Quiksilver Gets a Letter from an Unhappy Investor

/20 Comments/in , , /by

A reader sent me an article I imagine most of you have already seen, though I haven’t seen it covered in industry media. It tells us that Ryan Drexler of Consac, an owner of 2 million Quiksilver shares, has sent a letter to Quik Chairman Bob McKnight and CEO Andy Mooney stating that the company’s turnaround strategy has failed and that they should look to sell the company. Here’s a link to one of the articles that was published. A simple Google search will lead you to others.

And look what I just found! If you go here and click on the small document in the center of the page, the actual letter will open as a PDF. God, I love the internet.

He says, in part, “The 11-point turnaround plan announced by Andrew Mooney 16 months ago has thus far failed to deliver the desired results and, based on the deterioration in the company’s core brands since that time, has in actuality had a profound detrimental effect on the financial position and operating performance of the company, in my opinion.”

Mr. Drexler is known in some circles as an activist investor, and this isn’t the first company with issues he’s approached this way. There is a certain rhythm/process/ that happens when an investor does this, and the letter reflects it. I am not prepared to say, as Mr. Drexler does, that Quiksilver’s turnaround plan has failed. But I will continue to say what I’ve been saying; there’s a certain conflict between being a public company and Quiksilver maximizing the value of its brands, and the company’s weakening balance sheet limits the time they have to reinvigorate those brands.

The performance of the stock, as Mr. Drexler points out, suggests that he isn’t the only one with concerns. I’ve also become aware that certain of Quicksilver’s European debt is trading at $0.60 on the dollars. Actually, that’s on the Euro. The CUSIP is Z4840DAB6 if you want to check yourself.

I don’t know what’s going to happen, and maybe this is the last we hear from Mr. Drexler. On the other hand, it may be the start of a process. Quiksilver is on a shortening financial leash. At one time, I thought the solution might be to take the company private by doing a tender for the shares, but I no longer think that can happens. Even if you paid $0.00 for the shares, you’d own a company losing money with $900 million in debt and be faced with the same problem current management has.

I guess Quik’s board will have to respond to Mr. Drexler and perhaps we’ll see that response. The company’s next quarterly results are due to be released in early December. I’ll probably have more to say about their options when I see those. I mostly like Quik’s strategy. But I‘m becoming worried that they don’t have the time or money to pull it off.

About a year ago, a reader reminded me, I wrote this article relating some of Quiksilver CEO Andy Mooney’s comments in a conference call to the broader market and conjecturing on what some of Quik’s challenges might be. I don’t think I’d looked at since I posted it (I tend to be really, really, tired of articles by the time they finally make it on my web site), but it seems to have held up pretty well.

Zumiez’s Quarter and Omnichannel Insights

/0 Comments/in , /by

Zumiez reported a 12% increase in revenue for the quarter that ended August 2nd to $177 million from $158 million in the same quarter they last year. Their net income was up 57.3% from $4.74 to $7.46 million. Naturally, with that kind of good result, the stock fell 18.8% the next trading day from $32.4 to $26.31.

I don’t think I’d make it as an analyst on Wall Street. It’s not that I’d only focus on the current quarter’s results. The analysts also had some concerns about the rest of the year and those aren’t unreasonable. But if they took any kind of longer term perspective (which I’m beginning to think isn’t allowed if you’re an analyst) they might have focused on Zumiez’s efforts with the omnichannel stuff a bit more. I’ll get back to that, but first let me do what I always do- the numbers.

Zumiez ended the quarter with 535 stores in the U.S., 33 in Canada and 14 in Europe. They expect to end the year with 18 European stores. The sales increase was the result of having a net of 53 more stores open in this year’s quarter as well as a 3.4% increase in comparable store sales. Remember they include ecommerce in their comparable store sales (as I think they should). Interestingly, the 3.4% increase includes a 22.2% increase in ecommerce and only a 1.4% increase in comparable brick and mortar sales. Total ecommerce sales were 9.6% of total sales ($17 million) compared to 8.8% in last year’s quarter.

North American sales rose 10.1%. European sales were up 57.6% to $9.5 million and represented 5.4% of total sales.

The gross profit margin fell from 34.9% to 34.5% mostly due to a 0.6% decrease in product margin. SG&A expenses rose from $47.3 to $49.3 million. They fell as a percentage of revenues from 30% to 27.9%. 0.70% of the decline was because Zumiez didn’t need to accrue any additional cost for the Blue Tomato earn out.

The balance sheet is in good shape. I would note that for the six months ended August 2, net cash provided by operating activities was $30.5 million compared to $9.9 million in the same six months last year. I like cash.

Okay, now for the fun part. Here’s the first risk factor Zumiez lists. “Our ability to attract customers to our stores depends heavily on the success of the shopping malls in which many of our stores are located; any decrease in customer traffic in those malls could cause our sales to be less than expected.”

I don’t necessarily take risk factors too seriously, but I don’t ignore them either. This one caught my attention because it was listed first, I didn’t recall seeing it before, I posted something about the future of malls recently, and I think the trends in malls have a strong relationship to the evolution of a retailer’s omnichannel strategy. Or maybe I mean that omnichannel strategies are causing some of those trends.

It’s all kind of a big mish mash of trends, possibilities, experiments, false starts, new ideas, and unexpected relationships. I don’t know the answer. Neither does Zumiez. But they do seem to know they are stuck with it and are working hard to find out what works and what doesn’t.

Let me quote CEO Rick Brooks a few times. Please keep being quotable Rick. I love it when I can write these things by cutting and pasting.

“…we view really what we are doing- the integration of building a channeless retail experience for our customers- as a never ending job because the customers are in charge, they are the ones that have the power in today’s world because of smart technology, we need to go where they want to go, however they want to do it, we’re going to be there to serve them and we don’t know exactly what that’s going to look like again. I tend to think with their early stages of this transition not the latter stages.”

“So we’re going to try all sorts of things, we’re going to measure what happens when we close stores and markets, what happens to the integrated omnichannel business. Well we already know it’s a huge list when we open stores in markets. But so we’re going to continue and to really experiment with these ideas and measure where we’re going to be.”

“As we continue to expand our omnichannel capabilities and bring our highly differentiated and lifestyle relevant product and perspective to the marketplace, we believe that we can maintain strong merchandise margins through full price selling.”

“We also strongly believe that the enhanced connection with our consumers that is enabled by heightened omnichannel presence will be a key point of differentiation in the rapidly evolving retail landscape.”

I’ve written a few times that the biggest risk was taking no risk at all, and I’m guessing Zumiez’s management team would buy into that. They don’t know how this all going to work, but they know it’s happening and if they aren’t part of it, they will not prosper.

I’ve quoted CEO Brooks enough, but also interesting was his discussions about opening (or closing) stores. The goal is not to open stores. It’s to have the right kind and size of stores in the right place supported with the correct omnichannel presence and activities. Whatever you do with stores, you do it to meet a customer requirement. Maybe there are some places where you would have opened stores in the past, but now you won’t and not opening will be net positive for your bottom line.

If I could get Mr. Brooks and members of his team in a bar and get a few drinks into them, I’d love to find out how their organizational structure is evolving in response to the omnichannel and retail evolution. To me, it seems like every function is connected to and influenced by every other function in ways they haven’t been before. At least for me (a closet organizational dynamics junkie) this is going to be fun.

You can see where a strong balance sheet comes in. Whether you’re a brand or a retailer, you need to be paying attention. You’re going to spend some money on things that aren’t going to work, but that has to be okay.

Quik’s July 31 Quarter: Restructuring Results Slow to Appear.

/22 Comments/in , /by

You know, maybe it’s a delusion, but an awful lot of corporate reports for the companies I follow are starting to sound the same. I need to read something else. Most of them say some variation of we’re trying to figure out how to integrate brick and mortar with online, sales growth is hard to come by, we’re rationalizing expenses and improving efficiencies, we’re reducing SKUs, we’re improving systems to get the right inventory to the right place at the right time, we have some constraints caused by our balance sheet, the U.S. market is especially tough, we’re pinning our hopes on Asia/Pacific, we’re trying to improve product, we’re focused on building our brands and managing our distribution, and the market is very promotional.

I think that covers it, and now I have to somehow relate that introduction back to Quiksilver. I guess I can do that by saying they are dealing with most of these issues.

Sales for the quarter ended July 31, 2014 fell 18.9% from $488 million in last year’s quarter to $396 million. Sales declines in the Americas, EMEA and APAC respectively were 26.8%, 12.8% and 1.8%.

The gross profit margin was down from 49.1% to 47.8%. The Americas gross margin fell from 41.9% to 40.2%. In EMEA it went down from 58.4% to 55.6%. In APAC it rose from 51.4% to 56.8%. The decline in gross margin “…was primarily due to increased discounting in the wholesale channels of North America and Europe (320 basis points), partially offset by net revenue growth from our higher margin direct-to-consumer channels (160 basis points).”

SG&A expenses were down just 1% from $215 to $213 million, but as a percentage of sales they were up mightily, from 44% to 53.8%. They reduced athlete and event spending by $5 million, but had a gain on the sale of a building of $5 million. Employee compensation fell $4 million because they didn’t have the severance costs they had last year. They spent an additional $5 million on marketing other than athletes and events, had $3 million more in bad debt expense and $2 million in higher depreciation.

Operating profit went from a positive $23 million to a loss of $206 million. However, that includes noncash goodwill impairment related to European assets of $182 million. Remember, however, that even though it’s noncash, it’s indicative of lower expected future cash flows from the assets being written down.

Ignoring all the noncash charges in this year and last year’s quarter, operating income fell from a positive $25 million to a negative $24 million, so it’s hardly good news. Interest expense was about $19 million compared to $20 million last year. There was a bottom line net loss (including the write down) of $222 million compared to a profit of $1.8 million last year.

Here’s the chart from the 10-Q that lays it all out for you by segment. You can see the 10-Q here if you want, though I doubt anybody ever goes to look. The Americas segment is just what you’d think it is and most of its revenue comes from the U.S., Canada, Brazil and Mexica. EMEA is Europe, the Middle East and Africa, but mostly the revenue is from Great Britain, continental Europe, Russia and South Africa. APAC (Asia and the Pacific Rim) is mostly Australia, Japan, New Zealand, South Korea Taiwan and Indonesia. Notice how China does not make the top six yet.

Untitled

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Quiksilver, by the way, ended the quarter with 658 company owned stores. They are on pace to open a net of 60 new stores by the end of this fiscal year.

Please note that APAC’s operating income rose $3 million on a small decline in sales. Ain’t nothing like raising that gross margin.

In the Americas, “This net revenue decrease was primarily due to lower net revenues from our DC brand in the wholesale channel of $47 million driven by reduced clearance sales, narrowed product distribution to mid-tier wholesale customers, and the licensing of DC children’s apparel. In addition, net revenues decreased in the Quiksilver and Roxy brands by $14 million and $7 million, respectively, in the wholesale channel due to licensing of Quiksilver children’s apparel, lower customer demand, and less effective order fulfillment compared to the prior year. Americas segment net revenues decreased 28% in the developed markets of North America, but increased 9% on a combined basis in the emerging markets of Brazil and Mexico.”

The licensed kids business was responsible for $11 million, or 16% of the decline in the North America wholesale business.

I want you to specifically note that they are pulling back DC’s distribution with the goal of strengthening the brand. It’s about time. In this case at least, they are giving up some sales in a good cause.

There isn’t much good news about revenues in AMEA. The decline is “…due to lower revenues in the wholesale channel across all three brands driven by lower customer demand as a result of poor prior season’s sell through, and less effective order fulfillment compared to the prior year. These decreases were partially offset by double-digit percentage growth in the e-commerce channel … ”

Lower demand, poor sell through, and troubles with order fulfillment is quite a triple whammy.

In APAC, wholesale revenues were down but that was offset by growth in retail and e-commerce.

Here’s revenue for the quarter by brand.

smallchart1

 

 

 

 

 

 

The decline in the Quiksilver brand “…was primarily due to reduced net revenues in the Americas and EMEA wholesale channels of approximately $14 million and $15 million, respectively. A portion of the decrease in Quiksilver brand net revenues ($6 million) was due to the licensing of children’s apparel.

The Roxy decline “…was primarily due to lower net revenues in the Americas and EMEA wholesale channels of approximately $7 million each, partially offset by increased revenues in the e-commerce and retail channels.” Roxy was not licensed for children’s apparel.

DC’s decrease in revenue “…was primarily driven by lower net revenues in the Americas and EMEA wholesale channels of $48 million and $10 million, respectively. The Americas net revenue decrease was driven by reduced clearance sales, narrowed product distribution to mid-tier wholesale customers, and the licensing of DC children’s apparel.” They also reported successfully launching DC’s offering in “accessibly priced canvas footwear market,” and expect a positive impact going forward.

So it seems we can conclude that wholesale in the Americas and EMEA kind of sucks. You can see the problem in this chart showing sales by channel.

smallchart2

 

 

 

 

 

I’d like to point out the relative contribution to revenue of wholesale compared to retail and e-commerce. There were gains totaling $7 million in retail and e-commerce and a decline of $100 million in wholesale. E-commerce revenues were down 9% in the Americas by the way. Global comparative store sales were up 1% during the quarter. So when Quik talks about retail and e-commerce offsetting wholesale, it’s not much of an offset overall.

Looking at the balance sheet, you’ve got a current ratio that improved from 1.73 a year ago to 2.46 as of July 31. Long term debt is up slightly from $808 to $812 million. Total liabilities to equity have vaulted from 2.97 to 10.6 times. Liabilities fell significantly from $1.64 to $1.2 billion, but equity was down from $553 to $114 million.

Quiksilver notes that they are updating their profit improvement plan “…based upon recent difficulties within the wholesale channels of our Americas and EMEA segments. As part of updating our PIP, we will establish additional SG&A reduction objectives and allocate capital to our emerging markets, e-commerce and retail channel growth plans.” So more expense cuts to come.

In a short section on page 29 of the 10-Q called “Known or Anticipated Trends,” Quik gives us a look at what the future looks like. Over the next few quarters they expect net revenue comparisons will be “unfavorable.” That means they will be lower when compared against the previous year’s quarter. For the year they expect them to be “unfavorable” in North America and Europe wholesale but favorable in emerging markets and e-commerce. Didn’t say anything about retail.

“Unfavorable” is such a benign sounding word for such an unfortunate result, speaking of benign words.

They also tell us that the adjusted EBITDA for the year that ends October 31 will be lower than for the previous year. I tend to believe that if the adjusted figure is worse, the as reported will be even worse. Maybe I should have said “unfavorable.”

There’s a lot going on. Some of the things I think Quik is doing right have caused what I hope are short term difficulties. Reducing DC’s distribution is absolutely critical to the brand’s success, but in the short term costs revenue. They’ve stopped or at least reduced discounting on their web sites. Again, a possible short term revenue hit, but good for the brands. Just as a guess, I expect core shops to like that.

In the conference call, CEO Andy Mooney announced, as part of their positive accomplishments, that “…we moved a large number of small independent accounts to a B@B service model.” I understand the financial rationale for doing that, but I have reason to believe you shouldn’t expect those accounts to see it as positive.

And literally as I write this, I got an email telling me that Quik is reorganizing its marketing function to help give it a better connection to the core.

They also decided not to order any products in quantities below production minimums because of the additional cost. That eliminated some orders, but helps gross margin. Some late deliveries were the result of changing from regional to global demand planning, but it’s a good thing to do anyway.

There was also some discussion about the previously announced program to selectively reduce prices. They don’t expect it to reduce margins given the other efforts they’ve taken to reduce SKUs and rationalize production.

Quik is making changes in every facet of their operations. That some of them didn’t quite go according to schedule isn’t a surprise. I just heard from a client that they’ve got a container held up in customs because of an “invasive moth.” God, you just can’t make this stuff up and to some extent it happens to every company every year.

But Quiksilver doesn’t have the luxury of time. Its brand building (rebuilding?) has to be successful sooner rather than later. Its balance sheet can’t continue to deteriorate, but it sounds like we can expect further losses in the next few quarters. For all the things I think they are doing right, there’s a time limit here that’s gotten shorter as a result of a couple of tough quarters.

The Issue Continues to be Competitive Positioning: PacSun’s Quarter

/0 Comments/in , /by

Back in its glory days, PacSun was a destination for its young customers and expanded to around 900 stores. It lost its way for reasons that included too much growth and overexposure, unattractive stores, problems getting the right product to the right stores at the right time, thoughtful, better positioned competitors, and a weak economy.

I remember Gary Schoenfeld, in his first earnings conference call as CEO, saying something like, “Nobody needs 900 PacSun stores.” By the end of this year’s August 3rd quarter, the company was down to 618 stores. During his tenure, Gary has improved the executive team and in process turned it almost completely over, worked to better merchandise the stores, and invested in systems to get the right product to the right stores at the right time. Well, the list is longer than that, but basically Gary and his team are doing the things a CEO of a large retail chain should be doing.

But the really hard thing here is the competitive positioning issue. When you’ve lost your target customers’ attention- their commitment to come to your store or buy from you on line- how do you get it back in a weak economy that’s over retailed and offers the customer endless alternatives?

Part of PacSun’s answer to trying to reengage its “teen and young adult” target customers is its Golden State of Mind campaign, which I like a lot. My liking it, of course, is irrelevant. I’m a few decades removed from being the target customer, and get strange looks when I walk in a PacSun store. But they’ve put a stake in the ground. They’ve identified what they think is a point of differentiation and are trying to make it work. Good. Here’s how CEO Schoenfeld put it in the conference call.

“We remain keenly focused on differentiating and elevating PacSun through the best branded assortment and specialty retail, continuously elevating our merchandising mix to appeal to our trend and style savvy 17 to 24 year old guys and girls and connecting our customers to the creativity, diversity and as I like to say, the optimism that is so uniquely California lifestyle and synonymous with PacSun.”

As we review PacSun’s numbers, and their discussion of those results, don’t get distracted from the issue of competitive positioning. They can do everything else right but if ultimately they can’t distinguish themselves from their many competitors in a way that makes their target customers want to buy from them, it won’t matter. Just like for every business.

Revenue rose slightly from the same quarter last year from $210 to $211 million. Comparable store sales were up 0.3%. The average sales transaction was up 7%, but the total number of transactions fell by 6%;

The gross margin fell from 29.8% to 29.1%. Remember the gross margin is after buying, distribution and occupancy costs. The merchandise margin fell from 53% to 52.3%

Selling, general and administrative expenses rose from $56.7 to $60.6 million. As a percentage of sales, they increased from 27.0% to 28.6%. 0.8% of that increase is the result of marketing costs that happened earlier than expected. The other 0.8% results from “…consulting costs supporting long-term strategies and store impairment charges, partially offset by a decrease in store payroll and payroll-related expenses.”

This left PacSun with an operating income that fell from $5.9 million to $1 million.

The next item on the income statement is the “(Gain) loss on derivative liability” we get to discuss every quarter. This relates to 1,000 shares of convertible preferred stock PacSun issued to Golden Gate Capital as part of getting a $60 million term loan. The value moves around a lot every quarter and impacts the income statement. In last year’s quarter, it was a loss of $21.2 million. For this year’s quarter, it’s a gain of $10.4 million. That’s a $31.6 million difference from last year to this year.

The bottom line impact is that PacSun showed a $19.2 million loss in last year’s quarter and a profit of $7.5 million in this year’s. Obviously, the big change in the value of the derivative liability distorts that, and will in future quarters. I recommend you look at the change in operating income when you consider how PacSun is doing.

On the balance sheet, the current ratio improved slightly from 1.05 to 1.12. Total liabilities to equity deteriorated from 13.89 to 18.29 times. However, once again we’ve got to point out that derivative liability which is carried as a current liability. It was $50.5 million at the end of last year’s quarter and is down to $19.1 million at August 2nd this year. If that didn’t exist, the current ratio would have declined from 1.47 to 1.28. We learn in the conference call that inventory on a comparable store basis was down 5%.

I want to highlight something they say about operating cash flows. “Net cash provided by operating activities in the first half of fiscal 2014 was $1.1 million, compared to $17.1 million of cash used for the first half of fiscal 2013. This increase of $18.2 million was due primarily to increases in accounts payable and other current liabilities.” One interpretation would be that they are paying their bills a little more slowly. That’s not necessarily a bad thing, as we former cash managers can tell you.

CEO Schoenfeld also notes in the conference call that the overall market is very competitive and specifically points to denim as “…not a very fun business to be in right now.” I think we all know that.

He also makes an interesting comment about how PacSun had, in the last couple of years, moved its non-apparel women’s business “…to a more private label and trying to compete on price with some of the more aggressive fast fashion retailers.” He makes it clear that didn’t work, and they are once again focused on who PacSun is and what it stands for.

That’s where they have to be focused. As I indicated, I like the Golden State of Mind positioning concept, but as they’ve moved into the different competitive environment of the broader fashion business I am waiting to see how that resonates.

Globe’s Results for the Year: Poor Bottom Line, But Operating Progress

/0 Comments/in /by

While I was buried under Billabong’s annual report, Globe also filed theirs for the year ended June 30. Globes proprietary brands, in case you don’t remember, include Globe, Callaz, Dwindle, Enjoi, Blind, Almost, Cliché, Darkstar, Tensor, Speed Demons, Dusters, and FXD. Its licensed brands include Stussy and Vision Streetwear.

 
For the year, Globe’s revenues rose 24% from $84.1 million to $104 million (all numbers in Australian dollars). In spite of the sales gain, they reported a loss that more than doubled, rising from $6 to $12.3 million. However, the operating loss showed a much better result.
 
The cause of the bottom line loss was a $17.1 million noncash impairment charge by which they wrote down the value of the Globe brand on their balance sheet to $0.00. After tax, the charge was $12.8 million. Without this charge, Globe would have reported net income of $0.5 million compared to a loss of $5.2 million the previous year.
 
As regular readers know, I feel strongly both ways about these kinds of write downs. On the one hand, they are noncash, and there is a rigorous, required process you have to go through to determine the write down which doesn’t necessarily relate to actual brand value. That’s obviously true since they’ve written the Globe brand down to nothing, but it’s selling product and has value.
 
On the other hand, they’ve got to do it because the expected future cash flows from the brand aren’t as promising as they once thought they were. It’s not, therefore, something you can just ignore.
 
My ambivalence is apparently shared by Globe’s Board of Directors. They say, on the one hand, that the charge is not “…reflective of the directors’ long term view of the potential of the Globe brand.”
 
On the other hand, they say, “The impairment charge is largely a result of the significant changes that have impacted the action sports industry, and its key brands, over the past few years. This has been driven by a range of factors including difficult broader economic conditions, challenges for the Action Sports retail account base and the saturation of some of the more iconic action sports brands. As a result, the performance of the Globe brand has been affected and the market for buying and selling brands in the industry has declined. “
 
So if it’s worth more than nothing, it’s sure as hell not worth as much as it used to be. I wonder what the directors’ definition of “long term” is.
 
Ignoring the $17.1 million charge, Globe management tells us the company’s “…sales and profitability improvement came from multiple sources across the consolidated entity as a consequence of the investment and diversification into new markets and brands over recent years.” They’re right as far as I can tell.
 
The Australian segment revenues were up 42.3% from $26.6 to $37.9 million. That’s growth of $11.30 million. However, revenues in the country of Australia grew $12.1 million, so revenue in the rest of the segment declined.  The overall segment growth “…was driven by the 4-Front street wear division, due mainly to the introduction of Stussy, and the continued growth of F.X.D., the Group’s proprietary work-wear brand.”
 
Revenue in Europe rose 46.7% as “…the Globe brand continued to grow across all categories of footwear, apparel and skate hard goods…”
 
At $39.5 million, revenue in North America was basically the same as the previous year. “In North America, despite growth in skate hardgoods and Globe apparel, sales were down by 9% for the full year in constant currency, following last year’s restructure which resulted in certain operations being discontinued within the Dwindle division.”
 
However, revenue from the United States fell 15% from $24.5 to $20.8 million.
 
The EBITDA loss in North America improved from $3.1 million in 2013 to a loss of $1.03 million in 2014. Australia’s EBITDA improved from $1.4 to $3.3 million. In Europe, it rose from a loss of $7,000 last year to an EBITDA profit of $3.6 million this year. 
 
For the whole company, segment EBITDA improved from a loss of $1.8 million to a profit of $5.9 million. After corporate expenses, the overall company EBITDA improved from a loss of $4.7 million to a profit of $2.4 million.   
 
Globe’s operating improvement was also driven by an increase in the gross margin from 44.1% to 46.4%. Selling and administrative expenses rose from $26.4 to $28.5 million. As a percentage of revenue they declined from 31.3% to 27.5%. We get no discussion of either the gross margin or the specifics of the expenses.
 
The balance sheet has arguably weakened a bit, with the current ratio declining from 2.33 to 1.89. Total liabilities to equity rose from 0.51 to 0.91. Cash has increased, and growth in receivables and inventory of 18.5% and 23.8%, respectively, seem in line with sales growth. On the liability side, I would note that trade and other payables rose 47.7% from $13.5 to $20 million and there’s $1.5 in borrowing where there was none last year.
 
My sense is that there are some significant changes in revenue by brand going on at Globe. I can’t really get a handle on it from the very limited information in the filed report. Whatever’s going on, revenue and gross margin are both up nicely. The intangible write down killed the bottom line, and it looks like the U.S. market is a challenge (not just for Globe). But overall, there are some positive things happening, though profitability has to improve.

 

 

Billabong’s Annual Results: Progress on a Long Road

/2 Comments/in , /by

As I recall, the report I wrote on Billabong last year broke the 4,000 word barrier. I’m probably the only person who read the whole thing. But there was chaos and uncertainty last year and it seemed necessary to explain everything that was going on. 

As of this year’s end at June 30, there’s still chaos and uncertainty, but the chaos is more positive in the sense that it’s self-generated as Billabong’s new management team restructures pretty much every function and activity in the company in pursuit of a more efficient and competitive organization. The uncertainty is around how quickly they can get it done and just what the impact will be.
 
Before we get started, here’s the link to Billabong’s investor relations page.   Under “Featured Report” you can view, from top to bottom, the financial report, the presentation CEO Neil Fiske used to explain the results, and the press release. I’d suggest ignoring the press release. A little further down under “Upcoming Events” is the link for the August 28 earnings presentation, where you can listen to CEO Fiske discuss the results.
 
My suggestion is that you go review Neil Fiske’s presentation. It’s the best summary of what’s going on.
 
Normally, this is where I’d leap into the income statement results. We’ll get to that. But because so much is going on, and so much change is happening I am, bluntly, less concerned about the income statement than I’d normally be. I’ll start by highlighting some things Billabong has to do well if the turnaround is going to work. All numbers are in Australian dollars.
 
Success Factors
 
Let’s head directly to the balance sheet. Last year at June 30, with issues of unhappy lenders and liquidity problems highlighted by a “Wow, am I glad I wasn’t the CFO” current ratio of 1.02, Billabong wasn’t likely to be a going concern without a restructuring. As we know, they got the restructuring done. At June 30, 2014, there’s an imminently manageable current ratio of 2.2. Receivables and inventories are down significantly (due to the sale of West49 and Dakine, closing of 41 stores, and writing down and liquidating some inventory) with total current assets reduced by 20.4% to $496 million. Cash is $145 million compared to $114 million a year ago.
 
Current liabilities are down 63% from $612 to $225 million. Non-current borrowings, however, are up from $6 to $212 million as a result of the restructuring. Overall, total liabilities are down 30%. Total liabilities to equity has improved from 2.27 to 1.90 times.
 
Even with the improvement in the balance sheet, CEO Fiske tell us that market and branding programs, as well as the new management team, will be funded from efficiencies and expense reductions in other areas. They don’t really have a choice. Billabong is financially out of the hospital, but not yet ready to run a balance sheet fueled triathlon.
 
Cash generated by operating activities was a negative $77 million compared to a positive $12 million in the previous year. Most of this, we’re told, was due to refinancing and restructuring costs.
 
Second, and maybe it should be first, let’s talk about the quality and potential of brands. Billabong is placing its bets on the Billabong, RVCA, and Element brands. Of the Billabong stable of brands, these are clearly the three that offer the volume and/or growth potential the company needs. That they’d focus on them is unsurprising (Billabong’s other brands are Kustom, Palmers, Honolua, Ecel, Tigerlily, Sector 9 and Von Zipper).
 
Neil Fiske’s predecessor, Launa Inman, spent something like $1 million on consulting to find out what the brands stood for and where to position them. We never heard much about the results of that work. Let’s hope it’s given CEO Fiske some useful information.
 
These three brands already have a market position and stand for something with their existing customers. The challenge for older, established brands in our industry is to keep their existing customers as they age while also appealing to new ones. This is the time, when the public markets will be a bit patient if only because they recognize they have no choice, when Billabong can clean up its inventory and distribution even at the short term cost of some sales, and they are doing that. At the highest strategic level, every step the company is taking is about solidifying and building these brands.
 
Management is a big issue, and it sounds like there’s progress there. There’s a new executive leadership team in place, and below that level we’re told there have been 63 key hires or internal promotions. Some of the senior team has come on board within the last 100 days.
 
It speaks well of Neil Fiske and the company’s prospects that he’s been able to get so many apparently highly qualified executives on board so quickly. There are global heads in place for each of Billabong, RVCA, and Element.
 
You know that Surf Stitch and Swell were sold after June 30, with the deal to close shortly. Other owned brands are being evaluated for their potential. He didn’t quite come right out and say it, but it was pretty clear that brands not pulling their weight will be sold.
 
My guess is we’ll see some additional brands sold. It would be consistent with the “bigger, better, fewer” approach to its business Billabong has enunciated as well as its continuing, if lessened, financial constraints.
 
Next, they’ve got to fix North America. CEO Fiske was direct in describing the problems in North America. He noted that the corporate and leadership turnover hit the region hard and that the impact would be with the company a while longer. He further stated that it has suffered from a lack of good inventory management, poor buying decisions, and a historic tendency to overbuy inventory.
 
When we review the numbers, you’ll see the impact clearly.
 
Let’s not forget all the critical operational stuff that has the potential to generate many millions of dollars in incremental cash flow. SKUs are already down 20% with, I suspect, further reductions to come. They are rationalizing their supply chain and expect over some years to capture $20 to $30 million in incremental profit. Like most companies, they are working to get the right product to the right markets faster and are coordinating that effort with their marketing and merchandising.
 
What I just blithely said in two sentences is a monster project that touches every part of the company. It will be- it already is- messy, complex, and full of surprises. If it wasn’t I’d be worried they weren’t doing enough of the right things fast enough. Not to overdramatize, but Billabong is basically rebuilding itself for the modern world. It will take a while, and will really never be completely done because the market will keep changing.   But it has to happen.
 
Yeah, maybe I did overdramatize.
 
By the Numbers
 
This is complicated. That’s because there’s been a lot going on over the last year. The on again, off again, finally closed deal costs, the restructuring costs, and the write downs made financial comparisons a bit difficult. Billabong has tried to help by providing a breakdown of all these costs and financial statements with them excluded.
 
I hate the way companies exclude so called extraordinary or nonrecurring items, because there seem to be some new ones every year. But in this case, the numbers are so big I mostly think it’s a good thing to do. I’m going to work almost exclusively from the statutory report.   We’ll start with the numbers required to be reported, and then break out all the hopefully one-time items that Billabong calls “significant costs.”
 
As reported, revenue from continuing operations rose 1.6% from $1.107 to $1.125 billion. The gross profit margin slipped a bit from 51.1% to 50.6%, but that’s not surprising given the cleaning up going on. I’m glad it wasn’t more.
 
The loss before taxes and discontinued operations fell from $654 million to $167 million. But almost all that improvement was in the Other Expense category, which fell from $748 million to $167 million. Last year, remember, was the year of the huge noncash write downs for goodwill and brand value.
 
Interest expense, to nobody’s surprise, rose from $12.4 to $34.2 million “…driven primarily by the new financing arrangements…”
 
Believe it or not, income tax expense was $75 million, up from $30 million last year. Yes, I know- losing money but paying taxes seems odd. But lots of deals and lots of restructuring can make it happen. Feel free to read all the fine print about it you’d like.
 
After tax loss from discontinued operations was down to $30 million from $179 million last year. The discontinued operations include Dakine and West 49 which were sold during the year, and the interest in Nixon which was restructured.   That leaves a bottom line loss of $240 million compared to $863 million in the prior year.
 
Okay, let the fun begin. Below are the segment revenues and EBITDAIs for both years as reported. These numbers include discontinued operations and the significant items.
 
 
Europe isn’t exactly a thing of beauty, but at least the loss declined some even as revenues fell. You can see the biggest problem by far is in the Americas. If you’re interested, revenue from discontinued operations was $238 million last year and $98 million in fiscal 2014. In his discussions of the Americas, CEO Fiske refers to Billabong’s forward orders growing and RVCA “reaccelerating.” About Element he says “…rebuilding underway.”
 
Now, here’s EBITDAIs by segment excluding first the significant items and then those items and discontinued operations.
 
 
You can see that the EBITDAI goes from a loss of $52.3 million as reported to a gain of $52.5 million. Take a moment to compare the third column in the first chart with the second column in the second chart.
 
They also provide the chart above in constant currency. But the results aren’t different enough for me to feel like I need to inflict it on you.
 
2014’s reported loss of $240 million becomes a net loss of only $14.4 million with all that stuff excluded. The 2013 loss of $863 million becomes a gain of $7.7 million. Those are pretty significant differences.
 
I want to say just a few words about what’s in those significant items. For those of you who really want the details, it’s all laid out starting on page 98 of the statutory financial report. I don’t think Billabong has to worry about its servers crashing as people flock to check it out.
 
Significant items from continuing operations totaled $116 million in 2014 compared to $669 million last year. The decline is mostly the result of the write off of goodwill, brands, and other intangibles falling from $440 million last year to $29 million this year.
 
You may remember my ranting from last year as I looked at these items. Some of them I can understand excluding, but in other cases the argument seems weak.
 
The poster child for ones I don’t think they should do this with is “Net realizable value shortfall expense on inventory realized.” They wrote off some bad inventory. It was “only”$14 million this year compared to $23 million last year.   I know it was a different management team, and you really, really promise not to do it again, but I guarantee you will have some inventory write downs this year.
 
What bothers me is not that they do this- I think it can have value in representing the company- but the apparent discretion management has to decide how much of it they do.   This is why I strive to pay the most attention to as reported numbers.
 
There are three things you should focus on as you evaluate Billabong going forward; the balance sheet, brand strength, and gross margin. The balance sheet will help you figure out if the company will have the financial strength to do what it needs to do.  Brand strength is, at the end of the day, the one thing they can’t get along without. Improving gross margin will tell us that the operational changes they are making are having an impact.
 
I like the plan. Now all they have to do is do it.

 

 

Thoughts on the Omnichannel; Decker’s June 30 Results and Sanuk’s Impact

/0 Comments/in , /by

Deckers is mostly of interest to us because of their ownership of Sanuk. We’ll talk about how Sanuk is doing. But Deckers management say some interesting, perhaps even insightful, things about online business and the omnichannel and I want to focus on those as well. Let’s start by getting some of the numbers out of the way. 

In a quarter that Deckers management describes as being historically their weakest, the company had a sales gain of 24.1%, with sales rising to $211 million from $170 million in the same quarter last year. “The increase in overall net sales was primarily due to an increase in our UGG brand sales through our wholesale channel and retail stores as well as an increase in our Teva brand wholesale sales,” says the 10Q.
 
But Tom George, the CFO, tells us in the conference call, that “Nearly half the upside revenue was attributed to the timing of wholesale and distributor sales and the other half with some higher than expected sales. The higher than expected sales contributed approximately $0.05 to the EPS while the other $0.21 was due to the timing of sales and operating expenses.”
 
So half of the revenue increase was just timing differences that don’t change their estimate of total revenue for the year. That is, the revenue was booked in the June 30 quarter instead of the September 30 quarter. But the other half of the revenue increase is from higher than expected sales.
 
In spite of that sales gain, the net loss rose from $29.3 to $37 million. How’d that happen?
 
There was a very minor decline in the gross margin from 41.1% to 41.0%. Gross profit basically rose with sales from $69.8 to $86.8 million. I guess that’s not it.
 
Ah, here we go. Selling, general and administrative expenses were up 21.9% from $112.6 to $137.3 million. That increase included $11 million for opening 37 new stores (they’ve got 126 stores worldwide), $4 million for marketing and promotions related to the UGG and Hoka brands, $3 million for “information technology costs,” and $3 million for ecommerce. As a percentage of sales, it fell from 66.2% to 64.9%.
 
Sanuk’s wholesale revenues were $32.3 million, up 16.4% from $27.8 million in last year’s quarter. That represented 21% of Decker’s total whole sale business of $154 million in the quarter. UGG was $74 million and Teva, $35.6 million at wholesale. Deckers tells us that “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 a shift in product mix.” They gained $7 million in revenue in higher volume but lost $2 million due to lower selling prices.
 
Sanuk’s total sales for the quarter were $36 million, up 19.6% from $30.1 million a year ago. That includes ecommerce sales of $2.71 million up from $2.09 million in last year’s quarter and sales in Decker’s retail stores of $243,000, up from $22,000.  We’re told in the conference call by President and CEO Angel Martinez that, “Sanuk had a strong quarter due in large part to the continued success of women’s sandals, most notably the Yoga Sling Series.” The brand is also being expanded into “…the broader selection of casual shoes and boots that can be comfortably worn during colder weather.”
 
He talks further about this in response to an analyst’s question. “…when we acquired that brand, the brand really was 70% men’s, 30% women’s. It was primarily distributed in surf shops and actions sports distribution. And we knew that the gender profile of the brand would need to alter significantly, if we would to have any hope of selling product in department stores for examples. So one of the things we are seeing with Sanuk is a major transition to a much more compelling women’s product offering.”
 
Even though its revenues are the smallest of Decker’s three biggest brands, Sanuk’s operating income, at $6.9 million, was larger than that of either UGG or Teva which, respectively, had operating income of $2.7 million and $4.8 million. That’s an operating profit margin of 21.4% for Sanuk compared to 13.4% for Teva and 3.6% for UGG.
 
In what can only be acknowledged to be a blinding glimpse of the obvious, I’d say Deckers needs to get that operating margin for UGG up. I suppose they are as the UGG brand had an operating loss of $510,000 in last year’s quarter. Decker’s marketing spend has increased from 5% to 6% of sales, with the majority “…being directed towards the UGG brand with the incremental dollars going towards the combination of digital programs and tactics aimed at broadening brand awareness and driving traffic to our direct-to-consumer channel.”
 
We’re also told that, “The increase in income from operations of Sanuk brand wholesale was primarily the result of the increase in net sales offset by a 5.1 percentage point decrease in gross margin as well as increased operating expenses of approximately $500. The decrease in gross margin was primarily due to a shift in sales mix as well as an increased impact from closeout sales.”
 
As you recall, when Deckers acquired Sanuk In July of 2011, there were some big contingent payments required. The last year of the earn out is calendar year 2015 and that earn out will be 40% of Sanuk’s gross profit. Deckers has a long term contingent liability of $28 million booked for that. There was an earn out due and paid in 2013 (I think it was less than 40%- maybe 35%), but there is none due in 2013. 
 
Meanwhile, Deckers ecommerce revenue rose from $10.7 million to $15.4 million. But operating income for that segment fell from $1.7 million to $809,000. Retail store revenues rose 29.4% from $32.5 to $42.0 million but the operating loss on those retail operations climbed from $9.8 million in last year’s quarter to $15.9 million.
 
The balance sheet remains in pretty good shape, though current ratio has declined just slightly and total liabilities to equity is up a bit compared to year ago. I’d note that they managed to reduce their inventory very slightly even as sales rose even while bringing some $17 million in product in early due to concern about a West Coast port strike.   Cash is up a bunch from $49.1 to $158 million.
 
Given the increase in cash, I find it interesting that after the June 30 balance sheet date, they took a mortgage on their corporate headquarters for $33.9 million. They expect to use those proceeds “…for working capital and other general corporate purposes.” I’m not clear why they did that.
 
Okay, on to interesting omnichannel stuff. 
 
Dave Powers, Decker’s President, Omni-Channel, tells us that total direct to consumer (DTC) was up 33% in the quarter compared to the same quarter last year.   But that includes 37 new retail stores and, as we’ve already noted, the loss from their retail stores was larger than in last year’s quarter.
 
Comparable DTC sales were up 10%, but that included a 39% increase in e-commerce sales and a “…low single-digit comparable store sales decline.”
 
As I’ve discussed a few times before, the holy grail of e-commerce is when the brick and mortar and online activities support each other. The sum has to be bigger than the parts or the rather significant investment in omnichannel activities just doesn’t make sense. Right now, we see Decker’s brick and mortar comparable store sales down, while e-commerce is up. How do you know when your e-commerce isn’t cannibalizing your brick and mortar?
 
Deckers knows this is important. Dave Powers says, “We now know that brick-and-mortar locations fuel e-ecommerce and vice versa. And we believe that a portion of our e-commerce growth is fueled by our increasing store base. We see the internet UGG program and similar omni-channel initiatives providing increased contribution to overall DTC comps going forward as we further tie our stores and website.”
 
He goes on, “The key next step of our omni-channel evolution will be the opening of a smaller concept omni-channel store in Tysons Galleria this fall. That will feature new in-store web technology such as interactive displays and the ability to reserve online and pickup in-store.”
President and CEO Angel Martinez notes that their average cost to build out stores is down 30%. He doesn’t attribute that all to smaller stores and omni-channel related stuff, but I imagine it’s had some impact. In another comment, he notes that stores may no longer need the back room. Obviously, that’s omnichannel related and has implications for further reducing real estate costs.
 
The devil, as always, is in the details, and here are a few of those. They are rolling out something they call Infinite UGG which “…gives us the ability to offer our retail customers every skew available from the UGG brand to our in-store POS system…Our UGG by You customization program will include additional files and design details for the consumers to choose from such as the popular daily bow and daily button…we’re also extending retail inventory online or RIO, a new tool launched this past spring in select stores in North America and EMEA advance of the fall and holiday selling season. RIO provides customers with visibility into store inventory, helping them to efficiently locate the product they want prior to visiting the store.”
From what I know, this isn’t unique to Deckers, but it certainly feels to me that they are doing the right things. CEO Martinez talks about this from a more strategic perspective.
 
“…just a few short years ago we were a wholesale vendor that delivered product twice a year and our success was largely driven by how well buyers, wholesale buyers responded to our collections at industry tradeshows. The consumer had very little influence in shaping our future direction. This dynamic has been turned completely upside down. The consumer is now the gatekeeper and we’ve transformed our business model to not only adapt to the new retail paradigm but also to thrive and to grow.”
 
“We now drop product more than 10 times a year and communicate with consumers on a much more frequent and personal basis. This constant flow of information is reshaping our growth strategies including our product development and store expansion plans, as we now have much better insight into pinpointing demand and directing capital towards what we believe will be high return, high productivity locations.”
 
Dave Powers adds to this when responding to an analyst’s question:
 
“So we’re starting to think about the stores as not just the store in a four-wall P&L but a store that impacts the overall macro environment of our brand in that metro area. The inverse of that is that we have the ability now through analytics and increasingly CRM and loyalty programs through e-commerce to better target customers in those metro areas we know where they are. And we can send them through merchandising and marketing initiatives digitally back to the store.”
Sorry for the long quotes, but I couldn’t say this important thing any better.   And I could go on with more quotes, but I think you get the picture. Deckers is making a big bet on the omnichannel. Well, who isn’t? But their conception seems particularly well thought out.
 
When Deckers first bought Sanuk, I suggested that they didn’t quite know what they’d bought and what to do with it. Given the price they paid, I have to believe they are not completely happy with the results to date. To justify the purchase price, they have to be able to take it from a quirky surf, beach, action sport brand to one that will sell well in broader distribution. But of course they have to do that without losing the quirkiness. 
 
Quite a challenge and the 5% decline in Sanuk’s gross margin during the quarter gives me pause.   So here we are again. Can a brand owned by a public company grow fast enough to satisfy Wall Street without damaging the brand? I hope the crew at Sanuk is following what Skullcandy is trying to do.

 

 

Maybe a Public Company Can Actually Pull This Off! Skullcandy’s June 30 Quarter

/0 Comments/in , /by

I’ve written probably way more times than you want to hear about how it’s been a good time to focus on brand building, distribution, and gross margin dollars rather than generating big sales increases that can only be realized in the short term with resulting long term damage to a business.   And I’ve sympathized with public companies who’d like to take this approach, but have a hard time doing it because of Wall Street growth expectations.

Well guess what? It looks like Skullcandy might just have a chance to do it. For the quarter, they reported a 6% sales increase to $53.9 million from $50.8 million in the same quarter last year. They had net income of $1.58 million compared to a loss of $689 thousand last year.
That’s nice, and it’s necessary. But from my point of view, what it does is buy Skull some time, and acquiescence from Wall Street, to continue doing what they’re doing.

Read more

Losing a Big Customer Sucks: SPY’s Quarter

/0 Comments/in , /by

Long time readers have been through the saga of Spy with me. But for the last couple of years, they’ve pretty much done things right. They’ve cleaned up inventory, managed expenses down, focused on a niche they can compete in, strengthened the management team, done some innovative product things, gotten out of products that weren’t working, and created and communicated a company vision consistent with their market position.

So then, in the quarter ended June 30 their largest retail sun glass customer stops carrying their brand. They also chose not to ship to their largest moto customer due to credit issues. I’m okay with that. I’ve always thought that only shipping to people who could pay you was a pretty good idea.

Quarterly sales declined 18.1% from $10 to $8.2 million, the first quarter over quarter decline in a while. The good news, they tell us in their conference call, is that the sales to the big retail sunglass customer were their lowest margin sales. We see that in their gross margin, which rose from 52.8% in last year’s quarter to 54.4%. But there’s a bit of lipstick on pig syndrome here, as total gross profit fell 13.9% from $5.28 to $4.54 million.

I also want you to see what they say about the sales decline in the 10Q, as it’s not as specific as the conference call in attributing most of the decline to the loss of one customer. “The decrease in sunglass sales during the three months ended June 30, 2014 is principally attributable to an overall decline in the consumer market coupled with several key retailers currently holding lower levels of inventory and fewer closeout sales of our sunglass products.” I am left wanting to know exactly how much in sales the one customer cost them.   I’m wondering why they didn’t mention it in this section of the 10-Q.  If most of the decline was from one customer, well, fortunes of war.  But if that customer doesn’t explain most of it, there’s a whole different problem.

Read more

All About Outdoor & Action Sports: VF’s Quarter

/0 Comments/in /by

That the outdoor and action sports segment (OAS) of VF’s business is critical to its overall success is pretty obvious from the numbers. Total company revenue for the quarter rose 8% from $2.22 to $2.4 billion. OAS revenue rose 16% from $1.1 to $1.28 billion. OAS generated more than 53% of the quarter’s total revenues. OAS revenue experienced “…double-digit percentage growth in every region and channel.”

But revenue from VF’s other segments- coalitions as they call them- grew by just one half of one percent from $1.116 to $1.123 billion. These other segments are jeanswear, imagewear, sportswear, contemporary brands, and other.
The same trend can be seen in VF’s operating profit. Total operating profit rose 6% from $269 to $285 million. OAS operating profit was up 16% from $100 to $131 million. Ignoring OAS, total operating profit for the other segments fell 8.4% from $168.6 top $154.5 million.

Read more