The 2010 SIMA Retail Distribution Study

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The first thing to say is thanks to SIMA for making this study happen and to Leisure Trends Group for doing the research. We don’t get access to near enough industry and market data.

As I’m not a member of SIMA, I don’t have access to the complete study. I’m working with the “Media Highlights” package that came out after the press release on the study.     

Two years ago, when the previous study came out, I did the same kind of analysis I’m going to do now. You can see that analysis here.
 
As usual, I’m doing this to try and identify trends and information that will help you run your business better and make you think about important issues. But the Media Highlights weren’t constructed with my needs in mind. SIMA’s goal in producing the highlights is to promote the industry to the broader market and to make it look good. I do not, by the way, fault them for a moment for doing that. It’s part of their job.
 
Anyway, keep that in mind here as we proceed.
 
The Headline Numbers
 
I’m sure most of you all saw these numbers in the press release. The “core channel” sales at retail (all these numbers are at retail) fell 13.5% between 2008 and 2010 from $5.32 billion to $4.6 billion. Sales at skate focused stores were down 11.6% from $2.85 billion to $2.52 billion. At surf focused stores, they fell 15.8% from $2.47 billion to $2.08 billion.
 
Footwear in core channels rose 8.2% to $1.5 billion and represents one third of total sales. Hard goods sales over two years were up 35.3% to $1.46 billion and represent another third. Well, if footwear and hard goods were up, but total core sales fell 13.5%, then apparel must be, well, not specifically too good. Down 41.1% actually to $1.0 billion. Interestingly, men’s/boy’s apparel accounted for 57% of overall apparel sales. Even with the weakness in juniors, that surprised me.
 
So if you’re like me you looked at these numbers and went, “Huh?!” On the face of it the hard goods increase and apparel decline seem just impossible even though it’s over two years. Then there’s the “other” category of sales which fell from $498.8 million to $18.4 million in two years. I hypothesize that there are some changes in classification and what’s included or not included going on here.
 
Core stores do not include military exchanges, company stores, and national department stores. I know what a military exchange and a national department store are. But when it excludes company stores does that mean, for example, that the Billabong store in my local mall is excluded?
 
That’s just what it means and, having discussed it with SIMA, I can see their point of view. If you called a company owned store, SIMA said, and asked them what their best-selling board short was, what might you guess the answer would be? The weighting towards company owned brands in company owned stores, SIMA argues, would skew the data.
 
You can see the difficulty SIMA and Leisure Trends have in decided who to survey or not to survey. The other side of the argument, of course, is that those board shorts sold in a company owned stores are real board shorts sold to real customers. Surveying them might skew the results, but all the brands who have company owned stores are working every day just as hard as they can to do just that.
 
Then there’s the issue of company owned stores that carry brands in addition to those brands owned by the company. What would SIMA do with Billabong owned West 49 and its 125 or so stores if it was a U.S., rather than Canadian, retailer? On the one hand, it carries other brands. On the other hand, Billabong is working to increase the owned brands component of those stores to as high as 60%. Would that skew the sample in such a way that West 49 stores shouldn’t be included in the survey?
 
I don’t know.  I’ve got an opinion, but I don’t know in a definitive way. You don’t know either. Neither do SIMA or Leisure Trends. They make the best decisions they can make given the information they have.
 
Internet and catalog sales contributed 16% of the total, compared to 14% in 2004. 55% of retailers are now selling on the internet. That’s double the 2008 percentage of 24%. I’m surprised it’s only 55%.
 
SIMA also estimates that surf and skate sales in all channels (including company stores, military exchanges and national department stores) fell 13.6% from $7.22 billion to $6.24 billion.
 
There’s a chart on page 5 called “Putting Things into Perspective-Retail Size of Other Sports/Recreational Industries that I didn’t agree with.” It lists that all channel estimate for surf/skate and shows 2010 retail sales for Outdoor (core), including paddle sales at $5.70 billion. Bicycle comes in at $3.2 billion, snow sports at $2.92 billion, scuba at $658 million, snowboard at $481 million and paddle by itself at $360 million. Next to the chart it says the following:
 
“Based on other work completed by Leisure Trends Group, surf/skate is impressively positioned among other retail industries.”
I don’t know what “impressively positioned” means. And I would dispute the idea that an industry’s size is determinate of its competitive positioning against other industries. I wish that could have been stated a little differently.
 
Definitions and Methodology
 
Just what is “core,” we’ve all wondered. In doing the research for this study SIMA says, “The CORE channel includes retail operations that classify themselves as specialty, lifestyle or sporting goods stores. Core stores do not include military exchanges, company stores, and national department stores.”
 
I asked SIMA if surveyed stores really did classify themselves and if that meant that Sports Authority could be “core.” They clarified that sporting goods stores are, in fact, included in the core numbers but couldn’t tell me about specific retailers because of confidentiality reasons. I can understand that. You aren’t likely to get much cooperation if the retailers submitting data don’t think it will be confidential.
During January and February of 2011, Leisure Trends did 446 telephone interviews with surf and skate retailers in the U.S. This sample was taken from a list of retailers reviewed and provided to Leisure Trends by SIMA. “The list of core shops that are surveyed is a list that has been compiled by brands’ accounts.” The brands provided the list.
 
“By being on the list, and qualifying for the study by having at least 10% or higher of their operation’s overall sales coming from surf and/or skate products they are considered within the Core Surf/Skate Channel,” SIMA told me.
 
That 10% bar seems kind of low for me. Especially as that’s for surf and skate combined. I wonder to what extent setting the bar that low expands the size of the total market?
 
I also wonder how they measure which retailer makes it to the 10% bar and what products are included in the calculation. It sounds like the retailers decide if they are 10% skate/surf. If a sporting goods store thinks they sell 10% skate/surf by including boogie boards, beach umbrellas, various brands of apparel, cheap complete skate decks, every swimsuit in the place and sun tan lotion, can they end up classified as being in what SIMA calls the core channel? Okay, kind of an extreme example but you can see my point.
 
SIMA clarified for me that they weren’t trying to define what a “core shop” means by the study and use the word only to define the shops that were surveyed. They suggested that something like “surveyed stores” might be a better term. I think it might be and hope they consider using it in two years.
 
Just to say it again, every study like this one has methodological and statistical challenges to deal with. There are tradeoffs and choices you make as you do your best to collect good data. But my readers know I think the core market is a lot smaller than this study suggests and I suspect many of you agree with me. If so, do me a favor and put a comment to that effect on my web site please.
 
Some Interesting Trends
 
The most interesting thing I found was that chain stores represented 35% of the total list of stores compared to only 9% in 2008.  The report notes that “Independent stores closed many doors in the past two years. Most of these were replaced by specialty chain stores causing a less than expected drop (-1.7%) in total surf and skate doors to 4,826 in 2010.”  That speaks more eloquently than I can to the way the industry is changing; or maybe it’s better to say the way larger brands are evolving out of the core action sports space.
Consistent with this, 81% of all surveyed retailers use a point of sale system, up from 60% in 2008. I conjecture that’s because a lot of the smaller, unsophisticated stores are gone, replaced by chains with good systems. SIMA points to two other trends that are probably driven by the growth of chain stores in their sample.
 
The first is the increase in the average number of store employees from 6.5 to 7.7. I’m guessing this could also reflect some recovery from the depth of the recession.
 
They also note more stores carrying snowboarding, wakeboarding, motocross, BMX and other sporting goods and suggest this is because more chains are in the sample. Probably true.
 
I’ve spent more timing writing and rewriting this than you would believe. It’s kind of old news, I’m working with incomplete data, and while SIMA was as cooperative as they could be, there was just some data they aren’t allowed to give me and questions confidentiality prevented them from answering. Why am I doing it?
 
As usual, because I think there’s a business lesson to learn. You just can’t look at the headline numbers and say, “Oh, this represents how the industry has changed.” 
 
The dramatic changes in certain categories (hard goods up so much, apparel down so much, the “other” category) gives me pause. They are indicative of huge changes in our competitive environment. They reflect vertical integration, the rise of chains, specialty shops going out of business, a broader definition of what our industry is, the use of systems by the survivors (and probably some different classification of product as a result), a lousy economy, and some others as well.   
 
You shouldn’t be depressed because the industry is smaller than it was two years ago. There’s good news for some segments, and for some companies, in there.    At the same time, you shouldn’t be giddy with joy as a hard goods company just because hard goods were reported to be up 35%.
 
What we can learn, as a reader of the press release and even the media highlights or the whole study if you have it available to you, is that you have to be cautious in drawing conclusions from summary data lacking a thorough understanding of how the study (or any study for that matter) was conducted. 

 

 

The Agenda Trade Show, U. S. Open, and Other Trade Show Comments

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As I walked around the Agenda Trade Show last week, I saw a lot of people sitting across tables from each other in the booths obviously doing business. That is the definition of a successful trade show. The sample of company executives I talked too seemed to confirm that.  People were surprised by the number of buyers. 

I’m not that worried about the vibe.  How busy or crowded a show is is hard to judge.  It’s impacted by things like the size of the aisles. And I don’t care how much free beer there is.

Okay, wait, I lied. I do care about free beer. But that’s neither here nor there. What’s important is that retailers and brands got together to do business. Whatever other good things happen at trade shows, without that there would be no adequate justification for any show.
 
We also continue to be over, I’m happy to say, the “My booth is bigger than your booth” syndrome that plagued us for so many years. Though there were a few larger spaces at the end of Agenda’s main hall, mostly booths were what I’ll call 10 by 10s that I’m told companies paid $2,500 for. One satisfied executive told me the total cost to attend the show was $5,000 and that they was doing the same amount of business as when they spent $120,000 on a show. He may have been exaggerating, but I’m sure he’s got a point.
 
If I’m Agenda show executives Aaron Levant and Seth Haber, I just perk right up when I hear that, because it implies a show value they aren’t getting compensated for yet. You might want to see another article I wrote on trade shows before ASR died that discusses towards the end the pressures any growing, successful show might be subject to.
 
I think Agenda management will be cautious about how it grows the show and try to have some continuity in who attends and how the show is focused. It’s not that they don’t want to make more money- I don’t actually know anybody who doesn’t- but they watched ASR and I’m guessing learned something from that. Growing too fast, getting too diffuse, charging more than the market can justify; these are all things we learned don’t work.
 
Meanwhile, speaking of how Agenda might evolve, there are the still ongoing conversations among various industry trade groups about putting together an industry week, part of which would be a trade show. I should say I’m not quite clear on what exactly an industry week would encompass besides the trade show which, I trust, wouldn’t last a whole week. But I like the industry week idea if it’s a way to involve consumers, do some educating, and introduce others to our industry.
 
If I were putting together an industry week, I’d be talking with Agenda, and maybe Surf Expo as well, about doing the trade show portion of that week. There’s no need to reinvent the wheel.
 
Surf, of course, needs some replacement for ASR. Skate seems to have found all they need in Agenda as currently configured, or at least that was what some people told me. I hope it isn’t indelicate of me to point out that skate companies left ASR at least partly due to differences with surf. I don’t have an opinion as to who was right or wrong, but I am unclear why skate companies, who seem to have found a good trade show situation at Agenda, would be quite so anxious to do a show with surf again. Reminds me of that old definition of insanity.
 
I’m probably lacking some facts here. Hope somebody calls and gives them to me.
 
And then I walked down the street to the U.S. Open with its air conditioned retail store and Invisalign tent, where you could learn how to get your teeth straightened without unsightly braces showing. I could see the obvious tie-in to surfing because, uh, well,….. Oh- right- the tent was on the beach.
 
Am I the only one who wandered around that place and was worried that all those stores and exhibits would have drawn most of the same people even if there was no surfing contest?
 
But then to approve my attitude I went across the street to Jack’s Surfboards to see a real specialty retailer doing what they do well. Jack’s, in business since 1957, certainly highlights the importance of location, but it was more than that. I felt like I was in a real surf shop. I could feel the echo of the places I frequented as a kid. It was well organized in a comfortable and attractively relaxed way and they had all the inventory they could possibly have without making the place feel confining.
 
So anyway, after a transition period since the closing of ASR, the skate and some youth culture brands have found a home at Agenda and the buyers are showing up. Like I said, that’s the definition of successful show. 

 

 

Orange 21 Revises Its Mary J. Blige Licensing Deal; It Will Terminate Early

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On July 18, Orange 21 (Spy Optic)  amended its licensing agreement with Rose Colored Glasses (Mary J. Blige’s company). The amendment provides “…for an earlier expiration of the Company’s license to sell Mary J. Blige (“MJB”) branded sunglasses (the “License”) on March 31, 2012.” For this, they paid Rose Colored Glasses $1,000,000 at signing and issued a non-interest bearing promissory note for $500,000 that’s due March 31, 2012. The filing only provides about half a page of real information. You can read it here.

My take on Orange 21, as you know if you’ve been reading what I’ve written about them, is that the tough economy and some management issues left them without the sales volume and margins they needed to support their required advertising and promotional programs. To try and address this issue, they took what I thought was the reasonable step of making licensing agreements with O’Neil, Jimmy Buffett’s Margaritaville brand, and Mary J. Blige to produce and market sunglasses under their names.

As of their last filing, we hadn’t been told that these programs were generating any meaningful sales, but there had been a lot of expense incurred for design, promotion, inventory and required contractual payments. It appears from the amendment that the licensing deal with Ms. Blige isn’t working out quite the way Orange 21 hoped it would. We don’t have any sales numbers from any of the licensing agreements.
 
Mr. Seth Hamot, Orange 21’s principal shareholder and Chairman, through his company Costa Brava, has previously invested $7 million in Orange 21. If the licensing agreements don’t produce the hoped for revenue increases, and the fundamental strategic issue of the brand not generating enough sales to pay for a competitive marketing program can’t be resolved, he may be called on to put in some more.
 
We should see the quarterly financials shortly.  That will give us a better feel for what might be next.                

 

 

Trade Shows Re Re Re Re Re Visited; I Got an Idea. A Couple Actually. Hope One is Good.

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Since ASR closed, and before that actually, we (well, me at least) have been struggling to figure out the role of trade shows as the economy, technology, and the industry changed. How do you get retailers to attend shows (paying them isn’t a good long term strategy)? Should consumers be involved somehow? What sports and products should be represented? Are shows about buying, or networking, or seeing new product or all of those or none of them? Do people even need to go to shows? How big should shows be and how long should they last? How do you keep the costs down? Do we even need another one?

Various organizations in the industry have been focused (and as far as I know, are still focused) on doing their own show individually or as a group. I’ve had a call from an organization that’s not in our industry but that does trade publications and shows for other smaller industries that wants to publish an action sports business magazine and maybe do a trade show. The existing trade show organizations are thinking about growing, or starting new shows, or just benefiting from the fact that companies that were at ASR need to exhibit somewhere else (I’m not sure that’s true).

I fell into the same thought process everybody else seems to be going through. Then I had a conversation last week with Roy Turner at Surf Expo. I always enjoy talking with Roy. He’ll tell me when he thinks I’m full of shit, though as a Southern gentleman, he’ll do it in such a way that I’ll somehow like being told. I’ve got to learn how to do that.
 
After I talked with Roy, I was thinking about what the action sports business really was (and has always been, actually), the role of fashion, consolidation, the impact of vertical retailing, and SIA and Agenda. I also reread an earlier article I wrote on trade shows right after ASR died.
 
I decided that I, and everybody else I think, have been focusing on the tactics of trade shows. That’s not necessarily a bad thing to do, but it keeps you from answering the fundamental strategic question of why ASR failed and what, if anything, should replace it. It’s kind of like when you buy an old house, you can remodel it. But it often makes more sense (financially as well as stylistically) to tear it down and start from scratch to get just what you want.
 
But we’re a pretty incestuous industry and momentum, resistance to change and cognitive dissonance (god, I love that term), makes it hard to throw out the old model and try something new.
 
What works? SIA seems to be doing really well. Why? First, because they are a one season business and just need one show. I’ve said that before. But what I’ve never realized, or at least what I so took for granted that I never thought about it, is that everybody there is somehow connected to sliding on snow. That’s strategic. It defines their purpose and who should attend.
 
The further ASR got away from that, the more they got in trouble. Like the old saying goes, if you try to be important to everybody, you end up important to nobody. Their attempted fixes were tactical, not strategic. It feels like as an industry some of that same mistake is being made because we want to dance with who we brung.
 
I’m not sure we can because there are a lot of party crashers out there. Maybe there’s a need for an “action sports” trade show but the real action sports industry is composed of those brands and retailers who cater to the participants in the sports and the first level of non-participants that associate themselves with the athletes and lifestyle. It’s pretty small. Most of the customers of most of our brands and retailers don’t fit into the action sports definition I used above.
 
What do they fit into? I’m tending towards youth culture. Hardly a new phrase, but I think very powerful if you think of a trade show in those terms, and begin painting with a blank canvas. Right now, Agenda seems closest to focusing this way and it’s interesting to watch them grow. But I’ve got a little different approach in mind.
 
If I were going to create a youth culture trade show from scratch, I’d start by developing the list of brand’s I’d want to have exhibiting. Would it include some surf/skate/snow brands? Sure. But I think I might want Apple there (who knows if they’d want to come). And Facebook. And some music companies, and some game companies, and some other brands and activities that I don’t even know about because I’m not quite as cool as I used to be. Okay, maybe I never was cool. Different issue.
 
Now if you ask me why Apple would want to attend, well, I’m not quite sure they would. This concept is not completely formed in my head. Maybe what I’d do is visit all the coolest retailers in the country, or otherwise compose a list of them (online included) and create a list of the brands they carried. The show I envision wouldn’t be about skate or surf or moto or fashion though I suspect it would include elements of all of those and more. It would be about “STUFF THAT’S IMPORTANT TO PEOPLE AGES 14 TO 25.”
 
Is it possible to do a show that would kind of cross over industries like this one would? I’m not sure. Figuring out what brands to invite and explaining how they all tied together and could benefit wouldn’t be easy. Getting retailers to decide to attend a show that wasn’t completely relevant to what they sold might be a challenge although, as I think about it, maybe retailers who see themselves focused on youth culture would come precisely because this would be the best place to find new products and brands.
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I’d also invite to attend (not to exhibit and maybe only for one specified day?) large companies who want to reach this demographic. And I’d charge them a lot of money to come. Maybe retailers wouldn’t be there that day and it would be a chance for brands to look for tie ins with large corporate players desperate to be cool.
 
A specifically action sports show made sense when we were all about action sports. Now, most of our business seems to be about youth culture (I’m open to a better term) so why aren’t we creating a youth culture trade show?
 
Partly, of course, because we can’t expect a trade organization to create a show that doesn’t cater directly to its members. But if trade shows are a waste of time unless retailers attend, then we damned well better create one that focuses on those retailers’ customer. Are they mostly action sports customers as I’ve defined them? Nope, they are youth culture customers.
 
It seems kind of obvious now and I have no idea why it took me so long to figure it out.  Please speak up if you think I’m crazy.

 

 

Dick’s Sporting Goods; Insights into the Development of the Action Sports Retail Environment

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Never thought I’d be looking to Dick’s for that. Dick’s, which has been around since 1948, had revenue of $4.9 billion in 2010 from 525 stores. The 444 Dick’s stores are around 50,000 square feet each though there are some two level ones that go up to 75,000 square feet. The 81 Golf Galaxy stores are between 13,000 and 18,000 square feet. The word action sports isn’t mentioned anywhere in their most recent 10K.

What’s intriguing is their business strategy. It’s intriguing because there’s a lot that would fit right into Zumiez’s annual report. A good independent specialty retailer will tell you that he tries to do a lot of the same things.

Let’s take a look at what Dick’s business strategies are and how they compare to the generally agreed on best practices in our industry. This may tell us something about how our industry is evolving.
 
Dick’s refers to itself as an Authentic Sporting Goods Retailer.
 
“Our history and core foundation is as a retailer of high quality authentic athletic equipment, apparel and footwear, intended to enhance our customers’ performance and enjoyment of athletic pursuits, rather than focusing our merchandise selection on the latest fashion trend or style. We believe our customers seek genuine, deep product offerings, and ultimately this merchandising approach positions us with advantages in the market, which we believe will continue to benefit from new product offerings with enhanced technological features.”
 
The focus on performance and enjoyment rather than fashion is what I’ve argued action sports is really all about, though we got away from it in the good old economy days and thought everybody who carried some hard goods was a “core” retailer. I might be putting words in their mouth, but it sounds like Dick’s thinks you can be “core” for a whole bunch of sports at the same time in 50,000 square feet. Our specialty retailers try to do it with two to maybe five sports. In their most recently completed fiscal year, 54% of Dick’s revenues came from hard goods. 
 
Dick’s second strategy is Competitive Pricing. They specifically do not try to be the price leader but will match competitors’ prices.
 
“We seek to offer value to our customers and develop and maintain a reputation as a provider of value at each price point.”
 
Their sheer size gives them some pricing (and costing) leverage that action sports retailers typically don’t have. No independent specialty shop can compete on price. Dick’s also has the advantage of selling product in nearly two dozen sports and activities, with the result that they can better manage their inventory to respond to seasonality and even out cash flow.
 
Dick’s carries a Broad Assortment of Brand Name Merchandise.  “The breadth of our product selections in each category of sporting goods offers our customers a wide range of price points and enables us to address the needs of sporting goods consumers, from the beginner to the sport enthusiast.”
 
What I particularly like about this is the obvious customer definition. Dick’s thinks it’s the place to go if you’re a participant in any of the sports or activities they support. You can be a beginner or an expert and they’ve got what you need. That sounds like something an independent specialty retailer in action sports might say.    Trouble is, you can imagine Sports Authority saying it too. But Dick’s differentiates itself from Sports Authority in ways that action sports retailers would recognize. Let’s look at some more of Dick’s business strategies.
 
They offer Expertise and Service.  “We enhance our customers’ shopping experience by providing knowledgeable and trained customer service professionals and value added services.”  “We actively recruit sports enthusiasts to serve as sales associates because we believe that they are more knowledgeable about the products they sell.”
 
This means having professional golfers in the golf part of the store, certified fitness trainers helping you buy workout equipment, and trained bike mechanics to sell and service bicycles. It may be a 50,000 square foot store but in your little part of the store, where you’re buying stuff for the sport you’re committed to, you’ll be working with experts who are just as committed as you are.  That will sound familiar to any action sports retailer, chain or single store.
 
Dick’s creates Interactive “Store-Within-A-Store.” 

"Our Dick’s Sporting Goods stores typically contain five stand-alone specialty stores. We seek to create a distinct look and feel for each specialty department to heighten the customer’s interest in the products offered.”
 
Once again, that’s not exactly an unfamiliar concept. A typical store will include a pro golf shop, footwear center, fitness center, hunting and fishing area, and a team sports store with appropriate seasonal equipment and apparel.
 
Their last business strategy is Exclusive Brand Offerings that “…offer exceptional value and quality to our customers at each price point and obtain higher gross margins than we obtain on sales of comparable products.”
 
Those would be shop brands. We all recognize and understand that. But Dick’s seems to go further. They work with existing, well known brands to develop products that are available exclusively at Dick’s under that brand’s name. That’s possible only because of their size and market power.
 
Though Dick’s isn’t active in action sports, you can’t help but look at their business strategies and get some understanding for why specialty retailers are having such a hard time. Dick’s has all the advantages that come with size; purchasing power, efficient distribution, access to capital, good systems. But they’ve gone further and are applying many of the competitive techniques we use to think of as being available only to the specialty retailer to the large format business. And they can do it without having the highest prices.
 
Dick’s isn’t a direct competitor for action sports retailers, though inevitably there is some crossover of brands. But if Dick’s can do it, so can other retailers. The good news is that if you really an independent action sports retailer (that is, your customers are participants and the first level of non-participants that are serious about the lifestyle) you’re got your location and your community connections as a point of differentiation. The bad news is I think that’s all you’ve got, so you better do that right.

 

 

Tilly’s is Going Public- A First Look at Their Registration Statement (S-1)

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Tilly’s started in 1982 with a single store in Orange County, California. The company name is World of Jeans & Tops, but it does business as Tilly’s. It was founded by Hezy Shaked and Tilly Levine. As of April 30 2011, they had 126 stores in 11 states averaging 7,800 square feet each. They filed last week for their initial public offering.

As is normal, the initial filing  has some important blanks not filled in yet. They will be completed as the process moves forward. In the meantime, we can look at the historical financial statements. I also want to talk about the impact of changing from an “S” corporation to a “C” corporation, the ownership structure post offering, and their competitive strengths and brand strategy. Let’s get started.

Sales have grown from $199 million in the year ended February 3, 2007 to $333 million in the year ended January 29, 2011.   During the same period, they went from 51 to 125 stores. Comparable store sales rose 17.3% in the first year of that period. They then rose 8.7% before falling 12.5% and 3.1% in the next two fiscal years and rising 6.7% in the year ended January 20, 2011. E-commerce revenues have grown from $15.4 million to $32.8 million in the last three complete years.
 
One has to wonder these days, in evaluating any consumer based IPO, whether the company can hope to return to its pre Great Recession growth any time in the next few years. It’s not the company’s fault; it’s just the economy.
 
The gross profit margin was 37.1% in the year ended February 3, 2007. The following year, it was 37.2%. For the January 31, 2009 year, it fell to 32.5% and for the most recent two years it was 30.9%. Selling, general and administrative expenses have of course grown in absolute dollars with sales, but as a percentage of sales has been more or less constant around 23.3% in the last three complete years.
 
Of the 126 stores Tilly’s has as of April 30, 72 are in California and 16 in Florida. There are also 17 in Arizona. The other 21 are distributed in 8 states with New Jersey, at 7, having the most. I would be particularly interested in learning something about the performance of the stores by location (which isn’t included). As we’ll discuss, part of their growth strategy is to increase their number of stores, and I wonder if performance has been similar in all geographies.
 
“C” and “S” Corporations 
Tilly’s has always operated as an S corporation. What this means is that the earnings were distributed to the owners who reported the income on their personal income tax returns. It also means that “No provision or liability for federal or state income tax has been provided in our financial statements except for those states where the “S” Corporation status is not recognized and for the 1.5% California franchise tax to which we are also subject as a California “S” Corporation.”
 
The chart below shows Tilly’s Operating Income and Net Income as reported on their financial statements. The Pro Forma Net Income line shows what their net income would have been over the last five years had they been a C corporation accruing tax at typical rates. Big difference. They will transition to a C corporation before the company goes public. This is disclosed in the registration statement of course. But the point is that you would not want to purchase the stock expecting Tilly’s to report net income going forward at the levels of the past.     
     

FISCAL YEAR ENDED (millions of $):
   

Feb. 3

Feb. 2

Jan. 31

Jan. 30

Jan. 29
   

2007

2008

2009

2010

2011

Operating Income

$31.5

$39.7

$23.8

$21.4

$24.9

Net Income (as reported)

$31.4

$39.9

$23.6

$20.9

$24.4

Pro Forma Net Income

$19.1

$24.2

$14.3

$12.7

$14.8
 
Post Offering Ownership and Control and Use of Proceeds
Buyers of this common stock will receive Class A shares and will be entitled to one vote per share. There will also be Class B shares that will be entitled to ten votes per share “on all matters to be voted on by our common shareholders.” The Class B shares will be owned by the founders and their family. When the offering is completed Mr. Shaked, who is Chairman of the Board, will control more than 50% of the total voting power of Tilly’s common stock. We don’t know from this first draft of the registration statement exactly how much he’ll control, but it says more than 50%.
 
“As a result, Mr. Shaked is in a position to dictate the outcome of any corporate actions requiring stockholder approval, including the election of directors and mergers, acquisitions and other significant corporate transactions. Mr. Shaked may delay or prevent a change of control from occurring, even if the change of control could appear to benefit the stockholders.”
 
Tilly’s will be considered to be a controlled company according to the rules of the New York Stock Exchange. As a result a majority of the board of directors don’t have to be independent. And the corporate governance and nominating committee and compensation committee do not have to be composed entirely of independent directors, as would otherwise be required.
 
Tilly’s says they will comply with these listing requirements anyway, but they don’t have to.
 
The company leases its 172,000 square foot corporate headquarters and distribution center from a company owned by its co-founders. It leases another 24,000 square feet of office and warehouse from one of the co-founders.
 
As usual, there are a lot of blank spaces in this early version of the Use of Proceeds section. We’ve seen from other sources that the goal is to raise $100 million. What’s going to be done with that money? The registration statement tells us the following:
 
“Therefore, our stockholders immediately following this offering, who were also the shareholders of World of Jeans & Tops prior to termination of its “S” Corporation status, will receive most of the net proceeds from the sale of shares offered by us.”
 
We don’t know what “most” is at this point.
 
After spending 30 years building a successful business, the owners deserve the benefits. But if they are getting “most” of the proceeds of the offering, where’s the money for growing the business to the 500 stores they are planning going to come from? At least that would be my perspective if I were a potential investor.
 
Competitive Strengths and Growth Strategy
Tilly’s lists six competitive strengths:
  • Destination retailer with a broad, relevant assortment.
  • Dynamic merchandise model.
  • Flexible real estate strategy across real estate venues and geographies.
  • Multi-pronged marketing approach.
  • Sophisticated systems and distribution infrastructure to support growth.
  • Experienced management team.
Their growth strategies are:
  • Expand our store base.
  • Drive comparable store sales.
  • Grow our e-commerce platform.
  •  Increase our operating margins.
If you read the discussions of their competitive strengths, you’ll note a great deal of similarity to other retailers in our space. Maybe that’s why they call them strengths and not advantages. Their growth strategies are exactly the same as every other multi store retailer.
 
It seems to me that an investor in this stock is basically betting on Tilly’s ability to operate better than its competitors. Of course they do have a successful operating history, but I don’t see an obvious competitive advantage here. I don’t think their plan to grow to 500 stores is necessarily unrealistic, but that most of the offering proceeds are being paid out to the owners makes me wonder how they’ll finance the growth.
 
We’ll get some more information as the amended S-1s show up.

 

 

Skullcandy: The IPO is Moving Forward

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Skullcandy filed another amendment to their S-1 today with many of the blank spaces from the previous iterations of it filled in as the next step in their initial public offering.  It appears they postponed it due a rough patch in the market.  Smart.

They list the maximum offering price as $19 a share. They are registering 9,583,334 shares and if they sell all of those, the offering will raise a bit over $182 million. But that includes the underwriters optional over allotment of 1,250,000 shares and is before expenses.

A big chunk of the proceeds go to the selling shareholders rather than the company. After underwriting discounts, commissions, and estimated expenses, the company expects to net about $66.6 million assuming a sale price of $18 a share.
 
$16.7 million will be used to pay off their unsecured, subordinated promissory notes. They’ll pay $17.5 million in “additional consideration…pursuant to our securities purchase and redemption agreement.”  $4.4 million will be paid in accrued interest that has to be paid when the notes are converted.
 
That leaves $28 million for “general corporate purposes,” as the saying goes.
 
This will clean up their balance sheet nicely. Proceeds, of course, could vary depending on how many shares are sold and at what price.
 
I hope this is the final amendment and I can get onto reading about Tilly’s IPO. 

 

 

There Is No Action Sports Industry. Or Maybe It’s the Same as its Always Been

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Sometimes I just can’t help myself. Many years ago, I wrote an article called “Are There Any Core Shops Left?” My good friend and editor at the time Sean O’Brien thought enough of it to put it on the Transworld web site for discussion. Without telling me. In hindsight, his instincts were good, but I was the slightest bit confused when I started seeing posts and getting emails that either told me how smart I was or hung me in effigy.
 
I think I might be about to do it again. What I want to tell you is that many of you who think you’re in the action sports business are wrong. And if you don’t act accordingly, things could become difficult. More difficult. I want our old economy back!
 
This has been in my head for a while in unformed ways. The launch of Nike’s Chosen campaign, their investment conference yesterday, an email I got from somebody who’s had a lot of success in our industry, and my evaluation of some of the recent industry deals including Volcom and Sanuk has caused neurons to fire and thoughts to coalesce. So let’s look at just what this industry is and has become, what I think are the major, long term, strategic trends, and the implications for how this industry, whatever it is, will change.
 
What Is the Action Sports Industry?
 
I’ve expressed an opinion about this before, but want to do it a bit more forcefully. The action sports industry is a small industry composed of businesses that sells products to participants in a number of individual sports and to the first level of non-participants that closely associate with the lifestyle and athletes. If that isn’t who most of your customers are, then you’re in the youth culture or fashion or some term I haven’t thought of business.
 
That doesn’t mean that your roots can’t be in action sports, and I’m not trying to imply any kind of criticism of a company that’s graduated out of action sports (we are way, way past any concerns about “selling out”. That almost sounds laughable now). But if you think you’re selling to action sports customers, as I’ve defined them and you’re not, you’ve got a challenge because you’re probably trying to punch outside of your weight class.
 
Why did we ever believe action sports was a bigger industry than it is? That’s easy; it’s due to 20 or 25 years of THE BEST ECONOMY EVER. With rising incomes and asset values, easy credit, and low inflation you can, as the saying goes, sell snow to the Eskimo. So any shop that sold hard goods could be known as a core store. But it wasn’t.
 
As I suggested in the title, then, the real action sports industry is a lot like it’s always been. We just thought it was different. What made it change?
 
Trends We Should Pay Attention To
 
How do you know when a successful brand has graduated out of the action sports market? That’s easy- they get acquired. Somewhere around $40 million in revenues, to pick a number, they start to get big enough to be attractive to a strategic buyer that makes it worthwhile to sell.  Hopefully, they also get smart enough to know that they don’t really have the resources, expertise, or competitive advantage to step outside the action sports market they came from without help. Expect more CONSOLIDATION as the trends I’m discussing here play out. 
 
Volcom pretty much said in their filings that industry conditions and difficulty growing meant it was time to sell while they could get a good price. Look at the deal Sanuk got. Notice that PPR’s CEO specifically said in an interview they didn’t pursue Quiksilver because they didn’t see the growth potential. Buyers want growth potential. Successful sellers know they have it, but that they can’t do it themselves.
 
And that means, if you try and grow out of the real action sports space, you’re going to face some big honking competitors. Bigger all the time. Nike’s almost its own trend. I’ll get to them. Think about Burton in the snowboard space a few years ago. Why did Burton own the hard goods market?
 
First, great product.  I’ve never heard anybody say different. Second, financial strength. That strength meant the best athletes and the biggest advertising and promotion program. So consumers wanted the product and it checked at retail at good margins as long as the distribution was well managed.
 
In its snowboard niche, Burton was like Nike in the athletic footwear market; unless they screwed up everybody was fighting over second place. But Burton has a problem Nike doesn’t have. Nike’s concern, they say, is about picking the best of their growth opportunities. Burton, as best as I can figure it out, hasn’t been able to grow much outside of its core snowboarding franchise. Even if it were for sale, Burton would not be attractive to a strategic buyer lacking that growth opportunity.
 
The lesson? Either plan to stay in the core action sports market, or be prepared to sell when you threaten to break out of it. 
 
Let’s talk about NIKE, THE ONE COMPANY TREND. At the start of this article were a couple of links to Nike that may interest you. Here’s another one to a press release on a conference they held last year. It’s worth a read. I actually have the transcript of that conference, though I can’t find it on line any more. It’s 75 pages long but worth reading. If you’re really interested, let me know and I’ll send you a copy.
 
Nike is $20 billion in revenue. As you’ve no doubt read, they are now taking the Nike brand directly into surf, skate and snow. They think they’ve now got the credibility to do that, having been somewhat cautious in their approach for a couple of years.
 
I have to say their timing surprised me a bit. For years, Nike flopped around the action sports space screwing up their attempts to get in it. Then they got a little realistic and decided to exercise some patience. They hired a few of the right people and used their unmatched product capabilities and financial strength to edge their way in cautiously. I thought they were doing fine. But it feels like they might have run out of patience sooner than they should have.
 
It will be interesting to see if the Chosen campaign is seen as authentic or arrogant.     
 
In its investment conference, Nike talked about its ability to market and merchandise a product or brand down to the city level. They pointed to their focus on customizing product for individual consumers (try it on line!). They discussed the process where an innovation from one product makes its way to other products and brands. They were very thoughtful about the integration of brick and mortar and digital and expect growth there. The analysis they’ve done about what kind of stores to put where is intriguing. And they had a good discussion of their integrated systems for managing costs and inventory, which I love.
 
Of course, it’s their investment conference, so you’d hardly expect them to highlight where things hadn’t worked out so well. Still, it was impressive. There was a clear analytic framework that I think gives them unusual flexibility for a company their size.
 
And that brings me to the email I received from the gentlemen with a lot of success in our industry who said, in part, “Based on how they [Nike] have single handedly destroyed the competitive brand environment in sports like Football, Tennis and Golf does this mean that Action Sports brands have to work on the basis that they will be relegated to being a fringe player in a culture and sport they created?”
 
Well, maybe. But let’s not over dramatize this. There’s nothing we can do about how Nike (or any of the other large companies) runs their business except, in this case, maybe learn some lessons from them based on the things they do well. I might have said this a time or two, but don’t worry too much about what the competition is doing- just run your own business well. If you adopt just a bit of Nike’s thoughtful, analytical approach to your market, you’ll be doing a good thing.
 
One thing you might think about is whether Nike is trying to ‘take over” the action sports market or just use legitimacy in that market to be credible with customers outside of what I’ve defined as action sports customers. See, this is why explaining what action sports is and being aware of how it’s changed is so important.
 
One way you need to do that is to FOCUS ON THE ECONOMY. I know it’s hard when you have to run your business on a day to day basis, but look beyond, the day, week, month, quarter and even the year. Recognize that, historically, the “good old days” were an aberration we’re not returning to in the foreseeable future. Want to know why? Go read this book so I don’t have to make a long speech. It’s a pretty easy read. The bottom line is that this is a financially caused, global recession and they last a long, long time. Always have. You must build your business around that assumption. Most of you, I hope, already have.
 
One of the economic things you’ve got to think about is inflation. You are going to see some product cost increases, and it’s not clear how much you will be able to pass through to your customers. Factor that into your financial model.
 
Next, we can’t forget VERTICAL RETAILING, which I expect will continue to grow and even accelerate. Vertical retailing is a financial and merchandising strategy that is viable partly due to changes in consumer perceptions and habits and because we’re selling a lot of product to a different consumer. You don’t have to be “core” anymore to be cool and most of our customers aren’t action sports consumers as I’ve defined them.
 
Where does this leave the “core” retailer? Well, kind of where they’ve always been if they are really core retailers; servicing the group of customers I’ve described above for whom community and expertise are the most important factors. That was never a huge market.
 
Specialty shops and small chains that really weren’t core retailers have mostly gone away. Even some really good retailers who have been around for many years are struggling. Partly that’s because we’re no longer in the best economy ever. But it’s also because they are dependent on customers outside the traditional action sports niche as I described it and don’t have an adequate advantage with those customers over the vertical retailers and large chains for the reasons we’re discussing here.
 
Some years ago, I created a list of things I thought core retailers had to do well to succeed. The list included good systems and financial data, close connection with the community, a reasonable internet presence, quality, trained employees to whom you could offer a career path, revenues in excess of $1 million and a willingness to take some risks in the product you carried as a point of differentiation.
 
It’s not a bad list, but when I wrote it I thought a specialty retailer who did all that would just kill it. Now it’s kind of a minimum bar to succeed. And doing all that isn’t enough if you’re trying to compete with the big, vertical brands for the non-action sports customer.
 
Price has become more of an issue than it ever was and (forgive this gross generalization) there is no financial model that makes sense for a specialty retailer that carries the same brands as the chains and vertical retailers and serves the same customers. This is going to be especially true as product costs rise.
 
Related to vertical retailing is distribution, or rather NOT DISTRIBUTING. Here’s a link to an article I wrote after SIA posted its sales report in March. Basically, SIA members reported higher margins and better sell through with lower sales. They sold less but earned more and created perceived value through scarcity. I’ve been beating the drum for focusing on gross margin dollars rather than sales or gross margin percent for years. It took the worst recession since the Great Depression to scare them into controlling inventories. I really hope they don’t screw it up next year.
 
Around 2000 when I took my first close look at THE INTERNET and its impact on the industry, I thought it was just another distribution channel. Maybe that was an adequate answer then, but it’s way more now.
 
It’s your most important point for customer contact and information. It’s a tool for managing and controlling inventory. There is no successful brick and mortar retail without a closely integrated internet presence. I could create a much longer list, but just imagine running your business without the internet and we’ll leave it at that. It’s no longer a choice and I guess it really hasn’t been for a long time.
 
So What?
 
Determining whether you are “action sports” or “not action sports” is obviously not as clear cut as I’ve made it sound. Most retailers and brands fit somewhere along a continuum. Yet determining who your customers are is critical (duh) and maybe the distinction I’ve made is a good way to start thinking about it. For most of you, it’s not the same customer you used to have.
 
For better or worse, big companies have learned to buy brands in our industry and support them without killing what made them special. Consumers won’t know that Volcom is owned by PPR. More importantly, if they did, they probably wouldn’t care anymore. 
 
The buyers of industry brands can’t justify their purchase prices unless those brands grow at a pace that means they take market share. So you, as an independent brand or retailer, are competing with businesses that were successful in their own right but are now backed by various 900 pound gorillas committed to growing them. Sophisticated, well managed gorillas at that.
 
Don’t despair. Just recognize the market you’re in and who you’re competing against. Then plan accordingly. Like the old saying goes, “Call on God, but row away from the rocks.”           

 

 

Quiksilver’s April 30 Quarter; There Are Some Numbers that Need Explaining

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Quik’s revenues for the quarter rose 2.1% to $478 million compared to $468.3 million in the same quarter last year. The gross profit margin rose from 53.2% to 54.8%. Sales, general and administrative expenses were up slightly, but fell as a percentage of sales. Interest expense was down as a result of their balance sheet restructuring from $21 to $15 million.

So how, you might ask, did they go from a bottom line profit of $9.4 million last year in the quarter to a loss of $83.3 million in the quarter that ended April 30, 2011?

First, there was a noncash asset impairment charge of $74.6 million compared to zip, zero, nada in the same quarter last year. If you ignore that charge, operating income was up from $35.9 million to $45.4 million.
 
The charge was “Due to the natural disasters that occurred throughout the Asia/Pacific region during the three months ended April 30, 2011 and their resulting impact on the company’s business…” Okay, I guess we can’t hold Quik responsible for earthquakes, tsunami, and core meltdowns. Although, I guess we’re all a bit responsible for the core meltdown we’ve had in our industry.
 
But I digress. That write down represents a real impact on Quik’s business going forward.
 
“The value implied by the test was affected by (1) a reduction in near-term future cash flows expected for the Asia/Pacific segment, (2) the discount rates which were applied to future cash flows, and (3) current market estimates of value. The projected future cash flows, discount rates applied and current estimates of market value have all been impacted by the aforementioned natural disasters that occurred throughout the Asia/Pacific region, contributing to the estimated decline in value.”
 
This says that cash flows are going to be reduced for some period (I don’t know what “near-term” means), risks are higher (that’s what you mean by raising discount rates, we finance trained people think) and, inevitably, given the other two factors, values are lower. It’s a noncash charge but not a meaningless charge given the impact on future business.
 
With that charge, pretax income fell from $19.5 million to a loss of $42 million. But the provision for income taxes rose from $9.4 million to $39.7 million. Huh? More taxes on a big loss? Shit. I’m going to have to delve into the dreaded income tax footnotes. Those of you who are into self-abuse can see the filing here and read the footnote starting on page 15. But beware- reading this can make you go blind.
 
I think I used that joke last week. I need some new material.
 
I’d urge you to go take a brief look at that footnote. Not because you’re likely to want to figure it out, but because hopefully you’ll then feel sorry for me as I attempt to explain it.
 
A deferred tax asset is a future tax benefit. It’s easy to understand why they exist. A company wants to tell its shareholders it made as much money as possible. It wants to tell the government it made as little as possible so it can at least postpone the payment of taxes. Quik has decided (I think it’s related to the asset impairment charge above) that their deferred tax assets were $26 million too high in the Asia/Pacific region. That is, they don’t think they are likely to get the benefit they were expecting, so they wrote them off.
 
There, that wasn’t too bad. Sorry to spend so much time on these two issues, but the numbers were so large I felt it was necessary.
 
Revenues rose 5.5% in the Americas to $210.7 million and it was fueled “…largely by our retail business,” according to CFO Joe Scirocco in the conference call. Company owned retail comparable store sales rose 23% in the quarter, and e-commerce sales grew 68%.   The Quik and DC brands were up, while Roxy was down. Wholesale revenues in the Americas “…were on plan and a couple of percentage points higher than last year.”
 
Wish they’d give us some numbers on how the wholesale business was doing in the U.S. 
Revenues fell 0.8% in both Europe and Asia/Pacific to $207 million and $58 million respectively. Europe was down 4% in constant currency and Asia/Pacific 12%.
 
Gross profit margin in the Americas rose from 46.6% to 49.1%. This was “…primarily the result of a favorable shift in product mix and, to a lesser extent, a greater percentage of retail versus wholesale sales.” 
 
It was up in Europe from 59.9% to 62% as a result of improved retail margins. It fell in Asia/Pacific from 53.5% to 53.1%.
 
In a trend that’s hardly unique to Quiksilver, you can see why lots of U. S. companies are more interested in international rather than domestic expansion. Oh- Quik is going into India and expects to open 10 new stores there in the next 12 months.
 
Quik reports, in one line in its 10Q, what it calls its Adjusted EBITDA. This is net income before “(i) interest expense, (ii) income tax expense, (iii) depreciation and amortization, (iv) non-cash stock-based compensation expense and (v) asset impairments.”
 
I’m kind of a bottom line, generally accepted accounting principles kind of guy, but sometimes this is worth looking at because it does eliminate some distortions. For the three months ended April 30, it was 13% both this year and last. For six months it was 10.7% last year and fell to 10.2% this year.
 
On the surface, the balance sheet is almost identical to a year ago, though equity has grown about 10% to $535 million due to the balance sheet restructuring. Liabilities have only fallen by about $42 million to $1.1 billion, but debt maturities have been pushed way out so there are no big repayments due over the next four years.
 
Inventories are up from $226 million to $290 million, or by 28% (18% in constant currency). They describe that as being to “…ensure timely production and delivery” and as representing “…a restocking relative to very lean inventories a year ago.” I wonder if there are any cost increases in inventory numbers yet. They note that “Consolidated average annual inventory turnover was approximately 3.0 at April 30, 2011 compared to approximately 3.6 at April 30, 2010.” Higher turns are generally better until you get to the point where you’re not able to fill orders.
 
Those are reasonable reasons to increase inventory, but I’d still be happier to see increases a bit more in line with sales growth. Maybe there’s also some stocking for the Quik girls line which just started shipping in February.
 
Quik makes it clear that they are not going to be rolling out a bunch of mall stores as their old retail strategy called for. But they do discuss a cautious experimentation with some concept stores. They talk about a couple of stores at Capbreton and Hossegor in Southwest France and a Paris store. All three are used for events and promotions. At Capbreton, they have a summer concert series and it includes an athlete training center. Apparently, they include not only all of Quik’s brands, but “…a deep stock of surfboards, wetsuits, skateboards and other products that reinforce our heritage and authenticity…”
 
They plan to import this concept into the U.S. The first such store is scheduled to open in Venice, California in the fourth quarter. It will be about 10,000 square feet.
 
My point of view on Quiksilver hasn’t changed much since they finished their financial restructuring. I’m still wondering where their sales growth is going to come from. Like most companies, they see some possible margin pressure in the second half of the year because of cost increases and uncertainty as to consumer response to price increases. Their conference calls have focused recently on lots of good things they are doing with product, teams, retail and brands. They are good things, but so far they haven’t translated into much top line growth.
 
It feels like they’re doing the right stuff but this market just isn’t going to respond like it used to.            

 

 

PacSun’s April 30 Quarter; How Long for the Strategy to Get Traction?

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While CEO at Pacific Sunwear, Sally Frame Kasaks took some appropriate tactical actions. The problem, I conjectured at the time, was that she just didn’t “get it” when it came to the youth culture market/action sports market. Gary Schoenfeld, when he became CEO, knew that PacSun’s success ultimately depended on its ability to reconnect with its core customers and be relevant to them. No amount of tactical change and expense control, as important as those were, was going to change that. The customer had lost a reason to come into PacSun stores and had to be helped to rediscover it if PacSun was to have a future.

That implied a major organizational change that is long term, difficult, and a bit chaotic. Mr. Schoenfeld replaced almost the entire management team with the goal, I assume, of implementing a new way of thinking and approach to the business through the entire organization. He launched new marketing initiatives, closed (is closing) nonperforming stores, reintroduced the footwear that Ms. Kasaks had eliminated, localized the inventory assortment (an ongoing project), and revamped stores that needed new fixtures and merchandising (that initiative is constrained by cash flow issues).

PacSun undertook this not short term project at a time of economic weakness and reduced consumer spending. Now, with the economy possibly weakening again, and cost increases likely to show up in the second half of the year (not just for PacSun), there’s some additional urgency to see improvement.
 
And for the quarter ended April 30, they saw comparable store sales increase by 1%, which is improvement. Sales were down 2.39% from the same quarter the previous year to $185.8 million, but they ended the quarter with 827 stores versus 883 a year ago, so you’d expect some sales decline. Women’s comparable store net sales rose 4%. Men’s decreased 3%.
 
Their e-commerce business is about $50 million. They relaunched the web site in April. Their e-commerce sales were flat for the quarter. I haven’t heard many companies say that their e-commerce sales weren’t up, but they just relaunched so we’ll wait and see. My concern, of course, would be that flat e-commerce sales could be indicative of their marketing programs not getting traction. 
  
Gross margin, however, fell from 22.3% to 19.1%. Of that decline totaling 3.2%, 2.7%, or 84.4% of the total decline, came from a “Decrease in merchandise margin rate primarily due to increased markdowns as a percentage of sales.” I would expect that one indication that their new programs were having a positive impact would be an improving product gross margin. 
 
The remainder of the gross margin decline was due to deleveraging of costs because of fewer stores and a lower sales base.
I’m going to scurry right over to the balance sheet and point out that merchandise inventory on May 1, 2010 was $106.6 million. On April 30, 2011, it had actually risen it was $115.8 million. Now, an inventory number is as of single day, and there can be big timing issues (if you receive inventory on the last day of the month, it shows up in the quarter that day is in. If it’s received the next day, on the first of the month of a new quarter, it doesn’t show up in the quarter that just ended).
 
Still, with stores being closed, sales down, and additional markdown being taken, you might expect a drop in inventory levels. However, management indicated in the conference call that they were comfortable with inventory levels. As you think about inventories, there’s another issue impacting companies in our industry. As cost increases show up, the same number of units will appear in inventory with a higher value, increasing inventories to the extent of the price increase. No idea if that is involved here or not.
 
Sales, general and administrative expenses fell 9.7% to $66 million. As a percentage of sales they fell from 38.4% to 35.6%. The net loss for the quarter of $31.5 million was similar to the loss of $31 million for the same quarter last year.
 
Comparing the current balance sheet with the one from a year ago, we see that the current ratio has fallen from 2.25 to 1.80. Total debt to equity has risen from 0.59 to 1.03. Cash and cash equivalents fell from $56.6 million to $24.7 million, accounting for almost all the decline in current assets. Current liabilities rose slightly from $79.6 million to $88.6 million. Long term liabilities rose from $84.9 million to $101 million due to the mortgaging of certain of the company’s facilities to raise cash.
 
PacSun closed 25 stores during the first quarter, and anticipates closing a total of 40 to 50 during the whole fiscal year. They note in the 10Q that they have almost 400 lease expirations occurring through 2013. That will result in some additional closed stores, but I’d expect that some of the leases they keep will be renegotiated under more favorable terms.
 
I don’t have to come up with a conclusion for this article, because CEO Schoenfeld pretty much stated it for me during the conference call:
 
“There’s no question that the merchandising and execution in our stores has vastly improved, yet we know we still have a lot of work ahead of us. Customers have many choices. We still have real estate challenges to resolve. Consumer response to higher prices this fall is hard to predict, and having made so many organizational changes internally, it will still take some time for our team to consistently execute at the levels that I believe we are capable of.”
 
On the other hand, it’s my column, so I get the last word. It’s more or less what I said after their last report. Can PacSun’s new strategy get traction with the target consumer before the economy and cash flow issues get in the way?