Deckers’ Full Year Results and Some Insights on Sanuk

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We’ve all been interested in Deckers since they bought Sanuk. I want to start by pulling what we can on Sanuk out of the 10K and conference call. But Deckers also said some interesting things about direct to consumer business and how brick and mortar integrates with online. Finally, of course, I’ll look at their numbers for the quarter and the year.

Sanuk’s Results
 
Let’s go right to this chart from the bowels of the 10K (which you can see here) for Sanuk’s numbers for the year ended December 31, 2013 (in millions of dollars).   The first column is 2013, the second 2012, the third the amount of the change ($ millions) and the fourth the percent change.
 
 
Still not the kind of increases they were hoping for when they bought the brand I imagine. Now, somewhere else in the middle of the 10K we are reminded that the earnout for Sanuk was, without any limit, “…36.0% of the Sanuk brand gross profit in 2013, which was approximately $18,600…” That’s $18.6 million, just to be clear.
 
If $18.6 million is 36% of the gross profit, then 100% of the gross profit is $51.7 million. Sanuk’s gross profit percentage, then, was 50.8%. Here’s what they say about Sanuk’s wholesale business. Ecommerce and retail margins would be higher I assume.
 
“Wholesale net sales of our Sanuk brand increased primarily due to an increase in the volume of pairs sold, partially offset by a decrease in the weighted-average wholesale selling price per pair. The decrease in average selling price was primarily due to an increased impact of closeout sales. For Sanuk wholesale net sales, the increase in volume had an estimated impact of approximately $10,000 and the decrease in average selling price had an estimated impact of approximately $5,000.”
 
Those numbers are in millions of dollars as well.
 
The next thing they tell us is that Sanuk’s operating income on its wholesale business only was $20.6 million, up from $14.4 million the previous year. That’s an increase of 43% and is 21.8% of wholesale revenues, up from 16% a year ago. By way of comparison, the UGG operating income on its wholesale business as a percentage of revenue in 2013 was 27.5%.
 
But there’s a catch. A pretty big catch, actually. I’ll let the folks at Deckers explain it to you.
 
“The increase in income from operations of Sanuk brand wholesale was primarily the result of decreased expense related to the fair value of the Sanuk contingent consideration liability of approximately $8,000, which was primarily due to changes made during 2012 to the brand’s forecast of sales and gross profit through 2015, which increased the expense in 2012 without a comparable increase in 2013. In addition income from operations increased due to the increase in net sales, partially offset by a 1.4 percentage point decrease in gross margin due to increased closeout sales as well as an increase in sales expenses of approximately $2,000.” That’s $2 million.
 
So they’d booked $8 million as an expense for the contingent payout they expected to have to make. But the brand didn’t perform as projected, so they don’t have to pay that. Without that $8 million they got to add back in in 2013, I guess operating income would actually have fallen on rising sales. Meanwhile, the gross margin fell and they had higher closeout sales. One wonders to what extent the sales increase was due just to closeout sales. And they had to spend an extra $2 million to do this.
 
Granted, Sanuk is only 8.9% of Deckers’ total revenues for the year, but it still annoys me when they make it this hard to figure out what’s actually going on. If I’d paid as much for the brand as they paid and it was performing like this, I’d probably do the same thing.
 
The Omni Channel
 
We’re all speculating about the integration and evolution of online and brick and mortar. Deckers has David Powers as the President of Omni-Channel for them. He had some interesting things to say about what they’re doing.
 
He says they are starting to open stores that are a couple of hundred square feet smaller than usual. This is driven by the realization that ecommerce and quicker delivery is going to start to reduce the need for as much square footage, if only because one third of a store’s footprint won’t be needed to hold inventory. I think they are right about that.
 
I’ve raised the issue that ecommerce has to generate enough incremental sales to offset the cost of the ecommerce function or it will reduce the bottom line. But that isn’t necessarily true if direct to consumer sales evolve in such a way that your expense in brick and mortar declines due to technology reducing staffing costs, lease costs falling because you need fewer square feet, and reduced inventory due to more flexibility in your inventory systems.
 
Dave Powers put it this way:
 
“We will continue to leverage technology to transform the shopping experience into one that is personalized and efficient for our customers driving conversion and long-term growth for Deckers. We need to continue to strengthen our understanding of who our customers are and use that information to develop deeper relationships with them. We are actively working on a unified system to connect and communicate to our customers as they move between our stores and E-Commerce sites.”
 
He goes on to describe their first multi-brand retail store:
 
“The store will serve as the showcase for our expression of Omni-Channel retail and a test lab for new concepts, utilizing the latest technology combined with compelling merchandising to elevate the customer experience. Our customers have the ability to shop in-store using digital touch screens, customize their products, and order online, ship direct to their home free of charge or to pick up in stores.”
 
In general, this feels like exactly the right approach. They are going to learn a lot of interesting things and I look forward to hearing about what works and what doesn’t and how the concept evolves.
 
The Numbers
 
Total sales for the year rose 10% from $1.41 to $1.57 billion. The sales are broken down in the table below by brand at wholesale and for other channels. The left column is 2013, the right 2012.
 
 
You can see that UGG represents about 53% of total revenues, and fell very slightly  at wholesale for the year, though it was up 10% overall. Direct to consumer is 32% of revenues. At the end of the year, they had 117 retail stores worldwide, 40 of which were opened during the year. U.S. sales for the year were $1.04 billion, up 7.1% for the year. International sales grew 16.5%. 
 
The gross profit margin rose from 44.7% to 47.3%. “Gross profit increased by approximately 1.5 percentage points due to reduced sheepskin costs and increased use of UGG Pure, real wool woven into a durable backing used as an alternative to table grade sheepskin in select linings and foot beds, as well as an increased mix of retail and E-Commerce sales, which generally carry higher margins than our wholesale segments, of approximately 1.2 percentage points.”
 
You may remember that Deckers got hit pretty hard when sheepskin prices rocketed and they tried, but weren’t able to push the price increases through to consumers. Those prices have come down some, but what I like is the UGG Pure idea. It’s allowed them to respond in a realistic way to market forces and general economic conditions by continuing to offer a quality product but at some lower price points. As CEO Angel Martinez put it, UGG Pure allowed them “…to offer our consumers luxurious quality at appropriate price points and extend into new categories.” 
 
I’d also like you to notice that the gross margin on the direct to consumer sales is only about 1.2% higher than wholesale. That’s additional margin worth having, but it’s nowhere near what people used to think it would be. It costs a lot to run direct to consumer operations. But remember that gross margin in direct to consumer operations is after a bunch of operating expenses. That is, it’s not just product gross margin.
 
Selling, general and administrative expense was up from $446 to $529 million. As a percentage of sales, it rose from 31.5% to 33.9%. The biggest piece of this increase ($53 million) came from the opening of new stores. SG&A expense includes $86.5 million in advertising, marketing, and promotion costs. That’s up from $78.5 million the previous year.    
 
Net income was up from $129 to $146 million.
The balance sheet is in good shape and strengthened over the year. I particularly note an increase in cash from $110 to $237 million (I like cash) and a reduction in inventory from $300 to $261 million even as sales rose. The decrease is mostly due to a decline of 18% in UGG inventory.
 
Deckers’ financial results are improving, and it looks like they might be taking the lemons the higher sheepskin prices gave them and turning them into lemonade through the UGG Pure and some other things they are doing. I also like their approach to DTC.
 
They are expanding the UGG brand into outerwear and a home fashion line starting this fall. Men’s’ and women’s lounge wear tops and bottoms are part of the line. Omni-Channel President David Powers noted in the conference call, “I think the real win here is the combination of loungewear and slippers and home together as a full lifestyle expression, and I think we’re learning what the best way to showcase that in our stores is.” We’ll see how that goes.
 
To end where we started, Deckers still seems to have some work to do with Sanuk, but perhaps their recent hiring is an indication that things are going to start improving if those people are allowed to run the brand.

 

 

VF’s Quarter and Results for the Year: One Sentence Caught my Attention

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Okay, strong balance sheet, revenue growth, profitable, blah, blah, blah. I’ll get to all that. But on page 22 of the conference call an analyst asked about their interest in potential acquisitions. The answer from CFO Bob Shearer, in part, was “…how we think about acquisition targets, and we think about it a lot, and yes, we have a list. But we think about brands that are complementary to our brand portfolio that help us reach customers/consumers.” 

I added the italics and bold type. You wouldn’t think that their having a list would get me quite this interested, but it does. Consider what it means. They have a list of companies they might want to buy. I assume they didn’t create this list by throwing darts or rolling die. Maybe there’s a drinking game! Probably not. They had a process whereby they looked at the brands they own, with whom and how they compete, and their customer segmentation. Then they surveyed the universe of competitors and analyzed and selected the ones they thought might be good fits.
 
Okay, I don’t want to make VF sound too omnipotent here. Maybe they aren’t as rigorous as I’m suggesting. Acquisitions in this industry, in my experience, have a large element of serendipity to them. Still, such a process would be consistent with the management rigor I think I hear in their public information. And it would be important managing their portfolio of brands.
 
Just so you see how important, here’s a list of the brands they own and the markets those brands are in.
 
 
That’s a lot of brands, a lot of markets, and quite a bit of market overlap. Randomly buying brands because they were “a good deal” and increased revenue would result in an unmanageable behemoth pretty quickly. That, I assume, is where the rigor of developing the list comes in. Deals they make will be supportive of markets where they already participate and have expertise.
 
Their management rigor also shows up in their operations. VF makes around 500 million units of product a year for 35 brands. They own 28 of their own factories and work with 1,800 contract manufacturers in 60 countries. They’ve got 29 distribution centers and 1,246 retail stores under various brands.
 
In what is probably an understatement, they say in the 10K (you can see it here), “Managing this complexity is made possible by the use of a network of information systems for product development, forecasting, order management and warehouse management, attached to our core enterprise resource management platforms.”
 
Why is this a good thing? Here’s another quote from the 10K.
 
“We believe that we will be able to remain cost competitive in 2014 due to our scale and significance to our suppliers. Absent any material changes, VF believes it would be able to largely offset any increases in product costs through: (i) the continuing shift in the mix of its business to higher margin brands, geographies and channels of distribution; (ii) increases in the prices of its products; and (iii) cost reduction opportunities. The loss of any one supplier or contractor would not have a significant adverse effect on our business.”
 
Not sexy maybe, but I’d characterize all this boring operations stuff as a critical competitive advantage. It’s particularly important for integrating and realizing value from an acquisition. Anybody can buy a company. It takes good management and hard work to integrate it effectively into an existing organization. And careful selection of the acquisition target, which brings us back to their list of company’s they watch. Having tied that together, we can now move on to the numbers.
 
Fourth quarter revenues were $3.29 billion, with a net profit of $368 million, or 11.2%. Outdoor & Action Sports revenues were up 12% for the quarter. The North Face rose by 12% and Vans by 14%. “Vans was up at a low-double-digit rate in the Americas, up 20% in Europe and up at nearly the same rate in Asia.”
 
For the year, VF’s revenues rose 5% from $10.77 to $11.3 billion. The growth was all organic. That is, there were no acquisitions in 2013.
 
38% of revenue was from outside the U.S. Direct to consumer, which includes retail stores, outlet stores and online represented 22% of revenue compared to 21% a year ago. Ecommerce by itself was $327 million, or 2.9% of total revenue. Of their 1,246 retail stores, 1,166 carry only a single VF brand. The other 80 are VF outlet stores. The plan is to open another 150 stores in 2014 focused mostly on Vans, The North Face, Timberland and Splendid.
 
They also note, “In addition to our direct-to-consumer operations, our licensees, distributors and other independent parties own and operate over 3,000 partnership stores…”
 
The Outdoor & Action Sports segment grew from $5.866 to $6.379 billion and represents almost 56% of total revenue for the year. It generated an operating profit of $1.106 billion, representing 57.3% of VF’s total operating profit for the year of $1.93 billion.
 
“The Outdoor & Action Sports Coalition revenues increased 9% in 2013 over 2012 primarily due to an increase in unit volume. The North Face, Vans, and Timberland brands achieved global revenue growth of 7%, 17% and 5%, respectively. U.S. revenues increased 7% in 2013 and international revenues increased 10% with balanced growth in Europe and Asia Pacific. Direct-to-consumer revenues rose 15% in 2013 driven by increases of 28% and 15% for The North Face and Vans brands, respectively. New store openings, comp store growth and an expanding e-commerce business all contributed to the direct-to-consumer revenue growth.”
 
The North Face grew its revenues by 20% in Asia and at a “mid-single digit” rate in Europe. They don’t tell us what happened in the U.S. but given those numbers it seems to imply that things weren’t that good.
 
One analyst, referring to The North Face, asked if they’d seen any changes in the competitive environment. Steve Rendle, Group President of Outdoor and Action Sports Americas answered, “The competitive set in the outdoor industry remains the same. As North Face transcends that outdoor space it takes on a whole lot of new competitors.”
 
Those new competitors a brand encounters as it extends its reach is something I’ve talked about often. It’s a whole new competitive environment and we can all think of brands that haven’t done well trying to extend themselves. But they weren’t VF’s size with its management processes and balance sheet. Part of how they expect to succeed, Steve Rendle says in response to another question, is because The North Face “…is very much a pre-booked business model…we will buy to that order book and that order book is about 90% to 95% of our total revenue.”
 
They don’t, in other words, risk making too much product and over distributing. As you know, I like that a lot. It’s important to building a brand.    
 
Vans, we learn, passed $1 billion in the Americas in 2013. They highlight that Vans is no longer just a footwear brand and is having success moving into apparel. They note that, “According to data from more than 160 US board shops, Vans is a top 10 brand in almost all of our men’s apparel and accessory categories.”
 
Okay, that has to be data from Action Watch. I’m wondering just what it means to be in the top 10. How many brands of men’s apparel or accessories does a specialty shop carry? Wish some analyst had asked for a more detailed explanation.
 
Van’s international business was up 23% for the year. There was a mid-20% increase in Europe and a “high-teen” increase in Asia. I’d like a bit more specific information. Given the overall increase of 17% and the increases they mention for Europe and Asia, what should I assume for the U.S? It’s interesting that they provide percentage growth numbers for the other areas, but not the U.S. or at least the Americas.
 
Gross margin rose from 46.5% to 48.1%. “The increase in gross margin reflects lower product costs and the continued shift in the revenue mix towards higher margin businesses, including Outdoor & Action Sports, international and direct-to-consumer,” management said.
 
Selling, general and administrative expenses rose from $3.597 to $3.841 billion. As a percentage of total revenues it rose from 33.1% to 33.6%. This was partly because they choose to make some additional marketing expenditures “…to support future growth for our largest and fastest growing businesses.” Kind of nice to have a balance sheet that supports that kind of decision making. It was also higher because Timberland was included for a whole year for the first time. Advertising and promotion expense alone was $671.3 million, or 5.9% of revenue.
 
Interest expense was $80.6 million for the year. The weighted average interest rate was 4.5%. I just mention that because I wonder about the impact on VF, and lots of other companies, when interest rates rise substantially. That is going to happen, and if I knew when I’d get very, very rich.
 
Net income was $1.21 billion, up from $1.09 billion last year.
 
The balance sheet is strong, with a current ratio of 2.5 and a debt to total capital ratio of only 19.3%. Inventory was up a bit, but less than you’d expect given the revenue growth. Receivables were up 11.3%- more than twice the revenue growth.
 
If I could ask a couple of balance sheet related questions just because I have an inquiring mind, the first would be about the accrued liabilities. They total $905 million, and are mostly broken down in Note J. But the biggest single entry, for $209 million, is “other.” It’s not that it’s a big number for VF, but I’m curious what’s in it. Oh well, guess we’ll never know.
 
The second would focus on Note M on their retirement and savings benefit plans. Not much a question as a comment. I note that their expected rate of return on plans assets in 2013 was 5.7%. Obviously, the higher your expected return, the less you have to put into the plans each year to meet the obligations. VF’s 5.7% may still, in my opinion, turn out to be a bit high, but it’s certainly reasonable. Good for them for being realistic. When you see a company (or a municipality, or a state) claim their pension plan is “fully funded,” that’s based on certain assumptions about how long people are going to live and how much the plan assets are going to earn. If those assumptions aren’t reasonable, then the plan is probably not fully funded. Ask the pension holders in Detroit.
 
Okay, I know nobody wants to hear any more about that, so I’ll move on.
 
VF’s four growth drivers are leading in innovation, connecting with consumers, serving consumers directly wherever and however they want to engage the company’s brands, and continuing to expand geographically from the Americas to Europe and Asia in mature and emerging markets. Those might sound a bit like platitudes taken in isolation. But in conjunction with the strategies and management processes we’ve highlighted here, they seem credible.

   

Sport Chalet and Ideas on the Retail Environment

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I don’t follow Sport Chalet closely. But they said something in their 10Q for the December 29th quarter that related to some other ideas I’d seen on how the retail market is changing. I thought they might be worth talking about together.

Sport Chalet’s Dilemma
 
Sport Chalet operates 52 stores, 34 of which are in Southern California. “These stores,” we’re told, “average approximately 41,000 square feet in size. Our stores offer over 50 specialty services for the Sport enthusiast, including online same day delivery, climbing, backcountry skiing, ski mountaineering, avalanche education, and mountain trekking instruction, car rack installation, snowboard and ski rental and repair, Scuba training and certification, Scuba boat charters, team sales, gait analysis, baseball/softball glove steaming and lacing, racquet stringing, and bicycle tune-up and repair.”
 
Founded in 1959, Sport Chalet was to have “A focus on providing quality merchandise with outstanding customer service…The goal was: to ‘see things through the eyes of the customer;’ to ‘do a thousand things a little bit better;’ to focus on ‘not being the biggest, but the best;’ to ‘be the image of an athlete;’ and to ‘create ease of shopping.’”
 
Well, if that was their goal in 1959 they were ahead of their time. I’m sure you’ve recognized that what they describe fits very well with the conventional wisdom of what a specialty retailer has to do today to compete.
 
 When the economy went south in 2007, things got tough for Sport Chalet, especially since most of their business was in Southern California.
 
“As a result, our sales, which are largely dependent on the level of consumer spending in the geographic regions surrounding our stores, declined and we incurred substantial losses. In response, we modified our business model to make the Company more efficient, improved our liquidity and reduced operating expenses during the downturn. Additionally, we reinforced our commitment to be first to market with performance, technology and lifestyle merchandise by expanding our specialty brands and continuing to emphasize the availability and proficiency of our sales staff while many of our competitors emphasized value pricing and severely reduced store staffing.”
 
You can see that they tried what I’ve characterized in other articles as “more of the same.” Again, it’s all the things that are supposed to let the specialty retailer compete. It seemed to start to work, and then it didn’t. For the nine months ended December 29, 2013, Sport Chalet lost $4.4 million on revenue of $264 million.
 
So they are “…renewing our focus on reducing costs and refining our inventory position and store strategy. We are reducing our costs by decreasing store and corporate office labor expense to align with current sales trends, cutting IT maintenance expenses in non-critical areas, switching to a more cost effective logistics provider, negotiating rent reductions and honing our customer satisfaction initiatives. Through the closure of underperforming stores, selected staff reductions, and the renegotiation of logistics and software contracts, we have reduced our annualized operating expenses by approximately $3.2 million.”
 
But things are still tough. They blame poor early season winter weather and are working with vendors to manage inventory levels (something every vendor loves to hear) and closing four stores.
 
As I see it, the strategy they have historically based their competitive strategy on requires high spending levels and high prices. They are trying some new strategies; next generation store format, online store growth, leveraging technology and data, mobile and digital leadership, and local marketing programs. They just list those in the 10Q- there are no specifics provided.
 
On the surface, none of those sound like bad ideas, but I’m not sure they can expect to have the financial ability to carry them through if consumer spending trends continue. Too many of their customers can’t afford to buy what they want to sell or, if they can afford it, can’t see any reason to pay the Sport Chalet price for it.
 
In spite of a business strategy we’d all tend to agree seems right for the independent specialty retailer, they are caught between a rock and a hard place. What’s going on?
 
Nordstrom’s Bar
 
Here’s a picture of the new bar they’ve opened at Nordstrom’s in the local mall. Notice the crowd at it
.
 
 
 
It’s big and takes up a lot of space. Space where I wonder if they wouldn’t be better off having merchandise. I don’t quite know what their concept is. Maybe it’s for husbands whose wives are shopping. That won’t work for me because my wife considers me a huge downer to have along when she’s shopping. I’m sort of like a six year old in the back seat of a car during a long trip constantly saying, “Are we done yet?” My mere presence in the vicinity ruins the experience.
 
I am all for retailers taking risks and trying new things. Some work, some don’t and you always learn something. I’m sure Nordstrom’s thought it out carefully and, perhaps unlike Sport Chalet, they can afford to experiment. But there’s almost a sense to it of not knowing what else to do as the retail environment changes faster than we can keep up.
 
That’s not completely a surprise. This country was well over retailed even before the internet came along. However, increasing debt and leverage managed to masquerade as real economic growth until 2007 and covered that up. Now, retailers are struggling to hold on to their piece of the pie.
 
How Big Is Online?
 
I was sent a Wall Street Journal article I can’t seem to get access to called “Online Shopping is Big. It’s Also Tiny.” It points out that among the major consumer segments, online sales are no more than 25% of the total. It only gets to 25% in the computers, electronics and appliances sector. That sector, in total (store and online combined) is $272 billion annually. Making the online part $68 billion. In toys and sporting goods online is “only” 12% of $128 billion in annual sales. It’s just 1% of the $884 billion food and alcohol market.
 
Still it’s gotten there in a little less than 20 years and while figuring out the future isn’t my strong point, I’m pretty sure we can expect some more online sales growth in most, and probably all, categories.
 
But what exactly does “online shopping” mean? Are you only shopping online if you research, select and order the product on a computer or some mobile device? If you go to a store but then order online from the retailer you visited, is that online? What about if you go to the store and the sales person orders it online for you after you’ve chosen and has it delivered to your house the next day?
 
The data from the Wall Street Journal isn’t broken down that way, but I know retailers are pondering the issue. How online relates to brick in mortar is something we’d all like to know more about.
 
What Does Walmart Think?
 
The Atlantic magazine, in its current issue, features a short interview with Walmart’s Senior Vice President for Mobile and Digital, Gibu Thomas. It’s called “Get Ready to Roboshop” and you can read it here.
 
Mr. Thomas has 1,500 people trying to figure out just exactly how on line and in store retailing are going to fit together. He projects U.S. on lines sales to be around $345 billion by 2016. But he thinks “mobile influenced offline sales,” as he calls them, will be $700 billion. Walmart apparently has a smart phone app that, if you allow it, will help guide your shopping experience in Walmart. He says that more than 75% of their customers under 35 have a smart phone. During the past holiday season, more than half the traffic to Walmart.com came from mobile devices.
 
So go read the interview. There was certainly some learning here for me. It seems like we shouldn’t worry about on line sales. They are here to stay, are going to grow, and there’s nothing we can do about it. Where retailers’ attention should apparently be focused is on integrating the brick and mortar and mobile device experience. I knew that, but seeing some numbers attached to it gives me some focus and sense of urgency. It appears I’d better get my web site working better with mobile devices.
 
My sense is that this approach might be particularly beneficial to Sport Chalet as a high end chain with fairly well to do customers (you aren’t poor if you’re planning a scuba trip). There may be an app in every retailer’s future. I think I’ll download the Walmart app and walk through one of their stores.

   

Billabong’s Half Yearly Report: Starting Over

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Billabong reported their financial results for the six months ended December 31, 2013 last Thursday. I’ve been diving into a hoard of details they posted. After all of that, I think I’m going to end up spending a lot less time than usual on some of those details. 

That’s because I largely agree with a couple of comments from Billabong management in their conference call. I’d like to start by sharing those with you. 
 
Early in his comments, CEO Neil Fiske said, “…18 months of leadership distraction and organizational turmoil, which impacted all our brands. It is important to recognize that the company’s protracted transactions process hit the Americas region particularly hard. First, by creating a long gap in leadership and subsequently, a significant loss of talent.” 
 
He goes on to describe the people they have hired, are hiring and have still to hire. Later on he notes, “During the next six months we expect to complete our portfolio review, looking at each brand’s growth plan and fit with our longer term strategy. We will also initiate work on the brand books as guiding documents that are the cornerstone of a new brand management system.” 
 
Then CFO Pete Meyers, talking about the six months results, says, “Overall a mixed result as Neil has outlined, but somewhat ancient history in the context of the opportunity to reform this business in the years ahead. By the way, you’ll notice that my slides are in the old format and that’s symbolic as they deal almost exclusively with the old Billabong and that the results today predate any impact of the turnaround plans that we’ve shared with you and next time they’ll be in the same style as Neil’s.”
 
Meanwhile, there will be a major (that is not a strong enough word) and really intriguing reorganization of the company. The Billabong, Element and RVCA brands will each get a global head responsible for global merchandising and marketing. They will each report to the CEO and be responsible for the brand’s income statement. 
 
However, says CEO Fiske, “…we are not centralizing design or merchandising into any one region. Rather, we are leaving design, merchandise and marketing teams in each region to be close to the market, fast and highly responsive to local customer needs.” 
 
There will also be regional presidents for each of the Americas, Asia Pacific, and Europe to“…drive sales distribution and channel development in their respective geographies, while providing critical input on customer needs back to the brand teams. They will drive the go to market model for each country based on a newly defined tiering system. Regional leaders will also take responsibility for growing the smaller emerging brands, for example Tigerlily in Asia Pacific or VonZipper in the Americas.”
 
The third piece of the organization contains the global functions. These will include the CFO, a chief operating office, somebody in charge of human resources and, most interestingly to me, “…a turnaround office leader focused on cost takeout and accelerating the impact of key initiatives.” 
 
The gentleman they’ve hired in that role (Bennett Nussbaum) has an impressive background in turnaround management and clearly doesn’t need a job. It will be interesting to see how he interfaces with the organization to keep it turnaround focused and how long this job lasts. I’d be curious to know if he reports to Neil Fiske or directly to the Board of Directors. I can imagine him ranging all over the company with quite a degree of discretion. I don’t recall ever hearing about a company hiring a turnaround manager who wasn’t the person in charge, but I think it’s a great idea in these circumstances. 
 
“The objective of the global support functions is to build global scale capability and efficiency, driving our cost down so we can reinvest in the brands. We can no longer afford to have three regional supply chains, three regional IT structures with different systems, five different direct consumer technology platforms, high cost logistics in fulfilment and underdeveloped human resource management.”
  
They are going to rely on these cost reductions to fund expanded brand marketing. Finding those cost reductions is part of the responsibility of the Turnaround Office. Their balance sheet doesn’t really give them another choice.
 
When I was in business school (which is beginning to feel like it was shortly after the second Crusade), they described this kind of organization as a matrix. Which I think is a great way to describe it, because there are definitely going to be some people who wake up and find out they’ve been living in a dream world. 
 
The positive thing about a matrix organization is that it can facilitate good communications and group the right people to work on an issue. The potential problem is that roles and relationship are sometimes not completely clear. What happens when what the head of the brand wants to do conflicts with the ideas of the regional president? Every organizational structure has its strengths and weaknesses. A matrix structure can be less efficient at decision making. You manage that through constant communication and developing mutual respect and trust. As was noted somewhere in the conference call, I’d love to have the frequent flyer miles these people are going to rack up. 
 
There are additional changes and reevaluations going on across the company at various levels. You can see why I’m not as focused on the historical financial statements as I might usually be. The company that is going to emerge over the next year or three isn’t going to look like the one that produced these six months results. Lots of different people. A new organization and reporting relationships. A focus on “…fewer, bigger, better stories that cut through the clutter and better align to our key merchandising programs.” Probably fewer brands in total. A reorganization of the marketing function. Fewer SKUs, fewer factories. There’s a lot more. With every month that passes, it’s going to resemble less and less the company who’s financials I’m discussing here. 
 
But it’s not in my nature to ignore those results, so let’s move on to them now. Remember the numbers are in Australian dollars. 
 
First, let’s look at the numbers as reported on the financial statements. These include brands that were sold during the year (Nixon, Dakine) as well as a bunch of expenses Billabong characterizes as “significant,” meaning they had to do with the refinancing and restructuring and the big general mess they had to manage. As I’ve said before, I don’t believe that just because you screw up you get to exclude certain expenses from your operating results on, I guess, the promise that you’ll never screw up again. 
 
Sales from continuing operations rose 3.2% from $563 million in the prior calendar period (pcp) to $580 million. Gross profit margin fell from 54.9% to 53.6%. The pretax loss from continuing operations was $40 million compared to $439 million in the pcp. Operating expenses were up a bit, but what stands out is that last year’s income statement had Other Expenses of $513 million largely from the write down of the brands and goodwill. The number this year was $61 million in charges. Last year’s finance costs, however, were just $10.3 million compared to $57.3 million in the current period. After discontinued operations, we have a bottom line, after tax loss of $126 million compared to a loss of $537 million in the pcp.
 
Here’s how that breaks down by region as reported, including discontinued operations and significant items. 
 
 
 
Let me point out that the segment EBTDAIs excludes the impairment charges. That’s the “I” on the end. The reason I’m telling you that is because the numbers from the presentation that came with the conference call, which I refer to below, talk about EBITDA. There ain’t no “I” on the end. I’m going to assume that’s a typo, because the segment numbers are the same in both places. 
 
The big problem, you can see, was in the Americas. “The result,” they tell us, “…reflects weakness in the Canadian market, smaller brands & South America.” We’re specifically told that Sector 9’s revenues were down 20% in the Americas. They also point to what they call “operational instability” in the region due to personnel changes and general uncertainty. “…we believe,” says CEO Fiske, “the decline in the Americas result has much more to do with the organizational turmoil and loss of talent associated with the 18 months of protracted deal related distraction than any underlying issues with the strengths of the brand.” 
 
There was an as reported EBITDAI margin of negative 5.7% compared to a positive 4.2% in the pcp. For their continuing business, EBITDAI margin fell from a positive 8.7% to 4.7%. 
 
Things look better in the Australasia region, where the reported EBITDAI margin rose from 5.3% to 6%. For the continuing businesses it was up from 11.8% to 12.6%. They closed some stores, but took out some costs to get the improvement. Comparable store sales were up 3.2% including online sales. 
 
In Europe, the reported EBITDAI margin deteriorated from (0.5%) to (8%). For the continuing business, it fell from (2.5%) to (3.5%). They point, like everybody else, to the lousy macro-economic situation in Europe and the expected startup losses of Surfstitch. Brick and mortar comps in Europe were up over 5%.  They still see some softness in the Billabong brand. 
 
At December 31, excluding the West 49 stores, Billabong had a North American store count of 66. There were 112 in Europe and 252 in Australia.
  
Next, from their presentation, is the chart that includes the “as reported” results and then removes significant items and discontinued businesses and gets us to the continuing businesses results they’d like us to focus on. 
 
 
 
As long time readers know, I tend to prefer the as reported numbers (statutory results as they call them in Australia) because they don’t allow for finagling. In this case, because the refinancing has gone on so long, cost so damn much, and had such a destructive impact, I think maybe looking at the continuing business is the right thing to do. 
 
Except for some of the significant items where it looks to me like finagling happened. Here’s the list of significant items. 
 
 
 
You can look at the list and decide for yourself which it is or is not okay to exclude. My point of view is that things like “inventory clearance below cost,” “redundancy costs,” maybe part of the financing costs and perhaps part of others are hard to justify excluding. You’ll note that by excluding them they managed to show a small profit from continuing businesses of $3.9 million. If I were a suspicious person, I could conceivably think they figured they might as well exclude stuff until a profit appeared. And honestly, I might have done the same thing. 
 
Over on the balance sheet, equity has fallen to $194 million from $618 million a year ago. Cash is up, and inventory and receivables are both down. How much of the declines are the result of the sale of brands and how much from better management is hard to tell. The current ratio has improved, but that’s because the refinancing transferred current liabilities for borrowings to non-current liabilities. Current borrowings were at $9.5 million, down from $280 million at the end of the prior calendar period. Total liabilities, however, rose from $674 million to $765 million. 
 
Cash generated from operating activities went from a positive $29 million in the pcp to a negative $27 million in the six months ended December 31, 2013. That’s almost completely due to the costs of the refinancing they tell us.
 
As you are probably aware, Billabong is in the middle of a rights offering which, if successful, will improve their balance sheet. 
 
So much for not spending too much time on the financials. Let’s start to wrap up with a comment by CEO Neil Fiske in response to an analyst’s question. 
 
“So what is important, I think, to all of our brands is that they have authenticity with the core of the market. It is a little bit of a paradox in the sense that when we focus on the core of the market and we grow relevance, share and aspiration with that core the brands become more widely appealing. So really our strategy is to focus narrowly, but create brand positions that are so well-defined and aspirational that inherently they have broad appeal.” 
 
A week or ten days ago, I wrote about some similarities between Billabong and Quiksilver. I suggested that what we had to watch for were clues to what products they were going to sell to which customers. Neil’s put it more eloquently than I did. And he’s focused exactly on the correct and most difficult management task. 
 
Long time readers will know I’ve asked the question, “Can you stay credible as you broaden your distribution?” I’ve suggested that the further away you get from the core, the harder it is to stay credible and compete because the more likely it is that the customer may know your brand, but not your story. And the story is the brand’s single most important point of differentiation. 
 
Goldman Sachs analyst Phillip Kimber asked a related question I really liked. 
 
“One of the key things in managing a brand is being very tight on the distribution in which it’s released to. I’m just wondering if that’s an issue that will be part of this turnaround –i.e. you may have to drop sales materially because you choose not to service them because you’re looking to strengthen the brand as a result. Is that part of this turnaround? 
 
Here’s Neil’s answer: 
 
“One of the things I think that we do have in our positive column is that we’ve really focused on quality of distribution, over the last couple of years in particular. As you recall we got a little sideways a couple of years ago in the US in particular with sales to the Closeout Channel. We’ve cleaned up a lot of that distribution and we are really focused on quality distribution channels. I think within the trade we are seen as having not over extended the brand and have kept our distribution quite clean and brand appropriate.”
  
He didn’t exactly answer the question, except to say he thinks they’ve done a good job with distribution recently. But it’s a big part of the what do you sell to which customer question. Right now, in the middle of a turnaround where cash flow and brand building are probably more important than sales growth, and where public market expectations may be lower, is a great time to be cautious in distribution and build the brands for the future.

 

 

Billabong and Quiksilver; Two Peas in a Pod

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Billabong’s announcement last week that it was, among other things, conducting a strategic review of SurfStitch and Swell caused me to focus on the similarities of its situation to Quiksilver’s. It also made me realize that most of what has been discussed publically by both companies is what I’ll call mechanical issues. I want to remind you what those are and then move on to the way more important and difficult to manage strategic issue they both face but, understandably, don’t spend a lot of time talking about in public. 

We all know that both Billabong and Quiksilver got into trouble due to some acquisitions they paid too much for, their aggressive forays into retail and their tendency to allow units to operate independently, resulting in an unsustainable cost structure.
 
I think those things would have come back and bit them in the butt even if the economy hadn’t cratered, but the teeth marks wouldn’t have required as many stitches. With their balance sheets out of whack, both had to sell assets, raise expensive capital, change management, cut costs, push for revenue in ways they would (I hope) have preferred not to, rationalize their sourcing and reduce SKUs, consolidate and coordinate design and marketing, and revise and upgrade their information systems.
 
Now, I call those things mechanical. That’s not to suggest they were easy to do, or that exactly what to do was always obvious. But nobody doubted they had to happen (and outside stakeholders didn’t give them a choice anyway). That gives you the refreshing liberty to say, “Let’s get at it!” and start without too much analysis. There was, to use one of my favorite phrases, some low hanging fruit.
 
The process isn’t complete (it’s never really complete- it’s a long term way of thinking), but it’s well underway. Both companies will see significant improvement in their bottom lines as a result.
 
So let’s move on to the hard part. What brands should sell what product to which consumer? I’m sure I could figure out a more erudite way to say that, but why bother. They had to start to address the mechanical stuff before they could really focus on market segmentation (there- that’s a more erudite term) because some of it represented survival issues. It’s hard to care which way you’re rowing when there’s a big hole in the bottom of the boat.
 
Part of the process of keeping the boat floating through the restructuring was to press for sales in places and in ways they didn’t want to do. I assume it helped in the short run- perhaps not so much in the long run. Both companies have some recovering to do from distribution decisions they made while managing those short term survival issues.
 
In the long term, the ONLY THING THAT MATTERS competitively is their ability to figure out the market segmentation thing. The mechanical stuff is necessary but not sufficient. The what product to sell to which customer issue is existential. If they don’t do that well, they’ve got no business or at best a dramatically different business. “Dramatically different” is code for a brand that doesn’t do this well and finds itself milking its market credibility with cheaper product in broader distribution until there’s nothing left.
 
Both companies want to grow the top as well as the bottom line. (What?! Public companies focused on top line growth?!  Shocked! I’m shocked!) If they could, at least for a while, just worry about improving the bottom line (and the balance sheet) their jobs would be a whole lot easier. The mechanical issues, as I so blithely call them, are simpler to manage. And as I’ve written, market segmentation takes care of itself initially though distribution management which builds brand strength for future growth.
 
But you can’t do that for too long. You risk finding yourself stuck in a niche you can’t get out of. For some brands, that wouldn’t necessarily be a bad result. It’s difficult for Quik and Billabong because that market niche might tend to be a predominantly older customer group that has been loyal to the brand for a long time but will inevitably buy less.
 
Their challenge over the longer term is to continue to appeal to their traditional customer groups (if only for the cash flow) while also reaching the younger demographic they have to evolve towards. Not easy.
 
So that’s why I perked right up way back when Launa Inman became Billabong’s CEO and, in her initial presentation of her strategy, talked about the need to figure out what the brands stood for and how the customers and potential customers perceived them. Billabong proceeded to spend a lot of money on that issue. We never heard the results, but why would we? You can tell all your competitors that you’re cutting costs, improving systems, reducing SKUs and consolidating certain function. They’re doing it themselves and are probably wondering why you didn’t get on with it sooner. But I can’t think of any good reason (outside of a brain tumor or psychotic episode) why’d you’d share findings about what customers think of your brands, why they buy them, and how you’re planning to position those brands.
 
Part of that evaluation will determine product direction. It’s fair to say that when you’re trying to keep a company alive, you aren’t likely to take a lot of product risk if only because you can’t afford things that don’t work. But armed with their evaluations of who’s buying what product and why, I would expect to see both companies be more aggressive with product development and introductions. The consolidation of those functions from regional to worldwide should make that easier by making it more cost effective. It’s time to take some risks.         
 
Most of us think it’s important that Billabong and Quik do well because they are positioned to represent the surf industry in the broader market. It seems to be an industry article of faith, practically a mantra, but it has the ring of truth to it.
 
I’m not sure any more what “the surf industry” means. Don’t feel bad surf people. I feel the same way about other segments of action sports and, by the way, am not quite sure what exactly the action sports market is either.
 
But recognize that neither Billabong nor Quik is a pure surf company in the way they were years ago.   The “core” surf market is way too small to support much growth for either company. Anyway, that seahorse left the barn years ago when they both acquired non surf brands that represent significant percentages of total revenue.
 
I will always look at the numbers (I can’t help myself). But the numbers, by the time we see them, only tell you what has already happened. As I try and figure out how Quik and Billabong are going to do, I’ll be looking for clues to their product and market segmentations decisions, because at the end of the day, that’s mostly what’s going to matter. And not, you might consider, just for Quiksilver and Billabong.

 

 

Thoughts from the SIA Show

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So I confess. I’m from Seattle and there was no way in hell I was going to be on a plane Sunday while the Super Bowl was on. I left Saturday. But in my two days wandering the show, I had some thoughts I wanted to share with you. 

There was a bit more of a somber attitude at the show then I’ve ever noticed. Everybody I talked to seemed to feel the same way. I particularly noted that the noise/crowd/enthusiasm difference between snowboarding and the rest of the show wasn’t as I was used to. That doesn’t mean there wasn’t a lot of business being done- my sense is that there was. I’d also note that the “core” (still hate that term) snowboard hard goods brands were interspersed with some large booth from brands I’d label as tangential to snowboarding and the snowboard ghetto, as we’ve come to call it, was more spread out. Perhaps that accounted for it. That’s probably a good thing. It recognizes market realities.
 
There were also business reasons why the mood was different. The apparent ongoing decline in snowboarding, a recovering, but still weak economy,  lack of California and Northwest snow, some negative publicity for snowboarding (deserved or not?) and issues of inventory may have had something to do with it.
 
Which brings me to distribution. Everything always seems to bring me to distribution in this industry. At the risk of oversimplifying (I get to do that because I don’t have to actually run a winter business any more), to make money in winter sports, you have to plan for what you think is an average winter in your market and produce/buy 10% (or 15% or 20%?) less than that. You make/buy only what you think you can sell at full margin during the season.
 
You do not wail and gnash your teeth when you run out of inventory and can’t fill reorders when it dumps late in the season. You just calmly remind the buyer to order more in preseason next year (or tell the customer to come in sooner if you’re a retailer) and thank your lucky starts that your inventory is clean.
 
Because the absolute best way to guarantee you don’t make money in winter sports is to have a bunch of left over inventory you have to close out. Not only do you make little to no money on that inventory, but it might have cost you a full margin sale at some point in the future.
 
That’s a particularly important point when all product is good and there’s no reason to replace it very often (On the plus side that reduces the cost to participate). There are fewer chances to make a sale than there used to be. I talked to a couple of industry types who had been offered free boards by brands and actually turned them down. They just didn’t need them and didn’t want to break in a new setup. Getting a new board for free was too much trouble, which sounds strange when I say it.
 
 My point of view on distribution and making money in this business seemed to be validated when I talked to three established snowboard brands who manage their production and distribution carefully. They’d all had issues with west coast retailers who couldn’t move product because of lack of snow. But the brand’s inventory was clean. So clean that they had trouble filling reorders from places with snow. Their solution, which worked because their inventory was clean, was to take the product from the first retailer and move it to the second.
 
Maybe the no snow retailer didn’t really want to give up the inventory even though they couldn’t pay. They just asked for big discounts to keep it. And maybe the product coming back doesn’t exactly match what the retailer with snow wants. Maybe the opportunity happens too late in the season to pull it off. Maybe some other stuff too. There is definitely friction in the process and some cost.
 
But at least these brands had the potential opportunity to take back some inventory and place it with somebody who could move it at full margin. They weren’t in a fight to be paid with a customer they wanted to keep for next season, and they’d made another customer very happy. Maybe there was some margin given up, but it was a lot less than if you had to close the stuff out.
 
This opportunity only existed because the brand was deliberate and cautious with inventory in the first place.
 
I also had occasion to talk with Jono Zacharias who, last time I updated my Outlook, was SVP for Global Sales at Westlife Distribution (686). He told me, speaking of distribution, something interesting. Apparently their best-selling pieces were the same in Europe, Canada and the U.S. this year. And their dogs- uh, I mean styles that didn’t sell quite so well- were the same in all three geographies.
 
I’m hypothesizing that says something about the internet and social networking. My sense is that wouldn’t have been the case a few years ago. Maybe it’s just a coincidence (it wasn’t true with Japan). If I were Jono, or a sales manager for another brand, I might go back a few years and check that out.
 
First, of course, you have to have the systems to do that. I’ve noted in my various articles all the companies spending money on systems to accumulate, integrate and analyze sales and inventory data. If there is some growing cohesiveness among styles and trends across geographies, then the implications for production, distribution and the numbers of SKUs you need could be significant. Just something to think about.
 
You know what? In spite of our industry’s macro problems, snow sliding is still FUN and SIA’s show does a great job reminding us of that. We’ve got something good to sell. The pace of change is disconcerting, but that usually means opportunity. Let me know if there’s a geographic convergence among your successful products. What can you do with that to run your business just a bit better?   
 
          

 

 

Intrawest Officially Trading as a Public Company. What’s the Impact?

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As many of you know, Intrawest, the owner of Steamboat, Winter Park, Tremblant, Stratton, Snowshoe, Mammoth, and half of Blue Mountain, started trading as a public company on January 31. The initial offering price for the stock was supposed to be $15 to $17, but it ended up going public at $12 in a soft stock market where fear of the Fed tapering and its impact on certain developing countries is taking its toll. As I write this Monday morning, the stock is at $11.78 at 9:40 AM Pacific time with the whole market taking another drubbing. The trading symbol is SNOW, which kind of makes sense.

I explained the rationale for the public offering a couple of weeks ago in this article. To summarize, they are great at running resorts, but the real estate crunch did them in. It left them with an untenable debt burden and they are resolving the problem by having most of the creditors agree to convert their debt to common stock. I guess I think they would have preferred another solution, but didn’t have one.
 
When I wrote my initial article, I did it based on an SEC filed S1 which didn’t have all the numbers filled in. That’s standard procedure. Now, with the company actually public, there’s a final prospectus with all those numbers, and I thought I’d point out a few things. You can see that document here.
 
The selling price is $12.00 a share, but the underwriting discount is $0.78 a share, so the selling shareholders get $11.22 a share before the costs of doing the deal.
 
With the deal done, the “initial shareholders” control 65.3% of the common stock. Those shareholders are all controlled by the Fortress Investment Group. For this discussion, you can pretty much think of Fortress as the seller of most of the shares.
 
As part of the deal, Fortress converted about $1.4 billion in debt to equity. Intrawest itself sold 3.125 million shares and will receive about $32 million. The initial shareholders sold 12.5 million shares and are receiving (probably on February 5th) about $140 million. To be clear, that $140 million is not available to Intrawest for operations. It goes to the entities who converted their debt to equity.
 
Let’s see what Intrawest has accomplished financially by doing this deal, starting with the income statement.
 
For the years ended June 30, 2011, 2012 and 2013, Intrawest reported net losses of $499 million, $336 million, and $296 million respectively. Yet in those same years, they had positive cash flow from operations of $21 million, $43 million and $42 million respectively.
 
If you look at the expenses for those years, you’ll see all kinds of noncash expenses for losses on sale of assets and impairments of goodwill, real estate, and long-lived assets. They are particularly big in 2011, and decline thereafter. The loss from operations is $197 million in 2011. It falls to $19 million in 2012 and is a positive $3.5 million in 2013.
 
But below the operating line is interest expense. Here’s the numbers for the three years in millions of dollars.
 
Interest expense on third party debt                     (143,463)             (135,929)             (98,437)
Interest expense on notes payable to affiliates    (160,943)              (195,842)             (236,598)
Total Interest                                                      (304,406)             (331,771)             (335,035)
 
That, I think, can be characterized as a lot of interest and the bottom line, as indicated above, reflected it. What’s the impact of getting rid of it which, after all, is the purpose of Intrawest going public?
 
In a pro forma income statement they provided, which assumes the deal is done (it is done now), interest expense in the year ended June 30, 2013 falls from the $335 million shown above to $48 million. Net income goes from a loss of $296 million to a profit of $5.4 million. Quite a difference.
 
With the assets all written down to a reasonable value and interest expense reduced dramatically, Intrawest can now go about making money running resorts. That’s not a slam dunk, but it’s lower risk than mountain real estate right now. And who knows, maybe there will be a time in the future when those now low valued assets will be worth a bunch again.

   

What Happens If (When?) Apparel Prices Rise?

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We sell a lot of apparel. It’s where we, as an industry, make somewhere between a lot to most of our money. We’ve benefited over many years from apparel prices that have risen slowly if at all, and certainly more slowly than inflation. This article demonstrates that. It further tells us that apparel prices have started to rise and that they may rise more in the future. 

The increase is due to rising labor costs in China, and the cost of inputs, especially cotton. What happens if the cost of getting a garment made continues to rise or even does some catching up with general price levels?
 
We’ll do what we can, of course, to keep that from happening. You are all aware of some movement out of China to lower labor cost countries. However, you’ll note in the article how much apparel still comes from China.
 
We’ll try and pass on some price increases to consumers, but that has its limits. Especially in this economy. Perhaps it’s an extreme example, but you may recall that UGGs tried to pass on a big increase in sheepskin cost to consumers and the consumers wouldn’t accept it.
 
I imagine we’ll cut the number of pieces we make with the goal of increasing volume per style. That’s already happening at some companies and it’s my longstanding recommendation that you take a look at your SKU numbers anyway. There’s money to be made there.
 
We’ll try and substitute cheaper materials without sacrificing quality. We’ll design for easier manufacturing.
 
We can look hard at our customers and try to figure which ones are, or are not, sensitive to price increases and why. Your dream is to have a customer who wants/needs your product so badly that price doesn’t matter. Mine too.
 
You might find yourself taking a hard look at your distribution as price increases can mean that certain products will no longer be competitive in certain channels.
 
I can’t help but notice that these are all good things to do anyway, and I hope they are already part of your normal business processes. Let’s hope apparel prices stay under control though, of course, “hope” is never a valid strategy. 

 

 

A Sustainable Competitive Advantage: The Zumiez 100K

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I have written before about the value of Zumiez’s hiring, training, and promotion process. They take kids with a passion for the activities and brands their stores sell, train them, support them, make them compete with their peers, and promote the ones who succeed. The average age of store managers is something like 23 and pretty much all their district and regional managers started out as sales people in a store. 

This approach to culture and staffing is so important to them that it’s been allowed to impede their growth plans when they couldn’t identify enough good people to staff new stores. In hindsight, I imagine they are thrilled that happened given the way the environment for brick and mortar is evolving.
 
Anyway, it’s easy to read SEC filings and intellectualize about this, but when you walk into the annual 100K party at Keystone, where the company’s best sales people are celebrated, you look up and see a sustainable competitive advantage staring you right in the face. That’s never happened to me.  The fact that I was afraid I was the oldest person in a room of 1,300 only dampened my enthusiasm a bit.
 
A competitive advantage is only sustainable if none of your competitors can duplicate it. I suppose somebody else could do what Zumiez does, but they’d better get started. They’re 30 plus years behind.
 
I’m guessing most of the Zumiez sales people don’t read my column. If they wrote one I’d sure as hell read it to find out what brands were succeeding. If they did read it, I’d tell them how lucky they are to have jobs involved with something they love (hell, maybe just to have jobs), solid support and training, the opportunity to advance based on performance and, if they want it, a career.
 
And finally, I’d tell them what a great thing it is to be part of something that can support and validate them. Without getting too deep into generational history (read this book if you are curious what I’m talking about), let’s just say that this is a group of young people who are going to have to pull together to solve some big problems not of their making. I’m seeing it with my own kids (they don’t work at Zumiez) as they form groups and relationships outside of the immediate family that involve strong personal bonds. I see it where I went to college, where the number of students who return for reunions are much larger than they ever were in my generation.
 
So the environment Zumiez has created not only works for these young people, but for Zumiez as well and is consistent with the way generations turn over and repeat themselves in our society over decades. And it has significant implications for how any brand markets itself today.
 
But, as usual, I digress. Back at the 100K, the introduction of brand founders was particularly interesting. In groups (there’s a lot of them), they march founders out on stage and give each one a chance to say a few words. Somebody told me they’d meant to bring a decibel meter to measure the applause each brand got (or didn’t get). That would have been brilliant. I would love to publish that list with the noise levels listed.
 
Among the brands that got the loudest cheers were brands that are urban, or youth culture, or whatever word you want to use. But they were definitely not action sports brands. Not to say that some action sports brands weren’t well received, but I thought the reception of the various brands was a good indication of how the industry is evolving.

It is true that a deeply imbedded, successful culture can be destructive to a company if the culture resists evolving with the competitive and economic environment. I can’t say for certain that Zumiez (or any other company) won’t someday have that problem.  But Zumiez can minimize that potential by just letting the young sales force that is part of its target demographic drive brand selection and be the arbiter of what’s “cool.”  If they do that I think this competitive advantage can continue to be sustainable.  That’s a hell of thing and unusual in our industry.

 

 

Tilly’s Quarter and the Retail Environment

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Tilly’s quarter ended November 2, though the 10Q didn’t come out until later. I’m late writing this, but I thought there were a few things in it you might want to think about, especially given the holiday results and warnings from industry retailers.

Just to be clear, I believe the country was over retailed even before ecommerce. With its explosion, it’s even more over retailed. Every retailer has to be thinking about where or if they should be opening (or closing) stores. Store sizes probably have to shrink. Inventory has to be managed differently as the coordination between brick and mortar and ecommerce becomes tighter.
 
Let’s start with some of Tilly’s President and CEO Dan Griesemer conference call comments. This first one sounds a lot like other CEOs.
 
“During the quarter, we experienced a continuation of the weak traffic trends that have affected many retailers, leading to lower than expected comparable store sales. Consistent with the past several quarters, consumers continue to focus their shopping into compressed peak periods and pullback during non-peak periods. This trend was consistent across all product categories, real estate formats and store vintages, as well as in our e-Commerce channel; affirming our view that our sales results were primarily driven by external factors.”
 
He seems to be implying that disappointing results are okay because they were caused by things outside of their control. I know a conference call has a high marketing content, but wouldn’t it be better if such results were caused by things they could fix?
 
“While acknowledging that teen unemployment remains high, and that other categories such as electronics and entertainment compete for teen dollars, we know that Tilly’s remains the top destination for the most relevant merchandise and brands important to our action sports inspired customers.”
 
You know if you aren’t a new reader that I don’t think that “action sports” is an adequate description of the market our retailers are in. More importantly, I’ve got a bit of a problem with the idea that Tilly’s is “the top destination.” If he’d said Amazon, well, maybe.
 
“Despite the challenging external environment, we continue to adhere to the proven business strategies that have guided Tilly’s success for over 30 years, including our differentiated business model and our sharp focus on evolving preferences and needs of our customer.”
 
Focus on customer requirements is a good thing and something all retailers are doing. Or should be doing. But I think Mr. Griesemer would agree the competitive environment has changed a bit in 30 years, and I hope Tilly’s business strategies have changed to reflect that. I don’t think any of us are using the same package of strategies we were using 30 years ago.
 
Finally, in response to an analyst’s question CEO Griesemer says, “…we recognize that we have a unique business, a unique business model.” Unique is a pretty strong word. Of course no analyst asked just what he meant by that. I don’t see Tilly’s as unique, and would have loved to hear why he’s comfortable using the term.
 
He talks about a lot of good things they are doing. They are “relentless” in pursuing the brands and styles their customers want. They are keeping the business and inventory clean, with inventory per square foot down 16% from a year ago. That’s a great result. They also talk about having “newness” in their stores multiple times a week. That certainly means with product, but it felt like he meant more, though he wasn’t specific.
 
Those are all good things, but I don’t see them rising to unique. But perhaps some of the discussion below will help us understand what Tilly’s thinks does.
 
Tilly’s balance sheet is solid, and doesn’t require any discussion.
 
Sales for the quarter fell very slightly, from $124.9 to $123.8 million. CFO Jennifer Ehrhardt reminds us that “This reflects approximately $8 million in back-to-school period sales that shifted into the second quarter from the third quarter this year, when compared to the 2012 fiscal calendar.” Ecommerce sales were $13.3 million, up from $12.9 million in last year’s quarter.  Gross margin fell from 33.5% to 30.9%. 2.4% of that decline was due to occupancy costs from new stores. Product margin improved by 0.2%.
 
Selling, general and administrative expense rose from $27.9 to $28 million. Net income was down 33.9% from $9.3 to $6.1 million.
 
They closed the quarter with 189 stores, up from 168 stores at the end of last year’s quarter. They expect to grow their store count by 15% in each of the next several years. “The stores are located in malls, lifestyle centers, ‘power’ centers, community centers, outlet centers and street-front locations.” That’s an interesting mix. If I had to guess, it might be that getting a good deal on the rent was an especially important factor in choosing locations.
 
Comparable store sales fell 2.4%. That includes a 1% increase contributed by ecommerce sales. The average store size at the end of the quarter was 7,788 square feet, but average sales per store were $592,000, down 16% from 705,000 in last year’s quarter. Picture each of their stores being a square that’s about 88 feet on a side. My gut tells me those are low sales for stores that size, and makes me think I’m right about their negotiating well with landlords.
 
I’m wondering if CEO Griesemer would tell me that what was unique about their business model was their ability to make money on lower store sales volumes because of their lower occupancy costs. I’d still have a hard time with “unique,” but I might be okay with calling it a competitive advantage.
 
Tilly’s is facing the same uncontrollable, external, headwinds all retailers in our industry are facing. My expectation is that those will last a while. In addition, rapid change driven by ecommerce has to be managed- maybe harnessed is a better term. The look and roll of brick and mortar is going to be different as a result.
 
Yet most retailers seem to go along opening (more cautiously, I admit) new stores that, from a macro point of view, we don’t need. The assumption, I guess, is that all the bad stuff will happen to their competitors.
 
I would remind you all that unique doesn’t necessarily mean good. Even if your evaluation of your own market advantages doesn’t rise to “unique,” be careful that your confirmation bias* doesn’t have its way with you.
 
* Confirmation bias is the tendency of people to favor information that confirms their beliefs or hypotheses. People display this bias when they gather or remember information selectively, or when they interpret it in a biased way. The effect is stronger for emotionally charged issues and for deeply entrenched beliefs. People also tend to interpret ambiguous evidence as supporting their existing position.