In spring of 2018, Pier 1 was still profitable, but its top-line and comparable sales were deteriorating. Wayfair, TJX Cos and other competitors were taking ever-bigger pieces of the home goods market for themselves. In May of that year, S&P downgraded Pier 1 to B-. It's not a great rating to be sure, but not one indicating a near-term risk of default or bankruptcy. 

Less then a year later, S&P rated Pier 1 deep in junk territory, with a CCC- grade, on the increasing possibility of a bankruptcy or out-of-court debt restructuring. Today its sales are falling in double digits and its profits have turned negative. The retailer most recently posted a net loss of more than $100 million, and is said to have hired financial advisors as it reckons with its balance sheet, according to Debtwire. 

There are dozens of retailers today in the same position Pier 1 was a year ago. Their profits might still be positive, but they're declining. Top-line and comp sales are in decline as well as shoppers seek cheaper or more convenient alternatives, or pull back spending on their category entirely. A string of good quarters could buffer their financial position, and a run of bad quarters could put them in a more vulnerable spot.​ Their state is much like that B- rating S&P slapped on Pier 1 a year and a half ago: not good, but not perilous either. As Pier 1 shows, though, the journey between close to the brink and on the brink can be a short one. 

"You're looking for a company who may close down some stores or may have to eventually look at the balance sheet," said Dennis Cantalupo, president of Pulse Ratings. When trying to identify companies that could have financial troubles ahead, he says he typically looks closely at a company's comparable sales and EBIDTA margin trends. After those metrics start deteriorating consistently, "eventually they'll start impacting the balance sheet and liquidity of a company," he said. "And that's when you start seeing reorganization." 

B3 is the last stop before C. In a May report on retail's "survival of the fittest," Moody's analysts Manoj Chadha and Janice Hofferber noted that "B3 issuers tend to have greater ratings volatility because they tend to be smaller, less diversified companies where even small financial shocks can have an outsized effect on their ratings."

"These are the companies that typically have weak liquidity and either lack the financial resources to invest in their e-commerce capabilities, have minimal pricing power, lack the scale to withstand pricing pressure and/or offer products that do not resonate with consumers," the analysts added. "Inefficient inventory management, fashion misses and undesirable store locations are a few of a myriad of reasons why some stores do not generate traffic."

At Pulse, ratings are for geared vendors and other creditors of retail companies, rather than for investors in debt instruments, which comprise the main audience for ratings agencies like Moody's. 

Pulse ratings run A through F. Middle grades of C, D and E+ can often show some operational deterioration and carry debt on their balance sheet, but aren't facing immediate financial distress in the form of liquidity shortfalls. Operational problems alone won't tip a retailer into the lowest ratings, Cantalupo said. 

"You need a bunch of things to get you to that E and F category," he said. "It wouldn't just be an operational problem; it'd be an operational plus a balance sheet plus a liquidity issue. And that's a fair way of grading a company. Just because you have a couple bad quarters of sales, doesn't mean you're credit risk."

He added, "Those companies that have built in financial cushion, they can weather that kind of storm." Cantalupo provided Retail Dive some of the retail companies carrying those middle ratings.​

Common metrics such as comp sales may not always tell the full story, and investor ratings can lag behind company performance and broader market expectations. 

Emma said he often looks at changes in inventory relative to changes in sales as an indicator of "problems versus solutions." For one thing, sales that fall faster than inventory can create a cycle of problems that drag from one quarter to the next. As Emma notes, inventory build-ups can also paint a positive picture of a company's liquidity, given that lending facilities are often tied to inventory, but mask a company's underlying problems. 

"One of the factors I evaluate with a retailer that is starting to post bad results is the relationship between revenue changes and the change in inventory levels," Emma said.

"Francesca's gross margin improved and it did see a positive comp for the third quarter. But, the rise in inventory compared to a year ago is something that could pose a challenge heading into the fourth quarter," Emma said, referring to analysis he put together on a list of companies Retail Dive inquired about. "L Brands and Big Lots also have that same dynamic where management is going to have to manage inventory levels down while at the same time providing enough 'open to buy,' to bring in the new items that enable a retailer to generate improved margins."

He added, "None of the names on this list are at the point where they have limited operational flexibility, which is something that comes into play when leverage levels start to rise."

We also took a look at bankruptcy risk metrics. In compiling Retail Dive's regular list of distressed retailers that face elevated risk of bankruptcy, reporters and editors have looked at CreditRiskMonitor's FRISK scores. The proprietary scores incorporate several indicators — including trading volatility, financial ratios, credit ratings and aggregated user data of the firm's service — to specifically predict the risk of a company filing bankruptcy within 12 months. 

For our distressed list, we typically look at retailers with FRISK scores of 1 (indicating a 9.99% to 50% chance of going bankrupt) and 2 (4% to 9.99%). But there are also 12 retail companies with FRISK scores of 3, indicating a 2.1% to 4% chance of bankruptcy. 

Companies with a FRISK score of 4 have similar risk, with 1.4% to 2.1% chance of filing for bankruptcy, according to CreditRiskMonitor's formulas. Their ranks include numerous retailers that have faced setbacks in sales or profits this year, among them The Children's Place, Express, Guess and L Brands. 

Here's a closer look at some of the retailers on the brink of distress:

Party City

Party City was once seen as relatively insulated from the upheaval in retail. That was due in part thanks to its wholesale business and private brands, which kept its prices competitive with discounters, buttressed its margins, and gave it multiple revenue streams and unique products. 

The year has brought volatility for Party City, however, not least from a helium shortage that likely knocked millions from its sales. More problematic, though, was a wretched October performance for its Halloween City stores, where sales per store fell nearly 21% for the month. Share prices imploded after the earnings announcement, dropping nearly 70% in a matter of days. 

"Their margins are healthy, but their same-store sales are deteriorating, [and] they still have significant debt on their balance sheet," Cantalupo said. That debt is a hangover from a series of private equity acquisitions that left it heavily leveraged as it went up for IPO. 

Michaels

Michaels, another former leveraged buyout, has been underperforming its rivals in the crafting business, losing both market share and profits while it also tries to manage tariffs. While the company has attributed soft performances to industry-wide trends, GlobalData Managing Director Neil Saunders said earlier this year that his firm's data shows a 4.6% increase in consumer spending on the crafting category. 

"This runs counter to the narrative that Michaels likes to push that spending on crafts has been soft," he said. "In our view, such a position comes from a misreading of the data and a misunderstanding of the dynamics at play in the market."

Earlier in December, S&P downgraded Michaels' credit rating from BB- to B+ citing heady competition in the category and the retailer's third quarter performance, which brought a 2.2% decline in comparable sales during Q3 and operating income slashed by almost half. 

"They're not in a situation where we're concerned about their short-term credit," Cantalupo said. "But we're watching their sales."

Office Depot 

Office supplies retail has been troubled for years as generalists like Amazon, Target and Walmart eat into the share of the big-box players, one reason why Office Depot and Staples tried to merge a few years ago. 

This year, Office Depot has been trying to manage sales and profit declines in its retail business while leaning on its offered services to try to revive growth. According to Morningstar, the retailer's revenue has declined 2% on a three-year annualized basis and operating income is down nearly 9%.  

"Office Depot is another one that fits the mold," Cantalupo said. "The retail office space has seen a lot of sales pressure. They've done a pretty good job I think of diversifying the business, but we're keeping an eye on them." 

Francesca's

Francesca's recently posted third quarter results that broke a 10-quarter streak of negative comps. It was a ray of light after a lot of time spent in a long, dark tunnel, with some suggesting earlier this year they were headed for bankruptcy. In the meantime, the apparel seller has closed stores, turned over executives, tried to sell itself and avoided getting kicked off the Nasdaq stock exchange. 

Along with boosting comps in Q3, Francesca's narrowed its operating and net losses and boosted its margins. "While we took higher markdowns to move slow selling merchandise, we saw sales trends strengthen in the quarter as we bought into new trends represented by our strong sellers," Interim CEO Michael Prendergast told analysts, per a Seeking Alpha transcript, after the Q3 results were out. "We were encouraged by new product sales and believe it validates our go-forward strategy."

Even with encouraging results, investors sold off the stock this month as the company disclosed it hired an executive search firm to find a permanent CEO, more than 10 months after former chief Steve Lawrence's resignation was announced.