Welcome to the 124th Pari Passu Newsletter, 

Our last restructuring deep dive will be hard to beat, but we will give it a shot today!

In light of the COVID-19 pandemic, we have seen a wave of retail bankruptcies accelerated by the decline of many brick-and-mortar retailers. Following lockdowns, supply chain disruptions, and consumer habits that relied heavily on physical stores, major chains like JCPenney, Neiman Marcus, and Pier 1 Imports have been forced to restructure and file for Chapter 11. 

The case of Tuesday Morning unpacks another dimension of retail bankruptcies and Chapter 22s, one driven by a complete reliance on physical store presence and complicated by third-party financiers. This case also explores the lease obligations, forbearance agreements, and a unique case of shareholder recovery. Tuesday Morning’s Chapter 22 is a long story, but don’t worry—we’ll break it down clearly and simply. Let’s dive in.

Tuesday Morning Overview 

Tuesday Morning was an American off-price retailer that specialized in home goods, décor, and gifts with over 700 locations across the United States [1]. The company operated in 40 states with distribution centers in Phoenix and Dallas.

Tuesday Morning sourced excess inventory, closeouts, and overstocked merchandise from manufacturers and sold them at a fraction of their original retail prices; around 80% of its inventory was domestically sourced [2]. Unlike traditional big-box discounters, Tuesday Morning focused on a boutique-style shopping experience, with frequently changing inventory that encouraged repeat visits. The company primarily served middle- to upper-middle-class customers looking for high-quality home furnishings at bargain prices, competing with retailers like HomeGoods, TJ Maxx, and Big Lots. 

To understand the historic performance, it is worth highlighting two different time periods of the company: FY 2015 and the period from 2016 to 2019. We will first provide a snapshot of the company’s FY 2015 financials, followed by its pre-pandemic profile: 

In FY 2015, Tuesday Morning was generating revenue of around $906mm, gross profits of around $327mm (gross margins of 36%), operating income of $12.4mm, and net income of $10mm (net margins of 1.21%). Prior to Tuesday Morning’s renovation efforts (which decreased cash flow and stock price dramatically), the company had a market cap of around $741mm in FY 2015 when it was generally healthy [31].

From FY 2016 – FY 2019, Tuesday Morning was generating revenue of around $1bn, gross profits of around $352mm (average gross margins of 35%), operating income of -$11mm, and net income of -$12.4mm (net margins of -1.19%) in FY 2019 [23] [27]. FY 2019 figures, rather than averaging multiple years, best represents the company’s pre-pandemic, pre-bankruptcy financials without distorting cash flow due to one-time developmental costs. Tuesday Morning’s net income fell consistently from 2016 to 2019, not due to weak sales but because of high COGS and SG&A. In parallel, the company pursued costly strategic initiatives, including relocations and store optimizations aimed at increasing revenue. These initiatives increased capex, which, while not affecting net income directly, significantly reduced cash flow. 

Corporate History

Founded in 1974 by Lloyd Ross, the company operated on a treasure-hunt business model, offering brand-name and designer products at discounted prices. Tuesday Morning transitioned from a garage sale format to formal retail stores in 1979. The company went public in 1984 with 57 locations and was later acquired by Madison Dearborn, a private equity firm specializing in middle-market companies, before returning to the public market in 1999 [2]. 

Tuesday Morning’s expanding business and discount appeal to customers strengthened its reputation in the retail industry, leading the company to gain greater access to manufacturers who approached them directly with their stock. The company had remodeled many of its old stores following its 1994 improvement of its distribution system; both of these factors led to steady growth into the mid-2000s. By 2004, Tuesday Morning had expanded to 641 stores in North America [24]. In 2015, Tuesday Morning implemented store optimization strategies and relocations of existing stores. By 2018, these efforts contributed to the company achieving a record $1bn in sales and expanding its footprint to over 700 physical locations [25]. 

Pre-Bankruptcy Financial Condition

Causes of Distress

However, despite this period of expansion and record sales, underlying vulnerabilities in Tuesday Morning’s business model left the company exposed to external shocks. The two main factors contributing to Tuesday Morning’s financial distress were a sharp decline in revenue due to COVID-related shutdowns and costly lease obligations. 

COVID 

A unique aspect of Tuesday Morning’s shopping experience came from its exclusive reliance on its brick-and-mortar stores. Consequently, COVID had a devastating impact on Tuesday Morning’s sales. The closing of all retail locations and key parts of their supply network halted nearly all new revenue starting March 2020 [2]. The niche nature of the company’s retail model didn’t help; unlike traditional retailers that could leverage strong branding or premium pricing, Tuesday Morning was dependent on maintaining low prices to drive customer demand, which made profitability challenging. 

By the end of March 2020, the company faced a severe liquidity crisis after being forced to close all of its leased stores while still owing approximately $10 million in monthly rent. 

As a reminder, Tuesday Morning’s fiscal year ends June 30 of each year, not December 30. In Q2 2020 (before COVID), Tuesday Morning had $4.9mm in cash [29]. With 100% of the company’s revenue coming from physical store sales, the closing of all locations during COVID had a devastating impact on the company; from Q2 2020 (December 2019) to Q3 2020 (March 2020), revenues dropped from $324mm to $166mm. Gross profits dropped by $54mm from $106mm in Q2 2020 to $52mm in Q3 2020 [29]. The closing of all physical stores wiped out all operating cash flow since there was no new revenue, and market cap dropped to $7.6mm in Q4 2020 [23].

In an effort to preserve liquidity, Tuesday Morning halted payments on pending vendor invoices and suspended new orders. In March 2020, the company drew down $55mm from its revolver, increasing its total RCF obligations to $91mm [26]. In March 2020, the company also had $47mm in cash [32], most of which likely came from revolver drawdown (recall the company only had $4.9mm in December 2019). The company also tried to secure emergency financing from government relief programs such as the Main Street Lending Program under the CARES Act, but did not meet borrowing requirements [28]. 

Recall that in FY 2019, Tuesday Morning reported a net loss of $12.4mm despite generating over $1bn in revenue. This net loss was driven by high COGS ($655mm) and SG&A expenses ($363mm). The costly COGS expense stemmed from the nature of the company’s bargain business model; the high COGS expense contributed to the company’s 3-year net loss streak from 2017-2019 [27]. 

Below, we will elaborate on the second driver of net loss, SG&A expenses, and how the company’s lease obligations contributed to its filing. 

Retail Leases

Like many retail bankruptcies, Tuesday Morning’s lease obligations were a major factor in its Chapter 11 filing, as high fixed rent expenses quickly became unsustainable when revenue plummeted. In FY 2019, annual rent expenses totaled $121.5mm (compared to $1bn in revenue). This constituted a large portion of the $363mm total SG&A expenses, and there were no sale-leasebacks prior to the company’s filing. 

Although Tuesday Morning managed to pay March rent in full, it lacked sufficient cash flow to continue payments. A logical question you may have is why Tuesday Morning couldn’t pay a few months more of rent if they drew $55mm of their revolver. While exact uses for the $55mm were not disclosed, the additional liquidity provided by the revolver likely went to vendor payments incurred before the bankruptcy filing (costs that still needed to be paid despite the sudden halt in revenue) rather than covering additional months’ rent. The decline in the company’s accounts payable from $91mm in FY 2019 to $5.5mm in FY 2020 further indicates that vendor payments were likely made during this period [23]. Typically, retailers use accounts payable as a source of liquidity since they can sell products now and pay suppliers later. However, it seems that in this case, Tuesday Morning’s slowing revenue caused this dynamic to flip; in order to catch up on costs and vendor payments, the company turned to using accounts payable as a use of cash rather than a source of liquidity.

Because Tuesday Morning could not cover its rent expenses, the company formally requested rent deferrals. Some landlords agreed to rent relief, but most rejected the request, issuing default notices or pursuing legal action. As financial pressure intensified, the company defaulted on most of its April and May rent payments. In May 2020 (the time of filing), Tuesday Morning had $14.6mm in outstanding letters of credit secured under its prepetition ABL credit agreement. LOCs are important when considering leases because they are often used as financial guarantees for landlords, especially when upfront cash payments are not provided by tenants. When Tuesday Morning defaulted on lease obligations, landlords likely drew on these LOCs, forcing the company or its lenders to replenish the amounts used. This further strained liquidity and contributed to the company’s eventual filing. 

First Chapter 11 Filing

Prepetition Capital Structure

Below is Tuesday Morning’s prepetition capital structure. As you may notice, Tuesday Morning did not hold an overbearing amount of debt Even though the company’s leverage ratio of 8.6x is quite high ($20mm Q2 2020, pre-distressed adjusted EBITDA/$155mm total debt), we cannot characterize this business as a high leverage business because the leverage ratio in this case is largely driven by lease liabilities rather than financing debt; the majority of the company’s debt outstanding ($107mm) is related to its hundreds of leases [23], [2]. This $107mm included obligations to vendors and landlords like unpaid rent prior to bankruptcy and rejection damages from approximately 200 terminated leases [2].

However, total liquidity was still relatively robust with $65mm of availability under its $180mm first lien revolving credit facility (RCF) and $46.7mm in cash and cash equivalents [23]. Tuesday Morning was not able to fully draw down on the revolver due to constraints in its borrowing base, which we will expand on later. 

Forbearance Agreement

Tuesday Morning pursued two main initiatives before filing for Chapter 11: a forbearance agreement and securing a DIP lender. 

First, Tuesday Morning bought more time to restructure and avoid immediate default by entering a forbearance agreement with existing first lien lenders on May 14, 2020. As a review, a forbearance agreement is a temporary arrangement between a borrower and lender(s) that delays enforcement actions such as defaults. The biggest benefit here is to give the company more time to negotiate debt terms, pursue new financing, or prepare for Chapter 11 in an orderly manner [6]. To better understand how this works, let’s take a look at a quick example:

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