."

Some analysts close to the chain have suggested that the way to improve profitability and margins would be to forsake businesses such as consumer electronics where the chain has no chance of competing with powerhouses such as Best Buy and Circuit City Instead, they suggest that Service's focus should rest on jewelry, which supplies 90% of its profits. Interestingly, the category occupies only 7 ft. of space, a disproportionate amount of space in light of the return.

Another growth opportunity might be in exercise equipment and accessories, often a high margin business. The one problem is fending off The Sports Authority and specialty stores.

The possibilities and risks are many for Service Merchandise. Now the chain must draw on the experience of its 37 years to stay afloat.