Orange 21’s Quarter. Sales Improvement, But More Ongoing Cash Needs

/0 Comments/in /by

As you know, I tend to hate proforma financial statements, but once in a while they make sense. Orange’s quarter ended June 30 is one of those times. They sold their factory in Italy (LEM) on December 31, 2010. The June 30, 2010 quarter contains sales and expenses associated with LEM. The June 30, 2011 quarter does not. 

Happily, Orange has helped us out and provided a pro forma income statement for the June 30, 2010 quarter as if LEM was gone. We’re going to use that one to evaluate what’s going on.

The “as filed” income statement for the June 30, 2010 quarter showed revenue of $9.53 million and a profit of $408,000. The proforma statement for that quarter, taking out the LEM sales and expenses, showed revenue of $8.4 million and a loss of $925,000. Now, most people would think a profit of $408,000 would be better than a loss of $925,000 and they’d be right. But our interest is in figuring out how Orange might do going forward and it’s much easier to see that without the late, not so lamented, LEM in the way.
 
They do a really good job explaining this in their conference call. It might be worth a listen, but I suspect most of you prefer that I listen to it and tell you what they said.
 
Sales for the quarter ended June 30, 2011 were $8.99 million, up 6.8% from the pro forma sales number for last year’s quarter. For the six months ended June 30, sales were essentially flat compared to the previous year excluding the LEM sales.
 
Aside from the Spy brand, we know Orange also has had deals to sell licensed product from Margaritaville, O’Neil, and Mary J. Blige. So far sales from those products haven’t been significant, and I’ve already written about the deal to get out from under the contract with Mary. It’s costing them $1.5 million, but they would have had to pay royalties of $2.5 million if they hadn’t renegotiated. They also indicated that, as a result of the revised deal, that they have more flexibility to get rid of the existing inventory.
 
So most of that sales increase is the Spy brand. Good for the Spy brand. Not so good for the licensed brands effort. They note in the conference call that the management reorganization that started in mid-April put the Margaritaville product sales on hold and that sales of that brand have been “lackluster.” They said they were working together to determine the true value of the Margaritaville eyewear brand.   No, I don’t know what that means exactly.
 
The net loss was $2.95 million, much worse than the same quarter last year whether as filed or proforma. This is progress?
Yes, if you look at some of the charges during the quarter that resulted in the loss. There was non-cash stock and warrant compensation, severance payments, and the settlement with Mary J. Bilge charged to the company during the quarter. Together, these three come close to the total loss.
 
I do see their point that if you ignore all the “stuff” things can be construed to be looking up. But the stuff happened and continues to impact the company. This is like “The Turnaround That Wouldn’t End.” Yet the fact that it hasn’t ended (badly) suggests two things. First, that there is some significant brand strength there.
 
Second, moving over to the balance sheet and cash flow, it suggests that 45% shareholder Seth Hamot has a lot of money. As of June 30, 2011 his company, Costa Brava, had lent Orange $9.5 million and is prepared, under a line of credit established in June, to lend them $3.5 million more if they need it.
 
They say they are going to need it and will borrow it either from the Costa Brava line of credit or from their asset based lender BFI, assuming that line continues to be available. They think these lines will be enough over the next 12 months “If the Company is able to achieve some or a combination of…” sales growth, improved working capital management, reduce inventory, and/or better operating expense management.
 
They do have a lot of money tied up in inventory ($8.5 million down from $9 million a year ago). But a year ago, a bunch of that inventory had to involve LEM. I don’t know how much. Inventory is higher due to purchases “…in anticipation of sales that did not occur,” including for the licensed brands, and product purchased from LEM under a take or pay contract. Orange is required to purchase almost $5 million in product from LEM during 2011.
 
Net receivables have fallen from $6.5 million last June 30 to $5.5 million this June 30. But their gross receivables are $7.4 million. Against that they have an allowance for doubtful accounts of $625,000 and an allowance for returns of $1.25 million. If you happen to look at the whole 10Q, you can see on page 33 a discussion and table of how they calculate the return allowance. You’ll see that the average return percentage at June 30 for the Melodies by MJB brand was 18.8%. Gives you some indication of why they decided to renegotiate that deal. The Spy brand, by way of comparison was 5.4%.
 
The conference call included a rather lengthy discussion of all the operational and marketing changes they are making. These include new sales and marketing initiatives, advertising campaign, online ecommerce and branding platforms, revamping of the marketing mix, a more focused approach to sales, and a newly invigorated sales team.
 
That all sounds good of course, but the devil’s in the details we didn’t get. And when they said, “The rollout of the focused and fun Spy brand identity, with a creative execution in the market that will have a measureable effectiveness which will include a new level of sales and operational performance to meet the new demand for the brand,”  I decided we’d just have to wait and see what happened.
Strategically, I think it’s their plan to take the Spy brand into all the niches they think it fits in. That’s going to include optical retailers, just as an example, and they are looking at some surf space as well.
 
I can imagine a time in the not too distant future where this brand might be for sale. Well, I’m sure it is right now for some price (all brands are), so let me rephrase that. I won’t be surprised to see a sale after the promised turnaround is a little more evident. When that is, I guess, depends on Mr. Hamot’s appetite for continuing to finance Orange 21.

 

 

Skullcandy Licensing Agreement with Sonomax

/0 Comments/in /by

Don’t know how many of you saw this (I missed it for a while), but back in June, Skullcandy signed a licensing agreement with Sonomax to use its technology in Skullcandy’s headphones. Here’s the press release on the agreement and some information on Sonomax. The direct to consumer web site for Sonomax product is here. As far as I can tell, Skullcandy didn’t announce the deal. As they weren’t public yet, they didn’t have to.

Basically, Sonomax head phones allow you to go through a four minute process that sculpts your ear buds to your ear, giving you a custom fit. It works with a “…disposable fitting system that delivers a customized earpiece.”

I gather they aren’t cheap, but as somebody who’s had his share of trouble getting and keeping comfortable ear buds, I’m interested.
“Sonomax intends to modify its current earphone product line to incorporate Skullcandy’s industrial design and branding. The companies will work towards creating a line of Skullcandy products featuring SonoFit,” the press release says.
 
It’s a non-exclusive deal, but I’m glad to see Skullcandy bringing some more technology to its product, even though others will eventually have it too. At least Skullcandy is first. It’s not clear how long it will be until the product is actually available for purchase.
 
Sonomax is a small, almost development stage, company. Its calendar 2010 revenues were $643,000 Canadian and it lost $4.15 million. Its balance sheet is none too wonderful and I’d say it’s going to need to raise some more cash expeditiously if it hasn’t already since the end of 2010.
 
Skullcandy releases its first quarterly earnings tomorrow. I’ll take you through them once I have the 10Q.       

 

 

VF’s June 30 Quarter Results; Pretty Impressive

/0 Comments/in /by

VF released its earnings and had its conference call back on July 21, but the 10Q was only released August 10th.  The results, as you probably already heard, were good. Revenue for the quarter was up 15.4% to $1.8 billion and net income rose 16.2% to $130 million. They accomplished this with a gross margin that fell from 47.1% to 45.9% partly by reducing their marketing, administrative and general expenses as a percentage of revenues to 35.7% from 36.5% in the same quarter last year.

The decline in the gross margin percentage was the result of product cost increases that weren’t fully passed on to their customers. The product margin was actually a bit lower as the reported gross margin benefited by 65 basis points from the closing of a European jeanswear facility. It also benefitted from the higher margins in the direct to consumer business.

They expect some further margin reductions in the rest of the year because of higher cotton prices and their decision not to pass through all the cost increases. They also note that cotton prices have fallen from $3.00 a pound to $1.00 a pound, and hope to see that positively impact product cost starting in 2012. 
 
VF has seen little impact from price increases on unit volume. But they are waiting to see how the consumer reacts to even higher prices in the second half of the year. All brands and retailers are waiting. VF is hoping that if cotton prices come down next year they might be able to recapture some margin they lost when they didn’t raise prices as much as costs rose.
 
Price increases accounted for 3% to 3.5% of the quarter’s total revenue gain of 15.4%. Two-thirds of that came from the U.S. jeans business. 
 
International revenues rose 30% in the quarter. They represented 29% of total revenue. Asia was up 30%. Europe was up 30%, Latin America 40%, and Mexico 26%.  They think international may hit 33% of total revenue this year, and they plan for it to reach 40% in five. If you’re interested in learning more about VF’s growth plans, you might go here.
 
Direct to consumer revenues were up 17% as a result of new store openings, a 46% increase in ecommerce revenue, and growth in comparable store sales. They’ve opened 44 new owned stores this year so far and are on track to open a total of 100. Operating margins for the direct to consumer business is up 3% this quarter, so you can see why they find it attractive.
 
There was no growth from new acquisitions this quarter compared to the same quarter last year. All $246 million came from existing businesses, though $43.5 million was the result of foreign currency translation. It’s great that VF breaks these numbers out in a separate table. 
 
VF, as you’re probably aware, divides its business into six segments they call coalitions. The quarter’s results for those segments are shown below.
 
       

Quarterly Sales

Change Since Same

Coalition Profit
       

In Millions of $

Quarter Last year

In Millions of $

Outdoor & Action Sports
  

$718
  

23.0%
  

$81.5
  

Jeanswear
    

$613
  

10.3%
  

$94.7
  

Imagewear
    

$244
  

15.6%
  

$26.0
  

Sportswear
    

$120
  

10.1%
  

$9.7
  

Contemporary Brands
  

$118
  

11.3%
  

$8.2
  

Other
      

$26
  

-3.2%
  

$0.0
  
                   
 
Most of our interest, for some reason, is in the Outdoor & Action Sports segment that includes Vans, The North Face, and Reef as well as other as six other brands. The North Face and Vans grew 21% and 22% respectively during the quarter. No mention, as usual, of what Reef did. The entire segment grew 14% domestically, and 42% internationally during the quarter (34% in constant dollars).  Revenues in Asia were also up 42% during the quarter compared to the same quarter the previous year.
 
These results don’t include the Timberland acquisition, which is expected to be completed in the third quarter.
 
The balance sheet remains very strong, but there are a couple of interesting things I want to point out. Just to give you a couple of numbers, the current ratio improved from 2.3 to 3.0 and the debt to total capital ratio fell from 24.5% to 18.7%. High current ratios are good, low debt to capital ratios are good for those of you who don’t have a financial background.
 
On January 2, VF changed its inventory accounting method from LIFO (last in, first out) to FIFO (first in, first out) for that inventory it wasn’t already accounting for using FIFO (about 25% of the total). The impact for the first six months of the year would have been to reduce their cost of goods sold by $8 million.
 
Okay, small number so why am I tormenting you with this technical accounting crap? If everything you put into inventory always cost the same, it wouldn’t matter. In an inflationary environment, the product you enter into inventory is going to be at a higher cost than the product you bought earlier. So if you decide you’re going to sell the older inventory first, you decrease your cost of goods sold and increase your profit. 
 
No big deal. This isn’t about VF but it’s about your need to be aware that this accounting change can matter if we’re dealing with product cost inflation, as we have been in the case of products made with cotton. 
 
On a related issue, inventory at the end of the quarter rose almost 17% from a year ago. But they note in the conference call that 9% of that was due to higher product costs. So units in inventory grew at a slower pace consistent with sales growth.
 
Three things stand out for me from reviewing VF’s quarter besides the good financial results. The first is the push into international. They’ve decided, along with a lot of other larger companies, that the growth opportunities are much greater outside of the U.S. The second is the growth of their direct to consumer business. Hardly a new industry trend, but I think we’ll continue to see more of it. Having this many brands with this kind of growth and margins makes it irresistible.
 
Finally, VF chose last year to make an incremental marketing spend of $100 million to promote their brands. They are continuing, and in fact have increased that spend slightly, this year. It shows a lot of confidence in their plan, as well as the strength of their balance sheet.     

 

 

Orange 21 Revises Its Mary J. Blige Licensing Deal; It Will Terminate Early

/4 Comments/in /by

On July 18, Orange 21 (Spy Optic)  amended its licensing agreement with Rose Colored Glasses (Mary J. Blige’s company). The amendment provides “…for an earlier expiration of the Company’s license to sell Mary J. Blige (“MJB”) branded sunglasses (the “License”) on March 31, 2012.” For this, they paid Rose Colored Glasses $1,000,000 at signing and issued a non-interest bearing promissory note for $500,000 that’s due March 31, 2012. The filing only provides about half a page of real information. You can read it here.

My take on Orange 21, as you know if you’ve been reading what I’ve written about them, is that the tough economy and some management issues left them without the sales volume and margins they needed to support their required advertising and promotional programs. To try and address this issue, they took what I thought was the reasonable step of making licensing agreements with O’Neil, Jimmy Buffett’s Margaritaville brand, and Mary J. Blige to produce and market sunglasses under their names.

As of their last filing, we hadn’t been told that these programs were generating any meaningful sales, but there had been a lot of expense incurred for design, promotion, inventory and required contractual payments. It appears from the amendment that the licensing deal with Ms. Blige isn’t working out quite the way Orange 21 hoped it would. We don’t have any sales numbers from any of the licensing agreements.
 
Mr. Seth Hamot, Orange 21’s principal shareholder and Chairman, through his company Costa Brava, has previously invested $7 million in Orange 21. If the licensing agreements don’t produce the hoped for revenue increases, and the fundamental strategic issue of the brand not generating enough sales to pay for a competitive marketing program can’t be resolved, he may be called on to put in some more.
 
We should see the quarterly financials shortly.  That will give us a better feel for what might be next.                

 

 

Dick’s Sporting Goods; Insights into the Development of the Action Sports Retail Environment

/2 Comments/in , , /by

Never thought I’d be looking to Dick’s for that. Dick’s, which has been around since 1948, had revenue of $4.9 billion in 2010 from 525 stores. The 444 Dick’s stores are around 50,000 square feet each though there are some two level ones that go up to 75,000 square feet. The 81 Golf Galaxy stores are between 13,000 and 18,000 square feet. The word action sports isn’t mentioned anywhere in their most recent 10K.

What’s intriguing is their business strategy. It’s intriguing because there’s a lot that would fit right into Zumiez’s annual report. A good independent specialty retailer will tell you that he tries to do a lot of the same things.

Let’s take a look at what Dick’s business strategies are and how they compare to the generally agreed on best practices in our industry. This may tell us something about how our industry is evolving.
 
Dick’s refers to itself as an Authentic Sporting Goods Retailer.
 
“Our history and core foundation is as a retailer of high quality authentic athletic equipment, apparel and footwear, intended to enhance our customers’ performance and enjoyment of athletic pursuits, rather than focusing our merchandise selection on the latest fashion trend or style. We believe our customers seek genuine, deep product offerings, and ultimately this merchandising approach positions us with advantages in the market, which we believe will continue to benefit from new product offerings with enhanced technological features.”
 
The focus on performance and enjoyment rather than fashion is what I’ve argued action sports is really all about, though we got away from it in the good old economy days and thought everybody who carried some hard goods was a “core” retailer. I might be putting words in their mouth, but it sounds like Dick’s thinks you can be “core” for a whole bunch of sports at the same time in 50,000 square feet. Our specialty retailers try to do it with two to maybe five sports. In their most recently completed fiscal year, 54% of Dick’s revenues came from hard goods. 
 
Dick’s second strategy is Competitive Pricing. They specifically do not try to be the price leader but will match competitors’ prices.
 
“We seek to offer value to our customers and develop and maintain a reputation as a provider of value at each price point.”
 
Their sheer size gives them some pricing (and costing) leverage that action sports retailers typically don’t have. No independent specialty shop can compete on price. Dick’s also has the advantage of selling product in nearly two dozen sports and activities, with the result that they can better manage their inventory to respond to seasonality and even out cash flow.
 
Dick’s carries a Broad Assortment of Brand Name Merchandise.  “The breadth of our product selections in each category of sporting goods offers our customers a wide range of price points and enables us to address the needs of sporting goods consumers, from the beginner to the sport enthusiast.”
 
What I particularly like about this is the obvious customer definition. Dick’s thinks it’s the place to go if you’re a participant in any of the sports or activities they support. You can be a beginner or an expert and they’ve got what you need. That sounds like something an independent specialty retailer in action sports might say.    Trouble is, you can imagine Sports Authority saying it too. But Dick’s differentiates itself from Sports Authority in ways that action sports retailers would recognize. Let’s look at some more of Dick’s business strategies.
 
They offer Expertise and Service.  “We enhance our customers’ shopping experience by providing knowledgeable and trained customer service professionals and value added services.”  “We actively recruit sports enthusiasts to serve as sales associates because we believe that they are more knowledgeable about the products they sell.”
 
This means having professional golfers in the golf part of the store, certified fitness trainers helping you buy workout equipment, and trained bike mechanics to sell and service bicycles. It may be a 50,000 square foot store but in your little part of the store, where you’re buying stuff for the sport you’re committed to, you’ll be working with experts who are just as committed as you are.  That will sound familiar to any action sports retailer, chain or single store.
 
Dick’s creates Interactive “Store-Within-A-Store.” 

"Our Dick’s Sporting Goods stores typically contain five stand-alone specialty stores. We seek to create a distinct look and feel for each specialty department to heighten the customer’s interest in the products offered.”
 
Once again, that’s not exactly an unfamiliar concept. A typical store will include a pro golf shop, footwear center, fitness center, hunting and fishing area, and a team sports store with appropriate seasonal equipment and apparel.
 
Their last business strategy is Exclusive Brand Offerings that “…offer exceptional value and quality to our customers at each price point and obtain higher gross margins than we obtain on sales of comparable products.”
 
Those would be shop brands. We all recognize and understand that. But Dick’s seems to go further. They work with existing, well known brands to develop products that are available exclusively at Dick’s under that brand’s name. That’s possible only because of their size and market power.
 
Though Dick’s isn’t active in action sports, you can’t help but look at their business strategies and get some understanding for why specialty retailers are having such a hard time. Dick’s has all the advantages that come with size; purchasing power, efficient distribution, access to capital, good systems. But they’ve gone further and are applying many of the competitive techniques we use to think of as being available only to the specialty retailer to the large format business. And they can do it without having the highest prices.
 
Dick’s isn’t a direct competitor for action sports retailers, though inevitably there is some crossover of brands. But if Dick’s can do it, so can other retailers. The good news is that if you really an independent action sports retailer (that is, your customers are participants and the first level of non-participants that are serious about the lifestyle) you’re got your location and your community connections as a point of differentiation. The bad news is I think that’s all you’ve got, so you better do that right.

 

 

Tilly’s is Going Public- A First Look at Their Registration Statement (S-1)

/0 Comments/in , , /by

Tilly’s started in 1982 with a single store in Orange County, California. The company name is World of Jeans & Tops, but it does business as Tilly’s. It was founded by Hezy Shaked and Tilly Levine. As of April 30 2011, they had 126 stores in 11 states averaging 7,800 square feet each. They filed last week for their initial public offering.

As is normal, the initial filing  has some important blanks not filled in yet. They will be completed as the process moves forward. In the meantime, we can look at the historical financial statements. I also want to talk about the impact of changing from an “S” corporation to a “C” corporation, the ownership structure post offering, and their competitive strengths and brand strategy. Let’s get started.

Sales have grown from $199 million in the year ended February 3, 2007 to $333 million in the year ended January 29, 2011.   During the same period, they went from 51 to 125 stores. Comparable store sales rose 17.3% in the first year of that period. They then rose 8.7% before falling 12.5% and 3.1% in the next two fiscal years and rising 6.7% in the year ended January 20, 2011. E-commerce revenues have grown from $15.4 million to $32.8 million in the last three complete years.
 
One has to wonder these days, in evaluating any consumer based IPO, whether the company can hope to return to its pre Great Recession growth any time in the next few years. It’s not the company’s fault; it’s just the economy.
 
The gross profit margin was 37.1% in the year ended February 3, 2007. The following year, it was 37.2%. For the January 31, 2009 year, it fell to 32.5% and for the most recent two years it was 30.9%. Selling, general and administrative expenses have of course grown in absolute dollars with sales, but as a percentage of sales has been more or less constant around 23.3% in the last three complete years.
 
Of the 126 stores Tilly’s has as of April 30, 72 are in California and 16 in Florida. There are also 17 in Arizona. The other 21 are distributed in 8 states with New Jersey, at 7, having the most. I would be particularly interested in learning something about the performance of the stores by location (which isn’t included). As we’ll discuss, part of their growth strategy is to increase their number of stores, and I wonder if performance has been similar in all geographies.
 
“C” and “S” Corporations 
Tilly’s has always operated as an S corporation. What this means is that the earnings were distributed to the owners who reported the income on their personal income tax returns. It also means that “No provision or liability for federal or state income tax has been provided in our financial statements except for those states where the “S” Corporation status is not recognized and for the 1.5% California franchise tax to which we are also subject as a California “S” Corporation.”
 
The chart below shows Tilly’s Operating Income and Net Income as reported on their financial statements. The Pro Forma Net Income line shows what their net income would have been over the last five years had they been a C corporation accruing tax at typical rates. Big difference. They will transition to a C corporation before the company goes public. This is disclosed in the registration statement of course. But the point is that you would not want to purchase the stock expecting Tilly’s to report net income going forward at the levels of the past.     
     

FISCAL YEAR ENDED (millions of $):
   

Feb. 3

Feb. 2

Jan. 31

Jan. 30

Jan. 29
   

2007

2008

2009

2010

2011

Operating Income

$31.5

$39.7

$23.8

$21.4

$24.9

Net Income (as reported)

$31.4

$39.9

$23.6

$20.9

$24.4

Pro Forma Net Income

$19.1

$24.2

$14.3

$12.7

$14.8
 
Post Offering Ownership and Control and Use of Proceeds
Buyers of this common stock will receive Class A shares and will be entitled to one vote per share. There will also be Class B shares that will be entitled to ten votes per share “on all matters to be voted on by our common shareholders.” The Class B shares will be owned by the founders and their family. When the offering is completed Mr. Shaked, who is Chairman of the Board, will control more than 50% of the total voting power of Tilly’s common stock. We don’t know from this first draft of the registration statement exactly how much he’ll control, but it says more than 50%.
 
“As a result, Mr. Shaked is in a position to dictate the outcome of any corporate actions requiring stockholder approval, including the election of directors and mergers, acquisitions and other significant corporate transactions. Mr. Shaked may delay or prevent a change of control from occurring, even if the change of control could appear to benefit the stockholders.”
 
Tilly’s will be considered to be a controlled company according to the rules of the New York Stock Exchange. As a result a majority of the board of directors don’t have to be independent. And the corporate governance and nominating committee and compensation committee do not have to be composed entirely of independent directors, as would otherwise be required.
 
Tilly’s says they will comply with these listing requirements anyway, but they don’t have to.
 
The company leases its 172,000 square foot corporate headquarters and distribution center from a company owned by its co-founders. It leases another 24,000 square feet of office and warehouse from one of the co-founders.
 
As usual, there are a lot of blank spaces in this early version of the Use of Proceeds section. We’ve seen from other sources that the goal is to raise $100 million. What’s going to be done with that money? The registration statement tells us the following:
 
“Therefore, our stockholders immediately following this offering, who were also the shareholders of World of Jeans & Tops prior to termination of its “S” Corporation status, will receive most of the net proceeds from the sale of shares offered by us.”
 
We don’t know what “most” is at this point.
 
After spending 30 years building a successful business, the owners deserve the benefits. But if they are getting “most” of the proceeds of the offering, where’s the money for growing the business to the 500 stores they are planning going to come from? At least that would be my perspective if I were a potential investor.
 
Competitive Strengths and Growth Strategy
Tilly’s lists six competitive strengths:
  • Destination retailer with a broad, relevant assortment.
  • Dynamic merchandise model.
  • Flexible real estate strategy across real estate venues and geographies.
  • Multi-pronged marketing approach.
  • Sophisticated systems and distribution infrastructure to support growth.
  • Experienced management team.
Their growth strategies are:
  • Expand our store base.
  • Drive comparable store sales.
  • Grow our e-commerce platform.
  •  Increase our operating margins.
If you read the discussions of their competitive strengths, you’ll note a great deal of similarity to other retailers in our space. Maybe that’s why they call them strengths and not advantages. Their growth strategies are exactly the same as every other multi store retailer.
 
It seems to me that an investor in this stock is basically betting on Tilly’s ability to operate better than its competitors. Of course they do have a successful operating history, but I don’t see an obvious competitive advantage here. I don’t think their plan to grow to 500 stores is necessarily unrealistic, but that most of the offering proceeds are being paid out to the owners makes me wonder how they’ll finance the growth.
 
We’ll get some more information as the amended S-1s show up.

 

 

Skullcandy: The IPO is Moving Forward

/3 Comments/in /by

Skullcandy filed another amendment to their S-1 today with many of the blank spaces from the previous iterations of it filled in as the next step in their initial public offering.  It appears they postponed it due a rough patch in the market.  Smart.

They list the maximum offering price as $19 a share. They are registering 9,583,334 shares and if they sell all of those, the offering will raise a bit over $182 million. But that includes the underwriters optional over allotment of 1,250,000 shares and is before expenses.

A big chunk of the proceeds go to the selling shareholders rather than the company. After underwriting discounts, commissions, and estimated expenses, the company expects to net about $66.6 million assuming a sale price of $18 a share.
 
$16.7 million will be used to pay off their unsecured, subordinated promissory notes. They’ll pay $17.5 million in “additional consideration…pursuant to our securities purchase and redemption agreement.”  $4.4 million will be paid in accrued interest that has to be paid when the notes are converted.
 
That leaves $28 million for “general corporate purposes,” as the saying goes.
 
This will clean up their balance sheet nicely. Proceeds, of course, could vary depending on how many shares are sold and at what price.
 
I hope this is the final amendment and I can get onto reading about Tilly’s IPO. 

 

 

Quiksilver’s April 30 Quarter; There Are Some Numbers that Need Explaining

/0 Comments/in /by

Quik’s revenues for the quarter rose 2.1% to $478 million compared to $468.3 million in the same quarter last year. The gross profit margin rose from 53.2% to 54.8%. Sales, general and administrative expenses were up slightly, but fell as a percentage of sales. Interest expense was down as a result of their balance sheet restructuring from $21 to $15 million.

So how, you might ask, did they go from a bottom line profit of $9.4 million last year in the quarter to a loss of $83.3 million in the quarter that ended April 30, 2011?

First, there was a noncash asset impairment charge of $74.6 million compared to zip, zero, nada in the same quarter last year. If you ignore that charge, operating income was up from $35.9 million to $45.4 million.
 
The charge was “Due to the natural disasters that occurred throughout the Asia/Pacific region during the three months ended April 30, 2011 and their resulting impact on the company’s business…” Okay, I guess we can’t hold Quik responsible for earthquakes, tsunami, and core meltdowns. Although, I guess we’re all a bit responsible for the core meltdown we’ve had in our industry.
 
But I digress. That write down represents a real impact on Quik’s business going forward.
 
“The value implied by the test was affected by (1) a reduction in near-term future cash flows expected for the Asia/Pacific segment, (2) the discount rates which were applied to future cash flows, and (3) current market estimates of value. The projected future cash flows, discount rates applied and current estimates of market value have all been impacted by the aforementioned natural disasters that occurred throughout the Asia/Pacific region, contributing to the estimated decline in value.”
 
This says that cash flows are going to be reduced for some period (I don’t know what “near-term” means), risks are higher (that’s what you mean by raising discount rates, we finance trained people think) and, inevitably, given the other two factors, values are lower. It’s a noncash charge but not a meaningless charge given the impact on future business.
 
With that charge, pretax income fell from $19.5 million to a loss of $42 million. But the provision for income taxes rose from $9.4 million to $39.7 million. Huh? More taxes on a big loss? Shit. I’m going to have to delve into the dreaded income tax footnotes. Those of you who are into self-abuse can see the filing here and read the footnote starting on page 15. But beware- reading this can make you go blind.
 
I think I used that joke last week. I need some new material.
 
I’d urge you to go take a brief look at that footnote. Not because you’re likely to want to figure it out, but because hopefully you’ll then feel sorry for me as I attempt to explain it.
 
A deferred tax asset is a future tax benefit. It’s easy to understand why they exist. A company wants to tell its shareholders it made as much money as possible. It wants to tell the government it made as little as possible so it can at least postpone the payment of taxes. Quik has decided (I think it’s related to the asset impairment charge above) that their deferred tax assets were $26 million too high in the Asia/Pacific region. That is, they don’t think they are likely to get the benefit they were expecting, so they wrote them off.
 
There, that wasn’t too bad. Sorry to spend so much time on these two issues, but the numbers were so large I felt it was necessary.
 
Revenues rose 5.5% in the Americas to $210.7 million and it was fueled “…largely by our retail business,” according to CFO Joe Scirocco in the conference call. Company owned retail comparable store sales rose 23% in the quarter, and e-commerce sales grew 68%.   The Quik and DC brands were up, while Roxy was down. Wholesale revenues in the Americas “…were on plan and a couple of percentage points higher than last year.”
 
Wish they’d give us some numbers on how the wholesale business was doing in the U.S. 
Revenues fell 0.8% in both Europe and Asia/Pacific to $207 million and $58 million respectively. Europe was down 4% in constant currency and Asia/Pacific 12%.
 
Gross profit margin in the Americas rose from 46.6% to 49.1%. This was “…primarily the result of a favorable shift in product mix and, to a lesser extent, a greater percentage of retail versus wholesale sales.” 
 
It was up in Europe from 59.9% to 62% as a result of improved retail margins. It fell in Asia/Pacific from 53.5% to 53.1%.
 
In a trend that’s hardly unique to Quiksilver, you can see why lots of U. S. companies are more interested in international rather than domestic expansion. Oh- Quik is going into India and expects to open 10 new stores there in the next 12 months.
 
Quik reports, in one line in its 10Q, what it calls its Adjusted EBITDA. This is net income before “(i) interest expense, (ii) income tax expense, (iii) depreciation and amortization, (iv) non-cash stock-based compensation expense and (v) asset impairments.”
 
I’m kind of a bottom line, generally accepted accounting principles kind of guy, but sometimes this is worth looking at because it does eliminate some distortions. For the three months ended April 30, it was 13% both this year and last. For six months it was 10.7% last year and fell to 10.2% this year.
 
On the surface, the balance sheet is almost identical to a year ago, though equity has grown about 10% to $535 million due to the balance sheet restructuring. Liabilities have only fallen by about $42 million to $1.1 billion, but debt maturities have been pushed way out so there are no big repayments due over the next four years.
 
Inventories are up from $226 million to $290 million, or by 28% (18% in constant currency). They describe that as being to “…ensure timely production and delivery” and as representing “…a restocking relative to very lean inventories a year ago.” I wonder if there are any cost increases in inventory numbers yet. They note that “Consolidated average annual inventory turnover was approximately 3.0 at April 30, 2011 compared to approximately 3.6 at April 30, 2010.” Higher turns are generally better until you get to the point where you’re not able to fill orders.
 
Those are reasonable reasons to increase inventory, but I’d still be happier to see increases a bit more in line with sales growth. Maybe there’s also some stocking for the Quik girls line which just started shipping in February.
 
Quik makes it clear that they are not going to be rolling out a bunch of mall stores as their old retail strategy called for. But they do discuss a cautious experimentation with some concept stores. They talk about a couple of stores at Capbreton and Hossegor in Southwest France and a Paris store. All three are used for events and promotions. At Capbreton, they have a summer concert series and it includes an athlete training center. Apparently, they include not only all of Quik’s brands, but “…a deep stock of surfboards, wetsuits, skateboards and other products that reinforce our heritage and authenticity…”
 
They plan to import this concept into the U.S. The first such store is scheduled to open in Venice, California in the fourth quarter. It will be about 10,000 square feet.
 
My point of view on Quiksilver hasn’t changed much since they finished their financial restructuring. I’m still wondering where their sales growth is going to come from. Like most companies, they see some possible margin pressure in the second half of the year because of cost increases and uncertainty as to consumer response to price increases. Their conference calls have focused recently on lots of good things they are doing with product, teams, retail and brands. They are good things, but so far they haven’t translated into much top line growth.
 
It feels like they’re doing the right stuff but this market just isn’t going to respond like it used to.            

 

 

PacSun’s April 30 Quarter; How Long for the Strategy to Get Traction?

/0 Comments/in /by

While CEO at Pacific Sunwear, Sally Frame Kasaks took some appropriate tactical actions. The problem, I conjectured at the time, was that she just didn’t “get it” when it came to the youth culture market/action sports market. Gary Schoenfeld, when he became CEO, knew that PacSun’s success ultimately depended on its ability to reconnect with its core customers and be relevant to them. No amount of tactical change and expense control, as important as those were, was going to change that. The customer had lost a reason to come into PacSun stores and had to be helped to rediscover it if PacSun was to have a future.

That implied a major organizational change that is long term, difficult, and a bit chaotic. Mr. Schoenfeld replaced almost the entire management team with the goal, I assume, of implementing a new way of thinking and approach to the business through the entire organization. He launched new marketing initiatives, closed (is closing) nonperforming stores, reintroduced the footwear that Ms. Kasaks had eliminated, localized the inventory assortment (an ongoing project), and revamped stores that needed new fixtures and merchandising (that initiative is constrained by cash flow issues).

PacSun undertook this not short term project at a time of economic weakness and reduced consumer spending. Now, with the economy possibly weakening again, and cost increases likely to show up in the second half of the year (not just for PacSun), there’s some additional urgency to see improvement.
 
And for the quarter ended April 30, they saw comparable store sales increase by 1%, which is improvement. Sales were down 2.39% from the same quarter the previous year to $185.8 million, but they ended the quarter with 827 stores versus 883 a year ago, so you’d expect some sales decline. Women’s comparable store net sales rose 4%. Men’s decreased 3%.
 
Their e-commerce business is about $50 million. They relaunched the web site in April. Their e-commerce sales were flat for the quarter. I haven’t heard many companies say that their e-commerce sales weren’t up, but they just relaunched so we’ll wait and see. My concern, of course, would be that flat e-commerce sales could be indicative of their marketing programs not getting traction. 
  
Gross margin, however, fell from 22.3% to 19.1%. Of that decline totaling 3.2%, 2.7%, or 84.4% of the total decline, came from a “Decrease in merchandise margin rate primarily due to increased markdowns as a percentage of sales.” I would expect that one indication that their new programs were having a positive impact would be an improving product gross margin. 
 
The remainder of the gross margin decline was due to deleveraging of costs because of fewer stores and a lower sales base.
I’m going to scurry right over to the balance sheet and point out that merchandise inventory on May 1, 2010 was $106.6 million. On April 30, 2011, it had actually risen it was $115.8 million. Now, an inventory number is as of single day, and there can be big timing issues (if you receive inventory on the last day of the month, it shows up in the quarter that day is in. If it’s received the next day, on the first of the month of a new quarter, it doesn’t show up in the quarter that just ended).
 
Still, with stores being closed, sales down, and additional markdown being taken, you might expect a drop in inventory levels. However, management indicated in the conference call that they were comfortable with inventory levels. As you think about inventories, there’s another issue impacting companies in our industry. As cost increases show up, the same number of units will appear in inventory with a higher value, increasing inventories to the extent of the price increase. No idea if that is involved here or not.
 
Sales, general and administrative expenses fell 9.7% to $66 million. As a percentage of sales they fell from 38.4% to 35.6%. The net loss for the quarter of $31.5 million was similar to the loss of $31 million for the same quarter last year.
 
Comparing the current balance sheet with the one from a year ago, we see that the current ratio has fallen from 2.25 to 1.80. Total debt to equity has risen from 0.59 to 1.03. Cash and cash equivalents fell from $56.6 million to $24.7 million, accounting for almost all the decline in current assets. Current liabilities rose slightly from $79.6 million to $88.6 million. Long term liabilities rose from $84.9 million to $101 million due to the mortgaging of certain of the company’s facilities to raise cash.
 
PacSun closed 25 stores during the first quarter, and anticipates closing a total of 40 to 50 during the whole fiscal year. They note in the 10Q that they have almost 400 lease expirations occurring through 2013. That will result in some additional closed stores, but I’d expect that some of the leases they keep will be renegotiated under more favorable terms.
 
I don’t have to come up with a conclusion for this article, because CEO Schoenfeld pretty much stated it for me during the conference call:
 
“There’s no question that the merchandising and execution in our stores has vastly improved, yet we know we still have a lot of work ahead of us. Customers have many choices. We still have real estate challenges to resolve. Consumer response to higher prices this fall is hard to predict, and having made so many organizational changes internally, it will still take some time for our team to consistently execute at the levels that I believe we are capable of.”
 
On the other hand, it’s my column, so I get the last word. It’s more or less what I said after their last report. Can PacSun’s new strategy get traction with the target consumer before the economy and cash flow issues get in the way?    
 

 

 

A Little More Information on Volcom’s Sale to PPR

/1 Comment/in /by

Often when a deal happens, all you know for sure is what’s in the press release. Typically that press release doesn’t offer a completely objective perspective about the process and motivations that lead to a deal. But if it’s a public company, and you’re willing to dig into mounds of fine print, sometimes you can find out a bit more.

That would be true with PPR’s acquisition of Volcom. Don’t get all excited. I don’t have any deep dark secrets to tell you. There’s nothing that would change my opinion that Volcom made themselves a good deal at the right time for the right reasons (in fact, this reinforces my opinion). But we’ll know a bit more about how and why the deal happened.

When I reviewed Volcom’s last quarterly report, I noted that a law suit had been filed as a result of the deal alleging that Volcom and PPR had done various bad things not in the shareholders’ interest. A second one was also filed but both are now being settled. We don’t know the terms, but one of the conditions was that Volcom amend its Schedule 14D-9 to include some more information on the deal. So we have the plaintiffs in those two lawsuits to thank for some of the additional insight.
 
From various documents filed as part of the deal, we know that the first contacts between PPR and Volcom management was on February 8th and 9th, 2010 where “…there were initial discussions about the businesses and histories of Volcom and PPR, as well as ways the companies might work together.” On March 11, PPR told Volcom they were interested in a potential strategic transaction. No purchase price was mentioned. There were ongoing meetings and conversations through April, but around April 28, Volcom told PPR that it intended to pursue its strategic plan “…rather than continue talks with regard to any potential strategic transaction…”
 
There was further contact on July 15 that lead to an informal meeting in Newport Beach, California between PPR CEO Pinault and Volcom CEO Richard Woolcott and President Jason Steris. Nothing happened and there were no further discussions for several months.
 
Meanwhile, on October 22 another company contacted Volcom and said they were interested in acquiring Volcom. Volcom had conversations with that company between October 25 and the end of December, 2010. Bidder A (as this company is called) signed a confidentiality agreement and proceeded with its evaluation of Volcom. On February 1, Bidder A informed Volcom that its review supported a price from the low $20s up to $25.00 a share.
    
It was December 16, 2010 when PPR contacted Volcom again about a potential strategic transaction. A confidentiality agreement was signed on February 1, 2011. Due diligence was undertaken for about two months and on March 4, PPR told Wells Fargo Securities (representing Volcom) that their analysis supported a price of $23.00. On March 17, Wells told PPR that Volcom was talking to other potential buyers as well.
 
PPR formally bid $23.00 a share on April 21. There were some additional meetings. PPR increased its offer to $23.50 on April 29.  The first offer was contingent, among other things, on CEO Wolcott’s “…entry into a new employment arrangement with PPR.” The second offer “…was not conditioned upon Mr. Richard Woolcott’s entry into a new employment agreement.”
 
I have no idea if that change has any significance at all. But the lawyers thought it was important enough to be included in the narrative so I’m just curious.
 
Now it gets interesting. On May 1, Wells contacted PPR’s representatives and told them their bid of $23.50 per share was not the highest. Bidder A had bid $24.00 earlier in the day. They recommended that PPR increase its offer before the Volcom Board of Directors started discussing the offer later that day.
 
Damn! This even gets exciting when you read about it in lawyer speak. It’s what makes doing deals “fun.” Think of the sense of urgency, the impact of different time zones and the fact that there were three companies involved. And three sets of lawyers. And, I assume, three sets of financial advisors. PPR increased its offer to $24.50.
 
In what I’ll call “dialing for dollars” Volcom’s representatives went back to both PPR and Bidder A and asked them to increase their bids. Both declined.
 
“Later in the night (Central European Time) of May 1, 2011…” Volcom’s lawyers told PPR’s lawyers “…that if PPR were willing to modify certain terms of the proposed merger agreement, the Volcom Board of Directors was prepared to approve the merger agreement and sign it immediately.” Those modifications obviously happened and “The Merger Agreement and Share and Voting Agreement were executed by the parties in the morning (Central European Time) of May 2, 2011.”
 
The Schedule 14D-9 lays out this whole process in much more detail on pages 10-22. You might want to take a look at it.
 
In those pages, we also learn something about the motivation for the deal. In the normal course of business successful companies will be approached by various entities about possible strategic transactions. This was true for Volcom from 2007 through 2009. As a public company, they have a fiduciary responsibility to consider if any of these transactions might be in the best interest of their shareholders. It feels from reading the pages above that it was somewhere around the end of 2009 when Volcom decided to look at the possibility of a transaction more seriously.
 
Not that they had to do one- but the world had changed enough (financial crisis, great recession, difficulty in growing) that taking a more serious look made sense. Still, in August 2010, Volcom released some financial projections as part of their five year plan that showed the company growing its earnings per share from $0.91 in 2010 to $3.37 in 2015. If they thought they could accomplish that, why sell at $24.50 a share?
 
I don’t know the answer to that, but I do know that in August of 2010, and prior to that when the projection was being prepared, we were all hoping for an economic recovery that has turned out to be more anemic than expected. People who don’t change their opinions when the facts change probably shouldn’t be running companies. Maybe those projections were part of the negotiations. The documents indicate they were provided to the potential acquirers.
 
As noted in the Schedule 14D-9, Volcom considered the risks of being independent when evaluating the offers to buy the company. “The Board of Directors considered in its assessment, after discussions with the Company’s management and advisors, the risks of remaining an independent company and pursuing the Company’s strategic plan, including the risks relating to:
               • increasing competition in the branded apparel and eyewear industries; and
               •trends in the branded apparel and eyewear industries, including industry consolidation, input costs and pricing trends.”
 
They put it a little more strongly in the revised Schedule 14D-9 where they replaced an existing paragraph with the following as they explained the background and justification for exploring a transaction (emphasis added by me):
 
“…in light of the Company Board’s further review of the recent state of the sports apparel and eyewear industries and the increased competitive challenges for the Company, the Company Board authorized members of Volcom’s executive management team to formally engage Wells Fargo Securities to act as financial advisor to Volcom to explore a potential sale of Volcom and authorized Wells Fargo Securities and members of the Company’s executive management team to continue discussions with Bidder A.”
 
In a fairly short time, then, Volcom management had gone from a very positive August 2010 projection to thinking they should sell the company for a price that would be way too low if they still thought they could make those projections while staying independent. Good for them. I can’t resist pointing out that I’ve highlighted the same issues Volcom identified in my analysis of their public filings, so I can’t really do anything but congratulate them on their insightfulness.
 
For those of you who might want to sell a company someday, I’d note again that Volcom negotiated from a position of strength when they did not have to do a deal. Look how long it took, and of course it’s not closed yet. Even when you’re not a public company, doing it well takes a long time and is a lot of work.