Volcom’s March 31 Quarter and Some Related Thoughts on the PPR Deal

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We’re probably down to the last one or two quarterly filings we’re going to see from Volcom as all filings will cease when the PPR acquisition of Volcom closes. There was no conference call this quarter because of the impending deal, so all I’ve got to work with is the 10Q.

Total revenue was up 12.6% compared to the same quarter last year from $77.4 million to $87.1 million. Keep in mind that they completed the acquisition of their Australian licensee last August. This is responsible for $5.16 million of the total product revenue increase of $10 million for the quarter. Gross margin on product fell from 4.1% from 53.9% to 49.8%. “This decrease,” they say, “is primarily due to more in season discounted product sales and lower margins achieved on off-price sales during the three months ended March 31, 2011 compared to the three months ended March 31, 2010.”

Revenue for the quarter rose in each of Volcom’s four segments; United State, Europe, Electric and Australia. Operating income, however, fell in all four. In the U.S., it was down from $2.74 million to $897,000. In Europe the decline was from $8 million to $6 million. Electric’s operating income fell from $266,000 to0 $119,000. Australia showed an operating loss of $26,000.
 
Selling, general and administrative expenses rose from $31 million to $36.6 million. $2.2 million of the dollar increase was the result of the acquisition of the Australian licensee. Payroll accounted for another $900,000, advertising and marketing for $800,000 and increased bad debt expense $700,000. As a percentage of revenues, it rose from 40% to 42%.
 
The result of the lower gross margin and higher operating expenses is a net income that fell from $7.5 million to $4.6 million.
The balance sheet is still strong. It will shortly become irrelevant with the closing of the acquisition, but I would note that accounts receivable rose 22.6% to $73.2 million. I assume that part of that is due to receivables acquired when they bought their Australian licensee, but I don’t know how much.
 
In an interesting but probably ultimately unimportant development, a class action lawsuit was filed on May 4 (two days after the PPR deal was announced) claiming Volcom’s directors breached their fiduciary responsibility.  “The complaint alleges that the Offer and Merger involves an unfair price, an inadequate sales process, and that defendants agreed to the transactions to benefit themselves personally.”
 
Volcom says the case lacks merit, and I imagine they are right. The lawsuit’s contention, or at least one of them, is that Volcom only talked to PPR and if they had shopped the company more widely, they should have gotten more money. Maybe, but I still think the deal
was fully priced.
 
Over the last year, and maybe more, we’ve noticed that Volcom has had some issues with too much inventory and has had to discount to move it. We see the receivables increase and the allowance for bad debt that’s more than 10% of receivables. We note their comments (like other companies) about issues with rising costs and deliveries.
 
I’ve written about what a great job Volcom has done in defining and owning their market space, but how it can be hard for a company to grow out of a market position it is so closely identified with. Related to that I’ve noted some of the apparent challenges the brand has had in the department stores.
 
Volcom’s management didn’t need to sell the company. But if I and others have noticed some of these issues, you know Volcom’s spent a whole lot of time figuring out how to manage them. Apparently, the conversation with PPR took place over a year. With its balance sheet strong, and the brand’s integrity intact, I suspect Volcom looked at the strategic issues I’ve highlighted above and decided it was a good time to negotiate from a position of strength. That’s how you’re supposed to handle the market issues that lead to consolidation.
 
Obviously, PPR will help Volcom manage any cost, manufacturing and delivery issues it has. More importantly to Volcom’s shareholders, though, is that the company found a strategic buyer willing to pay a premium over what a strict financial analysis might suggest the company is worth.
 
PPR’s brands may be sophisticated, but they aren’t cool. Volcom is cool and, PPR is assuming, will help them break into a customer group they don’t really understand and haven’t been able to crack. I think they’re right, as long as they don’t “help” Volcom so much that they try to make it into something it ain’t.

 

 

PPR Buys Volcom, Probably

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You know, I should have seen this coming and been sitting on 10,000 shares. But no such luck and anyway, I don’t own shares in companies I write about. Still, the deal’s not a complete surprise. Vans, DC, Reef, Sector 9 and Hurley are a partial list of industry companies that have been acquired by larger companies that wanted to get into or expand their action sports offering and grow their credibility with that customer group. Consolidation is not new, and most successful companies in our industry seem to reach a point (usually as they start to grow into the larger fashion market) where they perceive they need some help to continue growing and succeed in that broader market.

Volcom has been showing some symptoms of needing that help. Last time I wrote about them, in March, I said,

“But there comes a time, especially as a public company, when that strong brand positioning with a targeted consumer can make growing more of a challenge as the new customers you need don’t feel a strong connection with the brand and the customer you have may feel alienated if and as you do what you have to do to build a connection with the new one.”
 
“It’s not like this is a surprise to anybody who’s been around our industry for a while. Large or small, public or not, every company deals with this when they grow. I wrote last week about how Quiksilver is pushing its DC brand and my concern that they might push it too hard. Burton, when it changed its name from Burton Snowboards to just Burton, was dealing with this issue.”
 
I noted in the article that Volcom was counting on some broader distribution including the department store channel for growth, but that I wasn’t quite sure a company with the motto “Youth Against Establishment” fit in the department stores.
 
I went on to say, “Volcom says they make premium product that typically sells at premium prices and they’ve got a very distinctive image they’ve worked hard and successfully to build over 20 years. That sounds boutique like to me- not department store. Just saying.”
 
They’ve also had some issues with dependence on PacSun and too much inventory. In 2010 revenues were up 15.2% over the prior year, but net income increased hardly at all, from $21.7 million to $22.3 million. A decline in gross margin from 50.2% to 49.2% explains most of that.
 
During PPR’s conference call announcing the acquisition, one analyst ask why, if Volcom actually believes it can earn $2.20 to $2.40 a share in 2014 it was selling now for this price. The PPR CEO answer was something along the lines of “Uh, oh, well, I guess they think it’s a fair price.” Great question I thought and maybe Volcom’s answer has something to do with the issues I raised.
 
By the way, the reason I put “probably” in the article title is because no deal is done until it’s closed. Also, from time to time an offer from one company will result in a higher offer from another company. The board of directors of a public company has a fiduciary responsibility to do what’s in the best interest of their shareholders. They couldn’t just ignore a better offer they think has an equal chance of closing. Of course, what’s “better” can be open to interpretation. I don’t actually expect there to be another offer. PPR, as we’ll get to next, is an 800 pound gorilla and I consider the deal fully priced.
 
PPR had 2010 revenues of 14.6 billion Euros (2.3 billion of which was sold online). That’s north of $21 billion at the current exchange rate. Western Europe is about 59% of their revenues.  North America is 16%. They have 60,000 employees and their products are distributed in 120 countries. Volcom, at $321 million in revenues in 2010 is a tad smaller, but much, much cooler. It’s around 1.5% of PPR’s revenues. I’d like to tell you all about them, but their web site is in French. I guess I can at least say they are a French company.
 
 Oh- wait- here’s the English version. Their luxury group of brands includes Gucci, Bottega Veneta, Yves Saint Laurent, Balenciaga, Alexander McQueen, Boucheron, Sergio Rossi, and Stella McCartney. I’m pretty sure none of these brands are hanging in my closet even though I’m such a fashion forward guy. The Stella McCartney stuff just doesn’t accentuate my bust.
 
They also own PUMA, FNAC and Redcats. Okay, I know what PUMA does. FNAC is apparently in the process of being sold. In 2010, the luxury group was 27% of sales and PUMA was 18%. PPR has over 800 stores globally. Here’s a link to the English version of their 356 page reference document which I am not reading. It has some easy to absorb graphics you might be interested in. It’s a big file and a bit slow to download.
 
This is PPR’s first adventure into the action sports market. It should be interesting to watch. On an operational level it seems obvious that Volcom should benefit from PPR’s size in terms of systems, manufacturing, access to capital and operations. Those synergies are usually real, but also usually harder to achieve than people expect. I guess Volcom will report through PUMA. It was interesting to hear PPR management say that Volcom was complimentary to PUMA and then note that PUMA was not involved in action sports. Maybe they just meant complimentary in terms of getting Volcom into shoes in a much bigger way, which apparently we can expect.
 
PPR, of course, is particularly well situated to increase Volcom’s presence in Europe, where both Volcom and PPR think they have a lot of room to grow. It sounds like we can expect to see quite a few more Volcom stores worldwide (no numbers given). I wonder if Volcom product would fit into any existing PPR owned stores. Many PPR brands can reasonably be characterized as boutique brands and, as I suggested before, if Volcom’s description of their brand and its positioning is accurate, maybe that’s where they belong. But I have a hard time seeing Volcom in a Gucci store at the moment. Maybe Europe is different.
 
Volcom may be strategically important to PPR, but it’s an awfully small piece of the whole. As I listened to the PPR executives describe Volcom, it felt like they were reading Volcom’s description of itself and its market position right out of Volcom’s 10K. Even though they’ve been talking for a year, I was left unsure if PPR “got it” or not. Over the years, I’ve watched European companies try to break into the U.S. action sports market and just do it wrong. I’ve watched U.S. companies have the same problem going to Europe, if only because we start out thinking of Europe as one market.
 
One European analyst called Volcom a “sports” company and inquired of management if they were thinking of launching a PUMA action sports brand. Happily, PPR made it clear that was a bad idea. There was also a question about whether Volcom and PUMA could be distributed together.
 
PPR talked about “…building the Volcom business globally while maintaining its authenticity” and keeping it positioned as it is today without changing the target customer. Of course that’s what they want to do, or they wouldn’t be buying Volcom. But as I’ve written, it’s also the challenge. Every action sports brand comes up against this. At some level growing and maintaining authenticity becomes as challenge. PPR has, of course, dealt with all forms of distribution and growth issues, but I am not aware that PPR management has experience with this in the youth culture market. Growth, after some point, requires changing, or at least expanding, the target customer.
 
They will be relying on the Volcom team to continue managing the brand. The deal, however, is an all cash one at $24.50 per share (22.6 P/E ratio according to one investment banker) with no earn out component we learned in the conference call. I sure hope Richard Woolcott and his team are happy working with PPR.
 
Given the challenges Volcom faces, they’ve made themselves a good deal at the right time. PPR can certainly make them more efficient operationally, in manufacturing, and financially. They will help Volcom grow especially in Europe, and there will be an expanded retail presence. In the longer term, if PPR and Volcom managements have some patience with each other, we might see Volcom make a transition into the fashion market in a way no other action sports brand has done.
 
Youth Against Establishment indeed.

 

 

Volcom’s Numbers and Opportunities for Growth

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What I’ve admired about Volcom is its consistent approach to the market over most of the life of the company. You get rewarded for that consistent approach with a strong market position and brand awareness among your target customer group. Reef did the same thing with a similar result over many years.

But there comes a time, especially as a public company, when that strong brand positioning with a targeted consumer can make growing more of a challenge as the new customers you need don’t feel a strong connection with the brand and the customer you have may feel alienated if and as you do what you have to do to build a connection with the new one.

It’s not like this is a surprise to anybody who’s been around our industry for a while. Large or small, public or not, every company deals with this when they grow. I wrote last week about how Quiksilver is pushing its DC brand and my concern that they might push it too hard. Burton, when it changed its name from Burton Snowboards to just Burton, was dealing with this issue.
 
I’ll get to Volcom’s numbers. But the numbers tend to work out if the strategy and positioning is correct. Let’s take a close look at some of the comments in Volcom’s annual 10K and recent conference call to see how they’re managing it.
 
Brand Positioning and Growth
Volcom characterizes itself as, “…an innovative designer, marketer and distributor of premium quality young mens and young womens clothing, footwear, accessories and related products under the Volcom brand name.” They say they have, “…one of the world’s leading brands in the action sports industry, built upon our history in the boardsports of skateboarding, snowboarding and surfing. Our position as a premier brand in these three boardsports differentiates us from many of our competitors within the broader action sports industry…”
 
As an apparel/soft goods brand, it’s easier to build your franchise across sports in the action sports market than it is if you’re a hard goods brand based on an individual sport. It’s also easier to grow beyond action sports into the broader market. Everybody needs pants, shirts, and shoes, but not everybody needs snowboards, skateboards and surf boards. I think that’s non-controversial, so I’m not going to spend time on it.
 
Volcom characterizes its brand as “…athlete-driven, innovative and creative. We have consistently followed our motto of “youth against establishment,” and our brand is inspired by the energy of youth culture.” They go on to say that, “We seek to enhance our brand image by controlling the distribution of our products. We sell to retailers that we believe merchandise our products in an environment that supports and reinforces our brand and that provide a superior in-store experience.”
 
From what I can tell, that works just fine in “core” shops and in certain chains, like Zumiez. But once you get to Macy’s and Nordstrom, and your motto is “youth against establishment,” are you controlling your distribution and can these retailers “support and reinforce” the brand?
 
Well, this is hardly an issue that’s unique to Volcom. Every successful brand in our industry thinks about issues of distribution (where to sell and how fast) every day. And of course you have to be successful enough for Macy’s and Nordstrom to want you in the first place before it becomes an issue so it’s kind of under the heading of “good problem.”
 
Volcom indicated in the conference call that they are presently in 150 Macy stores. But I want to return to what they said, and what I wrote, after their last conference call on their Sept. 30, 2010 quarter.
 
“In the conference call, Nordstrom’s is mentioned as having stopped carrying action sports last year. In their previous conference call [for the June 30, 2010 quarter], Volcom was describing the opportunity they had at Macy’s. In this call, we’re told, “Macy’s has been more difficult for us right now in terms of our door count has been reduced over the course of, I think, this year, kind of quarter to quarter.” Quite a change for one quarter. Now Volcom is saying that “…Bloomingdales is our bright spot for our department store business.” But they’re only in eleven stores.”
 
“Those of you who read my last article on Volcom know that I visited a handful of Macy’s stores to look for Volcom and other action sports brands. What I found was that Volcom and other brands were either miserably merchandised or not present at all. It seems kind of clear that there’s some work to be done before Volcom moves much of its inventory in those channels.”
 
Over three quarters, then, Volcom’s description of its success in department stores has been pretty volatile. Last quarter, Nordstrom was noted as having stopped carrying action sports, but this quarter’s 10K lists them as a customer of Volcom.
 
I’m confused. At least in the U.S. Volcom’s growth prospects are closely tied to their performance in some broader distribution channels including department stores, but from public data, I have no clear idea how they are doing there.
 
If Volcom’s management asked me (I won’t hold my breathe) I’d probably suggest that rather than department stores, which are apparently having some difficulties understanding and merchandising action sports brands, they might look for growth in the U.S. through  fashion boutique kind of stores. Volcom says they make premium product that typically sells at premium prices and they’ve got a very distinctive image they’ve worked hard and successfully to build over 20 years. That sounds boutique like to me- not department store. Just saying.
 
But then there’s the public company thing. The department stores offer the possibility of larger purchases which is obviously attractive to any public company that wants quarterly growth.
 
When I wrote about Quiksilver last week, I noted that margins and growth opportunities seemed higher outside of the U.S. The same may be true for Volcom, as we see when we review their numbers. Boy, life was sure easier for a strong action sports brand in this country before the economy went to hell.
 
The Numbers
 
Sales for the quarter ended December 31 rose 22% to $78.6 million. The U.S. segment (which includes Canada and Japan and most other international territories outside of Europe and Australia, but not Electric) increased 18% to $54.3 million. Their five largest full price accounts grew 19% to $15.4 million and represented 29% of the segment’s revenues. It was the same percentage in Q4, 2009. PacSun was $7.9 million for the quarter, up 31% and represented 15% of the U. S. segment revenues.
 
Gross margin for the quarter fell from 49.2% to 45% overall. In the U.S. segment (remember that’s not just the U.S.) It was 42% down from 48.1% in the same quarter in 2009. The reason is that they were too optimistic in their sales projections and inventory had to be liquidated in the fourth quarter. Probably has something to do with the rise in PacSun revenues.
 
Net income for the quarter was $1.6 million, down from $3.4 million in the 4th quarter of 2009.
 
For the year, revenues rose 15.2% to $321 million. That’s still below 2008’s $334.3 million.
Gross profit margin fell from 50.2% to 49.2%, but that’s an improvement over the 48.8% of 2008.
 
U.S. segment sales rose 15.3% to $218 million and represented 67% of revenues. Europe, at $70.3 million, was essentially constant and was 22% of the total. Electric grew 30.3% to $27.5 million and was 9% of the total. Australian segment revenue was only $7.7 million, but remember Volcom just acquired it’s licensee in that country last August 1, so the numbers will be much higher this year.
 
Sales in the U.S. (the country- not the segment) totaled $161.4 million. Canada was $37.4 million and Asia/Pacific $32.1 million. 18% of 2010 revenue came from Volcom’s five largest customers. That’s down from 20% the previous year, and 28% the year before that. PacSun was 10% of total product revenue in 2010. 10% of total product revenue is $32.1 million. PacSun operates only in the U.S. and Puerto Rico. Knowing Volcom’s U.S. sales, we can calculate that 20% of those sales were to PacSun. 
 
Volcom sells product that it categorizes as men’s, girls, snow, boys, footwear, girls swim, Electric, or other. Of these nine categories, men’s was $168 million, or 52.4% of product revenue. Girls, at $55 million or 17% is the next largest.   
 
The gross profit margin in the U.S. segment was 46.1% for the year. It was 55.6% in Europe, 58.9% for Electric, and 43.8% in Australia. Management tells us that the Australian gross margin will be around 50% once it’s fully integrated.
 
We don’t have a gross margin number broken out for just the U.S. If I were a betting man, I bet that the gross profit margin in just the U.S. is lower than that 46.1% for the U.S. segment. As with Quiksilver, you can see that Volcom’s bias would be to increase sales outside of the U.S., where margins are significantly better.
 
Volcom notes that one of its strategies is to take control of its international operations in countries where they have licensees when the license agreement expires. The one in South Africa expires at the end of this year. Brazil is at the end of 2013. So is Argentina, but it can be extended for five years. Indonesia’s expires at the end of 2014.   
 
 Selling, general and administrative expenses rose 16% from $111 million to $129 million. As a percentage of sales, they rose a bit from 39.5% to 39.8%. Of that total advertising and promotion accounted for $26.8 million in 2010 and $21.9 million in 2009. In 2011, estimated minimum payments for professional athlete sponsorships are projected to be $8.7 million.
 
Net income rose slightly from $21.7 million to $22.3 million. In 2008 it was $21.7 million. As percent of sales, it fell from 7.7% to 6.9%.
 
The balance sheet continues to be solid with no long term debt even after they paid out $24 million as a special dividend to shareholders.
 
Other Information
 
Retail’s always interesting to talk about.  Volcom owns 13 full-price retail stores and licenses 11 more around the world. They own the two multi-brand Laguna Surf and Sport stores and have 10 outlet stores. As you’ve probably heard, they are purchasing those 10 stores from the operator. Volcom seems focused on retail locations that “present our brand message directly to our target market.” I think that’s a good reason for a brand to have a limited number of retail outlets.
 
Volcom has basically the same cost pressures that other companies are feeling, and expects input costs to be up between 15% and 20% in the second half of the year. What was a bit different was their apparent confidence that, “As far as the cost increases go, generally, those are going to be passed through as price increases.”
 
Maybe that says something about the strength of the brand. Other companies are not quite so certain they will be able to pass through all the costs increases, recognizing that the consumer will have something to say about that. CEO Woolcott acknowledges later in the conference that consumer acceptance of price increases is an open issue.
 
Volcom has as strong a brand as any significant player in our industry. Maybe, within its target segment, stronger. But, as was discussed above, the price of that kind of strength can be difficulty growing outside of that segment. Like a lot of brands, I think we’ll see a strong international focus from Volcom. That’s where the margins and growth opportunities seem to be. In the U.S., it will be interesting to watch where growth happens. I imagine Volcom would like to sell less to PacSun, core stores can be hard to get enough consistent growth out of and, as I indicated, some of the department stores just don’t seem to get it.

 

 

What’s Up with Quiksilver? The Stock Was up Huge Today

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Quiksilver’s stock jumped 22.7% today (December 9th) from 4.75 to 5.68 on the biggest volume since last March. These kinds of moves don’t happen in a vacuum, so I thought I’d check around a bit. An investment banker I know was kind enough to alert me, and I found the following reported on Bloomberg:

“PPR SA has agreed the sale of its Conforama chain to Steinhoff International Holdings Ltd. for 1.625 billion euros, La Tribune reported, without saying where it got the information.”
“PPR Chief Executive Officer Francois-Henri Pinault is interested in buying Quiksilver Inc., La Tribune said. He has reestablished contact with the company, as well as with Rhone Capital, which holds a 19 percent stake in the California-based maker of clothing for skateboarders and surfers, according to the newspaper.”
The link is here, though I’m quoting the whole thing.
Who’s PPR SA? I didn’t know either, but here’s a blurb on them from Yahoo Finance.
PPR SA Company Profile
PPR has transformed itself from a conglomerate to the world’s third-largest luxury group (behind LVMH and Richemont). PPR’s stable of global luxury brands includes a 99% stake in Italian luxury goods company Gucci Group, and luxury brands Alexander McQueen, Balenciaga, Boucheron, Bottega Veneta, Stella McCartney, and Yves Saint Laurent, among others. The group’s other activities include the multichannel merchant Redcats, Fnac music and book stores, the Conforama chain of household furniture and appliance stores, and the German athletic shoemaker PUMA. More than half of PPR’s sales are generated outside of its home country. PPR is run by Fran�ois-Henri Pinault, the son of its founder Fran�ois Pinault.
Is this actually going to happen? Somebody thinks something is going to happen given the way the stock jumped.   I don’t know what the price might actually turn out to be, but Rhone Capital would sure make a nice return quickly.
Love to do more analysis of this, but the unfortunate fact is I don’t have any information.  Maybe soon!  Or maybe not.

 

 

Volcom’s Quarter Ended Sept. 30 and Some Strategic Industry Issues

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Those of you who read my stuff know I never try to be the first published. When Volcom did their press release I reviewed it. I listened to the conference call and read its transcript and thought about it. Then I reviewed their 10Q when it was finally released. Then I thought about it some more.

Now, I’ve thought enough. What I was thinking about as I reviewed Volcom’s material was the distinctions (and similarities) between the action sports, youth culture, and fashion markets. You see, I’m not sure just what market we are any more. Action sports, to me, is that fairly small market composed of consumers who are participants in the sports and maybe the first level of nonparticipants who are closely interested in the sports and the lifestyle. Fashion is by far the largest market. If the people in that market want a surf brand, they may be as content with Hollister as with Quiksilver. Or they may just like a plaid shirt style they saw somewhere and are happy to buy it at JC Penney. They may not even know that isn’t cool.

I see Volcom as being in the youth culture market, but holding on to its action sports roots and trying to reach up into fashion as a condition of growing. That could leave Volcom (or any other brand) stretched a bit thin in terms of market positioning.
So let’s look at Volcom’s results and discussion around those results in term of the changes that are going on in our industry and market and see if we can draw broader conclusions that go beyond Volcom.
 
The Balance Sheet and Issues of Strategy
 
Volcom’s balance sheet at September 30 remains very strong, if not quite as strong as a year ago. But it’s strong enough for them to pay a $1.00 a share cash dividend to shareholders of record at November 8th at a cost of $24.4 million. Even though it’s strong, I want to spend time on the receivable and inventory numbers, as this might get us to some of the broader industry trends I want to focus on.
 
Consolidated accounts receivable were up 17% to $81.8 million at September 30, 2010 compared to one year ago. Days sales outstanding were up to 91 days from 88 days a year ago. So on average it’s taking them three days longer to collect.
 
Inventories over the year are up 65% from $22.4 million to $37 million. By comparison, sales grew 11%. Inventory turns over the year fell from 5.8 times to 4.6 times. The number of days it took them to turn their inventory, therefore, rose from 63 to 80 days. Higher is generally better than lower when you talk about inventory turns, though too high a turn rate can indicate you’re not keeping enough inventory on hand.
 
With those numbers as background, let’s look at their discussion of inventory. Here’s what Volcom said about their inventory situation in their 10Q. “We believe that as of September 30, 2010, we have excess inventory levels on hand and in order to align these inventory levels with current in-season demand, we anticipate that we will experience higher inventory liquidation sales during the fourth quarter of 2010.”
 
They talk about this at some length in the conference call and give more detail on how it happened and what they are doing about it. First, they note that their 2010 strategy “…has been to gain floor space and market share throughout our account base. Along with increased focus on marketing and promotions, these initiatives have included incentive programs to improve retailer margins in order to insure continued strong orders for Volcom products.”
 
They certainly aren’t the only company with a strong balance sheet that thought a recession was a good time to take some market share, and they are probably right about that. But they chose to do it partly with programs (including some pre-book discounts and a little more markdown allowance) that reduced their gross margin in their United States segment (that includes Japan and Canada but not the Electric results in any of those countries) from 49.9% in the same quarter last year to 45.4% in the same quarter this year. Overall, their gross profit margin fell from 51.6% to 49.6% in the quarter.
 
Moving into next year, they expect to curtail some of these incentive programs. “We believe this will help us recover some of the lost gross margin, while maintaining our market share gain.”
 
Will whatever market share gain they’ve achieved be maintained when they remove the incentives? Yup, that’s the big question. Billabong was concerned enough about this issue that they chose to limit their discounts and incentives during the recession even at the cost of some sales. I’ve argued pretty strongly that your focus in a period of slower sales growth needs to be on expense control and generating gross margin dollars even at the expense of sales growth. It’s an issue for every solid brand in the industry and we’ll find out over time what the right answer is. It is, of course, possible that there are different answers for different brands.
 
Meanwhile, speaking of issues everybody in the industry has to deal with, Volcom indicated they are seeing upward pressure on manufacturing, freight, and raw material costs in the area of 15% to 20% FOB.  That’s more than some other companies have suggested. But Volcom, and everybody else, has to ask how consumers will react in this economic environment as brands try and make up for some or all of these costs increase with higher prices. And Volcom will be dealing with that as they withdraw certain
of these incentives from their customers.
 
Just this morning, somebody sent me a short, article on these costs increases coming out of China. You can read it here.
 
We are, by the way, still talking about inventory. What I like about how this article is working out is that we’re tying balance sheet to income statement to global strategy. It’s important to understand those relationships.
 
Why did inventory get so high? Volcom chose to carry more inventory “…to capitalize on potential in-season business.” They did this because of “…the retailers’ general reluctance to pre-book at historic levels.” They also “…made earlier and bigger buys on select styles due to longer lead times in China, and to take advantage of volume pricing.” When they did that, they had higher expectations for the second half of the year which did not materialize.
 
I wonder if retailer’s reluctance to pre-book should be looked at as an opportunity to sell in season or as an indication that consumers are expected to remain cautious in their spending.
 
Some of this inventory is going to carry over to next year and was bought with that in mind. I think that carrying over some styles in certain basic product is a good idea as long as the market will accept it. But Volcom said they “…plan to get rid of…” about $3 million in inventory in the fourth quarter and that will impact their margins.
 
How exactly are they going to get rid of the excess inventory? They don’t exactly say, but they do note that they expect that sales to PacSun will increase 17% in the fourth quarter. In the third quarter, PacSun bought $6.9 million. 17% would be an increase of about $1.17 million, and I wouldn’t be surprised if a chunk of $3 million in inventory they want to get rid of is going there.
That certainly creates an opportunity to discuss PacSun’s strategy and place in the market and Volcom’s relationship with them, but this article is going to be long enough and I’d better move on.
 
Before I get off inventory, there’s one more industry strategy issue that relates to it I want to discuss. It’s the role of the department stores. In the conference call, Nordstrom’s is mentioned as having stopped carrying action sports last year. In their previous conference call, Volcom was describing the opportunity they had at Macy’s. In this call, we’re told, “Macy’s has been more difficult for us right now in terms of our door count has been reduced over the course of, I think, this year, kind of quarter to quarter.” Quite a change for one quarter. Now Volcom is saying that “…Bloomingdales is our bright spot for our department store business.” But they’re only in eleven stores.
 
Those of you who read my last article on Volcom know that I visited a handful of Macy’s stores to look for Volcom and other action sports brands. What I found was that Volcom and other brands were either miserably merchandised or not present at all. It seems kind of clear that there’s some work to be done before Volcom moves much of its inventory in those channels.
 
Volcom’s inventory numbers, then, span a bunch of industry strategic issues that are important to all the players in our industry. These include the strength of the economic recovery, increasing product cost, delivery issues, the impact of fast fashion, changes in the retail base and its willingness to place preseason orders, and the inevitable difficulties of growing into the fashion/department store market. Nobody’s business model works the same way forever.
 
And that is the end of the inventory discussion. Finally.
 
Income Statement
 
For the quarter, revenue rose 11.4% to $104.7 million. For nine months, the increase was 13% to $244.6 million. Electric was the best performing segment, with an increase of 29% to $8.9 million. That’s 8.5% of the quarter’s total revenues.
 
Gross profit rose from $48.5 million to $52.8 million in the quarter, but gross profit margin fell from 51.6% to 49.6%. Selling, general and administrative expense rose by 17.6% to $33.9 million.  As a percentage of revenues, they rose from 30.7% to 32.4%. Volcom states:
 
“The increase in absolute dollars was due primarily to increased payroll and payroll related costs of $1.5 million, incremental expenses of $1.1 million associated with our recently acquired Australian licensee, increased marketing and advertising costs of $1.0 million, and increased commissions expense of $0.6 million associated with an increase in revenues between periods. The net increase in various other expense categories was $0.9 million.”
 
Operating income was down 8.6% to $18 million. Net income fell slightly from $13.3 to $13 million. It would have fallen by another million if Volcom hadn’t had “other income” that was about $1 million higher than in the same quarter last year due to a foreign currency gain.
 
Conclusion
 
I hate calling a section “conclusion,” but I couldn’t come up with anything pithy and witty and wanted you to know the income statement part was over. What I hope you’ve gotten out of this is the importance of the inventory change and number and how it relates directly to a series of strategic issues that Volcom, and the rest of the industry, is managing. I wish I had more detail on their inventory. How they manage the issues around inventory will have a lot to do with how Volcom progresses as a company. That’s always true, but my point is that it’s particularly true in our current operating environment.
 
As I said at the start, Volcom is a youth culture company with its roots in action sports and reaching for fashion as a condition of continued growth. They seem to have arrived at that time in their growth and development (due partly to economic conditions) when their business model may have to evolve a bit. That’s not a criticism. Every company that starts small in this industry hopes that someday they have to deal with the issue.             

 

 

How’s Volcom Doing? Their Quarterly Results

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I swear I wrote as fast as I possibly could during the conference call and hope I got all the good stuff. The press release was pretty much lacking in detailed management discussion and there were no footnotes to the financial statements. I know probably nobody will care by the time the actual quarterly report is filed with the SEC, but I promise to go through it and let you know what interesting info (if any) there is in the details.

Revenues for the quarter were up 15.4% to $62.4 million compared to $54.2 million in the same quarter the previous year. Gross profit in was up 13.2% to $29.8 million compared to $26.4 million. Gross profit margin was 47.7%, down from 48.6% in the same quarter last year. In its US segment, which includes the US, Canada, Asia/Pacific, Central and South America, it fell from 48.8% to 46.1%. It rose in Europe from 44.8% to 46.1% because of more direct retail selling and less to distributors.

In the first quarter of the year, the gross profit margin was 54.7%. In the complete years of 2007, 08, and 09 it was, respectively, 48.4%, 48.8%, and 50.2%.
 
Okay, let’s pause here and focus a bit. Volcom management tells us in the conference call that the lower gross margin percentage in the U.S. segment was primarily due to incentive pricing that was part of a strategy to gain market share. They also note that they carried more inventory to capture in season orders and that low margin liquidation sales were higher than in the second quarter last year in the U.S. segment. And CEO Richard Wolcott said they were “Getting great sell through.” They say that sell through reports show that Volcom product is “resonating” well with customers.
 
This is pretty much the part of the conference call where I go crazy with frustration because I don’t get to ask any questions. The ones I might have asked include:
  • If sell through is so great, why is the gross margin down?
  • If you are gaining market share, is it strictly because of the discounts you’re offering that lead to the lower gross margin or do you think you’ll hold that share when you raise prices? Anybody can get more share if they charge less.
  • Does carrying more inventory to capture in season orders mean your prebooks were off? Do you get as good a margin on those in season sales as on the prebooks?
  • Is carrying more inventory for in season orders a temporary tactic or do you expect to continue it?
  • You noted that low margin liquidation sales were higher in the second quarter last year. There decline should contribute to a higher gross margin. Can you give us any insight as to the size of those sales and their impact on gross margin?
These questions might be particularly appropriate given that during the question section of the conference, they said to expect some gross margin pressure during the third quarter and that higher liquidation and incentive sales were expected. Some of these pressures come from problem with supply and costs in China right now. Volcom specifically notes delays in snow product delivery due to labor shortages in China. Almost every company, of course, has to deal with these same pressures. 
 
Sales, general and administrative expenses stayed about the same as a percentage of sales at 47.6% but went up about $3.9 million. That’s part of their plan to increase market share and it’s probably the right time to do that. They have a balance sheet that allows them to.
 
Operating income tell from $504,000 last year to $67,000 for the quarter this year. For six months, operating income rose from $6.9 million to $11.1 million. Net income was $872,000 in 2009 for the quarter compared to $68,000 in the quarter ended June 30, 2010. You’re better off looking at operating income though. In last year there was a foreign exchange gain of $651,000 during the quarter. In the same quarter this year, it was loss of $66,000. The income tax provision fell from $352,000 to $31,000. Basically, in the quarter ended June 30, 2009, Volcom was a million bucks better off due to items below the operating income line.
 
In discussing the general economic environment, they say the macro demand environment has weakened a bit and retailers have become more cautious. In the U.S., they describe the retail attitude as “somewhat choppy.” They indicated that the core was continuing to grow (I wonder what that means exactly) but that some retailers were still having difficulties. In a related comment, they see the Billabong acquisition of West 49 as a positive because it will strengthen West 49. If you saw my analysis of that deal, you know that West 49’s most recent financials were weak and that I thought that weakness might have been a major motivator for the deal.
 
In Europe, Volcom sees a challenging environment. The business there has held steady for the last several quarters. Volcom in Japan is still “having problems” because of the macroeconomic situation.
 
But even with the current economic weakness, CEO Woolcott believes “…that investing now will serve us well when the recovery really begins to turn on.” I think he’s right.   The issue for all of us is when is that going to happen. And of course it wouldn’t hurt if the sun would come out in Southern California. I was just down there for the Group Y Action Sports Conference, the Agenda show, and to see the U. S. Open and felt like I’d never left Seattle. I also got to see Jack’s, a retailer I’d never been in before. I was impressed and will have more to say about that in another article.
 
In the U.S., all of their categories were up except juniors which fell 22%. That seems to be the category from hell for everybody right now. I have a hunch that’s going to continue and some brands getting on the “fast fashion” band wagon isn’t going to improve the situation. Revenue from Volcom’s five largest U.S. accounts was down 2% to 15.3 million and represented 30% of U.S. product sales. PacSun was down 2% to $8.7 million (17% of U.S. segment). Volcom has new displays in 25 top PacSun doors, and noted that they were enjoying working with the new PacSun management. It will be interesting to watch the direction of Volcom’s sales there.
 
CEO Woolcott said, “The Macy’s business is doing particularly well, especially in men’s and boys’.” Volcom has become among the top surf skate brands in men’s, boys and kids there, he indicated, and they believe this is due to an increased focus on Volcom’s merchandising and marketing efforts there.
 
I sure hope they are working on the merchandising in Macy’s. I stopped off to see the Volcom presentation in Macy’s a while ago and you can see what I found about half way down this article. http://jeffharbaugh.com/2010/05/19/volcoms-1st-quarter-ended-march-31-numbers-macy-inventory-management/. It wasn’t pretty but of course it was only one store and, I hope, not typical.
 
I’d love to be able to explore the gross margin issue in more detail, and I’ll let you know if there’s any more info in the 10Q when it’s filed. In the meantime, Volcom is pursuing a strategy which makes great sense as long as some economic improvement isn’t too long in coming. I guess every brand is to some extent hostage to a recovery.

 

 

Volcom 1st Quarter Ended March 31- Numbers, Macy, Inventory Management

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Volcom filed their 10Q on May 10th. After I listened to the conference call and they said how well the brand was doing in Macy’s, I was determined to get into a Macy’s and see for myself before writing this. I’ve done that now, so we’ll take a look at the numbers then move on to what I saw in Macy’s. Seems to me there are some interesting strategic issues there; not just for Volcom but for the industry.

Numbers

First thing I did was go get the March 31, 2009 balance sheet so I could make a reasonable comparison. Still no long term debt, more cash and short term investments, day’s sales outstanding reduced from 76 to 60 days. The inventory turn, as reported in the conference call, was 4.8 times. Everything’s fine; certainly no issues here that would prevent them from pursuing their long term strategy. Balance sheets aren’t much fun to analyze when they are solid. On the other hand, it doesn’t take much time.
 
On the income side, they did better than they had expected. Revenue was up 13% to $77.4 million reflecting strength across all product lines (except juniors which was down 17%) and all segments. Gross profit rose from $34.4 million to $42 million, and gross profit margin was up from 50.3% to 54.2%. Gross profit margin was weakest in the US at 49.7%. It was 60.4% in Europe and 62.2% for Electric.
 
It would be well if you remembered that the in the same quarter last year consumers weren’t buying anything, and companies were discounting to move inventory. So at some level impressive increases are not surprising. We’re seeing them from other companies as well.
 
PacSun represented 10% of their product revenues for the quarter, down from 11% last year. They expect revenues from PacSun to remain flat in the coming quarter. Here’s what they say about PacSun. It’s worth reading.
 
"We recognize that any customer concentration creates risks and we are, therefore, assessing strategies to lessen our concentration with Pacific Sunwear. We cannot predict whether such strategies will reduce, in whole or in part, our sales concentration with Pacific Sunwear in the near or long term. Because Pacific Sunwear has represented such a significant amount of our product revenues, our results of operations are likely to be adversely affected by any Pacific Sunwear decision to decrease its rate of purchases of our products. A decrease in its purchases of our products, a cancellation of orders of our products or a change in the timing of its orders will have an additional adverse affect on our operating results."
 
I’m not quite sure how to interpret this. Anybody have any ideas, please let me hear them. First, they don’t know if the concentration is going to go down or not, or when. But you’d expect the concentration to fall with an overall increase of sales at Volcom. If not, that would mean PacSun was buying more if it were to continue to represent the same percentage of Volcom product revenues. Would Volcom sell them more? Then there’s the talk about the impact of PacSun decreasing their purchases. Why would they do that? Maybe (I hope) because Volcom won’t sell to them at the prices they want? This reads almost like a "Risk Factor." They didn’t put this discussion in here for no reason.   I will watch with interest.
 
After PacSun, revenue from the next four largest accounts represented 4% of product revenue.
 
Selling, general and administrative expenses rose from $28 to $31 million. Operating income rose 73% from $6.3 to $11 million. Net income was up 78.5% to $7.5 million. Volcom expects to double revenue by 2014 with operating margins improving to 15% to 20%.
 
One interesting operating comment they made during the conference call was how they were carrying higher inventory of certain basics for reorders, but that these were products that would be sold for several seasons. Having cut my teeth in this industry on the one season snowboard business, I just get all a dither when I hear about product that can be sold through multiple seasons at normal margins. I don’t know how much product it is, but there’s a lot of money and headaches to be saved doing that.
 
Strategy and Macy’s
CEO Richard Woolcott outlined six general strategies that Volcom will pursue. They included:
·         Maximizing wholesale distribution
·         International growth
·         Making Volcom the hottest brand in active sports
·         Growing the Electric brand
·         Having exceptionally innovative product
·         Cautiously increasing their direct to consumer business including ecommerce.
 
I suppose, except for the grow Electric one, most larger companies in this industry would subscribe to these objectives. The devil, as always, is in the details. And that brings me to my visit to Macy’s.
 
I only visited one. It was at the Alderwood shopping center north of Seattle. I was on my way back from a very pleasant weekend in Vancouver with my wife.
 
I wish I’d thought to take a picture, but you’ll have to settle for the thousand words. Less, actually. This Macy’s tended to give each brand its own space coming out from the wall. The wall itself would have the brand logo, and the width of the space was determined, I assume, by the success of the brand. So there was Adidas, North face, etc. I don’t remember them all. I looked for Volcom and didn’t see it. Nor, I realized, did I see Quiksilver, Billabong or any other of our major brands.
 
I had to ask for Volcom. "Around the corner on the left," I was told. I looked. Couldn’t find it. Asked somebody else. "Over there in the corner by the door."
 
Finally, I spotted a little Volcom sign on the wall right next to a Quiksilver sign. I was in the corner area of the store that I’d estimate was 30 feet square. Maybe a bit bigger. There was also an O’Neill sign up there. This area was full of racks. The merchandising technique seemed to be to see how many garments you could cram on a single rack. This wasn’t the Volcom area. Or the Quik or the O’Neill or the Billabong or the Element area (I think there were some other brands as well). But all those brands were there. Not in their own area, like other brands in the store, but all together in one area with the racks of Volcom not significantly distinguished from the racks of, say, Quiksilver.
 
The message I got from Macy’s was, "Here’s some more brands. We’ve got to carry them, but we don’t understand them (they all kind of seem the same anyway) and they aren’t important enough to us to merchandise them well."
 
To say that I was a bit dismayed is putting it mildly. Every brand there was damaged by the presentations or lack of presentation, of their brand. If this is "maximizing wholesale distribution," we’re in trouble. And I doubt this contributes to making any brand in that dog pile of brands "the hottest brand in action sports." Made me appreciate what core retailers do for brands.
 
Maybe I walked into the wrong Macy’s. At my earliest convenience, I’m going to visit another.
 
Volcom had a good quarter. But what I saw at this Macy’s store highlights the difficulties inherent in growing as distribution expands.     

 

 

Volcom Quarter & Nine Months Ended 9/30/09

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Volcom’s Quarter and Nine Months Ended September 30

Back on October 29th Volcom released a press release with its third quarter results and hosted a conference call on those results. Everybody read, and listened, and analyzed, and wrote stuff.
On November 9th, with no press release, they filed their 10Q for the same time period. Nobody seems to have noticed, and maybe nobody cares. But I do.
I don’t think there should be a conference call until the 10Q (or annual 10K) is out and people have had a chance to review it. The numbers in the press release and conference call are of course the same as in the 10Q. But there’s more detailed information in the 10Q, but some of those numbers only come out orally in the conference call and you have to write really, really fast to get it down. Either that, or listen to the replay fourteen times which isn’t any fun.
Then there’s the part where the analysts ask questions and request some additional “color” on an issue. You do sometimes get some good information this way and “color” can mean more detail. But it can also mean interpretation, estimate, evaluation, etc.
I read the press release and listened to the conference call. But here’s what I got out of the actual, uncolored numbers and management discussion from the 10Q.
The balance sheet is very strong, with about $90 million in liquid assets and no long term debt. It’s strong enough that we don’t even have to discuss it.
At the conference call, Volcom management said that the third quarter results had exceeded their expectations “primarily driven by revenue that was above plan in all three of our business segments. “ It was $9 million higher than the high end guidance provided at the last conference call.
That I suppose is a good thing, though another interpretation might be that they did a lousy estimating at the last conference call. I guess the worse you estimate one quarter, the better you can look next quarter. Oh well- a lot of that going around in this economy. Companies are justifiably cautious.
The conference call message is that they did a lot better than their last estimate but the 10Q tells us that revenue for the quarter fell 15.9% to $93.9 million, and net income was down 18.5% to $13.3 million. For nine months, revenues are down 18.2% to $216.5 million and net income fell 39.8% to $18.3 million. Net income as a percentage of sales fell from 14.6% to 14.1% for the quarter and from 11.5% to 8.5% for nine months.
Volcom reports their results for three segments; United States (which includes most of the world except Europe), Europe, and Electric. For the quarter and for nine months, revenue and gross profit were down in all three segments. Operating income for nine months was also down for each of the three segments. For the quarter, it fell in the United States and Europe, but rose in Electric.
They also report revenue for eight product categories; means, girls, snow, boys, footwear, girls swim, Electric, and other. For nine months, all the categories but snow were down. It rose from $23.3 to $23.9 million. For the quarter, everything but snow and girls swim was down. Snow rose from $22.9 to $23.1 million and girls swim from $110,000 to $156,000.
You can see the detailed breakdowns for the segments and product categories on pages 14 and 15 of the 10Q here. http://www.sec.gov/Archives/edgar/data/1324570/000119312509229368/d10q.htm.
Volcom believes that “…our overall decline in revenues was driven primarily by the deteriorating global macroeconomic environment and the decline in discretionary consumer spending worldwide.” I agree with that and it’s true for most, if not all, industry companies. The trouble is that nobody can do anything about it except protect your brand, control expenses, and take advantage of competitors’ weakness.
The discussion of Volcom’s relationship with PacSun was interesting, and I’m going to quote here what they said.
“Sales to Pacific Sunwear decreased 42.4%, or $17.6 million, for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008. We currently expect a significant decrease in 2009 revenue from Pacific Sunwear compared to 2008. It is unclear where our sales to Pacific Sunwear will trend in the longer term. Pacific Sunwear remains an important customer for us and we are working both internally and with Pacific Sunwear to maximize our business with them. We believe our brand continues to be an important part of the Pacific Sunwear business. We also recognize that any customer concentration creates risks and we are, therefore, assessing strategies to lessen our concentration with Pacific Sunwear.”
It’s almost schizophrenic, isn’t it? ‘Well, the business is going to be down. But it’s important to us! We aren’t quite sure what this business will be in the future, but we want to maximize the business with them. But you got to be careful about customer concentration!’
This is indicative of the same old problem that companies in this industry face every day- especially when they are public. You have to find growth, but you can’t do it in such a way that it damages your distribution and, potentially, your brand equity.
Volcom is also in 105 Macy stores, they pointed out in the conference call.
Volcom managed to increase their gross margin from 49.4% to 51.6% for the quarter and from 49.9% to 50.5% for nine months. This is a good result that they attribute to limited discounting, better inventory management and an increased margin from Japan after they acquired their Japanese distributor in November, 2008. Total gross profit, of course, was down consistent with the decline in revenues. 
Acquiring your distributor increases your gross margin, but also increases your selling, general and administrative expenses. For the quarter, these grew from 27.1% to 30.7% of revenues and for nine months, from 32.5% to 38.3%. This percentage increase was also the result of having to spread costs over a lower revenue base, increased bad debt write-offs, and incremental expenses for retail stores. In dollar terms, these expenses fell in the quarter from $30.3 to $28.9 million. For nine months, they were down from $86 to $82.7 million
The decrease during the quarter was due to reduced commissions because of lower revenues, decreased amortization, bad debt declining by $400,000 and a $1.5 million decrease in other categories including tradeshow, warehouse and legal. A lower exchange rate also helped. These declines were offset by a $1.5 million increase associated with the Japanese distributor.
Volcom is of a good size and in a good market position to take advantage of other brand’s problems and rebounding consumer spending, whenever that happens. In the meantime, they are controlling expenses, trying to source better, managing inventory and doing everything else they can do to maximize those gross profit dollars. Every company should be doing all those things all the time- not just when the economy is lousy.
But there’s a limit to how much good operational management can improve your bottom line. You can’t cut expenses and reduce inventory forever.   Ultimately, I expect Volcom to be one of the strong brands that benefit from the impact of the recession. But where will growth come from, and when will it begin?  

Volcom’s Quarter Ended June 30, 2009

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Volcom filed their 10Q in the last couple of days. There’s some good news here, though of course Volcom’s income statement for the quarter and six months reflects the impact of the recession. And the issue of how to manage their PacSun business is an interesting one.

Let’s start with the balance sheet. The filing includes balance sheets for June 30, 2009 and December 31, 2008. I went back and plucked out the June 30, 2008 balance sheet to make a better comparison to June 30, 2009.

I should start by saying that their balance sheet was already strong last June, and it’s strengthened further. Cash and short term investments rose from $71 to $96 million. Accounts receivable and inventories fell by 20% and 18% respectively. Accrued payables and expenses were down 18% from a year ago. Those changes are consistent with the recession and how you manage in it.
 
Volcom’s current ratio rose from 4.78 to 6.22 while total debt to equity fell from 0.20 to 0.15. Those are both good things. They had no drawings under their line of credit (though $1.6 million in letters of credit were outstanding). Availability under the line was $38.4 million. Volcom has a balance sheet that allows it to continue to pursue its strategy and take advantage of competitor weaknesses during a tough economy. I may have mentioned a time or two that having a strong balance sheet right now is a real advantage for any company.
 
Revenues, to nobody’s surprise, declined. They fell 25% for the quarter to $54 million and 20% for six months to $123 million. Gross profit margin for the quarter actually rose from 48% to 48.6%. For six months it fell from 50.3% to 49.6%. Selling, general and administrative expenses fell 7.4% for the quarter, reflecting careful management of expenses and compensation. I’d note that these declines are not as dramatic as I’ve heard about in some other companies. Again, Volcom has the balance sheet to maintain its initiatives.
 
Net income, however, fell 82% in the quarter from $4.8 million to $872 thousand. For six months, it was down 64% from $14.2 to $5.1 million. Revenues and gross profit dollars were down for the quarter in Volcom’s three operating segments- United States, Europe, and Electric.
 
 Volcom reported that sales to PacSun decreased 23.7%, or $5.4 million, during the six months ended June 30, 2009 compared to the same six months the prior year. $5.4 million is approximately 18% of their total sales drop of $30 million from the first six months of 2008 compared to the first six months of 2009. They don’t say what the drop was for the quarter ended June 30 compared to the same quarter last year.
 
They say that PacSun represented 16% of product revenues in 2008 (I assume they mean the whole year), and 14% for the six months ended June 30, 2009. That would be $17 million.
    
Let’s try playing around with the numbers a bit more. If $5.4 million is a 23.7% drop, what were total sales to PacSun for the six months of the prior year? A little less than $23 million. That’s about 15% of total sales during that period.
 
Volcom “…expects a decrease in 2009 revenue from Pacific Sunwear when compared to 2008.” They go on to say, “Pacific Sunwear remains an important customer for us and we are working both internally and with Pacific Sunwear to maximize our business with them. We believe our brand continues to be an important part of the Pacific Sunwear business. We also recognize that any customer concentration creates risks and we are, therefore, assessing strategies to lessen our concentration with Pacific Sunwear.”
 
How can Volcom maximize their business with PacSun while lessening their concentration with them? Can you maximize your business while you decrease it? They seem to think so since 2009 revenue from PacSun will be less than 2008. You can lessen concentration either by selling PacSun less or by selling everybody else more. Those are the only two choices I can see.
 
Only from public companies who are required to focus on quarterly results can you get these kinds of semi-contradictory statements. Volcom has to figure out how to replace sales from PacSun in an environment where finding sales growth isn’t easy. They are “assessing strategies” for accomplishing this but don’t have it solved. Oh well- not even the best companies are having an easy time right now. 

 

 

Volcom’s Quarterly Conference Call: It Didn’t Sound 29% Bad to Me

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         I’m just back from two years In Ireland, where I made a futile attempt to have one pint in every pub in Dublin. I’ve missed a bit, but I did hear about Volcom’s quarterly conference call last Friday, the 29.4% decline in its stock that followed, the industry discussion that has ensued about the reduction in Volcom’s projected third quarter sales at PacSun, and the apparent concern over the ability of industry companies to sell their denim and other brands if PacSun was to change its branding strategy. 
         So I listened to the conference call. All one hour, 32 minutes, and 19 seconds of it. Moan. Volcom beat estimates for its second quarter, held to its guidance for the year, and announced what I took to be some very positive developments in new products, distribution and retail.
         But Volcom reduced guidance for the third quarter from 45 to 38 or 39 cents and said it expected sales to PacSun, its biggest customer representing 29 percent of last year’s revenues, to decline in the third quarter.
         When asked for some specifics about why this was happening (some “color” as the analysts call it) management just repeated the same non-specific answer about how they had a great relationship with PacSun, considered them an important customer, looked forward to a continued good working relationship with them and were all over it.
         I didn’t think much of it at first, but by the fourth time they gave that answer and no details I was wondering if there was something more to this. (Apparently, judging from the stock’s performance, so does the stock market.) Is there? I have no idea. But I might have approached the issue a bit differently.
         Before I tell you how, go check out a daily stock market chart for Volcom and some of the other publicly companies in our industry. Notice that many of the prices aren’t exactly up. They are kind of unup. Well, actually they are down and it’s hard to put a positive spin on that.
         Is it industry related? Maybe. But the whole stock market has been in a downtrend since early April. Investors Business Daily regularly points out that three out of four stocks follow the market direction. So anybody who might be concerned that any of Volcom’s comments (or lack of comments) with regards to PacSun caused a decline in industry stocks needs to look at the longer-term trend and general market conditions as well.
         If you’re a public company and the analysts think you didn’t quite provide a good answer to a question they think is important, and you reduce your guidance for the coming quarter, your stock goes down. But not, one would think, by 29 percent when you have some good news as well. If I were Volcom, I might have suggested that questions about PacSun’s brand strategy be directed to PacSun.  I might have suggested that if PacSun was going to focus on brands like Levi (and its own brands for that matter—not news) that over time Volcom’s sales to PacSun might, in fact, become less important given Volcom’s distribution strategy, which they characterized (correctly, I think) as cautious. And I would have focused on all the other positive initiatives Volcom highlighted and how they might, over time, reduce the company’s dependence on PacSun.
         If you’re a public company, then you are to some extent a prisoner of the quarterly filing cycle. That’s life. But it seemed to me that a reduction of Volcom sales (at least as a percentage of total sales) to PacSun could be seen as strategically positive if PacSun is changing its brand strategy in a way that’s not consistent with Volcom’s market positioning.
         And (of course) if it’s not too big a reduction. No matter what your strategy is, it’s damn hard to get profit growth without an overall growth in sales.
         Somehow, all the good things Volcom had to say were overshadowed by the implications of the third-quarter decline in sales to PacSun and the possibility that there was more to it than Volcom explained. I just wonder if the question couldn’t have been answered so that the decline in the stock wasn’t so dramatic.
         Unless of course, there was more to it than Volcom explained.