Skullcandy’s September 30 Quarter; This is Going to Get Interesting

/2 Comments/in /by

Since Skullcandy went public, I’ve characterized the bet they are placing as “whether or not you can be cool in Fred Meyer.” I’ve also asked if coolness is enough of a market differentiator in a product which, especially at the lower end, is increasingly something of a commodity. And finally, I’ve wondered if Skull can have any lasting technological advantage given the resources of some of their competitors. 

Let’s see what their 10Q and conference call tells us about these issues.
 
The Income Statement
 
Sales for the quarter ended Sept. 30 rose 17.1% from $60.6 million in the same quarter last year to $71 million. Gross profit rose from $28.8 million to $34.1 million as the gross profit margin rose from 47.5% to 48%. Operating income was up from $8.2 million to $10.6 million, and income before taxes grew like mad from $3.39 million to $10.2 million. That seems pretty good, but there are complications.
 
The first thing you should know is that interest and other expenses were $4.84 million last year. This year during the quarter they totaled $403,000. That’s a pretax improvement of $4.4 million that has nothing to do with selling headphones and related products. Most of that expense in last year’s quarter was related to the initial public offering and was a one-time expense. Without that, the income before taxes improvement wouldn’t be nearly as great.  Skull points this out in their public information.   
 
Next, keep in mind a transaction from last year. On August 26, 2011, Skull acquired Kungsbacka 57 AB. That was the company’s European distributor. Once they acquired it, in the middle of last year’s quarter, their numbers changed. Before the deal, they sold to Kungsbacka at a lower margin, but didn’t have any of the operating expenses of running a European business. Once the deal was complete and they were going direct, their sales and gross profit rose, but so did their operating expenses.
 
I think getting control of your distribution as you grow is a good idea, and it’s common in our industry. But Skull notes in the 10Q that, “As a result, the three month ended September 30, 2012 are not comparable to the three months ended September 30, 2011…” That’s neither bad nor good. It’s just inevitable and you need to keep it in mind.
 
If we can’t just compare quarters, let’s dig into some details and try and figure out what we think.
 
North American sales as reported rose only a little from $56.3 million to $57.4 million. International sales accounted for almost all of the net sales growth, rising from $4.4 million to $13.6 million. But remember the impact of the Kungsbacka deal. Last year, until the deal date, Skull only operated in one business segment. With the acquisition, they are now in two; North America and International.
 
The 10Q says, “Included in the North America segment for the three months ended September 30, 2012 and 2011…are international net sales of $6,015,000 and $10,713,000… that represent products that were sold from North America to retailers and distributors in other countries.”
 
In last year’s quarter, before the acquisition closed on August 26, sales to Kungsbacka were just sales. After the closing date, they were part of the international segment. And, with a whole quarter under their belt in this year’s quarter, international sales in North America fell, as you’d expect because they got moved to the international category.
 
Let’s take all those international sales out of both quarters and see how things are going just in North America. Skull tells us that North American sales included $10.7 million of international sales not all of which, I guess, were to Kungsbacka. If we subtract, we find that North American sales were $45.54 million. That includes Canada and Mexico.
 
This year, North American sales were reported as $57.41 million, including $6.02 million of international. Subtracting, we come up with $51.39 million of sales in North America. So sales in North America, excluding any product sold internationally from North America, rose from $45.5 million to $51.4 million, or by 13%. Total international sales were up 29.7% from $15.1 million to $19.6 million.
 
You can expect, they tell us, that more sales will transition from the North American to the International segment.
 
On an as reported basis, the 2.1% North American sales increase was “…primarily driven by increased Astro Gaming sales of $4.7 million.” We also learned that online sales, as a percentage of net sales, fell 3.8% to $6 million compared to last year’s quarter. Skull notes that, “An increase in Astro Gaming online net sales was offset by declines in our direct audio consumer business.” Online sales fell from 9.1% to 8.3% of revenues in the nine month period ending September 30 of each year.   “Online sales,” we’re told, “continue to be negatively impacted by price competition in the ease of online price shopping.”   
 
Total gross profit in the North American segment declined by $54,000 to $27.18 million in the quarter compared to last year’s quarter. The gross margin fell to 47.3% from 48.4%. They attribute the decline to “…a shift in sales mix to higher price point products with lower gross margin structures” as well as how some of the Astro Gaming inventory had to be accounted for at acquisition. I would have expected that the Kungsbacka acquisition would have had a positive impact on North American gross margins (because North America would no longer be selling to Kungsbacka at distributor pricing, or at all for that matter) and I was surprised they didn’t mention that.
 
The mention of lower gross margins on the higher price point merchandise was a concern to some analysts. As you know, I’ve been a champion of focusing on gross margin dollars as well as gross margin percentage so I’m maybe not so concerned.
 
The Strategy
 
CEO Jeremy Andrus reminds us in his conference call comments that Skullcandy is “…focused on 4 key strategic areas to drive continued long-term growth. Raising our average selling price, expanding the gaming category, growing international and developing other brands and categories.”
 
Here are some numbers from the conference call for the quarter that tell us something about their sales breakdown worldwide.
 
Product that retails for $30 or less represented 38% of dollar volume and 67% of units. Over the ear products were 26.5% in dollars, but only 7.4% in units. Products in the $30 to $75 range were 28.1% in dollars and 15.4% in units. And products retailing for $100 and over were 5.3% in dollars and 1% in units. The numbers don’t exactly to add to 100% and I can imagine that “over the ear” includes product in more than one price category, but you get the picture. At the moment, the less expensive products are their biggest sellers by units and dollars.
 
Management notes in a couple of places that there is increased competition in the low end buds and that they have lost some market share to competitors in that segment. While I’m obviously not the target market, I paid $2.99 for a recent pair of buds I bought because I knew they were going to get broken at the gym, lost, or left in a pocket and put through the wash.
 
That low end buds would become a bit of a commodity (try to name a consumer electronics product that hasn’t eventually become one- especially at the lower end) can’t be a surprise to anybody. Skull management pretty much acknowledged this when they introduced their 2XL brand “…developed to sell into drug, convenience and grocery channels.”
 
The Skullcandy brand is already in certain retailers (like Fred Meyer) that I’d say is equivalent to where the 2XL brand is be sold. I wonder if 2XL will replace the Skullcandy brand at certain price points and retail outlets, or if they will both be sold in the same place. 2XL, they say without giving any numbers, is small but growing quickly.
 
The Astro gaming headphone brand was about $10 million in international sales at the time Skull acquired it. Skull is pursuing the gaming market with both Astro and Skull branded products. Astro will be the premium product in Skull’s gaming offerings. They’ve just launched the Skull gaming product so it’s not a lot of business yet.
 
In international, Skullcandy is “…still in the early stages of building our direct business in Europe and expanding distribution in other foreign countries.”
 
They are also working to move up their average price points. They think they have a lot of potential in the $50 to $100 price range and “…have invested heavily on product development and are reengineering the development process through an in-house team of designers, developers and acoustic engineers. Everything from the form, function and sound quality are now being controlled in-house.” During the quarter sales in this price range rose 60%, but “…this segment is still relatively small.”
 
What’s It All Mean?
 
They’ve got the 2XL brand, but it’s still small. They see a lot of potential in Europe, but that’s at early stages. They are focusing on higher price point products in both the Astro and Skullcandy brands, but are just rolling them out. Meanwhile, they’ve got some competitive pressure in the $30 dollar and under price point which was their largest by units and dollars during the quarter. Online sales, except for Astro, declined.
 
How’s the overall business environment? “We are confident in our ability to continue to drive long-term sales and earnings growth. That said, the overall retail environment is definitely a bit uneven right now in the U.S. and overseas, particularly in Europe. Over the past few months, we have seen retailers become more cautious in their outlooks for the holiday season and at this point, it is impossible to gauge the impact of Hurricane Sandy.” Those problems aren’t unique to Skullcandy.
 
What’s the short term impact of this? “As a result, the company is lowering its operating margin and profit projections in the fourth quarter and revising its fully diluted earnings per share outlook for 2012 to a range of $1 to $1.04 from the previous range of $1.10 to $1.20.” Management expects “…the fourth quarter to roughly mirror what the third quarter has been in terms of revenue.”   They would not provide a lot of guidance for 2013 because they are in the middle of their budget process, but CEO Andrus did say“…my general sense is that operating margins will be flat next year.”
 
Here we are at the crossroads that every successful, fast growing company eventually arrives at. It’s no surprise that Skull’s lower priced products (that produced 38% of revenue and 67% of unit sales during the quarter) are to some extent becoming commodities and are under competitive pressure. I’d expect that to continue. If there’s continued price and margin pressure there, one wonders what kind of volume they need to do to be competitive in this segment. Their new 2XL brand is to be part of the solution to that.
 
Skullcandy management sees growth opportunities in Europe and in moving to higher price points with both the Skullcandy and Astro brands, but those are at early stages of development. How quickly can they be expected to compensate for the lower priced, more competitive business in North America? And if, in these small but growing niches, competitive positioning is based on the cache of the Skullcandy name- it’s “coolness” if you will- how big is that market?
 
Like I said, this is going to get interesting.

 

 

Nike’s Quarter- It’s (Still) Good to Have a Big Balance Sheet

/0 Comments/in /by

Nike’s 10Q was released three days ago, so it’s time to take a look at their results. Sometimes I wonder why we even talk about Nike.   I guess it’s because after arrogantly stumbling around in the dark in the action sports world for a few years, they developed some patience, mixed it with a bit of humility, hired some people who understood this market and used their undeniable skills in product development, distribution and marketing, along with their financial strength, to take a chunk of it. 

But that’s only part of it. We’ve got to look in the mirror and recognize that when we (of course these were all individual company decisions) decided to grow and look for business outside the core action sports market of participants and the first level of lifestyle enthusiasts, we made things a lot easier for Nike and other mainstream companies like them. Remember when we weren’t mainstream?
 
It was inevitable and even appropriate for some companies, and I’ve got no criticism for the companies who pushed into the mainstream. But the competitive equation changed as that happened. When and as the market becomes more about fashion, it gets harder to compete with a mainstream company whose revenues for the quarter is probably larger than the whole core action sports market for the year.
 
Nike had $6.7 billion in revenues in the quarter ended August 31. That’s up 10% from $6.1 billion in the same quarter last year. But its gross margin fell from 44.3% to 43.5%. They note that factors including higher product input costs, more North American sales (up 23%), where margins are lower, and other factors actually decreased their gross margin by 4%. But all but 0.8% of this was offset by product price increases, fewer closeouts, more direct to consumer business, and projects to reduce product costs. Ain’t pricing power grand?
 
Now, no doubt the lower gross margin made them a little more cautious financially.
 
Nah. Their “demand creation expense” (advertising and promotion) rose 29% from $692 million to $891 million. Operating expenses were up 12% from $1.13 billion to $1.26 billion. Those two increases, along with a tax rate that rose from 24.3% to 27.5%, meant that net income actually fell 12% from $645 million to a mere $567 million.
 
Now, you can imagine the conference call if this was anybody besides Nike. There’d be moaning, wailing, gnashing of teeth, expressions of incredulity, and probably groveling as analysts and management alike tried to get their heads around how a company can possible increase their spending so much while net income declined.
 
Obviously, Nike could have not spent all that money and kept their net income from falling in the quarter. But they didn’t take that approach and nobody expected them to. The conference call was very positive, with discussion of all the great marketing opportunities they took advantage of, how well the brand is positioned, and their focus on “…innovative product, strong brand connections with consumers, and transformative distribution…” The implication, with which I agree, is that if you do those things well, the bottom line will work out.
 
Wait a minute. I’m not sure, but I think, yes, it appears to be!  It’s a public company not just managing for quarterly results, but consistently pursuing its long term strategy even at the expense of the short term bottom line!
May have over oozed sarcasm there. I know Nike isn’t the only company that does it. But it’s appropriate to remember the importance of a good strategy consistently applied over time, especially when coupled with a rock solid balance sheet.
 
Nike’s Other Businesses unit, which includes Converse, Hurley and Nike golf, had revenue of $635 million, up from $585 million in last year’s quarter. Other Businesses used to include Umbro and Cole Haan, but they are being sold so are segregated as “Businesses to be Divested.” Converse experienced “low double digit growth” during the quarter. Hurley’s growth was “mid single digit.” That’s all we’re told.
 
Nike brand revenues were up 11% in footwear, 10% in apparel, and 13% in equipment. In constant currency those numbers, respectively, are 16%, 15%, and 17%. Footwear was $3.69 billion, or 55.3% of total revenue. Apparel, at $1.76 billion, was 26.4%. Equipment, at $386 million, is only 5.8%. The remainder is the other businesses and the units being divested.
 
Direct to consumer sales rose 21% from $909 million to $1.1 billion.
 
Without the 23% revenue increase in North America, Nike’s revenues for the quarter would have been up just 1.3%. Western Europe was down 5% to $1.17 billion (Up 6% in constant currency). Greater China revenues grew 8% (7% in constant currency) to $572 million, and Japan was down 6% to $183 million (down 7% in constant currency). Emerging markets grew 8% to $867 million.
 
Of its total earnings before interest and taxes of $779 million, $630 million, or 81%, came from North America. That $779 million includes a loss at the corporate level of $265 million which results from “…unallocated general and administrative expenses…” It also includes a $375 million loss in the Global Brand Divisions which “…primarily represents NIKE brand licensing businesses that are not part of a geographic operating segment and general and administrative expenses that are centrally managed for the NIKE brand.”
 
That’s about it. For all its size, a discussion of Nike’s results never requires writing a treatise. Lessons? Well, the one about a good strategy consistently applied and the value of a strong balance sheet. That’s not new. And I suppose the one where we opened the door for Nike and similar companies as we inevitably took our little, quirky, underground industry mainstream. That’s not new either.
 
Maybe that’s why I don’t write about Nike every quarter.

 

 

Globe’s Results for the Year

/4 Comments/in /by

I’m kind of late getting this done. The June 30 fiscal year results were released at the end of August. But we only see Australian company results twice a year, so it still seems worthwhile. Happily for me, there’s not that much information in the report so it shouldn’t take long. The “Review of Operations” for the whole year is four short paragraphs- less than half a page. I guess not much happened.  You can see Globe’s whole report here.  It’s the fourth item down on the page. 

To summarize, Globe’s revenues fell 6.1% from $88.5 million to $83.1 million in the pcp (prior calendar period- the previous full year in this case. And all numbers are in Australian dollars). Earnings before interest, tax, depreciation and amortization (EBITDA) were down 41.3% from $2.93 million to $1.72 million. Net income fell 94% from $1.089 million to $62,000. However, those numbers include $1.0 million from settlement of a lawsuit. Without that, Globe’s EBITDA would have been $72,000 and it would have had a bottom line loss.
 
Australasia revenues were $25 million, up 4.3% from $24 million in the pcp. In North America, revenues of $41.8 million declined 15.2% from $49.3 million in the pcp. The press release refers to North American revenues being down “…in single digit percentage terms…” but I keep coming up with 15.2%. Maybe that’s a constant currency number, though it’s not clear.
 
Revenue from Europe rose 7.7% from $15 million to $16.2 million. In Australia (as opposed to the Australasia segment) we see revenues up 6.4% from $21.2 million to $22.5 million. With revenues up $1.0 million for the whole segment, we can see that all the growth in that segment came in Australia itself.
 
Revenues in the United States fell 17.1% from $31.6 million to $26.2 million. In other foreign countries (which I assume means everywhere but the U.S. and Australia) revenues were down 3.5% from $35.5 million to $34.3 million.
 
The sales decline was blamed mostly on the strength of the Australian dollars. We’re told they were basically flat in constant currency.
 
Globe doesn’t provide the gross profit number we’re use to see in the U.S. But there is a cost of sales figure, which I imagine is a reasonable proxy. If we use it to calculate a gross merchandise margin, we see it’s basically unchanged, falling just 0.1% over the year from 45.4% to 45.3%. But the press release says, “Reduced gross margins, which are largely responsible for this decline in profitability, resulted from a combination of sales mix, competitive market pressures and an increase in cost of goods.”
 
They don’t tell us exactly what the gross margin decline was, but it’s pretty clear that what we in the U.S. call ‘cost of goods sold” isn’t the same as “cost of sales” in Australia. Wish I spoke better Australian accounting. Yet you would think an “increase in the cost of goods” would show up in the “cost of sales” as a percentage of merchandise sales. I’ve got some Australian readers. Can one of you tell me the definition of “cost of sales” in Australia?
 
There’s no long term debt on the balance sheet, and the usual ratios are fine. Cash is at $10.2 million down from $12.3 million in the pcp. I would note a 2.2% increase in total receivables to $12.5 million. However, trade receivables rose 11.1% from $8.4 million to $9.4 million. Receivables were down in the Australasia segment even with the revenue increase. But in North America, where revenues fell 15.2%, receivables rose 37% from $2.8 million to $3.85 million. Yikes. That seems to imply something not specifically too good.
 
There was a 14.8% increase in inventory to $14.5 million. They note that there some footwear shipments that arrived in the first quarter of the current year that had been expected to arrive before June 30. Don’t know how big those shipments were, but obviously they would have pushed the year end up inventory up even further.
 
In general, you’d prefer to see receivables and inventory decline when sales decline. It would be interesting to see how much of the inventory growth was in units as opposed to being caused by the higher cost of goods they refer to.
 
The last balance sheet thing I’d mention, under “Other Financial Assets” is an amount of $1.35 million called “Investments in other entities (available for sale).” No big deal, but I wonder what it is because that’s what I do.
 
Well, there was a bit more information in the report than I thought on first read. But we don’t get any sense at all about what they might be planning to do to reverse some of the trends they highlight in the press release. And the sales decline in North America coupled with the increase in receivables is troubling. I guess, unfortunately, it will be six months before we find out how things have evolved. Make that four and a half months, as I’ll try to be more diligent in writing about it. 

 

 

Buckle’s Quarter and a Note on Auction Rate Securities

/0 Comments/in /by

I should start out by telling you that the Buckle July 28, 2012 balance sheet is strong. But long term investments include $15.1 million in Auction Rate Securities (ARS). An ARS is a long term security with an interest rate that resets via a “Dutch auction” every 7 to 49 days depending on the terms of the security. Until about February of 2008, the ARS market was very active and very liquid and was a great way for corporations to park excess cash and earn a little extra return. Now it’s not liquid. I guess I mean it’s still not liquid. 

How do you know what an investment that isn’t trading regularly and isn’t liquid is worth? Well, you use “Unobservable inputs that are not corroborated by market data and are projections, estimates, or interpretations that are supported by little or no market activity and are significant to the fair value of the assets.”
 
Every time I read that somebody (not only Buckle) is using “unobservable inputs” as the basis for evaluating an investment, I chuckle. And Buckle notes that “…the Company has reason to believe that certain of the underlying issuers of its ARS are currently at risk…” But they also point out that even if the investment ends up being worth nothing, they’ll be fine, and I agree.
 
I first wrote about ARSs a few years ago and wanted to remind you that the issue is still around. The reason you might care (aside from “unobservable inputs” making you chuckle too- god I love that) is that our current economic mess was caused by a certain level of paralysis in the financial system. You can see, in the case of the ARS market at least, that there’s still some paralysis out there.
 
Buckle’s performance in the quarter ended July 28, 2012 was pretty much exactly the same as in the pcp (prior calendar period- same quarter the previous year). Sales rose 1.5% from $212.4 million to $215.5 million, but comparable store sales were down 0.8% or $1.6 million. “The decrease in comparable store sales was primarily due to a 4.2% decrease in the number of transactions at comparable stores during the period and a 0.9% decrease in the average number of units sold per transaction, partially offset by a 4.6% increase in the average retail price per piece of merchandise sold.” The sales increase came from opening new stores. They had 439 stores in 43 states at the end of the quarter.
 
The average retail price of a piece of merchandise sold was up $1.94 or 4.6% in the quarter compared to the pcp. I think it’s interesting that the average accessory price point was up 13.7% ($0.54). Accessories were 10.1% of revenues up from 8.9% in the pcp. Denim was 36.2% of revenue. Tops represented 33.9%.
 
Online sales rose 12.1% to $16 million. Those aren’t included in the comparable store sales number.   
 
Gross profit fell a bit from $87.1 million to $86.5 million. The gross profit margin was down from 41% to 40.1%.
 
Selling, general and administrative expenses were almost constant, falling from $50.4 million to $50.1 million. Net income declined just barely from $23.6 million to $23.2 million.
 
In the conference call, they noted that private label business was around 30% of sales compared to 28% in the pcp. In response to an analyst question about their target for private label, CEO Dennis Nelson responded, “…we don’t set a specific number of what we want private label to be. We evaluate the product with the brands, and we have our plans. But depending how strong the brands look and are performing, cuts into the percent of how — what our private label is. So private label will continue to grow, it’s just a matter of how much the brands will grow.”
 
The point, which I’ve noted before for Buckle, is that private label isn’t just a way to make some extra margin. It’s part of their strategy for branding Buckle and merchandising their store. I think that’s the right way for a retailer to approach private label.
 
That analyst also asked, “…And then out of the remaining third-party offerings you have, how much of that product is exclusive to Buckle?” Here was the response.
 
“I would say the majority of our product from the brands is exclusive. I don’t know if that would be 80-plus percent. It might vary by season. And sometimes, in season, we’ll pick up some of their product that is out of their line if something is performing and we don’t have time to either tweak the fit, or the color or styling details.”
 
I was a bit surprised by that answer. What I think he’s saying is that of the 70% of product that’s not proprietary, 80% of that is merchandise only Buckle has. I need to walk back through a Buckle store and look at their merchandising with that in mind. Are they saying that 80% of the non-owned brands that Buckle carries are created exclusively for Buckle? While that’s consistent with what’s going on in the relationship between brands and retailers in general, it surprises me that the number would be that high.
 
Buckle’s quarter, then, was not too good and not too bad. The most intriguing thing to me is the comment about so much of their merchandise being exclusive to Buckle. I haven’t followed Buckle all that closely, but I think I’ll start.

 

 

Quiksilver’s July 31 Quarter: Net Income Rises due to Lower Tax Rate

/0 Comments/in /by

Quik’s net income for the quarter rose 16% to $12.5 million compared to $10.7 million in the pcp (prior calendar period- same quarter the previous year). But the provision for income taxes fell from $9 million to $2.5 million or from 45.6% to 16.8%. Here’s what Quik says in their 10Q about why that happened.

“This decrease resulted primarily from a shift in the mix of income before tax between tax jurisdictions. As a result of our valuation allowance against deferred tax assets in the United States, no tax provision was recognized for income generated in the United States during the three months ended July 31, 2012.” 

Operating income in the Americas (don’t know how much of that was the U.S.) was $33.2 million. Due to a normal loss in corporate operations of $14.4 million (there was an operating profit of $7.3 million in Europe and $1.5 million in Asia/Pacific), the Americas actually provided 120.4% of the reported total operating income of $27.6 million. As stated, they recorded no tax provision for the U.S. part of that.    
 
Accounting for income taxes can be complex, tax rates can move around a lot (obviously), and the tax provision may or may not be indicative of how the business is doing fundamentally. Ignoring, then, the impact of the lower tax rate, how did Quiksilver do? As always, I’ll start with the GAAP (generally accepted accounting principles) numbers.
 
Sales rose 1.8% from $503.3 million to $512.4 million. They were up 10% in the Americas, down 13% in Europe and rose 9% in Asia/Pacific. In constant currency those numbers are, respectively, 12%, 0%, and 13%. That’s an 8% constant currency increase overall.
 
Wholesale revenues rose 5% to $370 million. Retail revenues were up 7% to $119 million. Comparative store retail sales were up 4%. All those numbers are in constant currency, and I really wish they’d give us the “as reported” numbers as well, though of course they aren’t required to. Ecommerce generated $23 million in revenues, or 4.5% of total revenue.
 
Still in constant currency, Quiksilver brand sales rose 4%. The numbers for Roxy and DC were 5% and 16% respectively. They go on to say:
 
“Fluctuations in quarterly brand revenues are highly dependent on the timing of shipments, replenishments of inventory in the retail channel and special order sales, and therefore, are not necessarily indicative of longer trends. Also, decisions regarding customer segmentation and distribution within our wholesale channel may affect net revenues in a manner that is not consistent from period to period.” [Emphasis added]
 
The first sentence in that quote was in their last 10Q. The second one is new. The 10Q wasn’t out at the time of the conference call, but one of the analysts, during the call, asked, “…maybe you could update us on how DC is doing in some of the new distribution hubs here?” referring, I assume to JC Penney.
 
America’s Region President Robert Colby responded, “We’re really happy with the performance. We’re really happy with the decision that we made.”
 
Another analyst followed up, asking, “…if there were any initial sell-ins of large product lines, particularly in the Americas. And in department stores may have driven some of the strong revenues in those — in that region.”
 
In response, Bob Colby gave another iteration of “We’re really happy!”
 
The analyst was having none of it and asked a little more directly “Can you talk at all about how much that might have — just the initial sales there may have driven the quarter?”
 
Bob Colby said, “I’d rather not comment.”
 
This is a great example of why I don’t do my analysis until I received and reviewed the SEC filed document. And it’s also a pretty good example of why companies like to do a press release and conference call before it’s out. I wish the analysts would rise up and refuse to participate in the call until they’d had time to review the filing. 
  
Total gross profit declined very slightly from $255.1 million to $253.5 million. As a percentage, the gross profit margin was down from 50.7% to 49.5%. “The decrease in our consolidated gross profit margin was primarily the result of higher levels of clearance business, discounting, a shift in channel mix and the impact of fluctuations in foreign currency exchange rates. These factors also, in various degrees, had an impact on each segment’s gross margin.”
 
Selling, general and administrative expenses (SG&A) rose from $221.2 million to $225.8 million. That increase “…was primarily due to costs associated with staff eliminations, as during the three months ended July 31, 2012, we enacted personnel reductions in all three of our operating segments to reduce our SG&A in the future.” The severance and restructuring expense was $3.9 million.
 
Operating income was down 18.8% from $33.9 million to $27.6 million. Basically, the gross margin decline more than offset the sales increase. Interest expense, at $14.8 million, was down from $15.8 million in the pcp. There was a foreign currency gain of $2.24 million compared to a gain of $1.46 million in the prior pcp.
 
That gets us to a pretax income of $14.98 million, down 24.2% from $19.74 million in the pcp. I’ve already talked about the income taxes and net income lines.
 
The balance sheet hasn’t changed that much from a year ago. The current ratio fell from 2.45 to 2.33 times and total debt to equity was basically the same, falling from 2.13 to 2.07. Receivables rose 3.3%. They were up 10% in the Americas, down 12% in Europe (reflecting economic conditions there) and up 28% in Asia/Pacific. 
 
Inventory was up 7.2% (15% in constant currency). It was up 2% in the Americas, 16% in Europe and 3% in Asia/Pacific. They note that the increase was “…primarily the result of lower revenues than we had planned in our European segment and, to a lesser extent, higher input costs.” 16% of their global inventory, we learn in the conference call, is prior seasons’ merchandise.
 
Total lines of credit and long term debt rose from $748 million to $783 million. Total equity rose from $551 million to $563 million.
 
CEO Bob McKnight, in his opening remarks in the conference call, referred to Quik’s three long term initiatives as “…strengthening our brands, expanding our business, and driving operational efficiencies. Hard to disagree with those.
 
He mentioned that “…Roxy launched its outdoor fitness line, which is projected to do about $6 million in sales its first year. We know what’s going on with DC at JC Penney. They didn’t say anything about Quiksilver’s women’s line.
 
You wouldn’t expect to hear about it in a conference call, but I’d love to be a fly on the wall at a meeting where Quiksilver management was discussing market positioning and how to grow sales given that positioning. As you know, I’ve wondered in the past where Quiksilver’s growth would come from, and have expressed some concern they would be too dependent on DC and push the brand too hard.
 
If Roxy succeeds as an outdoor fitness line, is it less attractive as a surf brand? Is DC still cool if it’s in JC Penney or, as I’ve been writing about, maybe distribution is less important if you control the points at which the customer touches your product? Skullcandy is probably the best industry example right now of a company trying to prove that’s true. If you can be cool at Fred Meyer……………………
 
Quiksilver’s sales increase was negated by the gross margin decline. The discussion in the conference call and the new language in the 10Q lead me to hypothesize that stocking the new DC channel had a significant positive impact on their revenue numbers. Their income would have been down if not for the decline in the income tax provision. Europe is obviously a very tough market right now, and not just for Quik. 
 
For all the things Quik is doing right, I pretty much have the same concerns I’ve expressed over the last year or two.  I should point out that a bunch of people apparently think I’m out of my mind, as the stock soared the day after Quik released its earnings.  We’ll see.


 

Tilly’s Quarter: The Connection Between Operations and Marketing

/0 Comments/in /by

We need to start by recalling that Tilly’s converted from an S to a C corporation on May 2nd, 2012 and went public May 3rd.  That had an impact on its comparative financial statements.  Let’s review the GAAP results than look at that impact. 

Sales grew 20.5% to $105 million from $87.3 million in the pcp (prior calendar period- same quarter last year). They ended the quarter with 155 stores, up from 131 at the end of the pcp. Comparable store sales were up 5.1% compared to 15.2% in the pcp. Ecommerce sales were $9.8 million, or 9.3% of total sales.
 
The gross profit margin was essentially the same, rising one tenth of a percent to 29.6%. However, the merchandise margin fell by 0.3% but was offset by a 0.4% improvement in leveraging their costs over more stores and sales. Selling, general and administrative expense (sg&a) rose from $22.2 million to $34.5 million. As a percentage of sales, they rose from 25.4% to 32.8%.
 
As a result, they went from pretax income of $3.5 million in the pcp to a loss of $3.3 million. Net income fell from $3.5 million to a loss of $1.2 million.
 
Okay, now the IPO impact. There was “a one-time charge of $7.6 million, or 7.3% of net sales, to recognize life-to-date compensation expense for stock options that was triggered by the consummation of our IPO during the quarter.” That was charged to sg&a and without it, those expenses as a percent of sales rose only 0.1%.
 
The income tax result included a one-time $1 million net tax benefit that resulted from converting from an S to a C corporation as part of going public.
 
Tilly’s says that if you adjust their income statement for the stuff related to going public, their proforma net income for the quarter would have been $2.6 million instead of the GAAP loss of $1.2 million. That’s still down from the $3.5 million profit they reported in the pcp. However, they also provide a proforma income statement for the pcp, and say that profit would have been $1.7 million compared to the $3.5 million they reported.
 
The balance sheet is fine. Changes reflects the IPO, the growth of sales, and the opening of new stores.
 
Okay, those are the numbers. On to the fun stuff. As you know, “Tilly’s operates a chain of specialty retail stores featuring casual clothing, footwear and accessories for teens and young adults.”
 
 According to President and CEO Daniel Griesemer, They “…plan to capitalize on the significant opportunities we see to expand the Tilly’s action sports-inspired lifestyle brand, through the following four growth drivers. By expanding our store base, by driving comparable store sales increases, by growing our e-commerce business, and by increasing our operating margins.”
 
Fair enough I guess. That’s pretty much what every retailer wants to do. Ah, here’s a little more useful information. He goes on to say, “By flowing in merchandise to our stores five days a week, we continue to offer our customers new, on-trend and relative merchandise across a broad assortment of brands and categories. This also allows us to quickly identify and satisfy emerging fashion trends. We drove traffic to our stores by staying connected to our young dynamic multitasking customer as we engaged them through our catalogs, e-mails, in-store events and contests, social media and grassroots community programs, and traditional media.”
 
Here’s another quote from him: “One of the things that we have been good at for a long time is inventory discipline, keeping our inventory current and fresh and full of the most relevant product that our customer wants. Our dynamic business model is built around flowing newness into our stores almost on a daily basis, and addressing the opportunities that we have by reordering and getting back into and expanding key trending fashion trends and categories.”
 
Here’s one more, then I’ll stop. “Constantly flowing in newness and testing new brands, and so I am pleased that you saw it and we’re continuing to go forward with it.”
 
If you’ve been reading many of my articles over the last year or so, you’ll recognize some familiar themes here. Good inventory management that permits a focus on gross margin dollars rather than sales growth. The criticality of operating well. Connecting with your customers the way they want to connect with you. The importance of new brands. Identifying and being on trend. The blurring of the lines between brands and retailers and the additional pressures retailers will put on brands.
 
I doubt doing any of this was ever a bad idea; it just wasn’t so necessary. Note the imperative of a close connection between operations and marketing. Tilly’s talked about its promotions being executed as planned. That is, they weren’t done in response to what competitors were doing or because they had to dump some inventory that hadn’t sold. You won’t be able to take that approach if you’re logistics and inventory management aren’t right.
  
As usual, good strategic and operating ideas will, eventually, be adopted by most management teams- at least at companies that expect to prosper. When that happens, they cease to be a source of advantage. That seems to be what’s going on in our industry. It’s not that Tilly’s is doing anything wrong. Their history is one of success. But, as I’ve been pointing out, many companies are doing the same things. What was innovative begins to become standard practice.
 
I think we’re early in what I’d construe as a massive change in the consumer market and the retail/brand relationship. But if everybody is catching on, it’s time to give some consideration to what will happen next.

 

 

Zumiez Releases More Information on Blue Tomato

/0 Comments/in /by

Life is so not fair. Here I am on vacation, vowing to just get the Zumiez analysis done. I do that, I send it out and now I can relax, right? Nah. Literally 20 minutes later, along comes an 8K/A from Zumiez filed with the SEC giving us the Blue Tomato financial statements.

Let’s try and keep this short. First, here’s the link to my article on Zumiez’s quarter. I noted in that article:

“The Blue Tomato acquisition closed on July 4th. They paid $74.8 million for it (59.5 million Euros actually). Blue Tomato has 5 retail stores in Austria and a big online business. Lord knows Zumiez didn’t pay that price for 5 stores so it’s clearly a really big online business. There are also potential additional payouts totaling $27.2 million at the current exchange rate, part of which is in Zumiez stock, through April 2015.”
 
The presentation of financial statements in Austria is different from the U.S., but my review of the notes suggests that accounting standards are similar. There’s actually a footnote describing the differences and for our purposes, they aren’t that different.
 
The April 30 balance sheet (numbers in Euros) for Blue Tomato shows current assets of 13.85 million. That includes merchandise inventory of 3.9 million and cash of 5.2 million. There are also trade receivables of almost 1 million which I wouldn’t necessary expect from a retailer, but things work differently in Europe. Maybe it’s just money due from the credit card companies.
 
Fixed assets are 2.6 million. I assume that’s the net value after depreciation. There is only 355,000 in intangible assets. Liabilities are 2.85 million, of which 1.85 million is bank loans and overdrafts. Equity is 9.26 million. The balance sheet then, is very solid.
 
The income statement is for the 2011/12 fiscal year, but it doesn’t say on the income statement what month that year ends. I’m guessing it’s April 30 since that’s the balance sheet date. Revenue from merchandise sale was 29.5 million. Expenses for materials and other purchased services were 16.78 million, giving a gross profit of 12.69 million, or 43%.
 
However, this is a retailer. Remember that in the U.S. a retailer would typically include in cost of goods sold certain salaries and occupancy costs. Blue Tomato doesn’t present its numbers that way. That’s neither right nor wrong- just different.
 
Total personnel expenses, we see next, were 3.4 million of which 20.5% was for payroll taxes and contributions. Blue Tomato had 137 employees. They report operating income of 4.7 million, but that includes “other expenses” of 4.05 million. That’s kind of a big number to not identify. I’ll check the footnotes. Nope, no note explaining that.
 
Blue Tomato’s net income for the year is 3.49 million, or 11.8% of revenue.
 
Zumiez goes on to provide us with some more information in the form of unaudited, proforma income statements for the year ended January 28, 2012 as if the Blue Tomato acquisition had occurred on January 30, 2011. As Zumiez points out, all we’re doing here is adjusting some numbers and applying U.S. generally accepted accounting principles, and there’s no reason to think this actually represents how the year would have gone. Still, it’s instructive.
 
The bottom line is that Zumiez reported a net income of $37.4 million in the year ending January 28, 2012. If you add Blue Tomato in and adjust its accounting to U.S. standards, the net income of the consolidated entity is $30.92 million, a decline of 17.3%. Since Blue Tomato made money, how come?
 
First, as I discussed in my original article, there’s a write up of inventory value of $2.2 million that increases the cost of goods sold. But the bigger number is the increase in selling, general and administrative expenses of $11.25 million. That includes $2.3 million of additional amortization expense for the acquired intangible assets, $200,000 of additional depreciation expense, and $8.7 million of future incentive payments to the owners of Blue Tomato.
 
There’s also a tax benefit of $2.3 million.
 
I guess everybody is trying to figure out if Zumiez got a good deal, or paid too much or what. It’s very much a strategic purchase which means we won’t really know for a while. Let’s put it this way; with the limited information I have, I’d say they paid a lot, but purchased a high quality business. If it continues to grow, and offers Zumiez international expansion opportunities, it will have been a good deal.

 

 

Zumiez’s July 28th Quarter; Forget the Numbers. I Might Have Had a Strategic Epiphany

/2 Comments/in /by

Okay, I don’t mean it. No way I can ignore the financial results. It’s just not the way my mind works. But I was so struck with something President and CEO Rich Brooks said in their conference call that I wanted to start there. He said, as a brief part of a longer answer to an analyst’s question, “…we are an action sports lifestyle retailer.”

Well big deal, right? We all knew that. But for some reason, I paused, thought, and on the margin wrote, “Yeah, but is anybody else?”

That opened a mental floodgate. Well, obviously some independent, specialty retailers still are. And I guess some smaller brands (especially in hard goods) are all about action sports. But I perceive that most of our not small brands and multi-outlet retailers are more focused on youth culture than on action sports, though action sports is certainly an important part of that focus. Many of these brands and retailers would say they have their roots in action sports, or have a focus there, or however they put it, and they do. But more and more, with growth, their customers are increasingly removed from the action sports market.
 
The conventional wisdom, which I’ve supported, is that this is inevitable with growth, and is especially inevitable with public companies that have to seek regular growth. They use their roots in action sport to make their brand or stores or both attractive to the broader youth culture or fashion customer that they have to have to get the sales growth. Their target has to be the broader market. Being only an action sports brand or retailer probably restricts growth. 
 
Zumiez, on the other hand, starts with the action sports participant or close follower as their target, focuses there, and invites the broader customer base in if they’re interested. That doesn’t change as they grow. As they describe it, everything they do in their stores from the people they hire, to the way they merchandise, to the brands they sell are action sports based.
 
I suppose I’m oversimplifying this distinction to make a point- which I will eventually get to. Certainly some brands can argue that they are just as action sports focused as Zumiez. Yet as they work to grow their customer base past action sports, that argument gets harder to make.
 
To the extent this distinction is accurate, other brands and retailers are essentially building Zumiez’s market niche and competitive advantage for them. That’s why “…we are an action sports lifestyle retailer,” struck me. Zumiez’s competitors are doing its work for it. That’s my point.
 
Maybe I’m the only one surprised here. Zumiez’s management will tell you they’ve been pursuing this same market positioning since the company’s founding in 1978. And of course my analysis only becomes valid (if you think it is- can’t wait to hear) after the action sports market got much more inclusive, more broadly distributed, and of interest to really big players in the branded consumer products market. So to that extent, I guess Zumiez got a bit lucky.
 
Zumiez stuck to its strategy even as the market changed. Other brands and retailers chose to expand their focus with that market evolution. I’m not suggesting one is right and the other wrong, but it seems to have worked for Zumiez so far.
 
And, now those boring numbers. Probably shouldn’t say that. This will be where people stop reading.
 
Sales for the quarter ended July 28th were $135 million, up 20.4% from $112 million in the pcp (prior calendar period- same quarter last year). They ended the quarter with 457 stores in the U.S., 17 in Canada and five in Europe. Ecommerce sales were 6.9% of net sales compared to 5.3% in the pcp. Comparable store sales rose 9.5%. They ended the quarter with 50 more stores than a year ago.
 
The Blue Tomato acquisition closed on July 4th. They paid $74.8 million for it (59.5 million Euros actually). Blue Tomato has 5 retail stores in Austria and a big online business. Lord knows Zumiez didn’t pay that price for 5 stores so it’s clearly a really big online business. There are also potential additional payouts totaling $27.2 million at the current exchange rate, part of which is in Zumiez stock, through April 2015.
 
Acquisitions complicate financial statements a bit. Let me walk you through the impact. First, Blue Tomato contributed $1.5 million in net sales and a net loss of $600,000 during the quarter. There were $1.5 million in transaction expenses (stuff like legal fees) they booked as part of selling, general and administrative expense (sg&a) during the quarter. They also booked there $700,000 for the first anticipated incentive payment.
 
The inventory they acquired had to be written up $2.2 million and is being expensed to cost of goods sold over 5 months. That’s the period over which they expect to sell the inventory. Half a million of that was booked in the quarter and I guess most of the rest will be in the next.
 
There was also a $500,000 net foreign currency gain in the quarter, mostly from the Blue Tomato deal, that was part of other income.
 
We’re not quite done with Blue Tomato, but let me tell you that Zumiez had net income of $2.07 million in the quarter, down 19.5% from $2.59 million in the pcp. Zumiez shows some pro forma financial information “…as though the acquisition of Blue Tomato had occurred on January 30, 2011.” You can review Zumiez’s 10Q here if you’re interested in all the adjustments they made (see page 11). I’m sure you’re all rushing to see that.
 
What they report is that, on a proforma basis with Blue Tomato included, they would have had a profit of $930,000 this quarter and a loss of $1.07 million in the pcp.
 
And while we’re on one time event kind of stuff, you will recall that Zumiez move their home office and ecommerce fulfillment center. That cost them $1.3 million in the quarter.
 
The gross profit margin grew 1.4% from 33% to 34.4% in the pcp. Most of that came from product margin improvement of 1.2%. Sg&a expenses rose from $33.5 million to $42.6 million. As a percentage of sales, it rose from 29.8% to 31.6%. Most of the increase was the result of the Blue Tomato and relocation expenses already described.
 
Earnings before income taxes rose from $4 million to $4.8 million, but an increase in the tax rate from 35% to 56.5% left them with a lower net income. They “…estimate our effective tax rate will be adversely impacted by the tax effects of the acquisition of Blue Tomato.”  That’s what we’re seeing here. I’m not clear how long that impact lasts.
 
Let me see if I can work my way around to a closing by reviewing some comments that were made by Zumiez management in the conference call. CEO Brooks starts by talking about the continuing key drivers of the business; “…higher store productivity, domestic new store growth, greater penetration in e-commerce, and international expansion.”   He talks, as he has before, about Zumiez’s “…highly differentiated product assortments and exceptional in-store experience continues to attract and engage our core consumer…” Nothing new there.
 
Then, later, in response to an analyst question, he says, “I think our buyers do great job in terms of driving our margin forward and negotiating with our partners on price. I would also add that our inventory levels are, in terms of the quality of inventories, are in very good shape.” He also talks about how their brand selection, buying and inventory management means that most of their promotions are planned tactics as opposed to responses to market competitive conditions.
 
Further discussion is about the ongoing implementation of inventory assortment planning tools. “We’re talking,” he says, “about being able to, at a SKU level, be able to assortment plan on every brand category combination by week, by location. So, very powerful tools that allow us to build up from those base-level sort of plans up to what our overall open-to-buy planning is, and of course reconciling those things together.”
 
Finally, he talks about it becoming “…an omni-channel world.” Zumiez see online and brick and mortar as increasingly integrated going forward. He expects this integration to proceed “…to the point where I’m not sure I’m going to be able to tell you in future what’s driving volume and transaction in stores and what’s driving volume and transactions online because they’re going to be that tightly integrated. The consumer gets to choose and all that’s important is that we’re in every channel they want and the way they want us, with a great brand experience and the product they want.”
 
I’ve been pointing recently to how other companies are responding, in a way similar to Zumiez, to the power of the consumer, the need to offer them experiences (due to availability and lack of differentiation in product), the need to operate well and the tie in between those quality operations and your marketing, and the breakdown between the historical brand/retailer business model. You know- retailers becoming brands and brands becoming retailers.
 
You can see in Zumiez’s discussion how they see the pieces fitting together. Other companies have essentially said the same thing. I suppose they always did fit together, but in better economic times it wasn’t quite so important.
 
There is one fly in the ointment here. When Rick Brooks talks about his buyers doing a great job, what I hear is how hard they are squeezing their suppliers. Well, that’s their job. And it’s certainly true that their strategic positioning and investment in systems, which I have highlighted, may give them the ability to do that.
 
As everybody knows, the relationships between brands and retailers are evolving fast. But both sides still need to make money.
 
Zumiez made a strategic decision in acquiring Blue Tomato that in the short term (I’m not quite sure what “short term” means) has hurt their financial results and the market didn’t like it. Oh well. I think public companies are too quarter to quarter oriented anyway. We didn’t get any information about it this time, but I’m sure that some European stores are in Zumiez’s future now that they have a management team over there to lead implementation. As management emphasized, Blue Tomato’s culture is very similar to Zumiez’s. It will be interesting to see if they can pull off the same kind of brand positioning in Europe that Zumiez has in the U.S. when they do open more stores there.   

 

 

PacSun’s Quarter: Still Losing Money, But Elements of the Strategy Becoming Clearer

/0 Comments/in /by

Strategies don’t bear fruit in a quarter, or even in a year. There’s still a lot of work to be done before we can say that PacSun’s strategy has been successful if only because the company is still losing money. The goal has been the same for a couple of years now; to make PacSun relevant to its target customers again. Let’s see how they’re doing.

First the bad news. As reported, PacSun had a net loss of $17.5 million in the quarter ended July 28th compared to a loss of $19.3 million in the pcp (prior calendar period- the same quarter the previous year). Here’s where you can see the 10Q yourself.

Sales, however, rose 4.7% from $200.9 million to $210.3 million. Gross margin rose from 23.6% to 27.5%. They credit 2.6% of the gross margin increase to the merchandise margin going from 48.8% to 51.4% “…due to an increase in initial markups and a decrease in promotions.” 1.1% of the gross margin was due to same store sales rising by 5% and some “…reduction in rent expense related to negotiations with our landlords.” Comparative store sales were up 7% in men’s and 2% in women’s. On line sales rose 15%. They mention in the conference call that they are seeing a higher average unit retail “…offsetting a modest decline in traffic.” They expect that to continue in their third quarter.
 
PacSun had 727 stores open at the end of the quarter compared to 821 in the pcp. They expect to end the year with 625 stores.
  
For any new readers, I’ll remind you that a brand’s gross margin is mostly its merchandise cost while a retailer’s gross margin adds other expenses to cost. In PacSun’s case this includes buying, distribution and occupancy expenses.
 
Selling, general and administrative expenses were essentially stable at $64 million. As a percentage of sales they fell from 31.8% to 30.2%. The loss from discontinued operations was zero compared to $1.8 million in the pcp.
 
That results in a loss from continuing operations after taxes of about $17.5 million for both periods. However, this year’s quarter includes an $8.2 million loss on a derivative liability that’s related to the 1,000 preferred shares of stock issued to Golden Gate Capital as part of the $60 million term loan PacSun received from it. The change in value has to be reported at fair value every quarter. If you look at their operating loss before that and taxes it fell from $16.5 million to $5.7 million.
 
The balance sheet shows a current ratio that fell slightly from 1.44 to 1.27 over the year. Total liabilities to equity improved from 1.43 times to 0.78 times. Cash on hand rose from $13 million to $34 million. Inventory declined 11.4% to $145 million, consistent with the closing of stores. More importantly, on a comparable store basis, it was down 6%. Shareholders’ equity fell by half, from $166 million to $82 million.
They reported $18 million in positive cash flow. Net cash used in operating activities declined from $43.7 million to $13.5 million.
 
I’m sure you’re all tired of boring numbers by now, so let’s get on to the fun, uplifting strategic stuff.
 
In his opening comments on the conference call, CEO Gary Schoenfeld described their strategy this way:
 
“…we continue 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.”
 
They talk about the important role of new brands. CEO Schoenfeld mentions how they are finding them at trade shows he’s just come back from.
 
It’s interesting to watch the relationship between brands and retailers evolve. Years ago, I cautioned new brands about getting too involved with big retailers too quickly. I wouldn’t give that advice anymore. There used to be a certain negative stigma to a brand jumping out of the core specialty channel too quickly. As the customer base has broadened, the number of core specialty retailers declined, and the sensitivity of large retailers to brand management improved, a strong relationship with a major retailer can jump start a small brand.
 
We all know retailers are building their own brands, and some brands have made exclusive arrangements with big retailers. I wonder if we won’t see large retailers trying to buy brands as they become important to that retailer.
 
New brands fit into PacSun’s positioning as a California lifestyle brand. Take a look at their Golden State of Mind web site. The web site “…allows the user to experience all things California in 6 key categories, including fashion, music, art, entertainment, action sports, and of course, with our brands.” For PacSun (and for most others I’d say) it’s not just about action sports anymore. Hasn’t been for a while.
 
Schoenfeld goes on to say, “Customers are experiencing our brand and our unique filter of California lifestyle through multiple touch points in our stores and online, and we believe this will continue to be a critical differentiator for PacSun as we reestablish and emotional connection with customers across the entire United States.” True, but of course they aren’t the only one trying to do it.
 
Now the next piece of the mix. Remember that before Gary Schoenfeld became CEO, PacSun was placing the same assortment in all its stores? He started the process of changing that. This involves improved or new systems with timely information about what’s selling where. But it also requires discussions with the brands you buy and the manufacturers of your owned brands and some changes in logistics and inventory management. It’s operations, but it’s also marketing. You can’t separate the two in the existing competitive environment.
 
One more quote from Gary Schoenfeld: 
 
“I think we have gotten better at how we segment between store groups. But all of that, I think we can continue to improve upon as we go forward. And then probably the fourth element that’s common to both genders has been just an overall effort towards reducing SKU count, and therefore, making the stores easier to shop and easier to showcase key brands on the Men’s side and key fashion ideas, as well as critical essentials business on the Women’s side.”
 
Regular readers will know I’ve been writing for years about how operating well is a requirement just to get the chance to compete- not a competitive advantage. And even more recently I’ve described how a number of industry companies are bringing together online and brick and mortar, controlling all their consumer touch points, and working to provide the unique experience the consumers is demanding.
As they describe it, that’s what PacSun is trying to do. I don’t have any doubt that it’s the right approach. The market is demanding it. Though there are savings from operating well, I see the strategy as costing some money to implement.
 
PacSun got the $60 million term loan from Golden Gate Capital to have the resources and buy some time to implement its strategy. Some of the quarter’s financial metrics are encouraging and, as I said, I think it’s the right strategy.  But others are taking the same approach and have more financial resources.
 
I’ll end where I started. Strategies don’t bear fruit in a quarter, or even a year. This is a work in progress.

 

 

Spy’s Expense Cuts

/5 Comments/in /by
Spy announced on August 27 that they were reducing their North American and European employment by 20 positions, going to a distribution model in Europe (they had been direct previously), and spending less on marketing. They think these changes will cost them  $1.2 million in the quarter ($1.0 million in cash) during their 3rd quarter, but that they “…could result in annual operating cost savings of up to $6.0 million in 2013.”
 
Back on July 2nd, Spy filed an 8K announcing, among other things that they expected to raise some form of equity capital by August 31st. There has been no announcement that any equity has been raised.
 
When I wrote about Spy’s June 30 quarter, I pointed out that their majority shareholder had increased the line of credit to the company to $10 million (and that Spy owed him $15 million). I said (and had said before) that Spy’s brand focus was correct. I also said, “As long as Costa Brava is willing to fund them, they can continue to pursue their strategy.”
 
I feel strongly both ways about what Spy is doing. On the one hand, the balance sheet and cash run rate certainly seems to require expense reduction. On the other hand, their strategy has been to invest in the brand to get revenues to a level that could support the required marketing effort. For all the progress Spy has made in increasing brand sales, it looks like somebody think it hasn’t happened fast enough to justify the continuing required cash investment.
 
They don’t give a breakdown of exactly where the personnel and expense reductions happened. I’d be very interested to know that so I could better judge if this was a tactical decision to increase the U.S. focus or a more fundamental strategic decisions by funding source Costa Brava that that they couldn’t just keep pouring cash in.
 
What we do know from their 10Q is that in the quarter ended June 30, North American sales were $8.73 million and international only $740,000. You wonder how much expense there could be in Europe given the level of revenues there.  
 
Going from a direct to a distribution model in Europe does indeed reduce expenses. But it also reduces revenues since you aren’t going to be selling direct and your distributors will want to make a few Euros too. They didn’t indicate how much that reduction might be. Depends, I suppose, on the distributors and how quickly they can be up and running. 
 
I’ll look forward to their filling us in on how that transition is going. For all I know, this is a really positive development, but they haven’t supplied us with enough details to know that.