I Wonder if PacSun Might Carry Hard Goods; And What Would Zumiez Think?

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Just for a moment, hypothetically, let’s think about PacSun’s turnaround strategy, whether it might make sense for them to start carrying hard goods, and how other companies might react.

PacSun’s Strategy

That PacSun is in the middle of a turnaround is hardly disputable, if only because their management has characterized it that way. And in my judgment, they are pretty much doing the right things. First and foremost, they acknowledged that their stores had stopped being a destination for their target customers, and they are working to fix that. They want to “Reestablish PacSun as a destination for great brands.” What does that mean exactly?
 
First, it means completely revamping their management team- to the point where at their last conference call they said they had cut back their juniors inventory because they did not have the right leadership or strategy in place. The management changes are well under way and, when we listen to their next conference call (okay, when I listen to it), probably within a couple of weeks, we may find it’s complete.
 
That impresses me. While there’s absolutely nothing as disruptive to a company as a total makeover of top management, there’s also no way for a company to succeed if the team isn’t aligned and in agreement as to the company’s strategy. Those of you who were at the Group Y Action Sports Conference a couple of weeks ago heard exactly the same thing from Van’s Vice President of Marketing Doug Palladini as he explained Van’s success.
 
Second, they’ve recognized they can’t have the same merchandise selection in all stores, regardless of location, and are working to localize their inventory. Third they are starting, like a lot of other brands, to emphasize speed and freshness in product. “The days of shopping in Europe for trends and then delivering a whole new collection are pretty much behind us,” was how they put it. We may all bemoan fast fashion, but there’s no choice but to react to it if it’s what the customer wants.
 
Fourth, they are going to be more cautious with private label and have eliminated private label board shorts. Fifth, they’ve rolled out a new advertising and promotion campaign that has a more appropriate focus. Last, they’ve recognized that more stores isn’t the answer and are focusing on making the ones they have better places to shop.
 
The Hard Goods Issue
All good stuff. If I were a hard goods brand and PacSun asked me to sell them some hard goods I’d get excited by the fact that Pac Sun could buy a whole lot of product from me (though I doubt any hard goods brand can expect to be in all their stores). On the other hand, I’d need to feel good about their chances for making their stores an attractive destination for my customers again. If they were lame, I wouldn’t want to be there because the lameness might rub off on my brand.   I would, in other words, need to feel good about PacSun’s ability to implement the strategy I’ve described above.
 
I’d get to feel good by spending some time with the people in charge of implementing the hard goods strategy for PacSun.    Assuming there was such a strategy, that is.
 
I’d want to roll out the product in, say, 10 or 20 stores initially. And I’d want those to be stores that already reflected PacSun’s revised strategy- ones that were remodeled to reflect the new focus, had a reduced reliance on house brand product, and had inventory specifically selected for the location. I’d want to have some involvement in how my product was merchandised and I’d like to know where PacSun was going to get sales people who could represent and sell hard goods. And while all these discussions were going on, I’d be chatting with my friendly competitors who also make hard goods to try and find out if they were selling to PacSun.
 
Some level of hard goods can make sense for PacSun as part of a strategy of regaining credibility with their target customer.   It’s certainly part of what has differentiated Zumiez among mall stores and made them successful, and that brings us to an interesting part of the discussion.
 
Though both are mall based chains with an overlapping focus, Zumiez is not PacSun and PacSun is not Zumiez. They have different ambiances, and different, though obviously overlapping, target customers. Zumiez has always carried hard goods and has prided itself on having employees at all levels that are in touch with the action sports culture. Though PacSun may have originally been closer to the “core” than it is now, it was never as close as Zumiez and it drifted even further away with growth and some of the decisions it made.   Zumiez has always been closer.   That has been important in how it has kept its credibility with customers even as it has grown.
 
PacSun wants some of that credibility back. I have to assume Zumiez would rather not share that market space with a nine hundred store gorilla. Even though Zumiez is only more or less one third the size of PacSun by number of stores and their geography doesn’t completely overlap( PacSun is in all 50 states, Zumiez in 35) I have to believe that PacSun’s problems made life easier for Zumiez in some ways and in some locations.
 
How might things go if PacSun starts carrying hard goods? A couple of years ago, I might have said that if they represent the brands well it would be good for everybody. But economic times are different and I think that’s less likely. It will also depend on what hard goods, exactly, they carry. I don’t imagine it will be snowboards (though of course I don’t know that). I can certainly imagine skate and while surf fits PacSun (and not really Zumiez) it’s generally difficult to imagine selling surf boards in mall stores.
 
I’m sure Pac Sun expects to make money on any hard goods it sells, but that wouldn’t be the primary motivation. They want to rebuilt credibility with their target market and get that customer back in the store. It’s a component of their overall strategy.   Superficially at least, a PacSun with hard goods will have moved a bit towards Zumiez’s in its positioning. Will the customers see that? Will Zumiez’s customers be more likely to shop at PacSun? Or will customers who chose PacSun over Zumiez be disappointed? Depends on just how much actual customer overlap there is I guess. But unless they subscribe to the “a rising tide raises all boats” theory, I can’t see Zumiez as thrilled.
 
Other brands, not hard goods, are currently sold at both Zumiez and PacSun. Wonder how they would see this if it happened. Would PacSun pick up some apparel or other products from the hard goods brands they decided to carry? 
 
 A PacSun who carries hard goods and uses that to revive their credibility with the action sport oriented consumer is a stronger competitor to Zumiez.   A PacSun who carries hard goods and does it badly damages the idea of such stores in malls, and that could reflect on Zumiez. It’s not that PacSun will be the same as Zumiez, or even that they will necessarily target exactly the same customer group. But some of those customers may only see the superficial similarities. Think how consumer looked at Hollister.
 
As Zumiez, PacSun, and any hard goods brands that might consider selling to PacSun know, having hard goods doesn’t instantly give you credibility and attract customers. You have to do it just right and the devil is in the details.

 

 

Nike’s Annual Report- A Few Interesting Facts

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Nike came out with their 10K annual report maybe 10 days ago. Because we’re in the habit of focusing on the press release and the conference call which happens much sooner, nobody seems to have paid any attention to this 145 page document. But never fear, I’m a glutton for punishment and there were a few interesting facts I thought I might provide.

You’ll excuse me if I don’t do my usual financial analysis. With hardly any long term debt (given their balance sheet though some of us probably think $400 million is a lot), a few billions in cash, and just over $19 billion in revenue, I just don’t think I’d discover anything useful if I stared squint eyed at their cash flow statement for very long.

Revenue was down from $19.176 billion in 2010 from $19,014 the previous year. But their gross profit margin, at 46.3%, was the highest since 2006. “The increase in gross margin percentage was primarily the result of favorable product mix, cost reduction initiatives, lower input costs and sales growth in our NIKE-owned retail business. (Emphasis added)” The retail increase was from both new store openings and growing comparable store sales.
 
“While our wholesale business remains the largest component of our NIKE Brand revenues, our NIKE-owned retail business continues to grow, representing approximately 15% of our total NIKE Brand   revenues in fiscal 2010 as compared to 13% in fiscal 2009.”
 
In the U.S., they’ve got 18 Hurley stores, 145 factory stores for closeouts, 12 Nike stores, 11 Niketowns, 51 converse factory stores, and 106 Cole Haan stores. In the rest of the world, there are 205 Nike factory stores, one Hurley, 55 Nike, 2 Niketown, 12 employee only stores, and 68 Cole Haan. They’ve got more stores to handle their closeouts then most chains have stores.
 
 Net income rose from $1.487 to $1.907 billion. They reduced their inventories 13.4% to $2.041 billion.
They’ve got 34,400 employees worldwide and 42% of their sales are in the U.S. The three largest customers represent 24% of U.S. sales, but none are more than 10%.   Hurley’s sales grew from $203 million to $221 million, but that’s the only specific action sports number or comment we get in the whole document.
 
They note that 89% of their U.S. wholesale footwear shipments (excluding “Other Businesses” of which Hurley is part) were made under their futures program. I think that’s the same as prebooks, which is pretty impressive. The number for U.S. apparel shipments is 62%. Where do they get all this stuff made?
 
“Virtually all of our footwear is produced by factories we contract with outside of the United States. In fiscal 2010, contract factories in Vietnam, China, Indonesia, Thailand, and India manufactured approximately 37%, 34%, 23%, 2% and 1% of total NIKE Brand footwear, respectively. We also have manufacturing agreements with independent factories in Argentina, Brazil, India, and Mexico to manufacture footwear for sale primarily within those countries. The largest single footwear factory that we have contracted with accounted for approximately 5% of total fiscal 2010 footwear production.”
 
But not even Nike is immune from macroeconomics and some of the labor issues in China.
 
“We anticipate our gross margins in fiscal 2011 may be negatively impacted by macroeconomic factors including changes in currency exchange rates and rising costs for product input costs. We also anticipate higher air freight costs as we work with our suppliers to meet increasing demand for certain running footwear products in the first half of the year.”
 
I strolled through the U.S. Open of Surfing last week and kind of noticed that Nike and Hurley dominated the place. It looks like Nike has plans for our industry.

 

 

How’s Volcom Doing? Their Quarterly Results

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

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

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

 

 

VF’s Quarter Ended June 30- Good Numbers, China, and Retail Strategy

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VF Corporation, the owner of Vans, Nautica, North Face, Reef and a whole lot of other brands released their results last week for the quarter ended June 30. 

They also held a conference call I listened to.

They had a strong quarter and we’ll get to the numbers.  Oh hell, let’s start with a summary of the numbers.  Revenues were up 7% to $1.577 billion.  Their gross margin reached 47.1% (a record) and net income rose 48.7% to $111.5 million.  The balance sheet is strong to the point where don’t have to worry about analyzing it, though I would note that inventories fell almost ten percent from a year ago.  Lower inventory on higher sales points to good management.

But aside from the numbers, I thought there were three things that were worth discussion.  First, and probably least important, is that there was no mention of Reef.  That really only matters because in our industry we’d like to know what was going on with it.  It’s an awfully small piece of VF.

It’s no secret that Reef has had some difficulties.  You’ll probably recall that shortly after its acquisition by VF, they dropped “the butt” in their advertising and promotion.  I wouldn’t say that was the cause of the problems, but I’d note that when the going got tough, the tough brought back “the butt.”  I, for one, was glad to see it, so to speak.

On a more meaningful note, there was a discussion in the conference call of China and the costs there.  Let me give you a little background.

China has built its economic growth model (very successfully) on cheap labor and exports.  But they know that’s coming to an end and that they have to transition their economy over time to one where growth is driven by domestic consumer demand.  That means more skilled labor input and higher wages.  This is just normal economic development stuff and China would hardly be the first country where it’s happened.

You’re probably aware that there have been some recent and ongoing strikes in China for higher wages.  The government has at some level encouraged or at least tolerated these because they are aware of the economic evolution (described above) that needs to happen.  But at the same time, they want to control this process and when these strikes take place outside of the government union organization, as some have, they get nervous and worry about their control.  This is happening while the Chinese currency is being allowed again to gradually strengthen and after and after the big recession based drop in demand eliminated a lot of capacity which is now missed.

In the conference call, VF management noted that there were pressures from supply and demand imbalances.  As they described it, manufacturing capacity fell dramatically at the economic bottom, and hasn’t caught up with the rebound in demand.  Cotton (which VF obviously cares about) is at an all time high and demand is ahead of supply.  There are labor shortages in quite a few countries, they note.  Freight costs are running higher.  They indicated that only 200,000 shipping containers went into service last year.  In a typical year, it would be around two million.

As a result, they expect product cost increases of a few percentage points next year.  But they point out that less than 25% of their supply comes from China, that they own and operate a third of their manufacturing, and that they have been running factories for a century (well, not the same guys I guess).  That gives them the experience and operating acumen to manage the issues better than others.

The next issue is retail.  At the end of the quarter, VF had 768 stores across its brands.  They are on track to open 80 to 90 this year.  Total direct to consumer revenues increased by 7%, “…driven by new store openings in the quarter.”  If you’ve read what I’ve written about what Billabong, Genesco, and other multi brand companies are doing, you know that the push into retail by brands is only going to continue.  They have the size, the systems and the operating sophistication to be very successful in retail and the extra margin they can earn by putting their own brands into their own stores is just too attractive to pass up.  So the question for small specialty retailers (and maybe some not so small ones eventually) and brands that don’t retail is how do you compete?

Sorry, this isn’t the place to go into that, but you’d better be thinking about it.  I’ve been beating this drum for a while and expect to keep pounding it.

VF noted that Van’s revenues were up 24% in the quarter.  It grew 20% domestically and doubled in Asia.  The domestic growth was 75% from the wholesale business.  The remainder was from opening new stores.  They didn’t give any comparable store numbers.

They noted that the Vans business in China had nearly doubled and the brand was very strong there even though Vans only started there a couple of seasons ago.  Being small makes doubling easy, I’d point out.  They are investing in Vans which they see as a very strong brand.

 Gross margin improved 370 basis points.  A reduction in product cost added 200 basis points, retail performance was responsible for 70, and the rest just came from operating well including clean inventories.  They noted that big increases were easier to get quarter over quarter due to how bad things were last year.

They continue to be focused on making acquisitions and are especially interested in the outdoor and action sports area.  They haven’t made any this year and suggest that it’s because the prices being asked are too high.  They note that they have the ability to make a billion dollar acquisition, but that historically, they have focused on smaller ones.  Look for more deal from them.

The outdoor and action sports segment generated $584 million in revenue during the quarter, or almost 37% of the total.  That’s up 11.6% from the same quarter the previous year.  It is the largest of their six segments by revenue and generated $81.5 million in operating profit.  They said during the conference call that segment is outgrowing other parts of their business and offers higher margins. 

Finally, they noted that there was a note of caution back in people’s voices right now for spring bookings, though they hadn’t seen any meaningful cancellation.  I think we all share the sense that maybe we’re not coming out of this recessions quite as fast as we hoped; not as we expected, but as we hoped.  I for one am not surprised by that, though I am disappointed.  Financially caused recessions suck.                

 

 

Billabong Acquiring West 49

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Or Maybe Zumiez is Going to Buy Them
 
Oh, and Billabong Bought RVCA
 
Okay, Zumiez is Out of the Picture
 
Anyway, This is All Really Interesting- and Related
 
As you know, Billabong made an offer on June 30 to acquire the Canadian action sports retailer West 49. Only July 9th, Zumiez said that, subject to a satisfactory due diligence review, it would be prepared to make a higher offer. On the 14th, they said, “Never mind.” What we’ve got work with here are some of Billabong’s comments about retail in its last half yearly review conference call, it’s conference call and presentation on the proposed West 49 acquisition, West 49’s financial results for the quarter ended May 1 and the associated conference call, Zumiez’s announcement that they were prepared to beat Billabong’s offer (and then that they weren’t) and their announcement that they were opening some stores in Canada. Meanwhile as I was writing this, Billabong announced it had bought RVCA, which fits nicely in the discussion below on Billabong’s strategy and retail positioning.
 
Damn, I feel like a kid in a candy store. Although I have to admit that having Zumiez come and go and RVCA bought since I started researching this article has made for an interesting editorial challenge.
 
This analysis will be strategic in nature. Though obviously we’ll discuss the numbers and specifics of the offer what’s more interesting to me is what this says about the retail environment, the evolution of the industry and the shape that larger, successful industry companies are going to take as they continue to expand into the broader market. Let’s start by looking at the players.
 
West 49
The chain is a Canadian action sport retailer founded in 1995 by current CEO Sam Baio. They’ve got 138 mostly mall based stores (not unlike Zumiez- the plot thickens). There are 81 West 49 stores. They also have five Billabong stores.
 
The remaining 52 stores include 19 under the D-Tox label, 16 Off the Wall Stores, and 17 Amnesia store. Billabong’s presentation on this deal has some info on page describing how these other brands are positioned. You can see the complete presentation here and I suggest you take a minute to do that. It’s just 12 Power Point slides long and won’t take long.
 
Many of these other brands (Most? I’m not sure.) were acquired by acquisition. More brands, of course, means more marketing expense and some complexities in operating around, for example, inventory purchasing and management. Keep that in mind as we review briefly West 49’s recent financial results, which include all 138 stores. I wonder if Billabong would keep all those other store brands. Would Zumiez have renamed all 138 stores as Zumiez?
 
In the quarter ended May 1, 2010 West 49 lost $2.6 million Canadian on sales of $40.9 million. This was very close to the same sales and loss they experienced in the same quarter one year ago. Comparable store sales were down $2.6% (3% for West 49 branded stores). CEO Baio cited pressures on margins as a result of the competitive landscape and said they were still waiting for consumer confidence to return. As you’ve probably noted, other retailers and brands have shown some almost inevitable rebound in their quarterly results as the very difficult conditions of a year ago have eased. West 49 did not and that was some cause for concern.
 
The balance showed $0.00 in cash and cash equivalents compared to $7.9 million on January 30, 2010. Obviously, no business operates without some cash to pay its ongoing bills. For all I know, the day after this balance sheet they drew down an available line of credit in the ordinary course of business and the balance showed some cash again. But I’d note that the current ratio at 1.05 was barely over one.
 
We didn’t get any more information on their financial condition because at the end of the conference call, there were no questions. That’s because the stock is pretty closely held (note that Billabong already has 56% of the voting shares agreeing to the transaction) and I guess the analysts don’t follow it. I certainly don’t have the information to conclude that West 49 has serious financial or liquidity issues.  But the information I do have makes me think that concerns in those areas could be a factor in their being prepared to sell the business now.
 
Billabong’s Retail Strategy
This isn’t a new topic for me. I wrote about their half yearly review and spend a lot of time on their retail strategy. See that here. http://jeffharbaugh.com/2010/02/25/billabongs-semi-annual-report/. At least scan through it and read the quotes about their retail strategy. Here’s what I said early in that article.
 
“Billabong CEO Derek O’Neill is clear in the conference call that we shouldn’t ‘…expect for retail to suddenly become a huge component of our business but it’s clear we will continue to identify opportunities to get our product to market where required.’ I read a little bit of ambiguity as to Billabong’s retail strategy into that statement, or maybe a little understandable reluctance to state what they really think of the retail situation.”
 
Billabong has described its acquisition approach as “opportunistic.” At the same time, they’ve discussed the tendency of independent retailers to purchase lower and mid price point product and to often not be able to merchandise the complete Billabong line well. They have noted that their own retail had outperformed their wholesale business and expressed some concern about tight credit conditions and the health of independent retailers. The company is also looking for ways to short cut its product cycle so it can have product sooner that it will just drop in its own stores before it gets to the independents.
 
You really need to go read the complete quotes in that article. Billabong’s strategy may be opportunistic with regards to timing (anybody’s acquisition strategy is) but I don’t think there’s any doubt that they have been planning to make retail a bigger part of their business. The presentation on West 49 says, in part, “Billabong has a long track record of successfully acquiring and integrating ‘bolt-on’ acquisitions consistent with its key strategic objectives of growing its brand portfolio and expanding its retail distribution network.”  (Emphasis added) And their store count has grown from 49 in 2004 to 510 this year assuming they complete the West 49 deal.
 
An acquisition strategy, of course, supports a general business strategy and can be the tool a company uses to transform itself. You might go look at what VF Industries, Collective Brands, and Genesco have done by selectively buying (and selling) brands to grow their companies and reposition themselves in markets they found attractive. It wouldn’t completely surprise me to find that those company’s strategies are a subject for discussion around Billabong’s executive offices from time to time.
 
Nuts and Bolts
 Billabong has offered to buy West 49 for $99 million Canadian. That’s about $96 million US. The deal is supposed to close in September, and will be funded using Billabong’s existing credit lines. Remember a year or two ago when Billabong raised some capital to improve its balance sheet? It wasn’t really a necessary thing to do, and the timing could have been more favorable. But without it, Billabong wouldn’t be able to do this deal without a financing contingency. This is one of the things I really like about Billabong. They always have consensus on what their strategy is and they have their eye on the long term ball as they pursue it.
 
Presently, “…across West 49’s portfolio Billabong has a brand share of approximately 15%.” They will be looking to increase that over time, but will leave the stores multi branded. CEO Derek O’Neill indicated in the conference call on the deal that the share of Billabong product in the West 49 stores might reach 45% over a couple of years.
 
If the West 49 stores go from 15% to 45% Billabong and Billabong owned brand products, obviously some other brands are likely to be unhappy with their share. There is, as we all know and no longer try to dispute, an inevitable tension between retailers and brands when the brand becomes a retailer.
 
In the past, when Billabong bought Nixon, Sector 9 and Dakine they paid high (fair might be a better term) prices for profitable companies with clear growth potential that Billabong could support, but that could more or less run on their own. I applauded that strategy because my experience is that buying a company is easy. Integrating a company and fixing it if it’s broken is much harder.
 
This deal isn’t quite the same judging from the data on West 49’s performance we reviewed at the start of this article.    In addition, just from going from 15% to 45% of Billabong brand product in its stores implies a transition that Billabong didn’t have to manage with those other three acquisitions. Of course, they have managed it with other retailers they’ve acquired, but none of those had 138 stores.
 
The analysts expressed some concern in the conference call. Though they didn’t come right out and say it (analysts never do) they seem to have some concerns that Billabong might be overpaying for this one.
 
As an example, Craig Woolford, and analyst with Citigroup, asked, “…even if I look back to ’08, it looks like it’s [West 49] been a very low margin business at an EBITDA level. Can you comment as to some reasons why it’s had such low profit margins?
 
CEO O’Neill’s basic response was that they had a plan to increase those margins over time, and that they’d talked to West 49 CEO Sam Baio who had a credible plan to get those margins up to “mid to high single digit EBITDA.”   I should note that Billabong’s last quarter results had its EBITDA retail margins at 14%.
 
Analyst Woolford continued, “Forgive me if I sound cynical but why would the shareholders of West 49 sell — I mean on a sales multiple, it’s 0.5 times sales, surely they would feel that they can then improve margins themselves before selling out to Billabong?”  Other analysts had questions that focused on the multiple being paid and how the deal would improve Billabong’s earnings per share during fiscal 2011.
 
Billabong’s answer to why margins would improve and why it would turn out to be a good deal was three fold; synergies, elimination of the costs of being a public company, and the higher margins they get when they put their own product in the stores in place of another brand’s products. They also think there’s potential to open some more stores in Canada.
 
Those are all good answers, but only eliminating the costs of being a public company is a slam dunk. Synergies can be surprisingly elusive and take time and cost money to realize. Billabong, to be fair, has just announced an agreement in principal- not a closed deal. So they can’t necessarily talk about exactly what they’d do and how they’d do it. But with other acquisitions of similar size, the issues just didn’t come up in quite the same way.
 
Partly, they didn’t come up because Nixon, Sector 9 and Dakine weren’t public companies. There was no public stock price. But this is also a different kind of deal that will require Billabong not just to support its new brand behind the scenes, but to take a very active role in helping it evolve. As a result I thought, when they first announced their interest, there was a reasonable chance that Zumiez would end up owning West 49. 
 
The Zumiez Offer
On July 9th, Zumiez came out and announced that they’d like to buy West 49 too. They had previously announced an interest in opening stores in Canada. Like Billabong’s, Zumiez offer would not have been contingent on financing. It “…would be prepared to make an offer, that would not be subject to a financing condition, to acquire all of the outstanding common shares and preferred shares of West 49 for a cash price in excess of $1.30 Canadian per share [what Billabong offered]” The offer would be contingent on Zumiez’s satisfactory completion of a due diligence review.
 
If an offer had been made, Billabong would have had five days to decide whether or not to match it.
 
West 49 already had a deal with Billabong but, as a public company, they have a fiduciary responsibility to act in the best interest of their shareholders. If two deals are equally likely to close, shareholders tend to like the one with the higher price per share.
 
West 49, of course, would love a higher offer, but isn’t all that thrilled at the idea of telling a retail competitor who’s just announced it’s entering West 49’s market everything about itself as would happen during a typical due diligence review. I’ll be interested to see how the two parties finesse that.
 
I’m happy to tell you that I wrote the sentences above before Zumiez’s July 13 announcement that they couldn’t reach an agreement with West 49 on how to conduct a due diligence review. I’m not completely surprised by that result, but I am a little disappointed. I think it would have been great fun to have a good old fashioned bidding contest for a company in our industry.
 
As has been discussed above, Billabong has some work to do to realize the value of a West 49 acquisition. This is a bit different from some of its other larger deals, and has some stakeholders nervous about the price being paid and the sources of the improved performance.
 
Zumiez is exclusively a retailer with a proven model. Like West 49, its stores are largely mall based. Like Billabong, it could have eliminated the West 49 public company expenses and no doubt realize some synergies itself in a combination. It wouldn’t have gotten the benefit of higher margins that Billabong gets when it places more of its owned brand product into its retail, but maybe it would have gotten some better terms from suppliers due to higher volume, though it probably gets pretty good deals already.
 
The argument that Zumiez could have made was that it just has to transplant its existing systems and management programs onto the West 49 stores to achieve results comparable to what it gets in the US. That sounds conceptually simple, but would not have been in practice. For one thing, Zumiez has always prided itself (rightfully so I think) on its management training and the fact that everybody works their way up from being a sales associate. I have to believe that finding and/or training enough people to turn West 49 stores into Zumiez stores (which I assume would be the long term goal) would have been a challenge. And I’m assuming a lot of similarity between the US and Canadian markets, which may not be the case.
 
I don’t know if the $1.30 Canadian that Billabong is prepared to pay is a fair price or not, but my immediate take is that Zumiez could have justified paying a little more than Billabong. Guess we won’t find out now. 
 
RVCA Deal 
And as if there wasn’t enough going on, Billabong has announced the long anticipated acquisition of RVCA. It’s a comparatively small deal, so not many details were announced, but we know that RVCA will add about $30 million to Billabong’s annual revenues at its current size.
 
And it’s an easy deal to explain. Like they typically have in the past Billabong is buying a solid brand that they will support, but leave management to run from a marketing and product development point of view. They will benefit not only from the growth of the brand’s sales to non-owned retail, but from putting RVCA into Billabong’s retail distribution. Pretty much the same concept they had for Nixon, Dakine, Sector 9 and most of their other acquisitions.
 
It’s pretty simple to explain, and it’s worked before. As we’ve spent parts of this way too long article discussing, it’s an interesting comparison to a West 49 deal that I see as more complex for Billabong and not quite fitting their historical approach. At the end of the day, that’s why I think Zumiez might have ended up as the successful bidder if they had been able to get past the due diligence issue with West 49.
 
In the economic environment we have now and, I think, will have for a few more years, brands are uncertain of the viability of core shops and unsure how much growth they can expect from them. As they and their lines get larger, they are also finding they can merchandise better and make more money through their own retail. Vertical integration, fast fashion, the imperative for cost control, market expansion into the mainstream, and the need for growth if you’re a public company all will push companies in the direction Billabong is taking as they get larger.

 

 

Quik’s Quarter Ended April 30, 2010- Sales Down, Profits Up.

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As usual, we’re dealing with the numbers in the June 3 press release and the comments in the conference call rather than the actual quarterly filing with the Security and Exchange Commission that’s full of details. That just drives me crazy, and I want to explain why and what I think the result is in this case.

Quik’s press release headlines the 5% decline in revenue, the increase in pro-forma income from continuing operations from $0.05 to $0.11 cents per share, and the growth in income from continuing operations from four to six center per share.
 
So I read that and thought to myself, “Wow, pretty good pro-forma and continuing operations results. I wonder how much they earned.”
 
You know- earned. Like bottom line. Net profit after taxes. Income. The generally accepted accounting principles earnings number. The number that most people, including me, think has the most to do with stock performance over the long term.
 
I read the rest of the press release text. It’s not there. I listen to the whole conference call. Nope- nobody mentions it there either.   “Must really suck,” I think to myself.
 
It doesn’t sucks. But you have to look to the bottom of the Consolidated Statement of Operations in the press release to find it. And here it is. Net income attributable to Quiksilver, Inc. rose 235% from $2.813 million in the quarter ended April 30, 2009 to $9.424 million. It’s only 2.0% of sales, but it’s up from 0.57% of sales in the same quarter last year.
 
I know that EBITDA, proforma income, one-time items like Kelly Slater’s stock grants ($5.2 million), exchange rates, non cash charges, gains and losses on sales of assets, restructuring charges and the impact of discontinued operations all offer additional information and perspective. But when the “GAAP to Pro-Forma Reconciliation” table is a page long and the “Adjusted EBITDA and Pro-Forma Adjusted EBITDA Reconciliation” table (including a half page “Definition of Adjusted EBITDA” which even I couldn’t stand to read) is another page in a ten page press release, then I have to believe we might be missing the proverbial forest for the trees.
 
Especially when it’s mostly good news, as we’ll discuss below.
 
Press releases, unlike SEC filings, are a chance to put your best foot forward, and certainly I would want to do that. And there are certain legal requirements for what and how you say things. But sometimes these things feel like the priests exploring the mysteries of the temple in a language many of the parishioners can’t understand. To the extent that it’s aimed at Wall Street, the analysts and institutional investors, maybe that’s the way they want it and maybe it’s even appropriate. But when I see media outlets reporting this by basically parroting back what Quik says in the press release (because, I’m afraid, they don’t understand the details and implications themselves) I think there must be a better way.
 
Here’s the link to the whole press release including the financial statements if you want to take a closer look.  www.quiksilverinc.com/pr/0610/ZQK_Q2FY10_earnings_press_release_3jun10_Final.pdf

Sales fell 5.2% from $494.2 million in the quarter ended April 30, 2009 to $468.3 million in the April 30, 2010 quarter. The Americas segment represents 43% of total revenue and, at $200 million, was down 13.2%. Europe, at $209 million was down 1% and Asia/Pacific was up 12.1% to $58.6 million.  In constant currencies (ignoring exchange rate movement), Europe revenues were down 5% and Asia/Pacific down 17%.
 
My last quarterly analysis for Quik was called, “Great Tactics- What’s the Growth Strategy?” Guess I could have used that title again. The conference call talked again, without offering any specifics (which you wouldn’t expect), about great product and technology, and good reception for its product. But it noted that DC and Quik were flat while Roxy was down for the quarter. The juniors market, they said, continues to be a challenge for branded girls surf apparel. Roxy is about a $550 million business.
 
Part of the sales decline was due to their explicit decision to control inventory and we’ll see the positive results below.  But the question I thought screams to be asked at the conference call, but which is never asked (no priest wants to be excommunicated) is, “You’re doing a great job controlling expenses, reducing inventory, paying off debt, collecting your receivables better and sourcing and it’s dramatically improved your profitability. But expenses can’t go to zero and product will never be purchased for free. You may get some more improvements in these areas, but eventually, you’re going to have to grow sales to grow earnings. How and where do you see that happening?”
 
Quik has given a partial answer. They said they are very well positioned to take advantage of an improvement in the economy and a pickup in consumer spending.  I agree that they (and lots of other companies) are, but that improvement is out of our control. Quik also noted that they were upping their inventory purchases where they were confident there were additional sales opportunities.
 
Quik’s inventory fell by 26% from $308 in this quarter to $226 million in the same quarter the previous year. You see the impact of this in their gross margin percentage, which rose from 47.2% to 53.2%, a 12.7% improvement. Quik reported lower levels of discounting and clearance sales then they had expected across the whole company. Selling, general and administrative expense actually rose from $203 to $213 million, and from 40.9% to 45.5% of sales, but in spite of that operating income was up 17.4% from $30.5 to $35.9 million. Improving that gross margin is a powerful thing.
 
Interest expense, as expected due to last year’s new financing, was up compared to the same quarter last year from $13.5 to $21 million ($7 million was noncash). Instead of a $1.926 million foreign exchange loss, they reported a $4.614 million gain. The tax provision didn’t change much, and you already know what the bottom line was.
 
Over on the balance sheet, you can see a lot of improvement in addition to the inventory numbers already discussed. Overall, their total liabilities to equity fell from 3.44 times to 2.36 times, a big improvement. And current ratio (a measure of short term liquidity) doubled from 1.42 to 2.86 at least partly because of the restructuring that happened last year. Receivables were down 19% as reported (21% in constant currency) and the number of days it took them to collect those receivables fell from 70 to 60 days. The increase in the reserve for doubtful accounts from $36.7 to $52.2 million had something to do with that.
 
Accounts payable were down 19%. The line of credit outstanding fell from $224 million to $15 million and current portion of long term debt was down from $226 million to $45 million. Some of this was just transferring current liabilities to long term liabilities, but total liabilities were down $201 million reflecting debt repayment and good cash management.
 
Some years ago, I started telling people that a focus on gross margin dollars was a good idea. Two to three years ago, I began to suggest we needed to plan for lower sales increases and operate better to grow those gross margin dollars. I would guess that Quik’s management would agree with me. They are doing great work in balance sheet improvement. But the sales decline is troubling- especially if you look at the European and Asia/Pacific sales numbers in constant currency and consider the economic prognosis for those areas. Let’s hope their product development efforts support some sales increases in the near future.
 
The Press Release I Would Have Written    
“Quiksilver’s net income for the quarter ended April 30, 2010 rose 235% to $9.4 million compared to $2.8 million in the same quarter the previous year. This was achieved in conjunction with a 5.3% decline in net revenue that was accompanied by an increase in gross margin percentage from 47.2% to 53.2% and a managed reduction in total inventories of 26.4% from $308 million to $226 million. A $200 million reduction in total liabilities resulted in a total liabilities to equity ratio that improved from 3.44 to 2.36 times over the year. Receivables were reduced by 19% and were collected an average of 10 days faster than in the same quarter last year. The company is very well positioned to benefit from a continuing recovery in consumer spending.”
 
They can and should go ahead and here and add all the other stuff. It’s important for a complete understanding. But couldn’t they start with a short, simple, fairly easy to understand paragraph that doesn’t take the temple priests to interpret and tells everybody the good news?      

 

 

Orange 21’s Results for Quarter Ended March 31

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Orange 21 (Spy Optic) has been through a lot. The recession and resulting economic conditions were enough, I’m sure we’d all agree, for any company to deal with. But since CEO Stone Douglass came in, they’ve also settled a dispute with former CEO Mark Simo and No Fear, done a rights offering (they raise about $2.5 million net), replaced their bank line with an asset based line of credit, dealt with a bunch of bad inventory, rationalized and restructured their factory in Italy, borrowed $3 million from Costa Brava, which is owned by its largest shareholder, and cut expenses including ten percent pay cuts for employees, which are still in effect.

They’ve also negotiated deals with O’Neill, Jimmy Buffett and his Margaritaville brand and, recently, Mary J. Blige to design, manufacture and market sun glass lines under their names. If those lines are successful, it will give them volume and help utilize their factory’s capacity.

And as if doing all this wasn’t a full time job, they still had to run the business.
 
Yet every time I go in a shop and ask how Spy Optics is doing (most recently last week), people say good things and tell me it’s selling well. So in spite of all the distractions, the brand still seems to be well positioned.
 
Sales rose 11.4% to $8.3 million, and they saw improvement across all products lines. Sunglasses represent around 80% of sales and goggles, 20%. They believe “…the overall increase is partly due to an improvement in the economy and consumer confidence as well as an increase in our efforts with certain key accounts and focus on close out sales.”
 
You can see the impact of the closeout sales on the gross margin. There was “…an increase of $0.7 million in discounts related to an increase in close out and key accounts sales in the U.S.” Total gross profit grew 2.5% from $3.6 to $3.7 million, but gross profit margin fell from 48.9% to 45%.
 
Sales and marketing expense grew 13% to $2 million due mostly to commissions on sales increases and the addition of a VP of sales. General and administrative expenses fell 9% to $2 million. Here’s the link to the whole filing if you want to pour over the details yourself. http://www.sec.gov/Archives/edgar/data/932372/000119312510117198/d10q.htm
 
Research and development expenses were up 69% to $400,000. There was some additional head count, travel and entertainment, and some expenses for the newly licensed brands. You’d expect that.
 
Overall, the loss from operations grew from $776,000 to $889,000 and the net loss went up from $804,000 to $937,000.
I retrieved the balance sheet from March 31, 2009 to compare to the most current one. We see that receivables have fallen 6% from $5.3 million to $4.9 million. You like to see receivables fall as sales increase, though typically they rise.  Inventory was down 20% to $8.3 million, also a good thing. Total current assets were down 14.9%.
 
Current liabilities were down 25.2%. The biggest decreases were in the line of credit, which fell from $3.5 to $2.2 million, accounts payable, which were down 33.6% to $4.3 million. Looks a lot like good financial management and expense control. The current ratio improved from 1.21 to 1.38. Not a big improvement, but progress.
 
There were no big changes in the non-current assets. Long term notes payable jumped from $270,000 to $3.2 million due to the $3 million note from Costa Bravo. Much of the proceeds from that note were used to pay off the BFI line. I have to believe it’s easier and cheaper to have longer term money from a major shareholder than short term money from an asset based lender.
 
Total stockholders’ equity fell from $7 million to $4.6 million, or by 35%. Total debt to equity has increased (a bad thing) from 2.28 to 3.36 times.
 
Orange 21 is doing everything they can to control spending and improve their balance sheet. What they need most is higher revenue. Hopefully, a continuing economic recovery and sales from their new licensing arrangements will give them that. I guess it may also help that the cost of the product they make in their Italian factory will decline in dollars if the Euro continues to weaken.   

 

 

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

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

Numbers

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

 

 

What Are Big Brands Doing in Retail? It’s a Bit Scary

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Below is the handout I distributed at IASC’s Skateboard Industry Summit at the end of April where I talked about the evolving retail environment.  These are quotes from recent fillings and conference calls by Billabong, Genesco (owners of Journeys), Nike and Zumiez about how they see the retail environment and their involvement in it.  Except for Nike, you’ve seen these if you’ve read in detaill my most recent analysis of these company’s results.

These quotes aren’t my opinion or interpretation; they are what the senior executives actually believe and are doing.  In general, they are unclear about their growth opportunities in core stores and the survivability of those stores.  They think they can merchandise their own brands in their own stores better than in the core shops.  They like the higher margins.  You really need to read these comments.  Draw your own conclusions.

Billabong

 There is still “…a little bit of an apprehension to actually placing forward orders, and some customers preferring to do a little bit of business in season.” “I’d say that’s a trend that’s probably going to be there for a little while,” he continues.
 
Jeff’s Comment: I’d be curious to know just what he means by “a little while.”
 
“I can’t sit here at all and say that all the accounts that we are currently dealing with will still be there in three months time,” is how he puts it. He also thinks they may have to tighten credit by the end of the current six months.
 
“If you look at the wholesale level, most of the business going on, the buyers are focused on your price point category and up to your mid price print category.” “…in our own retail, which has definitely outperformed our wholesale side in this period, in our own retail we can showcase and merchandise a product across all the price points and we’re doing really well right across the board.”
 
“The cycles with our own retailers, we are beginning to drop product into our own retail even faster than wholesale channel. We are beginning to, on certain key styles…build product that may go into our own retail before even the wholesale consumer sees it in an indent (sic) process. But we’re beginning to utilize our own retail to test product a lot more and we’re just becoming a little more focused on that shortening of the whole supply side.”
 
“If you look at the big retail brands out there, they don’t have a buyer to get past, they just decide what they’re going to make and they put it in their own stores and therefore they could have a very short cycle.…we are looking more and more at some of our own retail stores where we can looking at touching on a more vertical model. And not having that delay with going out and having an eight week ordering pattern and then go away and ordering product, we’ll just go straight to retail.”
 
What percentage of total revenues could retail represent?” somebody asked. “It’s probably going to depend on what happens with the wholesale account base,” O’Neill responded.
 
Genesco
Genesco is looking at “very modest” store growth in Journeys. They say they don’t want to have happen to them what has happened to other retailers who have over extended themselves on their store count. They mention Footlocker, The Gap, and Starbucks as retailers who are closing stores because they got a bit overextended. They plan to open only 50 net new stores over the next five years across the whole company.
 
They also note that they have another wave of store leases coming up for renewal. They expect to get lower costs and more favorable terms when those leases are renegotiated. Overall, they expect that with very modest store growth and comparable store sales growing by only two to three percent, they can expand operating margins from the current five to eight percent and grow earnings per share by 15% to 20% annually. Obviously, they see a lot of opportunity in reducing costs and operating efficiently.
 
He notes that when, for example, a five store chain has a lease coming up for renewal, it will find Genesco on their landlord’s doorstep taking over that space. 
 
The other thing that’s happening, as they describe in discussing their hat, uniform and sport apparel business, is that they “…are consolidating the industry. The mom and pops are going out of business or they are credit constrained and can’t stay fresh.” 
 
President and CEO Robert Dennis talked about how the economics of their hat and hat related business has changed as they have gone from 150 to 800 stores. The difference, he says, “is enormous.” There is tremendous leverage with landlords, the companies from whom you license product, vendors, and infrastructure.
 
He also characterizes most of these small players’ systems as being “from the dark ages.” 
 
Nike
“We’re also starting to realize the broader benefits of becoming a better retailer. Over the past few years, we’ve spoken about expanding our direct-to-consumer business. We saw a huge upside to bringing innovation and excitement into the marketplace in our own stores, with our wholesale partners and online.”
 
“To do that we committed to building our retail capabilities, smoother product flow, surgical assortment planning that focuses on key items, more compelling merchandising, stronger brand stories and more efficient back-of-house systems. All balanced to produce greater consumer experiences and strong profitability. It’s a powerful mix that helped NIKE Brand Retail deliver 11% revenue growth and 140 basis points of gross margin expansion year-to-date.”
 
“We will continue to invest in bringing world-class solutions to consumers who are hungry for new retail experiences. Nowhere is this more important than online. The digital lifestyle is driving dramatic change in our industry and significant potential to our company. We are attacking that in every dimension; online shopping, customization, immersing our brands in consumer cultures and telling inspiring and entertaining stories.”
 
“Comparable sales for brick and mortar Nike-owned retail stores increased 17%, and online sales grew 25%. Profitability for the businesses grew even faster as better merchandising, lower promotions and more surgical mark downs drove gross margins up 550 basis points versus last year.”
 
Zumiez
 “Our stores bring the look and feel of an independent specialty shop to the mall by emphasizing the action sports lifestyle through a distinctive store environment and high-energy sales personnel. We seek to staff our stores with store associates who are knowledgeable users of our products, which we believe provides our customers with enhanced customer service and supplements our ability to identify and react quickly to emerging trends and fashions. We design our stores to appeal to teenagers and young adults and to serve as a destination for our customers.  Most of our stores, which average approximately 2,900 square feet, feature couches and action sports oriented video game stations that are intended to encourage our customers to shop for longer periods of time and to interact with each other and our store associates.”
 
 Jeff’s Comment: Except for the mall location, how is this different from any other core shop?
 
Zumiez pursues, on a national scale, the same branding strategy the best independent retailers pursue.  “We seek to build relationships with our customers through a multi-faceted marketing approach that is designed to integrate our brand image with the action sports lifestyle.” They spent $822,000 on advertising in fiscal 2009.
 
 “We have developed a disciplined approach to buying and a dynamic inventory planning and allocation process to support our merchandise strategy. We utilize a broad vendor base that allows us to shift our merchandise purchases as required to react quickly to changing market conditions. We manage the purchasing and allocation process by reviewing branded merchandise lines from new and existing vendors, identifying emerging fashion trends and selecting branded merchandise styles in quantities, colors and sizes to meet inventory levels established by management. We also coordinate inventory levels in connection with our promotions and seasonality. Our management information systems provide us with current inventory levels at each store and for our Company as a whole, as well as current selling history within each store by merchandise classification and by style.”

 

 

Vail 2nd Quarter Results- Watching Real Estate Will Be Interesting

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Given that Vail says the snow up to about Christmas was the worst in 30 years, you have to say that they really did okay. But I think the most interesting thing in the whole 10Q was the disclosure that 13 holders of contracts to purchase Ritz-Carlton Residences had sued to get out of the contracts and get their deposits back because of a disputed delivery date.

If you really wanted your new 2nd home, you probably don’t sue because it’s a little late being finished. Maybe you negotiate for some free upgrades (heated toilet seats?), but you don’t sue to get out of the deal. Unless, of course, you can no longer afford to buy the place and/or it’s now worth a lot less than you’ve agreed to pay for it. Hey, why should the winter resort real estate market be different from other real estate markets?
 
Apparently it isn’t. In the risk factors section, Vail talks about the “… increased risk associated with selling and closing real estate as a result of the continued instability in the capital and credit markets and slowdown in the overall real estate market, including the risk that certain buyers may be unable to close on their units due to a reduction in funds available to buyers and/or decreases in mortgage availability, as well as the potential of certain buyers being successful in seeking rescission of their contracts” They go on to note that, “… the Company cannot predict the ultimate number of units that it will sell and/or close, the ultimate price it will receive, or when the units will sell and/or close.”
 
Vail “… currently does not plan to undertake significant development activities on new projects until the current economic environment improves.” The 10Q can be found here http://investors.vailresorts.com/ and you might also want to review the March 11 investor presentation.
 
I’ve commented before, though long ago, on the relationship between mountain and real estate development for winter resorts with both. To maximize total value, you have to synchronize the development of both, not letting either get too far ahead of the other. As Vail puts it, “The Company’s real estate development projects also may result in the creation of certain resort assets that provide additional benefit to the Mountain and Lodging segments.”
 
Real estate revenues are recognized in the income statement only when a sale closes. Obviously this means, as we’ll see when we look at the financial statements, that sometimes there’s a lot and sometimes there’s a little. That’s just the way the real estate development business is. But of course if you don’t start projects, it’s going to be kind of hard to finish them and recognize revenue as your book of projects under development runs down. Let’s look at the numbers to see what this means.
 
Mountain revenue for the quarter ended January 31, 2010 was up 1.35% to $261 million compared to the same quarter the previous year. Lodging revenue fell 6% to $38.7 million. Real estate revenue pretty much disappeared, falling from $89.2 million to $870,000. That’s largely determined by when the sales close assuming, of course, that there are sales in the pipeline.
 
The Mountain segment includes the operations of the company’s five resorts as well as the related ski school, dining, and retail/rental operations. About half of its revenue comes from lift tickets, including season passes. It’s recognized in the income statement over the course of the season. Season pass revenue was up about 9% this season and is expected to represent about 35% of list ticket revenue for the fiscal year.   Vail noted that the Mountain EBITDA (earnings before interest, taxes, depreciation and amortization) was up by 3.6% due to this increase and to the “…cost reduction initiatives implemented during the second half of the prior fiscal year.” 
Mountain operating expenses were down 2.2%, the result of a freeze in the company’s 401K matching contributions, a company-wide wage reduction plan, and better inventory management offset by some higher food, fuel and medical costs.
 
In the Lodging segment, the average daily rate the company earned on its owned hotels and managed condos fell by 2.1% in the quarter compared to the same quarter the previous year. Revenue per available room was down 11.1%. EBITDA was down from $2.5 million to $0.9 million for the quarter ended January 31, 2010. This was due almost entirely, according to the company, to declines at Keystone properties and to higher employee medical costs.
 
Total revenue for the quarter ended up declining by 22.7% from $389 to $301 million. This was almost completely the result of the decline in real estate revenue. Total operating expenses fell 21.7%. All three segments showed declines, but again, most of the total was the result of real estate expense falling from $60 to $7.4 million.
 
Net income fell 32.8% from $60.5 to $40.7 million. And yes, it’s because of the decline in real estate revenue, but how do we look at Vail’s overall performance given the variability in real estate?
 
We can start by subtracting segment operating expense from segment revenue for the quarter and constructing the little chart below and show what I guess we’ll call operating income for each segment for the January 31, 2010 quarter and the same quarter last year. The numbers are in thousands.
 
SEGMENT                                            1/31/10                                1/31/09                               
Mountain                                              $106,960                              $102,301
Lodging                                                $888                                     $2,453                                  
Real Estate                                         $(6,547)                                $29,649
Total                                                      $101,301                              $134,403
 
Remember that below this line we’ve got all that interest, amortization, taxes, depreciation, investment income, and net income attributable to noncontrolling interests. How shall we allocate it among the three segments?
 
You got me. Perhaps I shouldn’t quite put it like that. There are ways to allocate, and some of them would be better than others, but you’d find that there isn’t just one right way to do it. But remember what I said (and what Vail said) above. The performance of each of these segments is related to the others.
 
Let’s say you got a dollar in the bank, and you need a total of three dollars to do a few projects. So you borrow two dollars and add them to the one dollar you already have in the bank to do the projects (they’re small projects). The projects are all related to each other. You have to pay interest on two of those three dollars, but which project do you allocate that interest expense to? Does it matter? Probably not. Would you learn anything by doing it? I don’t think so. Could you screw up your comparisons across sectors? You bet.
 
Vail’s quarterly earnings of $40.7 million represent a return on end of the quarter equity of 5.2%. It was 8.1% for the same quarter next year. They’ve got very little debt coming due in the next four years- only $2.6 million through fiscal 2013. At the end of the quarter, they had no debt drawn under their senior credit facility and the land they are holding for development was bought at favorable prices which means a low holding cost. They report that through March 7, for the season, they’ve seen some recovery since the poor early season snow. Total skier visits were now up 0.4% and lift ticket revenue was up 1.6%.
 
Vail suffered like most businesses from the recession. As you think about their future, the extent and timing of the recovery is where you have to focus. When can they begin to develop real estate again and what will they be able to sell it for? How committed are snow sliding consumers, and will their caution be, to any significant extent, a long term condition?