A Comment About a Billabong Deal and a Chance to Place Your Bet

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I was a bit surprised when VF’s preliminary bid for Billabong came as late as it did, and I was also intrigued by the partnership with Altamont. Why, I wondered, didn’t VF just buy Billabong itself? 

A couple of possible answers occurred to me. The first was that somehow they couldn’t afford it. But a review of their most recent balance sheet made me think that wasn’t the case. However, I did recall that they borrowed a bunch of money to pay for Timberland and had committed in their conference calls to reduce debt. Even though they could borrow the money to purchase Billabong, it might not have been a comfortable place to go for either VF or the analyst community that follows them.
 
Second of course is the fact that VF is primarily interested in the Billabong brand, and it’s a lot easier to just acquire that brand rather than acquire the whole thing and sell off the other brands. Here’s how they put it in the press release:
 
“VF’s primary interest in the transaction is in the Billabong® brand. This interest is consistent with VF’s stated intent to pursue acquisitions, particularly in the Action Sports category, to continue to build shareholder value. Altamont’s interest lies in acquiring Billabong’s other brands and related assets, and is predicated on the firm’s mandate to invest in situations where it can provide strategic and operational support to build business success stories.”
 
When it says Altamont’s interest is in “other brands and related assets,” I wonder what that means. Do the Billabong stores go with the Billabong brand? I guess Altamont would get West 49, though of course I don’t know that.
 
If a deal should be struck, Billabong shareholders would just get money, and they’d be done with it. But VF and Altamont would be the ones who would put up that money, and you have to wonder how they’d decide who put up how much.
 
They would have to agree on a value to the brands or assets being acquired by each of them. That certainly can’t be done before due diligence. How do you decide how much RVCA, for example, is worth before you know how much they are selling and have seen an income statement?
 
But even after due diligence it could be a bit of a hard thing to do. Valuation almost always has an element of subjectivity to it, and one might suspect that both VF and Altamont would want the assets their partner is taking to be valued higher so their partner’s piece of the purchase price was higher. Value also has to do with the future prospects of a brand and reasonable people can disagree on that.
 
Altamont is more what we call a financial buyer. That is, their valuation of an asset is based on what financial return they can expect. VF is more of a strategic buyer in the case of Billabong. By that I mean they look at the Billabong brand and look at how they can improve its operations and results by bringing their own strengths in, for example, sourcing to bear on it. They look for and expect synergies in other words. Read VF’s description of how they are managing their newest acquisition Timberland to improve its performance.
 
So VF might tend to come to a higher value for the Billabong brand than Altamont would, but it would be in their interest to convince Altamont that the value was lower. 
 
Not only, then, do VF and Billabong have a bias in favor of valuing the assets their partner is buying higher (so their own cost is lower), but it may not be easy to agree on those values because of differing perspectives. I imagine there would be ongoing discussions about this as due diligence proceeds. They really wouldn’t want to make a deal to acquire Billabong then find out that they couldn’t agree among themselves on who would pay how much.
 
I am sure you all realize I am speculating here, but I thought it might be valuable to think about the process that has to occur. But if you’re really interested in speculating, you can go to this Australian betting site and place your wager on whether Paul Naude and his group or VF and Altamont will snag Billabong. All bets are off if neither one buys it.

 

 

Quiksilver’s Year, Quarter, and Strategy; EBITDA Declines

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Three days ago, Quik filed its annual 10K with the Security and Exchange Commission for the year ended October 31, so I’ve had the happy task of wading through it and rereading the earnings conference call from a few weeks ago. You can see the 10K here if you want.  

I’ll look at the results for the quarter and the year, but I want to talk about the company’s strategy first and its similarity to other industry companies.
 
Strategy
 
This is right from page one of the 10K. “Quiksilver,” it says “is one of the world’s leading outdoor sports lifestyle companies. We design, develop and distribute a diversified mix of branded apparel, footwear, accessories and related products. Our brands, inspired by the passion for outdoor action sports, represent a casual lifestyle for young-minded people who connect with our boardriding culture and heritage.”
 
They continue, “Our mission is to be the most sought-after outdoor sports lifestyle company in the world by inspiring individuality, creativity, and freedom of expression through our authentic products along with the lifestyle and culture of our brands.”
 
Last year they said “We are a globally diversified company that designs, develops and distributes branded apparel, footwear, accessories and related products, catering to the casual, youth lifestyle associated with the sports of surfing, skateboarding and snowboarding. We market products across our three core brands, Quiksilver, Roxy and DC, which each target a distinct segment of the action sports market, as well as several smaller brands.”
 
What I’d like you to notice is that there is an evolution in how they define their target market and competitive environment. They acknowledge, of course, their heritage in action sports, but the focus seems to be moving away from it towards the broader outdoor market. Their potential market just got a lot bigger, but so did the number and size of their competitors.
 
A couple of years ago, I started asking where Quiksilver would get its growth from. Here’s their answer to me; they are now an outdoor lifestyle company.
 
Also from page one, Quik has three long term strategies. They are “1) strengthening our brands; 2) increasing our sales globally; and 3) increasing our operational efficiency.”
 
Can’t disagree with any of those, though I find them a little general to be useful. To be fair, nobody in these public documents wants to give their competitors more information than they have to, so there’s a limit on what we can expect to learn. Still, those three strategies, if that’s what we’re calling them, are pretty much the same thing everybody in this industry is trying to do. Or in any other industry I guess.
 
Some years ago when Burton took the “Snowboards” out of their name, it was because they wanted to address the broader apparel and fashion market. That’s a difficult road to travel not just because Burton is so closely identified with snowboarding but because once you get out into the fashion world, the competitors get bigger and more sophisticated and fashion is a different market than action sports.
 
That’s not a perfect analogy because Quiksilver has never been a hard goods company like Burton and, at $2 billion in revenue, is larger than Burton (I don’t have any actual numbers on Burton- that’s my best guess).
 
Companies like Quiksilver may, in reality, not have any choice but to go after the outdoor market. The outdoor market is certainly coming after them and as somebody once said, “The biggest risk in business is to not take any risks at all.”
 
Okay, on to some numbers.
 
The Quarter
 
Revenues in the quarter ended October 31 were $559 million, up 3% from $545 million in the same quarter last year. The growth mostly came from the Americas, which was up 12% to $279 million. Asia Pacific was up 6% to $87 million. Europe fell 9% to $192 million.
 
“Q4 results also point to 2 areas of concern. First is that we need to be careful managing inventory in light of uncertain economic situations in some of our key markets. The second and related area of concern is the level of clearance sales and discounting we saw in Q4. We ended Q3 with past seasons’ product, representing 16% of our total inventory. We focused on liquidating this inventory in Q4. We had significantly higher volume and lower recovery margin on these liquidations than in Q4 last year. The volume and recovery of liquidating the past season’s inventory had a meaningful impact on our Q4 gross margins.”
 
“Gross margin fell from 52% to 46% and was down in all three regions. “The gross margin erosion was driven by several factors, including increased sales of prior season goods in our wholesale channels, along with lower margins on those sales; increased discounting in our retail stores; increased sales to larger multi-door accounts who typically earn volume discounts that erode our margin; currency exchange rates; and the impact of decreasing sales in Europe, which has traditionally generated the highest margins of our 3 regions.”
 
Sorry for the long quotes, but sometimes I can’t say it any better and don’t want to put words in people’s mouths. Europe’s a bit of a mess (no surprise there) and Quik’s inventory got bigger than it should have is how we might summarize. At the end of the third quarter, 16% of Quik’s inventory was from past seasons. By the end of the 4th quarter, they’d sold $40 million of the old stuff, and the total past season’s inventory remaining was down to 7% of the total. They note in the conference call that “…the store of Q4 is really that we overbought during fiscal 2012 and we had higher liquidations through the wholesale channel because of that.”
 
SG&A expenses were down $12 million to $236 million. They reduced marketing and other expenses but increased e-commerce spending. There were charges of $4.7 million for severance and $3.1 million for lease termination costs. 
 
Net income was $4.4 million during the quarter compared to a loss of $22.1 million in last year’s quarter. I don’t have all the numbers I’d usually have for quarterly results, so I can’t take a hard look at what caused that change. Let’s move on to the whole year.
 
Annual Results
 
Revenues for the year rose from $1.953 billion to $2.013 billion. Quik lost $11 million in the year ended October 31, 2012 compared to a loss of $21.3 million in the previous year. Reported operating income improved from $41.5 million to $57 million. But last year, above the operating income line, it had asset impairment charges of $86.4 million. This year those charges were $7.2 million.
 
If we just remove those charges from the income statement, last year’s operating income would have been $127.9 million and this year’s $64.2 million. That would represent a decline of $63.7 million or 50%.
 
Quiksilver shows adjusted EBITDA which is net income or loss before interest, income taxes, depreciation, amortization, non-cash stock-based compensation and asset impairment. As they calculate it, their adjusted EBITDA fell from $194.3 million to $140.6 million.
 
The Quiksilver brand represented 39% of revenues during the year, down from 41% the prior year. The numbers for DC are 30% and 28% respectively, and 26% and 27% for Roxy. Pretty good balance. Other brands, including Mervin Manufacturing, are up from 4% to 5%.
 
Wholesale business as a percentage of revenues fell from 76% to 73%. Retail was up from 22% to 23%. E-commerce doubled from 2% to 4%. Apparel’s percentage of total revenue rose from 61% to 63%. Footwear was up 1% to 24% while accessories and related products fell from 16% to 13%.
 
I was interested to see that Quik ended the year with 605 retail locations, up from 547 at the end of the previous year. 291 were what they characterized as full price. 194 were shop-in shops (within larger department stores) and 120 were outlet shops. Of the total, 110 were in the Americas, 271 in EMEA (which is primarily Europe), and 224 in APAC (Australia and the Pacific).
 
Talking about their sales strategy, Quik notes, “We believe that the integrity and success of our brands is dependent, in part, upon our careful selection of appropriate retailers to support our brands in the wholesale sales channel. A foundation of our business is the distribution of our products through surf shops, skateboard shops, snowboard shops and our own proprietary retail concept stores, where the environment communicates our brand and culture. Our distribution channels serve as a base of legitimacy and long-term loyalty to our brands. Most of our wholesale accounts stand alone or are part of small chains. Our products are also distributed through active lifestyle specialty chains.”
 
Gross margin for the year fell from 52.4% to 48.5%. “We experienced gross margin decreases
across all three of our regional segments during fiscal 2012, primarily due to increased clearance sales at lower margins within our wholesale channel compared to last year (240 basis points), increased discounting within our retail channel (80 basis points), and the impact of changes in the geographical composition of our net revenues.”
 
Selling, general and administrative expense (SG&A) rose 2%, or $20 million, to $916 million. As a percentage of revenue, it fell from 45.9% to 45.5%. The increase was mostly due to spending more on their online business and to non-cash stock compensation expense.
 
Overall, the balance sheet hasn’t changed that much in a year, but there are a couple of things I’d point out. Cash is down from $110 million to $42 million. Inventory is actually down a few million, from $348 million to $345 million. Receivables were up from $398 million to $434 million, pretty much consistent with sales growth. Average days sales outstanding (DSO) rose from 78 to 85. “The increase in DSO was driven by the timing of customer payments at year end and longer credit terms granted to certain wholesale customers.”
 
Inventory days on hand fell from 119 to 103 “…primarily due to the increased clearance sales that occurred during the fourth quarter of fiscal 2012.”    Long term debt was more or less constant. Equity fell by more or less the amount of the loss.
 
Quiksilver’s sales for the year rose slightly, but it sounds like if hadn’t overbought and then been forced into liquidating, revenues would not have been up. We saw the big impact on their gross margin. It’s hard to be a public company and not plan for revenue growth I guess, but I’d argue they would have been better off if that’s exactly what they’d done. Wonder what the bottom line would have looked like if they’d left revenues even but held their gross profit margin by not overbuying.
 
Actually, I guess there’s no reason I can’t figure that out at the gross profit line.
 
If revenues had been the same as in 2011 at $1.953 billion but the gross profit margin had held at 52.4%, then gross profit would have been $1.023 billion. That’s about $40 million higher than reported in 2012. I don’t know what the tax impact might have been, but I’m pretty sure they would have earned a profit.
 
How many years is it now I’ve been suggesting it was time to focus on gross profit dollars rather than revenue growth?

 

 

Abercrombie & Fitch’s Quarter and Some Consistencies with Other Retailers

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I haven’t followed A & F as closely as I probably should. Too many companies (especially now that our market is something broader than action sports), not enough time. But A & E is the owner and originator of that iconic surf brand Hollister (heavy sarcasm). And especially after my recent post on cosmetics and skateboarding where I got into core versus having fun and giving consumers what they want, A & E seemed worth a look. 

Some of management’s comments in both the 10Q and the conference call also reflected concerns and strategies similar to other retailers I’ve recently reviewed and I wanted to call those out. I think maybe they are all reacting to trends that are going to become obsolete over the medium term. We’ll see.
 
I’m going to start with the October 27 quarter numbers, because you need them as a background to understand some of management’s comments. Sales rose 9% to $1.17 billion from $1.076 billion in the same quarter last year (foreign currency issues had a negative $7.9 million impact on sales). Cost of goods sold grew hardly at all, while gross profit rose $647 million to $732 million.
 
Obviously, the gross profit margin rose for that to happen- from 60.1% to 62.5%. It’s increase was “…primarily driven by a decrease in average unit cost and an international mix benefit, partially offset by a slight decrease in average unit retail and the adverse effect of exchange rates.” I think what they mean to say is that the price of cotton came down.   
 
Other expenses as a percentage of sales didn’t change much in aggregate, so those higher sales and gross margin improvements went right to the bottom line. Net income rose 40.5% from $50.9 million to $71.5 million. I should point out that for the three quarters ended October 27, A & E’s net income was down from $108 million to $90 million due to some issues with inventory and not being on trend as well as general market conditions.
 
A & F has four kinds of stores; Abercrombie & Fitch, Abercrombie (kids), Hollister, and Gilly Hicks. During the quarter, comparable store sales fell 3% after being up in 7% in the quarter last year. For nine months, comparable store sales are down 6% after being up 8% in the same period the previous year. Hollister, down 1%, was the best performing segment.
 
Hollister’s revenues rose from $518 to $602 million during the quarter. Abercrombie & Fitch stores rose only slightly from $436 to $440 million. Abercrombie stores fell $4.4 million to $100 million. Gilly Hicks revenues were up from $17.6 to $27.3 million, but you can see they are small as a percent of the total. Hollister accounted for 52% of total quarterly sales and without their growth it wouldn’t have been much of a quarter.
 
How did they get the 9% sales increase when comparable sales were down 3%? On line sales rose from $132.4 million to $158.3 million, and from 12% to 14% of total sales. And they opened 12 new international stores of which nine were Hollister. They did not open or close any stores in the U.S.
 
U.S. store sales fell from $725 to $709 million. International store sales were rose from $215 to $299 million (Obviously mostly Hollister). Operating income on the U.S. stores was $162.4 million, or 22.9%. For international stores, it was 29.16%.
 
For on line, it was 44%. That would certainly get my attention.
 
Okay, on to some of the common issues among retailers. I guess it’s obvious that the first one is on line business. There’s a lot of it, it’s growing, and it’s very profitable. The thing I don’t know, and I’ve asked the question before, is whether it is cannibalizing in store sales or helping them. We all hope and want to believe that there’s some strategy that creates synergy among all the ways we reach customers, but I don’t have evidence in hand that it increases total sales especially in this current economic environment which I expect to last a while.
 
(Preview of coming attractions: What has to happen in order for Gross Domestic Product to increase? Either the population has to increase or productivity has to rise. There are no other choices. How are we doing in those two areas?)
 
Abercrombie & Fitch “…believe the improvement in sales trend during the quarter is attributable to our inventory flow getting back on track, which produced newer more trend right merchandise.”
 
“Going forward, we intend to remain highly disciplined with regard to our strategy of starting with  conservative merchandising plans, shortening lead times and increasing the percentage of our "open-to-buy" that is available to chase current trends. In addition, we have sharpened our focus on capturing current street and runway trends.”
 
“Going forward, we continue to focus on our key strategic initiatives with regard to merchandising, inventory productivity, expense and average unit cost, insight and intelligence, customer engagement and targeted closures of under-performing U.S. stores [a total of 180 from 2012 through 2015].”
 
 
CEO Mike Jeffries put it like this in the conference call: “…we’re working to become faster and we’re doing that with conservative plans, shorter lead times and more dollars open to chase, which we have said is 60 to 105 days. I think that’s affecting the fashion content of our inventory. We’re also working hard to be different by brand. We’ve invested more in brand-specific design talent. And just in terms of fashion component, we’re reacting quickly to runway and street. And I think all those things are impacting our fashion assortments.”
 
You know, that’s an awful lot like what management at PacSun, Tilly’s, and Zumiez has said recently. They aren’t talking about big sale increases. They are trying to improve their supply chain to control inventory, manage costs, and be responsive to trends. They are trying to manage all the touch points with their customers.
 
They acknowledge that how they operate has a big impact not just on their bottom line but on the quality of their market positioning. And while they don’t say, “Fast fashion is eating our lunch!” it’s clear they are responding to that.
 
Yet I’m wondering if fast fashion is really going to have legs. I don’t mean it’s going to go away, but what, exactly, is it once everybody responds by being more trend sensitive and shortening their time from concept to delivery? Doesn’t the novelty of buying inexpensive new stuff all the time wear off after a while if that’s what everybody is trying to sell you.
 
(Preview of coming attractions number two: What do my Aunt Jenny’s egg beater, a particular brand of hoodie, and a water heater have in common? Hint: They all are made in the U.S. and are meant to last a long time.)
 
With Hollister, Abercrombie & Fitch have proven that you don’t have to be core to be cool. Fun, they’ve shown us with that brand, is cool. It’s not me saying Hollister is fun; it’s their customers and that’s all that matters.
 
But meanwhile, they’ve run into some of the same issues as our industry’s other retailers and are taking many of the same steps to respond. I’ve been a big fan of improving your operational efficiency to improve profits and market positioning for a few years now. Think what that might have done for your bottom line if you’d done it when sales increases were easier to come by. But once everybody is doing it, it’s no longer an advantage, and I’m unsure of the lifespan of the trend they are responding to.

 

 

Tilly’s Quarter and Their Business Approach

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Just for fun, let’s jump right to some comments in the conference call for Tilly’s quarter ended October 27, 2012. In discussing the quarter’s results, CEO Daniel Griesemer notes that, “While our third quarter comparable store sales growth of 1.9% [They were 8.5% in the same quarter last year] was below our expectations, this represents high quality growth at healthy margins.” 

Like other retailers I’ve reported on, he noted that back to school was strong, but then the market softened nationally. This seems to have carried into November for at least some companies.
 
He goes on to note that “…we chose not to pursue a course that would deliver a higher comp at the expense of earnings.”
 
I kind of like that approach. If you’ve followed me for more than a little while, you know that in the current and projected economic environment I’ve been a proponent of improving earnings through higher margins, better operations, and controlled distribution rather than big sales increases. My thinking is pretty simple; big sales increases are hard to come by right now. Focusing on operating income rather than sales makes some opportunities that exist among the interplay of production, distribution, marketing and operations in general clearer than they have been in a sales growth focused organization.
 
Just to give one example I’ve used before, the best marketing a brand can probably do is have a retailer sell through at full margin and then have to tell customers, “Sorry, sold out!”
 
This isn’t a panacea. Remember Billabong announced when the recession started that they were going to control promotions to support the brand and its image even at the expense of sales. We found out when they released their new strategic plan that they thought they had some operating issues to deal with. I agreed with Billabong’s decision. But what we now all know, and what I think Tilly’s CEO would agree with, is that the decision not to focus quite so much on sales growth requires that you look for the connections among the other parts of your business that not only reduce expenses, but improve the brand’s positioning.
 
In the case of a retailer, that has the potential to change the way they evaluate and decide to carry brands. Hey brands, that should resonate with you and lead you to evaluate your marketing and distribution differently.
 
Two other points from the conference call. First, like pretty much everybody else, Tilly’s is trying to give its customers an integrated experience across every touch point they have with the customers. CEO Griesemer says, “…we want our customer to get the same great Tilly’s brand experience across every channel, every access point; be it social media, or mobile, or in-store, or online, or through our catalog or e-mails, or whatever else – events, or all kinds of things.”
 
Working towards this consistency is no longer a choice.
 
And second, in my last two posts I’ve talked about Zumiez’s and PacSun’s quarters. I’ve compared them, saying Zumiez has a niche it owns but has to find a way to grow out of it without damaging that niche. PacSun, on the other hand, lost its niche and is trying to get a niche back to attract its customers.
 
Tilly’s CEO, talking about the action sports space in response to an analyst question, says, “Yes, we share an action sports-inspired lifestyle kind of platform with a whole lot of people. But as you well know, that has migrated significantly.” Later, still responding to that question, he says, “…this is a unique business with a unique customer. I think we’re going to continue to make sure we communicate that, so people resist the temptation to pigeonhole us into one particular category.
 
As action sports becomes comingled with fashion, youth culture or whatever you want to call it, figuring out where along the spectrum they belong is an issue Tilly’s is sharing with all brands and retailers in this space.     
 
Well, that was a little more fun than just starting with a bunch of numbers, but I suppose there’s no way to avoid that. If you’re so inclined, you can read the 10Q yourself here.
 
Sales for the quarter were up 16.4% from $107.3 million in last year’s quarter to $125 million this year. Ecommerce sales rose from $11.1 million to $12.7 million. They ended the quarter with 161 stores in 27 states. Average net sales per store declined from $730,000 to $705,000 and average sales per square foot were down from $94 to $90.
 
I would love to have some detailed information on how retailers thought ecommerce sales were impacting brick and mortar sales. Tilly’s does note that the 1.9% comparable store sales increase was “…due to higher net sales through our e-commerce store.” That’s not a surprise given the numbers on sales per store and square foot quoted above. 
 
The gross profit margin rose pretty much not at all from 33.4% to 33.5%. Selling, general and administrative expenses rose from $23.5 million to $27.9 million or from 21.9% of sales to 22.4%. Store selling expenses were up 17% to $18.8 million but as a percentage of sales rose 15.0% to 15.1%. 
 
Operating income rose from $12.3 million to $13.9 million, but net income was down 23.5% from $12.2 million to $9.3 million. The decline in net income was completely due to an income tax provision that rose from $140,000 to $4.53 million. That was the result of changing from a subchapter S to a C corporation as part of going public. You should look at this quarter’s tax provision as a percentage as more typical of what Tilly’s will experience going forward.
 
Okay that’s it. No big financial issues, and anyway I thought the first part of the discussion was way more interesting than this part.

 

 

Pacific Sunwear’s Quarter; Look! It’s a Profit!

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PacSun earned $948,000 in the quarter ended October 27 compared to a loss of $17.6 million in the same quarter last year. Their comparable store sales rose 1%. It’s the first time that’s happened since the third quarter of 2007. Their loss for nine months is $32.2 million compared to a loss of $68.3 million in nine months in the previous year. 

Okay, progress though not the end of the turnaround road. They did it by increasing their gross margin from 24.4% in last year’s quarter to 26.6% this year and by cutting selling, general and administrative expenses (SG& A) from 30.2% of sales to 27.2% of sales. Sales increased only slightly from $226.8 million to $228.4 million.
 
Remember, this is a company that’s still closing stores. They closed a net of five during the quarter and ended it with 722 stores compared to 820 a year ago. They expect to have closed an additional 75 stores by the end of the fourth quarter in January. I would guess that those closings will largely happen after the holiday shopping season.
 
Most of the gross margin increase came from the improvement in the merchandise margin from 47.2% to 49%. Of the 3% decline in SG& A, 1.80% came from a decline in non-cash impairment charges for long lived assets. These assets are mostly furniture, fixtures, equipment and leasehold improvements for stores being closed. In last year’s quarter, the charge was a bit over $7 million. This year, it was only $533,000.
 
They’ve now written those assets down to $6 million and, as of the end of the quarter, think they can recover it all. Is so, we shouldn’t see any future write downs for store closings.
 
There was also a 0.8% decrease in depreciation (which you’d expect as stores get closed and there are fewer assets to depreciate). There was also a 1.1% decrease in other SG& A expenses “…primarily due to the timing of advertising expenses and a decrease in consulting fees.” To the extent the decline was due to timing, I assume it just moved to the next quarter. Finally, there was an offsetting 0.7% increase in compensation due to an increase in employee benefits.
 
I also want to point out that net income includes a $5.6 million “Gain on derivative liability.” This has to do with their estimate of the fair value of the Series B Preferred shares using “highly subjective” inputs. Now I’m guessing that nobody really wants to get into those details, but should I be wrong, you can check out footnote nine in their 10Q. My holiday gift to you.
 
Over on the balance sheet, we see that cash has risen from $8.3 million a year ago to $23.9 million. Cash is good. Inventories are down from $152 million to $137 million as you’d expect with stores being closed. The inventory decline on a comparable store basis was about 4%. Current assets at $182 million are down just $3 million with cash basically replacing inventory on the balance sheet.
 
Net property and equipment has declined from $158 million to $131 million with the store closures and asset write offs we’ve discussed. Total assets are down $28 million to $348 million.
 
Current liabilities are up slightly from $129 million to $132 million, which is a bit of a surprise. Accounts payable are down $22 million which again makes sense with stores closing, but other current liabilities have jumped from $39 million to $65 million over a year. Oh- that’s mostly the derivative liability thing and a $6 million increase in accrued compensation and benefits.
 
Long term liabilities have risen 37% from $96.4 million to $132.2 million. Deferred lease incentives and rent are down (again, it’s the store closings). But other long term debt and liabilities have risen in a year from $55.2 million to $100.5 million. Shareholder equity is down 45% from $150.4 million to $83.3 million.
 
Okay, well those balance sheet numbers make me scurry to the cash flow for nine months. I see that net cash used in operating activities has fallen from $45 million to $22 million. And cash used in investing activities has fallen from $9.8 million to $3.1 million. That’s an improvement, but we’re still a long way from a positive operating cash flow.
 
CEO Gary Schoenfeld told the analysts that PacSun continues to be “…focused on 3 main tenets of our strategy: authentic brands, trend-right merchandising and reestablishing a distinctive customer connection that once again makes PacSun synonymous with the creativity, optimism and diversity that is uniquely California.”
 
He left it to poor Mike Kaplan, the CFO, to provide the guidance for the fourth quarter. Excluding the stores to be close by the end of the quarter, they expect comparable store sales to be down 1% to 3%. They project a “…non-GAAP net loss per share from continuing operations of $0.09 to $0.17 for the quarter…” I imagine that will translate into a loss at the net income line.
 
They reasonably pointed out that this year’s fourth quarter includes an extra week, which incurs expenses at the usual rate, but has weak revenue because of the time of the year.
 
I was all excited when I saw the profit and positive comp for the quarter, but less excited after I’d been through the numbers. There’s no doubt there’s been a tremendous amount of progress. Lots of battles won, but the war goes on. The company is still cash negative, and to some extent the positive comp (and it was only 1%) is the inevitable result of closing enough stores that aren’t performing. But when you get down to your good stores, you need to be doing better than 1%.
 
It’s not easy for me to evaluate PacSun while they are still closing bunches of stores. Apparently, that will mostly be over at the end of January. It’s interesting that yesterday I was reading and writing about Zumiez, and wrote that they had a solid market niche that they had to continually validate but also break out of as the action sports lifestyle market changed. That’s both their challenge and their opportunity.
 
PacSun’s challenge, on the other hand, is to figure out and establish to the satisfaction of their customers what their market niche is. They lost their “distinctive customer connection” and are working to get it back. But that means they aren’t gated, at least compared to Zumiez, by their historical market positioning. And that might be a good situation to be in right now.

 

 

Zumiez’s October 29 Quarter and a Strategic Observation

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Zumiez reported sales growth during the quarter of 16.9% from $154 million to $180 million. Without the Blue Tomato acquisition, sales would have risen 11.7%. The gross profit margin fell from 38.9% to 37.3%. Selling, general and administrative expenses rose from $37.1 million to $45.7 million, or by 23.2%. As a percentage of sales, they rose from 24.1% to 25.4%. 

Net income fell 10.4% from $14.1 million to $12.7 million.
 
Comparative store sales were up by 3.7% and ecommerce sale were 10.7% of the total, up from 6.4% in the same quarter last year (Remember that now includes Blue Tomato, which does quite a bit of online business). Zumiez ended the quarter with 495 stores; 471 in the U.S., 19 in Canada and 5 in Europe. They’ve added a net of 48 stores since October 29, 2011.
 
Let’s remember that the July 4 acquisition of Blue Tomato in Europe for $74.8 million plus contingency payments of up to $28.6 million had an impact on their results, as has the new ecommerce fulfillment center in Edwardsville, Kansas and moving their home office from Everett to Lynnwood, Washington. Without the costs associated with the corporate relocation and Blue Tomato acquisition, SG&A would have been 23.7% of sales; lower than the same quarter last year.
 
The 1.6% decline in gross margin “…was primarily due to a 90 basis points increase in ecommerce fulfillment and ecommerce shipping expenses and an 80 basis points impact of a $1.4 million charge recorded during the three months ended October 27, 2012 related to a step-up in inventory to estimated fair value in conjunction with our acquisition of Blue Tomato.” They gained 40 basis points by leveraging store occupancy costs over higher comparable store sales. It’s noted in the conference call that product margins would have improved slightly without Blue Tomato.
 
During the quarter, Zumiez booked $2 million in expense as part of the expected contingency payment for Blue Tomato. This explains part of the increase in the SG&A expense line. There was also a 1% increase in corporate costs and a 0.3% increase in amortization of intangibles as a result of the Blue Tomato deal. These increases were offset to some extent by a 0.4% decline in incentive compensation and a 0.9% improvement in store operating efficiencies.
 
Zumiez’s lease on its former corporate headquarters doesn’t expire until 2017, and they’ve got some ongoing costs for it. During the quarter, they booked $200,000 in cost of goods sold and $300,000 in SG&A. 
 
The balance sheet shows the impact of the Blue Tomato acquisition. If it’s slightly weaker than it was a year ago I guess, it’s still very solid, so no discussion is required.
 
Zumiez’s 10Q (see it here) tells us that, “The activity of Blue Tomato that was included in our condensed consolidated statements of income from the acquisition date to October 27, 2012 was net sales of $9.6 million and a net loss of $1.8 million.”  Of those Blue Tomato sales, $8.1 million were during the quarter. It doesn’t tell how much of the loss was during the quarter, but it obviously had a negative impact.
 
In theirs earnings release and conference call, Zumiez acknowledged that their sales and earnings during the quarter were below what they expected. “The shortfall in sales came primarily from softness in Europe, which we attribute to unfavorable weather and pressure on consumer spending as a result of difficult macroeconomic conditions,” said CEO Rick Brooks.
 
As an aside, I’d encourage all of you not to think the crisis in Europe is over. I didn’t quite know whether to laugh or cry when I heard that some of Greek’s debt had been effectively converted into zero coupon, perpetual bonds. Financial alchemy is so much fun!
 
For the fourth quarter, Zumiez expects same store sales to decline by 3% to 4%. 
 
“The fourth quarter guidance assumes a decline in product margin compared to last year, primarily related to a modest decline in our domestic margins as a result of our current sales projections and lower margin experienced for our Blue Tomato business due to their product mix and effects of the inventory step-up.”
 
They expect that acquisition related charges during the quarter will be $3 million.
 
To sum it up, Europe and Blue Tomato aren’t performing to expectations, there have been some substantial, though expected, costs for the acquisition and changes in location, winter business is weak, and the economy’s none too great in North America either.
 
With that as background, let’s move on to the strategic question I alluded to in the title.
 
Zumiez has positioned itself as an action sports lifestyle brand. CEO Brooks noted in the conference call that he believed in that lifestyle. “The lifestyle has real resonance,” he says.
 
I read public information not just to tell you how an individual company is doing, but to look for issues that everybody in this space probably needs to think about. The one I find myself thinking about right now is just what is the action sports lifestyle market and how big is it?
 
It’s hardly the first time this issue has been raised, and not just by me. The action sports industry is really pretty small, or at least that’s what I believe. And it’s been compromised by big players in youth culture, fashion, urban street wear; pick your term. The borders are no longer as clear as they once were.
 
When Volcom was sold to PPR, I complimented them on selling at the right time before they needed a deal. Volcom owned their market niche, but where did they go from there? They needed expertise they didn’t have to branch into the larger market. How successful they will be is still an open issue.
 
Zumiez is the core action sports shop in the mall. They own that niche. It’s been validated by other brands opening their own mall retail stores. But when you’re so successful, and so closely identified with a niche, how do you grow and how to you respond as the market evolves away from core action sports while still keeping your credibility in the market you’re successful in? 
 
Zumiez can and will open more stores (their target is 600 to 700). But as an example of what I mean, I want to focus on Zumiez’s discussion of its men’s footwear business in the conference call.
 
Here are CEO Rick Brooks’ comments on that business:
 
“I read it in many of your notes that we’ve seen athletic footwear really start to take off both in the sense of athletic shoes, but we’re seeing that really calling out basketball and running as categories. Obviously those are areas that we play.”
 
“If you don’t come to us for basketball shoes or for running shoes, they come to us for a skate shoe. So I think that we have some challenges there relative to just a cyclical cycle in footwear.”
 
“I would anticipate that we’re probably more likely in the early phases of an athletic footwear trend, than the later phase at this point based upon our experience what we see in the marketplace.”
 
“So as we think about what we’re going to do with footwear going forward, we definitely think we have some opportunities where we know we’re missing a few things with some key brands in our current business.”
 
I’d love to dig in more deeply on this subject with Rick. But what I’m hearing him say is that there’s some men’s footwear product Zumiez could be carrying they don’t carry now that would be responsive to market trends.
 
But it seems to me that product isn’t necessarily representative of the action sports lifestyle. The question for Zumiez (and other companies as well) is the extent to which they respond to these trends.
 
Do they carry it and compete for the customer who wants that product? Or do they decide that it’s not representative of the action sports lifestyle? If they carry it, they may hold onto a customer they would otherwise lose. But they may also find themselves in a market where their advantage is less (because it’s not all about the action sports lifestyle) and could even confuse their core customers. If they don’t carry it, they may lose a customer they had before and find themselves isolated as the market changes.
 
Well, this is why companies have managers, and I imagine Zumiez managers asks themselves this question every day about every product and every brand they carry or consider carrying. They’ve responded at least partly with an emphasis on systems that get the right product to the right stores (micro sorting they call it) and by giving store managers quite a bit of discretion, as they describe it, in selecting inventory.
 
But more globally, the issue is just what is the action sports lifestyle market? It’s not what is used to be.

 

 

Paul Naude Offers AUD 1.10, Billabong Reduces Full Year Forecast

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This is just intriguing. There is so much happening and it’s going on so fast (at least in corporate terms). It’s like a novel you can’t put down or a soap opera where waiting for the next episode to find out who does what to whom is excruciating. 

Like you, I’m working from the Billabong announcement and a couple of press reports so I have no solid information you don’t have. But I’ve always been a student (and sometimes a practitioner) of turnaround management and organizational evolution and this is fascinating. Dare I say fun (for me at least)?
 
All the numbers are in Australian Dollars.
 
Let’s start with a review. In February, Billabong turned down a $3.30 bid from TPG Capital (subject to due diligence) as too low. Subsequently, Bain and TPG withdraw offers of $1.45 after some due diligence (The TPG offer was made on July 24 and withdrawn on October 12.). Meanwhile, on April 12th, Billabong closed a deal to sell half of Nixon to TCP for proceeds of $285 million to be used to pay down debt. Former CEO Derek O’Neill departed the company on May 9 and Launa Inman was appointed Managing Director May 12. On June 21st, Billabong announced that it would sell shares at $1.02 (44% below the previous closing price) to raise an additional $225 million to pay down debt.
 
On August 12th, the company released and Ms. Inman presented Billabong’s half yearly results and plans for going forward. I wrote rather extensively about that.
 
Now Paul Naude, who took a leave of absence as a Director and President of the Americas on November 19, has made a contingent offer of $1.10 per share. When he did this last Friday, Billabong’s shares were trading at $0.73 each.
 
Just to increase the intriguing factor even more Billabong, at the same time they announced Paul Naude’s offer, released a trading update where they reduced their expected EBITDA from $100-110 million in constant currency to $85-92 million in constant currency. But that eighty-five to ninety-two million number is before $29 million of “significant items.” If you include those, the year-end constant currency range is from $56 to $63 million. The release does not describe the previous EBITDA estimate as excluding any “significant items.” As a result, I’d tend to compare that prior estimate to the $56-$63 million estimate. Using the midpoint of both estimates, that’s a decline of 43%.
 
The press release, should you want to read it yourself is on this page at the Billabong site. Right now, it’s the second on the list and is called “Bid Proposal and Trading Update.” This is the third time this year that Billabong has reduced its expected results. You can read for yourself the details of the causes in the release. We can sort of sum it up by saying soft sales and a lousy economy.
 
When I discussed Paul Naude’s decision to put together an offer back in November, I speculated that the offer price might be lower than what we’d seen before. Now I have to wonder, with the price of the stock having fallen since the downward revision of the year end results, if it might be reduced further. I also discussed briefly in that article just how a leveraged buyout, which this deal would be, works.
 
If I could ask Paul one question, it would be, “What did you know, and when did you know it?” It seems likely to me that when he took his leave of absence a month ago, he must have had some sense of the continued deterioration of business conditions. Yet the conditions under which he was allowed to pursue the deal required that he use no confidential information. Regardless of what he knew or was concerned about then, he had to put together his offer, and represent it to his potential partners, using only public information. That would have been the EBITDA estimate of $100 to $110 million.
 
Were I Paul’s partners (Sycamore Partners Management and Bank of America Merrill Lynch) the first question I would have asked in the first meeting was, “You were a director and the President of the Americas as Billabong’s performance went south. Now you’re coming to us and explaining how under your leadership this can turn into a really good investment. Explain to us why your really good ideas couldn’t be implemented.” 
 
I gather he had a really good answer. 
 
We’re a long way from a deal (Remember, I thought there would be a deal with TPG). Whether or not Billabong has to make a deal at some price depends on their balance sheet. If there should be a deal I’d expect the price to decline further as a result of the reduction in projected year end results. And I’m guessing you’d see some brands sold following the deal to pay down debt. The thing I’d be most interested to watch is how they’d propose to manage their brick and mortar retail.
 
I’ll keep watching and speculating right along with you. 

Decker’s Quarter: The Issue is Not with Sanuk

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The September 30 quarter (here’s the link to the 10Q) was not one of great happiness for Decker, the owner of UGG, Teva and, of special interest to us, Sanuk. But perhaps we should be interested in their other brands as well. Most of you who sell shoes and sandals are competing directly in the broader casual footwear market after all. 

Anyway, Decker’s sales fell 9.2% from $414 million to $376 million. In last year’s quarter, the gross profit margin was 49%. This year, it came in at 42.3%. Net income was down from $62.3 million to $43.1 million. What happened?
 
Well, it’s not Sanuk’s fault. Its sales for the quarter grew $15.6 million to $18.3 million, or by 17.3%. $1.3 million of these sales were on line. Sanuk is not sold in Decker’s retail stores. The brand’s sales for the whole year are projected to be $95 million. 
 
Sanuk’s operating income was up nicely from $1.5 million to $3.2 million. However, that increase “was primarily the result of a $1,400 reduction in accretion expense related to the contingent consideration liability from the Company’s purchase of the brand, a $900 reduction in amortization expense largely related to an order book that was fully amortized in 2011, and $500 of increased gross profit, partially offset by approximately $600 of increased marketing and promotional expenses.” After reading that closely, it’s hard to conclude that the operating income increase was primarily the result of selling more product.
 
Sanuk’s wholesale sales growth was the result of an increased selling price “…partially offset by a decrease in the volume of pairs sold.” Apparently they didn’t just increase prices for Sank. There was a shift in the product mix (sorry, no details given) and the introduction of a new shoe and boot line with higher prices.   
 
Unhappily for Deckers, Sanuk’s wholesale business represented only 4.9% of total revenue during the quarter. UGG, with revenues in the quarter of $284 million (down from $334 million), represented 76% of quarterly revenues.
 
Sheepskin is a primary material in UGG products. The cost of said sheepskin was up 30% in 2011 and another 40% in 2012. Obviously this sent the costs of UGG products through the roof. Deckers responded by raising prices and found that, as Chairman, CEO and President Angel R. Martinez put it“…our price increases over the past 2 years had pushed us above the consumer’s price value expectations for the UGG brand.” The warmest winter in the U.S. since they started keeping records didn’t help either.
 
There was probably no good answer for Deckers in the short term. Either they could hold their prices and see their gross profit go to hell, or they could raise prices to hold margins and see their sales drop. Not a happy place to be. The lesson for all of us, and I think it’s especially important these days, is that no matter how sophisticated your strategy, how well thought out your competitive positioning, how differentiated by marketing and features your product, and how many people “like” you on Facebook, every product can be substituted for and sometimes the stuff just costs too much.
 
Deckers sees sheepskin prices coming down some, and they “…made the decision to adjust our domestic pricing in mid-September on select classic styles, retroactive to all orders shipped since July 1.” They reversed some, but not all of their price increases. The issue is whether they can make enough of the price increases stick so that, given a decline in raw material costs that it sounds like will be less than the initial increase, they can recover their gross margins. Price increases, even when justified, have to be gradual I think.
 
Mr. Martinez goes on to say, “The price adjustment has been mischaracterized in recent industry coverage as “discounting.” But in fact, it’s an important strategic decision that we believe is in the best interest of the brand for the long term.” The good thing is that it sounds like they didn’t close this product out or take it to other channels. They worked with their existing retailers for everybody’s benefit, which is something we in the action sports world perhaps haven’t always done as well as we could. But I wonder where that high quality strategic analysis was when they raised their prices so much in the first place. Maybe subsumed by some pressure to make the quarter?
 
Deckers has hit what we hope is a one time bump in the road due to the large and rapid increase in the price of sheepskin. Sanuk seems to be doing fine. Given the price Deckers paid for it, I imagine they will push the brand for even better results. Please don’t push too hard.

 

 

SPY’s Quarter; Strategy and the View from the Balance Sheet.

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About a hundred years ago, around 1998, I spent a year as one in a long line of people who believed in the Sims brand enough to try and get it some traction (Some of you who are reading this are smiling; some are laughing. At me or with me- who knows). 

Sims benefitted from having a group of really competent people who had been with the company for a long time and were totally loyal to the brand. In difficult circumstances, while I was there and after, they cleaned up the brand and created a company that was doing $20 plus million a year, earning an operating profit, and had the potential to grow some.
 
But no matter how well they operated, they couldn’t overcome the high level of debt on the balance sheet and the discontinuities this created between what was good for the brand and what was good for the shareholders/debt holders.
 
Which, as you were probably expecting, gets me around to SPY.
 
Strategy and Balance Sheet
 
SPY’s sales grew 7.6% in during the quarter ended September 30, rising from $9.2 million to $9.9 million. They cut their operating loss from $2.4 million to $1.2 million and their net loss from $2.98 million to $1.78 million compared to the same quarter last year. As usual, there are some details to be discussed, and we’ll get to that. But first, let’s talk about the strategy and the balance sheet.
 
If you’ve followed SPY over the last few years through what I’ve written or other sources, you know that they’ve experienced a lot of challenges; some self-inflicted, some not. There’s been the Italian factory they bought then sold, a lawsuit with a former CEO, the detour into, and then out of, licensed brands, some inventory problems, management issues and turnover (now apparently ended), a lousy economy, and the August 2012 announcement that the company was reducing “…the level of its expenses to lower its breakeven point on an operating basis.”   Through all of the tumult, the SPY brand has somehow maintained credibility in the market.
 
Now, the company is refocused exclusively on that brand and it feels like the company is making progress. But sunglasses are a very competitive category produced by an awful lot of companies. It’s a high margin product so naturally everybody wanted a piece of that. Inevitably, that margin will come down (is already coming down?) because that’s what happens.
 
SPY needs to grow its revenues so that it can afford the cost structure it has to have to compete against much larger and better capitalized companies. To accomplish that, and to clean up all the problems mentioned above, they’ve had to invest and invest and invest. That gets us over to the balance sheet.
 
In the year since September 30, 2011 notes payable to stockholder have risen from $10.5 million to $17.5 million. The majority shareholder has lent the company another $7 million over the year. Interest on the debt is not being paid in cash, but is accrued as additional debt. Under current liabilities, the line of credit outstanding has risen by $2.1 million from $2.5 million to $4.6 million. Stockholders’ equity has dropped from an already negative $4.3 million to a deficit of $12.8 million. The only thing keeping SPY afloat is the willingness of the majority shareholder to lend the company money, and the 10Q tells us they are going to need more; “The Company anticipates that it will continue to have requirements for significant additional cash to finance its ongoing working capital requirements and net losses.”
 
Well, it’s hardly unusual for a company in this industry to find itself at the point where it needs the financial, back office and/or design/manufacturing strength of a larger company so they can “Take it to the next level” whatever the hell that means.
 
If it’s a company like Sanuk, who was more or less the same size as SPY when it was acquired by Decker and was growing, profitable and no doubt had a solid balance sheet, you can get paid a lot of money. But if you’re losing money, require more investment, and your balance sheet is upside down you don’t quite get such a good deal. In those circumstances, in our industry, “Taking it to the next level” has meant some of your debt gets assumed, you get an earn out if the company performs, and people get to keep their jobs.
 
My guess is it would make sense for SPY to be bought by a larger corporation. But whatever we might conclude the brand is worth, nobody is going to come anywhere close to paying the majority shareholder the $17.5 million he’s owed for a company that’s losing money and needs further investment.
 
There are also, of course, other shareholders who’d probably rather not lose their money. I don’t know exactly why or how SPY came to be a public company in the first place, but this would probably be more easily managed if it wasn’t a public company, though way less fun for me.
 
Nuts and Bolts
 
In the August restructuring, they took a $700,000 charge for the reduction in expenses I mentioned above. This one-time cost was for changing the direct part of its European business to a distribution model and for reducing its marketing spend. The result was a staff reduction of 20 positions.
 
For the quarter, 16.4% of its revenue, or $1.63 million, was international. I would expect that going from a direct to a distribution in Europe, while reducing some costs, will also lower their gross margin on the product being sold there. The reduction in their marketing spend, while understandable given their financial condition, is the opposite of what they’d indicated they were going to do in the past. See the conflict between what the brand and the balance sheet requires?
 
While overall sales grew by 7.6% in the quarter, the sale of the SPY brand during the quarter rose $1.4 million or 17% to $9.8 million. That included $800,000 of SPY closeouts. In the same quarter last year, the closeout number was $300,000. As we’ve noted, total sales were $9.9 million. Only $100,000 of revenue came from the left over inventory of licensed brands they’ve been getting out of. They don’t expect any significant future sales from those brands. It’s great to see that done.
 
The gross profit margin was 44% compared to 35% in last year’s quarter. The increase was the result of a number of factors, including the negative impact of the write down of the licensed brand inventory last year, purchasing more lower cost product from China, and decreased freight cost (they avoided some air freight). These positive factors were somewhat offset by lower international margins, increased closeouts, inventory reserves, and discounting, and some changes in accounting for product from the Italian factory.
 
Increased inventory reserves, discounting, and closeouts don’t sound all that positive. What would be really nice is if they would tell us the gross margins on just the SPY branded product since that’s where the company’s focus is.
 
Selling and marketing expense increased by $0.4 million, or 12%, to $3.8 million. They say this was “…driven primarily by increased marketing efforts to promote our SPY brand and our new SPY products and a portion of restructure expense included in 2012.” Yet if we breakdown the increase, there was a $500,000 charge as part of the restructuring which was meant to reduce exactly those costs. They spend an extra $100,000 in marketing costs and had a $200,000 decline in consulting and other marketing expenses.
 
So the increase was to promote the brand, but some part of the increase was a charge to cut those costs. Once again, I can only point to the conflict between the interests of the brand and the reality of the balance sheet.
 
I would expect there will come a point when the major shareholder who’s been financing SPY will be tired of putting in more money and it will be interesting to see what happens then. In the meantime, SPY has whittled its non-operating issues down to not much, and perhaps a good holiday season will result in a strong December quarter. 

 

 

VF’s Quarter. Thank God for 10Qs (What an odd thing to say)

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VF had a quarter in which total revenues rose 14.3% from $2.73 billion to $3.12 billion. Net income was up 26.8% to $381 million. I don’t find it as clear cut as that sounds, and the way to approach analyzing it is to go right to Note G- Business Segment Information in VF’s 10Q and reproduce part of it for our discussion. So here it is.

 

VF refers to its business segments as coalitions. In the chart above you see the revenue and operating profit each coalition produced during the quarter. Total company revenue rose by $398 million. The Outdoor & Action Sports coalition, which includes Vans, The North Face, Timberland and Reef, grew by $415 million, or 104% of total revenue growth.
 
Without the growth in Outdoor & Action Sports, VF’s total revenue declined very slightly.
 
Total coalition profit (profit before interest, taxes and corporate overhead which I call operating profit) grew by $111 million. Outdoor & Action Sports operating profit grew by $92 million to $413 million, representing 83% of operating profit growth and 67% of total operating profit. Outdoor and action sports revenue was $1.85 billion, up 29% from $1.44 billion in the same quarter last year. It represented 59% of total revenues for the quarter.
 
I guess we better dig into the Outdoor & Action Sports results as they appear to be kind of important to VF’s overall results and because they are what we’re most interested in.
 
First, let’s remember that Timberland, which is part of that segment, was acquired by VF on September 13, 2011. So its results were included in VF’s numbers for only a few weeks in last year’s quarter, but in the whole quarter this year. 
 
In last year’s quarter, “Timberland contributed $163.6 million of revenues and $11.0 million of pretax income…” In this year’s September 30 quarter, it contributed $499.1 million of revenues and $55.8 million of pretax income.
 
Let’s adjust the Outdoor and Action Sports segment for those revenue numbers. Without Timberland last year’s quarterly revenues would have been $1.27 billion. This year they would have been $1.35 million. That is growth of 6.3% in revenue for Outdoor & Action Sports.
 
I’m not going to try and do that adjustment for operating income, because the operating income number I have for Outdoor & Action Sports is before interest, taxes and corporate overhead, but the number they give for Timberland’s quarterly impact is just pretax and I’m afraid I’d be comparing apples and oranges.
 
The North Face and Vans grew 5% and 21% during the quarter respectively. Those brand’s direct to consumer businesses grew 10% and 18% respectively. Outdoor & Action Sports U.S. revenues increased 26% with 16% of that increase coming from Timberland. International revenues for the coalition rose 32%, but 30% came from Timberland. European revenues rose 24%, but fell 6% excluding Timberland.
 
We get some further interesting comments on those brands in the conference call. The North Face’s revenue growth in the Americas was in the high single digits. It experienced mid single digit declines in revenue in Europe for the quarter, though they say the brand continues to take market share there. If their revenues can decline, but they can still take market share, things must be pretty hard in Europe.
 
They also note that The North Face’s constant currency revenue were up 60% in Asia. No idea what size numbers we’re talking about.
 
Vans grew at a mid-teens rate in the U.S. Constant currency revenues were up more than 45% in Europe and more than 40% in Asia. Both Vans and North Face are increasing their marketing investments.
 
Total Timberland revenues actually “…declined slightly in the third quarter.” The growth in Timberland we talked about before was for the period when VF owned them. Timberland was obviously generating revenues before the acquisition. I gather it was down more (“moderately”) in the Americas due to the hangover in inventory from last year’s warm winter. It was flat in constant dollars in Europe. There’s further discussion about how they are still integrating Timberland into their business model with expected improvements in performance.
 
The company’s overall revenue growth of 14.3% came mostly from Timberland. Only 2% of that growth was organic. Direct to consumer revenue grew 28%, with 19% coming from Timberland. Direct to consumer was 18% of total revenue.
 
Gross margin grew nicely, from 45.3% to 46.7%. “Gross margin increased in the third quarter in nearly every coalition due to a greater percentage of revenues from higher gross margin businesses and the impact of lower product costs. The increase in the first nine months of 2012 also reflects the continued shift in the revenue mix towards higher margin businesses, including the Outdoor & Action Sports, international and direct-to-consumer businesses.”
 
Strategy
 
The first thing I’d note is CEO Eric Wiseman’s conference call comment that “We’re seeing some slowing in the U.S. economy, increasingly challenging conditions in Europe and slowing growth in China.” Those issues aren’t unique to VF.
 
Let’s go on and quote him again. “As you know, we’re constantly looking at the shape of our portfolio because we believe that the diversity of our portfolio is our strength.” What that means is that they will sell businesses that don’t meet their expectations and look to buy ones that do. And while, “We’re pretty focused on the integration of Timberland this year for all the appropriate reasons…acquisitions are our priority, and we’re beginning to look into 2013 about what we might do.”
 
Right now, Vans appears to be the best performing sizeable brand VF owns, and you know that performance has their attention. They are trying to create some of Van’s attributes at The North Face and I expect they will do the same thing with Timberland once it’s fully integrated.
 
Given the results they are getting from Vans and expect from The North Face and Timberland, I wonder if the sale of some of their brands that aren’t performing as well isn’t in the cards.
 
It used to be hard to be a big company and be “cool” in this industry. That doesn’t seem to be the case anymore. Either the formula has changed or they’ve figured it out. Or maybe it doesn’t matter like it used to. I just think the lines between action sports, youth culture, and fashion have blurred to such an extent that it’s harder to keep a specific identity that really differentiates you.