FTI CONSULTING’S 2014 HOLIDAY RETAIL FORECAST:

MORE MEDIOCRE

What the Heck Happened Last Holiday Season, and Could It Happen Again?

Let’s just say it upfront: Last holiday season was a dud by any measure. There is hardly any way to spin it positively. Pervasive and aggressive discounting across the retail landscape along with late-season severe weather issues contributed to the season’s disappointing results. One year later we note that two themes remain in place: reluctance of most shoppers to spend more freely despite firmer financial footing, and diminished pricing power of most retailers (big and small.) So we approach the 2014 holiday season with a fair degree of caution.

The 2013 holiday season was the slowest since the end of the recession, with nominal retail holiday sales increasing 1.8 percent by our measurement (adjusted GAFO* categories from November through January), which was considerably below the long-term average of 4.6 percent. (Exhibit 1)

Retail sales growth in November and December was soft, but January’s performance was horrid. Excluding January, sales increased by 2.5 percent — still a disappointing season by historical standards.

FTI CONSULTING’S 2014 HOLIDAY RETAIL FORECAST: MORE MEDIOCRE

1

THE 2014 HOLIDAY RETAIL FORECAST

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

YOY % (Nominal)

2013

2012

2011

2010

200

9

200

8

200

7

200

6

200

5

200

4

200

3

200

2

200

1

200

0

199

9

199

8

199

7

199

6

199

5

199

4

199

3

20 Yr. Avg Source: U.S. Census Bureau

EXHIBIT 1

Holiday Season Retail Sales (GAFO Categories and Non-store Sales Nov.-Jan.)

* Adjusted GAFO categories include general merchandise, apparel and accessories; furniture and home furnishings; consumer electronics and appliances; toy, hobby and sporting goods; office

supply and gifts, as compiled by the U.S. Census Bureau, plus electronic shopping and catalog retailers.

2

THE 2014 HOLIDAY RETAIL FORECAST

Entering last holiday season, consumers were in better financial shape than at any time since the end of the recession and were more upbeat as well, so the sluggish results were surprising. Aggressive promotional pricing throughout the season — not just in the week before Christmas — hurt 2013 holiday sales and profits more than we expected and have continued in 2014.

Additionally, extremely harsh winter weather impacted a considerable part of the country in late December and much of January, which many retailers cited as a cause of weak fourth quarter results. January 2014 was a bust for retail sales, with nominal sales growth declining slightly on a year-over-year (“YOY”) basis, which is rare. (Exhibit 2) But it wasn’t just bad weather that held back spending. Income growth slowed sharply in last year’s final quarter, and this hurt holiday sales, too.

Sales and earnings disappointment has continued across much of the retail sector well into 2014. As Kip Tindell, CEO of The Container Store, so aptly put it in July following soft quarterly results,

“We thought our sluggish sales were all

because of weather and calendar shifts

that began in November and continued

into the spring, but now we’ve come

to realize it’s more, … Consistent with

so many of our fellow retailers, we are

experiencing a retail funk.” His candid comment got a surprising amount of media coverage considering that what he said was so plainly evident

to industry observers: Discretionary consumer spending is experiencing a malaise of sorts, with the exception of automobile sales. It wasn’t supposed to play out this way in 2014.

The paradox of a strengthening U.S. economy, improving household finances and modest retail sales growth continues to confound. Following a soft first quarter, much of it also weather related, nominal retail sales growth improved to the 3.5 percent-4.0 percent YOY range, where it mostly has remained right through the recent Back-to-School season, which was widely thought to be mediocre at best. As we approach the 2014 holiday season, we note a similar economic climate to last

year’s — stronger economic growth, improving financial prospects for many American households (though to varying degrees) and a recovery that gradually is becoming more inclusive.

The labor market undoubtedly is in better condition than it was a year earlier, though we recognize the inherent shortcomings of the unemployment rate as an indicator of its health and the persistence of pronounced labor slack. (The unemployment rate excludes jobless Americans who have given up their active job searches, as well as part-time workers who want full-time jobs but cannot find them.) We believe the Labor Force Participation Rate, which measures the percentage of working-age civilians who are either employed or are seeking work, represents a more accurate picture of the labor market. It is at its lowest level since 1978. Nonetheless, jobs are more plentiful than they were a year or two ago, but don’t place too much faith in a 5.9 percent unemployment rate — it misses a lot.

-1%

0%

1%

2%

3%

4%

5%

6%

7%

JanuaryDecemberNovember

2013201220112010

Source: U.S. Census Bureau

6.8%

4.3%

3.3%

5.7% 5.3%

5.3%

5.5%

2.7%

6.6%

2.7% 2.3%

-0.1%EXHIBIT 2

YOY Percentage Change in Nominal GAFO Sales

To the chagrin of retailers, an improving economy in 2014 has not translated into robust spending. Indeed, much of the U.S. retail sector is in a funk that perhaps the holiday season can help shake off.

3

THE 2014 HOLIDAY RETAIL FORECAST

Despite the many imperfections of this recovery, Americans are as upbeat today as they’ve been since 2007, according to the two most respected consumer confidence polls. Yet it’s hard to be optimistic given last year’s weak holiday performance under similar conditions.

FTI Consulting’s 2014 Holiday ForecastWe are projecting a 3.5 percent increase in nominal retail holiday sales this season — significantly better than last year but still well below the long-term average. On the plus side, the consumer-oriented variables that drive our forecast model all are stronger than they were a year ago. An economic recovery that primarily benefited a small percentage of Americans for several years has gained traction in 2014 and gradually is becoming increasingly inclusive.

However, we expect the aggressive promotional environment to persist, and we see a dearth of new or must-have gift items. So while we remain cautious,

there is some upside potential if retailers manage to avoid the desperation discounting we witnessed last year — or downside if it worsens.

Some retailers already have said they’ll be more disciplined this season with respect to price discounting. It’s a worthy sentiment considering how badly things turned out last holiday season — but we’ll believe it when we see it.

That is not to say there won’t be big losers despite our expectations of a better holiday season. We would categorize potential losers into two camps (possibly overlapping). The first group is chronic underperformers that have managed to scrape by for years despite repeated missteps, failures in execution or inaction. Many cannot withstand another bad holiday season. The second group consists of companies poorly positioned to respond in a meaningful way to the online onslaught.

Recent Chapter 11 victim ALCO Stores is a good example of both. It was a midsized general merchandise chain that operated only in small rural towns. Over the last decade, it had to compete with the proliferation of dollar stores on its turf. But it also had to compete with online shopping — which effectively brought Wal-Mart to these small locales without shoppers having to drive for 30 minutes. Realistically, there was little in the way of an adequate response that could be mustered to counter these existential threats. Ultimately, ALCO Stores became expendable.

If recent historical trends remain intact, nearly three-quarters of expected sales growth will accrue to the online channel. The online channel, which accounts for approximately 15 percent of GAFO category spending during the holiday

season, continues to grow sales at a 15 percent YOY rate, leaving minimal sales growth for stores.

Trends to Consider This Holiday SeasonWe note several trends that remain intact since last holiday season and are worthy of mention:

Apparel Chains Remain Highly Challenged

The retail sales slowdown since late 2013 is noteworthy in that it has impacted nearly all product categories (see data pack available on our website), including many category leaders, but specialty apparel chains have experienced the most acute slackening of sales growth and margins. Apparel retailers continue to discount very aggressively in their efforts to woo reluctant shoppers despite the ineffectiveness of this strategy to boost results. The apparel-related bankruptcies of the past year resulted mostly in liquidation outcomes. Several midsized apparel chains will be flirting with danger in 2015 if operating performance doesn’t improve materially in short order, and we most likely will continue to see a wave of store closures in the specialty apparel sector.

We attribute much of the sales weakness at apparel stores to demographic shifts and enduring changes in consumer attitudes toward the category since the recession. Aging baby boomers and the financially challenged are doing more of their apparel shopping at general merchandise stores than at specialty shops. Teenagers still cannot find jobs and are spending less at teen and young adult apparel retailers, while millennials — who were impacted particularly hard

More Americans are telling pollsters that economic conditions are improving. This should translate into a better holiday season than last year but certainly not a strong one.

4

THE 2014 HOLIDAY RETAIL FORECAST

by the recession and seem to have a more pragmatic view of apparel — have other spending priorities.

The Online Channel Remains a Juggernaut

Despite sluggish retail sales, online sales continue to grow at a 15 percent YOY clip, nearly five times the rate of store sales. We project 2014 online sales to hit $300 billion, on their way to $510 billion by 2020 (both revised slightly higher compared with a year ago). (Exhibit 3) The online channel’s share of total retail sales (excluding autos and gasoline) now is 10 percent compared with 5 percent in early 2009. (Such market share is higher if we exclude the supermarket category.) Mobile devices today are a driving force, accounting for 16 percent of U.S. online sales last year compared with 4 percent in 2011, according to Custora, with online sales via tablets now surpassing those from other mobile devices. That’s not bad for a gadget that didn’t hit the shelves until 2010.

The Holiday Season Continues to Get Stretched Longer

Each year, it seems the holiday season begins earlier and ends later, with December accounting for five percentage points less of total holiday season sales (November through January) than it did 20 years ago, a decline of nearly 11 percent. This lost share has gone to the accompanying two months, mainly January due to gift card redemptions after Christmas. In recent years, the season has kicked off before Black Friday, and even October has picked up some market share compared with a decade earlier. For those who can’t tolerate Christmas displays and promotions before Halloween, the good news is that the holiday season can’t get much longer than it already has become.

The Traditional Black Friday Weekend Has Been Diluted

By now, it is evident that the official holiday season kicks off well before Black Friday. And with tens of millions of Americans hitting the malls on Thanksgiving, we are all but assured that this trend will continue — and likely strengthen. For many Americans, a traditional Thanksgiving dinner finishes in time to allow several hours for getting out of the house and stretching those legs at the nearest mall. Moreover, last year, we noted several large retailers advertising holiday-type deals as early as the start of Thanksgiving week. Many of these sales come at the expense of the traditional Black Friday weekend. This development diminishes the importance of the three-day Black Friday weekend and distorts sales comparisons across years unless the full four-day weekend is considered.

January Matters More Than It Did in the Past

The notion of January as a dead shopping month should be revisited. Consumers are not entirely shopped out after the holidays. Consequently, January remains the strongest month

for online shopping relative to total monthly retail sales — a trend that has strengthened in recent years. Combined with the spillover of spending from holiday gift card redemption, January is a more important selling month than it was a decade or two ago. Retailers should remember this when deciding on their January markdowns, as post-holiday shoppers still buy in-season merchandise through mid-January, and many are likely to be less price sensitive because they are using gift cards.

A Large Percentage of U.S. Households Continue to Struggle Financially

Last, we recognize that a sizable percentage of American households remain financially challenged and highly constrained in their discretionary spending options. Holiday season expectations are more subdued if you are selling to this demographic, which we would loosely define as the bottom two quintiles (40 percent) of households by income group — those with average pretax income under $30,000. In the totality of U.S. retail spending, their restraint is easily offset by the spending of higher income households. But for retailers whose customers make

0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

$800,000

Online Sales

2024

202

3

202

2

202

1

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

Source: FTI Consulting Inc.

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Online Market Share

$168,895

$197,883

$226,878

$266,837

$299,885

$333,665

$368,065

$403,054

$438,649

$474,902

$511,874

$549,631

$588,235

$627,745

$668,217

7.4%8.3%

9.1%

10.2%11.0%

11.7%12.4%

13.0%13.5%

14.0% 14.4%14.8% 15.2% 15.5% 15.8%

EXHIBIT 3

Projected U.S. Online Retail Sales and Market Share ($ in millions)

5

THE 2014 HOLIDAY RETAIL FORECAST

discretionary purchase decisions solely on the basis of price, there are few levers to pull other than trying to be as price competitive as possible. Unfortunately, this alone is not a winning strategy — or even a survival strategy — for small-to-midsized chains in the long run.

On a brighter note, lower energy prices are disproportionately benefiting lower income households, and the savings now amount to more than pocket change. Gasoline prices have fallen 60 cents per gallon since midyear and, if sustained, also offer the prospect of lower heating bills this winter. That would be a most welcome financial windfall to cash-strapped households, some of which surely will be spent putting a few more surprises under the tree.

Looking Ahead Most retailers today are confronting the harsh reality that they have greatly diminished pricing power with customers. Over the last two decades, falling prices for consumer goods largely were attributable to lower sourcing costs for mass produced merchandise, some of which were passed on to shoppers. This was a winning proposition for merchants and consumers alike, but such opportunities have been mostly exploited. Today, falling prices for many consumer goods mainly are a function of price transparency for shoppers and ensuing price competition among retailers.

Though it accounts for only 10 percent to 15 percent of retail sales in several product categories, the online channel has been an industry game changer

in a much larger sense by enabling shoppers to have nearly instantaneous price discovery at their fingertips regardless of where they make their ultimate purchases. We believe that the aggressive year-round discounting we have witnessed since 2013 is, in part, a reaction to this new reality. But customers aren’t necessarily buying more stuff; many are just paying less for the same stuff. Retailers hoping to survive or thrive in this environment should avoid the trap of competing solely on the basis of price against larger peers with huge scale advantages. It is easier said than done.

Rather than resort to this game of chicken, retailers first should consider a recheck of some other things within their control that can help boost profitability this holiday season:

• Optimize Store Labor: Validate that staffing is aligned with current traffic and sales trends. Don’t be afraid to invest in labor resources in areas where it can be reasonably expected to achieve high returns.

• Embrace Bricks and Mortar: Online may grab all the headlines, but stores still matter a whole lot more for most retailers. Let stores provide a business advantage that Web-only retailers are lacking.

• Product Allocations: Ensure that product is being allocated to match anticipated or actual sales trends rather than adhering to historical allocations that could repeat prior years’ mistakes.

• E-commerce: Develop special offers early on to capture wallet share, including free shipping. Save the last 72 hours for gift cards & in-store pickup.

Unfortunately, there is no panacea in such a challenging sales environment, but there probably are dozens of incremental opportunities for improvement that, collectively, can be highly impactful this holiday season and others to come.

We look forward to sharing some of our insights for competing more effectively in an increasingly “winner take all” world in our upcoming 2015 Retail Outlook: To

the Victors Go the Spoils.

Wishing You and Your Family a Joyous Holiday Season and a Prosperous New Year!

Falling energy prices disproportionately benefit low income households, many of whom are seeing up to $100 in monthly savings — some of that windfall surely will be spent this holiday season.

About FTI ConsultingFTI Consulting, Inc. is a global business advisory firm dedicated to helping organizations protect and enhance enterprise value in an increasingly complex legal, regulatory and economic environment. FTI Consulting professionals, who are located in all major business centers throughout the world, work closely with clients to anticipate, illuminate and overcome complex business challenges in areas such as investigations, litigation, mergers and acquisitions, regulatory issues, reputation management and restructuring.

www.fticonsulting.com ©2014 FTI Consulting, Inc. All rights reserved.

Authors

Robert DuffyGlobal LeaderCorporate Finance/Restructuring617 897 1501bob.duffy@fticonsulting.com Steve CoulombeLeaderRetail and Consumer Products617 897 1515steve.coulombe@fticonsulting.com Christa HartSenior Managing DirectorRetail and Consumer Products212 499 3619christa.hart@fticonsulting.com Keith JelinekSenior Managing DirectorRetail and Consumer Products248 894 8264keith.jelinek@fticonsulting.com Mark WeinstenSenior Managing DirectorRetail and Consumer Products617 897 1522mark.weinsten@fticonsulting.com John YozzoManaging Director212 499 3624john.yozzo@fticonsulting.com