Quik’s Quarter Ended Jan. 31, 2010; Great Tactics- What’s the Growth Strategy?

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A sales decline of 2.4% for the quarter ended Jan. 31, 2010 compared to the same quarter the prior year, from $443.7 to $432.7 million isn’t what you’d like to see.  Then you notice that their gross margin percentage rose from 46.7% to 51.3% and that their gross profit was up by 7.2% even with the sales decline and things look better.  Quik attributes this to a better economic environment, improved sourcing, reduced discounting and good inventory management.

 A year ago, on Jan. 31 2009, their inventory was $380.5 million.  At January 31st this year, it was down to $301.2 million, a decline of almost 21%.  Very impressive.  They have also reduced their receivables by 13.5% over the year and days sales outstanding (how long it takes them to collect their receivables) fell from 72 to 64 days.  Cash is up from $42 to $150 million.  Their current ratio has improved over the year from 1.63 to 2.24, indicative of the capital raised and the restructuring of their bank lines to improve liquidity.  Their total debt to equity has also improved from 3.81 to 2.91, also largely due to the equity raised.

But their long term debt and lines of credit still total $977 million.  While that’s down from $1.013 billion a year ago, it’s still a lot and they’ll have to work to reduce it if they want to improve their operating flexibility and maybe refinance their expensive (15% plus warrants) debt that they got from Rhone capital.  They expect to reduce that debt by about $100 million a year over the next three years.  In the conference call, they increased their estimate of free cash flow from $50 million to $75 million for the year.

I don’t typically lead with a balance sheet discussion, but it’s so pivotal to Quik’s future that it seemed to make sense.  Back to the income statement.

Selling, general and administrative expenses fell 1.8% to $203 million.  They expect their marketing expenses to be around $100 million in the current fiscal year, down from $120 million last year.  Operating income grew from $345,000 to $19 million.

Interest expense, to nobody’s surprise, was up from $14 to $21 million.  They expect total interest expense this year to be around $92 million $26 million of which, Quik reminds us, is noncash.  The loss from continuing operations was $65.2 million in this quarter last year, compared to $4.6 million this year.  The net loss fell from $194.4 million last year ($128 million of that was Rossignol related) to $5.4 million in the quarter ended January 31, 2010.

During the quarter, sales decreased by 8% in the Americas.  They fell by 2% in Europe and rose 16% in Asia/Pacific.  In constant currency terms they were down 12% in Europe and 15% in Asia/Pacific.  That translates into a decline in sales overall in constant currency terms of 11%.  As reported (that is, ignoring currency fluctuation), revenues were $187 million in the Americas, $178 million in Europe, and $67 million in Asia/Pacific.

They commented that the juniors market was difficult.  The Americas decrease was in Roxy and Quiksilver, offset by an increase in DC.  However, they note that increase “was partially related to the timing of shipments,” which means some of the increase was not organic growth, and will reduce next quarter’s sales.  In constant currency in Europe, the story was about the same, with declines in Roxy and Quiksilver offset by some growth in DC.

As with any company, there’s a limit to how much improvement you can see from inventory management, expense control, and sourcing improvements.  There is, I suppose, always room to do better, and I’ve been urging companies for maybe two years now to focus on gross profit dollars.  But at some point, to improve profits, you have to sell more.  What Bob McKnight said in the conference call was that Quik is “… in a prime position to benefit from future improvements in the world’s economies and in particular in consumer spending.”

I believe that, but what I also hear him saying is that they really need that improvement to get growth and profitability back on track.  For the second quarter, they expect to “…generate earnings per share on a diluted basis in the low single digit range.”  CFO Joe Scirocco believes they can still achieve the full year revenue objectives they outlined last quarter (he didn’t say profit projections), “…although some definite challenges remain, including a challenging juniors market, foreign currency headwinds, and uncertainty at retail.”

We didn’t get (and probably shouldn’t expect in a conference call) a lot of specificity as to where growth can come from.  CEO McKnight highlighted the core shop strategy that has been rolled out for all three brands where they have developed and are selling product only in their own stores and the best independent retailers.  I think that’s a great, and necessary, thing for them to do.  As I’ve argued before, however, I’m not sure that will be the source of enough additional revenue to make a big financial difference.  Hope to be wrong about that.

So I’m impressed by the steps Quik has taken to improve their liquidity, control expenses, manage their inventory and restructure their businesses for improved efficiency.  The last step will be reducing their leverage.  That’s just going to take some time and some cash flow.

The source of their future revenue growth (which they need if only because of their increased interest expense) is not clear to me.  I’ve said that a couple of times before in comments on their filings and it’s still true.  Like all of us, they are dependent on and hoping for a recovery in consumer spending.  They’ll get- are getting- some.  Like all of us, it won’t be as much as we’d like or have gotten use to.  But what they really need are some new places to sell their products.  At least in the U.S., I don’t know where else they can go with their distribution.  Maybe there are some opportunities in the rest of the world.

 

 

Zumiez’s 10K for Year Ended Jan. 30, 2010; The Strategy’s the Thing

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In my analysis of Billabong and Genesco, I have spent some time talking about their retail strategies and the possible impact on the action sports retail market, especially on the core retailers.  Zumiez’s 10K has me thinking about this again.

I would first like to thank Zumiez for keeping their 10K to only 75 pages, simplifying my task and reducing my work load.  I have a theory that the best companies have the shortest 10Ks; business models that are simple to describe and fewer problems to explain.  Maybe that’s a new investment strategy.

Zumiez’s financial results, like with every other publically traded company in any industry, reflect the recession and their efforts to manage through it.  There was inventory control, expense management, a reduction in capital expenditures, and focus on continuing to follow their basic strategy (which can be done, as usual, when you have a strong balance sheet like Zumiez’s).

Zumiez ended their fiscal year with 377 stores in 35 states averaging 2,900 square feet each.  As they note, their size seems to leave them room to grow given the number of stores that other similar retail chains have.  New store openings have declined from 58 stores in fiscal 2008 to 36 in 2009 and a projected 25 in 2010.

Their customers are “…young men and women between the ages of 12 and 24 who seek popular brands representing a lifestyle centered on activities that include skateboarding, surfing, snowboarding, BMX and motocross.”

They go on to say:

 “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. To increase customer traffic, we generally locate our stores near busy areas of the mall such as food courts, movie theaters, music or game stores and other popular teen retailers. We believe that our distinctive store concept and compelling store economics will provide continued opportunities for growth in both new and existing markets.”

 They talk about this strategy in more detail in the 10K and you can see the whole thing at http://www.sec.gov/Archives/edgar/data/1318008/000119312510064532/d10k.htm.  Focus on pages one through nine.

Ignoring whether or not you think this strategy is valid (their history tells us it has been), you’ll notice that this description of their stores and how they position themselves could essentially be the same description that any independent core retailer would use.  Except of course the core retailer wouldn’t be in the mall (I guess by definition?) and doesn’t, therefore, have the ability to locate in high traffic areas in the mall.  So your typical independent core retailer might to be more dependent on destination traffic than a Zumiez.   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.

In other words, as I’ve said a few dozen times before, the best retailers, chain or independent, give credibility to the brands they carry and do not rely on those brands to define them.  Zumiez is clearly not dependent on a handful of brands.  No single brand accounted for more than six percent of net sales in 2009.  Their private labels in total accounted for 15.7% of net sales, up only slightly over the last two years.  Ecommerce sales represented 2.3% of the total, up from 1.1% two years ago.

 And Zumiez has undeniable advantages in terms of negotiations with vendors and landlords, systems, and overall efficiencies associated with size.  Like they say, “compelling store economics.”  Genesco, by the way, pretty much said the same thing.  So would any multi hundred store retailer.  Here’s another kind of long quote that described part of that advantage.

“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.”

Pretty powerful stuff.  Then I noticed that in 2008, Zumiez’s net investment to open a new store (net of inventory and landlord contribution) was $311,000.  In 2009 it was down to $221,000.  In part that’s because of economic conditions, but it’s also indicative of the advantages of scale.

Let’s talk about the numbers while all this strategic stuff sinks in.  I’ll come back to it in my conclusions.

Net sales for the year were about even, falling $1 million to $407.6 million.  Comparable store sales were down 10% after having been down 6.5% the previous year.  Net sales per store were down 12.8% from $1.24 million to $1.08 million. Comparable store sales had grown an average of 12.6% a year in fiscal 2005 to 2007.  Gross profit as a percent of sales actually grew from 32.9% to 33.1%, an indication of good inventory management and control of the need to discount.  This gross profit percentage may look a bit low, but you have to consider how the company calculates it.

“Cost of sales consists of branded merchandise costs, and our private label merchandise including design, sourcing, importing and inbound freight costs. Our cost of sales also includes shrinkage, certain promotional costs and buying, occupancy and distribution and warehousing costs. This may not be comparable to the way in which our competitors or other retailers compute their cost of goods sold.”

I agree.  There’s no right or wrong way to do this but, though detail is lacking, I think Zumiez includes some costs that other don’t. 

Selling, general and administrative expense rose from $109 to $122 million both due to store openings and, I assume, because Zumiez had the balance sheet to let it continue to pursue its strategy.  As a percentage of sales, it rose 3% to 29.9%.

Operating profit fell by half from $24.6 to $12.7 million.  Though cash and cash equivalents grew from $78 to $108 million, interest income fell from $2.059 to $1.176 million, reflecting not only the difficulty in finding yield under current conditions but, I suspect, an unwillingness to take risk.  Net income fell from $17.2 to $9.1 million for the year.

Comparing fourth quarters you can see what looks like the beginning of some level of economic recovery (this is not unique to Zumiez).  Sales rose 5.5% from $125.5 to $132.4 million.  Same store sales had fallen 13.4% in the quarter ended Jan. 31, 2009.  They only fell 1.7% in the quarter ended Jan. 30, 2010.  Okay, so maybe that isn’t good news but it’s sure less bad.  Gross profit as a percent of sales was up from 32.4% to 36.3%.  Net income rose from $6.3 to $8.8 million in the quarter ended January 30, 2010 compared to the same quarter the previous year.

The balance sheet has actually strengthened slightly from last year by the measures I use and is in good shape.  I won’t bore you with a detailed analysis of nothing interesting.

Now we’re back to those pesky strategic issues and you know what?  I don’t think I’m going to write a new conclusion.  I’m just going to go see if I can’t use the same one I used when I wrote about Genesco (the owner of Journey’s) a few days ago.  Here it is.  I’m quoting myself, which is a little strange.

“I wrote not too long ago about Billabong’s retail strategy.  They might agree with Genesco executives about how the retail environment is evolving.”

“My own expectation is that due to some of the pressures on core store described above, their numbers will tend to decline until we have just the right number to service the enthusiasts who are truly prepared to pay extra for expert advice and service in a community based environment.  I don’t know how many stores that is or how long it takes, but when it happens, we will have come full circle in the action sports core store business; because that’s how it use to be.”

Zumiez thinks they can be a core store in a mall.  They are the only one who puts it quite so directly, but others are thinking that way too.  If they’re right, and they have other business advantages (as described above) what does the model of a successful independent core retailer look like?

I’m going to the IASC sponsored skateboarding conference this month and am going to moderate a panel discussion on retailing.  As you can see, I’ll have some interesting questions to ask.

 

Genesco’s Take on The Retail Business

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Genesco, the owner of Journey’s, reported its results for the quarter and year ended January 10th in early March. A couple of days later they made an investor presentation that discussed these results. I’ll talk briefly about their numbers, but what really caught my attention was their discussion of the retail environment and their retail strategy.

Genesco operates 2,270 retail stores in the United States and Canada. 90% of their revenues are retail and 10% wholesale. Revenues for the year were $1.57 billion, up only slightly from the previous year’s $1.55 billion. Earnings for the year were $28.8 million compared to $150.8 million the prior year, but there was a huge legal settlement that accounted for $124 million of the difference. The company says that adjusting for that settlement and some other non operating items, earnings from continuing operations grew from $40.8 to $43.1 million. Net earnings per share declined from $1.87 to $1.81.

Comparable store sales were flat in the 4th quarter compared to the same quarter the previous year. The Hat World group increased by 6% and Journey’s declined by 3% in the quarter.
 
The Journey’s group represents 48% of the year’s sales. Hat World group is 30%. However, they each generated about the same level of operating income during the year. The Journeys group, which includes Journeys, Journeys Kidz, and Shi by Journeys includes 1,025 stores of which 819 are Journeys. The Hat World group had 921 stores at fiscal year end.
 
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 might have mentioned PacSun as being over extended as well. They plan to open only 50 net new stores over the next five years across the whole company. The majority will be in the Hat World group.
If you can’t grow stores, you’d better improve your comparable store sales and control costs. One of the trends they think may be favorable to them is “a shift out of athletic shoes into brown.” They say they are only seeing hints of it now, but should know in the spring. That should get our attention don’t you think? Would it be completely a surprise given the number of athletic shoes and shoe brands out there? Yes, there can be too much of a good thing and markets can become saturated.
 
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.
 
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.” That sounds the slightest bit familiar.
 
The hat business, by the way does include stores that just sell hats. But it also includes stores, under the Lids name, where you can buy branded sports apparel of all kinds and the uniforms that you need, for example, for school sports. They go very deep in their hats, apparel and uniform stores, and the merchandise mix favors the local teams.
 
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 since he got there. The difference, he says, “is enormous.” There is tremendous leverage with landlords, the leagues from whom you license product, vendors, and infrastructure.
 
He notes that the team sports business is highly fragmented with perhaps 5,000 dealers, and Genesco’s business in this area is already the second largest even though it’s small. He doesn’t quite know whether to characterize their strategy in this space as a rollup or displacement. But 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. Wonder who the landlord would rather have as a tenant? He also characterizes most of these small players’ systems as being “from the dark ages.” That, I’m afraid has the ring of familiarity as well.
 
Action sports is kind of in the hat business, but we’re sure not interested in selling uniforms and team jerseys. But Genesco’s description of this retail environment and how they take advantage of it has to sound at least a little familiar as well. Larger retailers in our space are certainly taking advantage of the same pressure points Genesco is, and we can’t expect it to stop.
 
I wrote not too long ago about Billabong’s retail strategy. They might agree with Genesco executives about how the retail environment is evolving.
 
My own expectation is that due to some of the pressures on core store described above, their numbers will tend to decline until we have just the right number to service the enthusiasts who are truly prepared to pay extra for expert advice and service in a community based environment. I don’t know how many stores that is or how long it takes, but when it happens, we will have come full circle in the action sports core store business; because that’s how it use to be.    

 

 

Billabong’s Semi-Annual Report

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Billabong released its numbers for the six month ended December 31, 2009 last week and held a conference call. Though clearly not immune to a tough economy, the company’s raising of capital to strengthen the balance sheet, long term focus on brand equity, willingness to lose some sales rather than become too promotional, realism as to the operating environment, and nuts and bolts management of costs and inventory has left them in a pretty good position.

But what really caught my attention was the discussion of retailing during the conference call. I’d like to spend some time on that before I get to the financial results.
Billabong’s Retail Perspective
Billabong closed the year with 360 company owned retail outlets, up from 335 June 30th. 90 of those are in the European segment, 157 in Australasia, and 94 in the Americas. Retail now represents just a little more than 25% of the company’s sales.
No, I don’t know why those three numbers don’t add up to 360. I’ve emailed Billabong to ask.
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. Later conference call comments provided more insight into their thinking and created an intriguing picture of the retail market as Billabong sees it and how they may approach it.
They start by noting that there is still some softness in prebooks (though things have improved) both in terms of the size of the orders and the numbers of retailers they have received orders from for summer. CEO O’Neill indicates that 80% of the account base (referring, I think to the US) had orders in, where it would have been 90% two years ago. 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.
I’d be curious to know just what he means by “a little while.”
Next, he talks about tight credit conditions and the health of independent retailers. “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.
Finally, he says, “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.”
Any brand talking about the US market (and some other countries as well) might say the same thing. We’ve got a new set of economic conditions that look to be long lasting where independent retailers are falling out, the survivors are ordering more cautiously, consumer spending is down and focused on low to middle price points.
No surprise there, but now the plot thickens. “…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.”
And then, just to make this even more interesting, he says, “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.
There’s more, but I think that’s enough quotes. You can see the report and the conference call here. http://www.billabongbiz.com/news-business.php
In summary, given foreseeable economic conditions, Billabong isn’t sure what level of growth and profitability it can rely on from its independent retailers. Right now, it believes it can merchandise and sell its product better in its own stores because of the independents’ reluctance to order and tendency to order the lower to mid priced items, and its results bear that out. It’s 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. This is also, in part, a response to the branded retailers. Dare I say Forever 21? Seems like they are the poster child for product cycle blues these days.
Not to belabor the point, and certainly not to put words in Billabong’s mouth, but if a well managed company like Billabong is unsure of the role and importance of independent retailers going forward, and thinks they can do better business in their own stores, how will the role of those independents evolve? It’s always been an industry article of faith that core retailers were the bedrock of the business but that might be changing as companies get large and we become increasingly fashion based and fashion competitive.
By the Numbers
I have to begin by reminding you that Billabong’s functional currency is the Australian Dollar, and the numbers here are in that currency. Just for reference, at the moment one U.S. dollars equals 1.12 Australian dollar. A year ago a U.S. dollar cost 1.55 Australian dollars. That’s a 28% change over the year and that can wreak havoc on your financial planning and reporting. In this case, it did so I’m going to report some constant currency results along with reported results. Management notes that each one cent movement in the average monthly exchange rate between the Australian and the US dollar for the five months of the year that are left above or below the 0.90 rate they are planning will change reported net profit after taxes by $500,000 from their projection. 
Revenues fell 10.8% in reported terms from $810 million in the half year ended December 31, 2008 compared to the half year ended December 31, 2009. They were only down 2.8% in constant currency.
In the Americas, reported sales were 17.6 lower, but only down 6.2% in constant currency. They point out that “…direct comparisons to the prior year are somewhat misleading. The latest result includes a full six months of trading from DaKine versus three months in the prior year. The prior corresponding period also included three months of trading in the period that preceded the global financial crisis.”
They also note that sales to PacSun were down about 50% for the half year. Billabong anticipates that “…the retailer’s percentage contribution to the Group’s overall North American sales will decline to the single-digit level across the full financial year.”
Given Billabong’s focus on brand equity and interest in selling higher end product, I have to agree with their approach, though I don’t know how they easily replace those sales.
European sales were $164 million, down 7.6% in reported terms but up 2.6% in constant currency. Billabong reports strong momentum in Europe. Australasia revenue fell 2.5% in reported terms but only 1.4% in constant currency.
With sales down, cost of goods fell 14.2% as reported from $373 to $321 million. Gross margin percentage actually strengthened from 53.8% to 55.5%.   Selling general and administrative expenses were down 7.7% from $260 to $239 million. Finance costs fell 40.8% from $20.6 to $12.2 million due to the repayment of debt following the May 2009 raising of capital.
Reported net profit was down 15.4% from $82.4 to $69.7 million. They blame that almost entirely on unfavorable movements in exchange rates.
Much of the strengthened balance sheet is the result of the capital they raised in 2009. Between December 2008 and December 2009 cash increased from $169 to $213 million. Receivables fell 15% from $394 to $334 million and they reduced inventories 23.8% to $247 million. Total current assets were down 10.6% and noncurrent assets fell 11.3% from $1,317 to $1,168 million.
Trade and other payables were down 34.5% from $273 to $178 million. That explains most of the drop in current liabilities from $302 to $215 million. The current ratio improved from 3.04 to 3.81.\
By far the biggest change in the non-current liabilities is in borrowings which, as a result of the capital raised, were reduced by half from $810 to $397 million. Deferred payments also fell significantly from $161 to $107 million, reflecting a $34 million payment to the former owners of Dakine and other payments as well.
Between earnings and the equity raised, total equity grew 34% to $1,190 million. Total liabilities to equity plunged from 1.51 to 0.67. This is my kind of balance sheet!
Billabong is confident, but a bit cautious about the rest of the year.
“Retail markets remain extremely volatile and difficult to predict, consumer spending patterns remain erratic and global economic concerns continue to weigh on general sentiment. Against this backdrop, the Group’s North American business continues to experience challenging conditions. While there is some stability emerging within the independent specialty channel, there is no recovery evident amongst the Group’s larger mall-based customers. Australasia is showing mixed performances, with South Africa, Japan and New Zealand expected to remain soft but the balance of the region remaining steady. Europe, a highlight in the first half, is expected to remain relatively buoyant.”
They expect better foreign exchange hedge rates and the impact of previous expense reductions to help their results. The most intriguing thing to me, however, is still their perspective on and approach to the retail business. It will be interesting to see if other action sports brands share their perspective and if any take a similar approach.

Quiksilver’s Annual Report

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In the middle of December, when Quik came out with its quarterly and fiscal year results and held aconference call, I pretty much ignored it.  I glanced at the release and read the conference call transcript, but I had no idea how to evaluate the results of a company that was highly leveraged without a complete balance sheet and the associated notes even though they included some summary balance sheet information in the release.

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Aeropostale; the Power of Good Systems and the Right Market Position

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For the quarter ended October 31, Aeropostale reported sales up almost 18% to $568 million.  For nine
months, they rose almost 20% to $1.43 billion. Gross profit margin in the quarter rose from 36% in the
same quarter last year to 39.3%.  For nine months, it was up from 34.4% to 37.5%.  Selling, general and
administrative expenses were down as a percentage of sales for both the quarter and nine months
compared to the same period the prior year.  New income was up almost 47% for the quarter to $62.6
million.  It rose nearly 64% to $133 million for nine months.

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Hot Topic: A Competitive Strategy We Should Be Thinking About

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Hot Topic has reported their results for the quarter ended October 31 and their sales for the month of November. Their sales were down some for the quarter and more in November, but they continued to make money in the quarter and their balance is very strong.

But I don’t want to crunch their numbers. I do enough of that. I want to focus on their strategy and its relevance to the Action Sports Space. I’ve talked about his before but I feel like doing it again. I think it’s important. Here’s how the company describes itself.
“We are a mall and web-based specialty retailer operating the Hot Topic and Torrid concepts, as well as the e-space music discovery concept, ShockHound. At Hot Topic, we sell a selection of music/pop culture-licensed and music/pop culture-influenced apparel, accessories, music and gift items for young men and women principally between the ages of 12 and 22. At Torrid, we sell apparel, lingerie, shoes and accessories designed for various lifestyles for plus-size females principally between the ages of 15 and 29. At ShockHound, music lovers of all ages can come together and purchase MP3s and music merchandise, share their music interests, read the latest music news and enjoy exclusive editorial content about their favorite artists.”
“At Hot Topic, our business strategy is built on the foundation of pop culture and its relevance to our target teen customer. Within pop culture, we believe music plays a primary and integral role in the minds, activities and preferences of our target customers. Our comprehensive music strategy encompasses a high level of focus on the in-store music experience. We continue to: focus on music and music/pop culture oriented merchandise; operate a fundamentally regular price business; emphasize superior customer service; and ramp up our efforts to host unique in-store events.”
These people are after our customers. Not so much the people who actually surf, skate, and snowboard (though they’ll be happy to have those too, I’m sure) but the rest; the fashion influenced, lifestyle customers that are where at least a majority of our sales come from now.
We have to convince that customer that what we do (surf or skate or snow) is cool and that they should want to be a part of it. Hot Topic says, “Tell us what you think is cool and what you want your shopping experience to be like, and we’ll try and give it to you.” They don’t have roots to worry about and as we’re more and more the fashion business, I see it as a big advantage.
It’s not easy to make the transition from an activity based brand to a lifestyle, fashion brand. Hot Topic doesn’t have to.   

Zumiez’s Nov. 2009 Sales Results- A Couple of Comments

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Yesterday, Zumiez reported that sales for the four week period ended November 28th, 2009 decreased 1.8% compared to the same period the previous year. For the same period, they reported that comparable store sales fell 8.5% compared to a decline of 15% in the same period the previous year.

In the first place, I want to suggest that paying attention to four week numbers may be fun, but it doesn’t really tell us anything about trends. It’s just not enough time.
Second, there are various attempts out there to position a decline of 8.5% in comparable store sales as a somehow positive result because last year they were down 15%. I’m not talking just about Zumiez here- it’s true for a variety of statistics and economic indicators. Be careful how you interpret that kind of analysis.
Finally, as I’ve been writing for a while, the focus should probably be on gross margin dollars in our new economy, which is another reason I think four week sales numbers are of limited value.
Zumiez has come out with their press release on the quarter that ended October 31, 2009 (On November 19) and has held a conference call. But as of today, the 10Q with the details and notes has not been filed. I’ll have more to say when I’ve seen that document.

PacSun Oct. 31 Quarter Results: New Strategic Focus From New CEO

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Okay, so I finally hold in my hand both the transcript of the conference call and the actual quarterly report filed with the Securities and Exchange Commission. I’ve read them and cogitated on their meaning and finally have a couple of things to say that maybe somebody besides me will find interesting.

The most interesting stuff is strategic in nature. A couple of years ago I wrote that PacSun’s biggest problem was their market positioning. Nobody knew what they stood for. I’m still not sure I know, but at least new CEO Gary Schoenfeld knows that’s a problem. Former CEO Sally Frame Kasak had her hands full just stabilizing the situation and cleaning up the mess, and perhaps that’s why she didn’t address it. Perhaps it’s also part of the reason she’s no longer CEO.

An analyst asked the following question:   “Looking at the strategies that have played out over the last two years, is it your position and the board’s position that you have sort of aggravated the effect of an already bad environment? I mean, you are reversing many of the things that were done under previous management, so can we take it that what has happened to your business is not just the environment but things that, strategies that you have pursued, that the company has pursued that have just been flawed?”
Gary Schoenfeld’s answer: “I’m not sure that I want to say it quite as blunt as you just did but your conclusions — you know, I can’t say are way off the mark…”
Which strategies are they talking about? CEO Schoenfeld says they have “four essential priorities.”
First is “people and culture.” They’ve got five senior positions they are looking to fill, and they want to affect “…a transformation in leadership, accountability, teamwork, and an absolute commitment to wow our customers every day…” I won’t be surprised if they take a page or two out of Zumiez’s handbook for this. I expect it to reach down to the sales associates on the floor. Good.
Second is product. They are bringing back footwear, though in a more limited way then before. They are going to shift to some lower price points. “…retailers like Target have become a leader amongst girls in this category and we are actively having conversations with our key heritage brands to recognize that there probably are some changes that need to further be made for all of us to regain this critical segment. “ They also need to be more fashion focused, he indicated. They expect to narrow some assortments and “…do a better job of bringing newness to a market where wear now has clearly become the mantra for teen shoppers.”
The third strategy is the customer connection, which is related to the people and culture issue. “…it is more important than ever that our store associates are able to communicate effectively about the brands and fashion that we carry and able to clearly articulate the latest promotions to customers looking for value. We believe that through improved education and training, and frankly more selective hiring and promotion, our store teams will become much more effective engaging with customers and the critical role that they play in driving sales.” Yup, a page out of Zumiez’s playbook for sure.
Fourth, they will “…move towards a much more thoughtful localized store assortment and allocation process in order to make this happen. We simply cannot be successful without a much deeper understanding of our different customers and how their style and brand preferences vary across 900 stores in 50 states. Simply put, we are missing sales, hurting our margins, and damaging the customer experience by having had too much of a one-size-fits-all approach to merchandising.”
I agree that one size fits all is a mistake. But when they talk about a “localized assortment strategy,” what exactly does that mean? Do you differentiate by store, by city, by region? Who does the buying? Would buying and merchandising for different categories or different brands be done differently by geography? Do the responsibilities of store or district managers change? Gary Schoenfeld says he expect to do it “without any major investment in systems.” I wonder. This is one of those issues where the devil’s in the details and the details can be as complex as you want to make them..
What’s the goal if they successfully implement those four strategies? CEO Schoenfeld puts it this way. “…at the moment, PacSun doesn’t offer a clear point of difference and that is what we need to go about addressing and when I talk about becoming their [teens] favorite place to shop, I choose those words particularly because I think that’s what we need to do. We need to be a place where they are excited to go, they love the brands that we carry, the marketing that the brands do and the excitement that creates in our stores complemented by things that we can design and develop ourselves that gives us the flexibility to move quicker and to hit key price points that may be dictated by our competitors.”
The last thing I found interesting was the following statement by Gary: “I don’t know that the world ever needed 900 domestic PacSun stores and if you had a perfect sheet of paper, that number might be closer to 600, 700 stores. I think we will end this year under 900 and as we look at 30 to 40 leases coming up over each of the next three years, it probably puts us to where we are — in three years time we are probably somewhere in 750 to 800, and that probably puts us in a pretty good position.”
I think he’s right, and that a smaller number of stores is consistent with the strategy he’s outlined. I wonder, though, if you’re an analyst interested in the price of the stock what you thought of that. With fewer stores, lower inventory per square foot, and reduced consumer spending, where does the growth come from? Right now, that’s not where the focus is, and nobody asked that question. Let’s hope things improve enough so that they are focused on growth.
On to the numbers starting with the balance sheet. Total assets are down from a year ago 25% from $713 to $537 million. $111 of this drop was in property, plant and equipment. Current assets fell 36% or $112 million to $200 million. Cash rose by $10 million, while inventories were way down (which you would expect). Other current assets, which includes stuff like prepaid expenses, income taxes receivable, and non-trade accounts receivable, declined from $74 to $16 million.
Current liabilities are down by almost half from $204 to $103 million. That includes paying off $43 million of their line of credit, which is now at zero.    Long term liabilities, which include things like deferred lease incentives and deferred rents and the mysterious “other” long term liabilities fell a bit from $111 to $92 million.
Total equity is down from $398 to $341 million. The current ratio improved from 1.53 to 1.93, and total equity improved from 0.79 to .059. So the balance sheet is smaller, as expected, but stronger by both measures. Remember all these balance sheet numbers compare the October 31, 2009 balance sheet with the one at November 1, 2008- a year ago.
Sales for the quarter were down 17% to $268 million compared to the same quarter the prior year. This was mostly due to an 18% decline in comparable store net sales. For nine months, sales fell from $903 to $734 million, or 19%.  Gross margin percentage for the quarter fell from 28.7% to 27.4% and for nine months, from 29.2% to 26.2%. The merchandise margin for the quarter actually improved by 1.7%, but the need to spread occupancy costs over a smaller sales base cost them 3%. 
Selling, general and administrative expenses were down 6.2% for the quarter to $89.4 million, but as a percentage of net sales, they rose from 29.5% to 33.4%. For nine months they fell 12.8% to $245 million, but rose as a percentage of sales from 31.1% to 33.4%. The loss for the quarter grew from $2.5 to $10.9 million. For nine months, it fell from $36.8 to $33.8 million. Total stores were 904 compared to 940 at the end of the quarter last year.
The four strategies seem right to me but the issue of what PacSun stands for in the market and why it should be a destination for teens isn’t clear right now. Maybe with the implementation of these strategies, it will become clear. 

Spy Optics (Orange 21) Sept. 30 Quarter and 9 Month Results

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I  always look forward to Orange 21’s filings. It’s just about the only chance we get to see the numbers from a smaller company in this industry, because there just aren’t many of this size that are public and required to show us their results.

I also like them because since their change in management, when Stone Douglass came in first as a consultant and then as CEO, they’ve done a lot of things right. They’ve controlled their inventory and reduced expenses (employee expenses have been cut 10% in the U.S. and 20 to 30% at their Italian factory on a temporary basis). They raised some capital (About $2.5 million net as of November 16th). The lawsuit with Mark Simo and No Fear has been settled. Their factory in Italy is being rationalized and its overall performance improved. As far as I can tell, the brand is well positioned.
So why are they losing money? Well, to nobody’s surprise, it’s a lot about the lousy economy.   But let’s start with their balance sheet. I went and pulled the balance sheet from a year ago so we can make a reasonable comparison between September 30 2009 and 2008.
Total assets are down 51% from $41.4 to $20.3 million. A huge chunk of that is goodwill (remember, that’s a non cash item) of $9.6 million that’s been written off over the year. Most of the rest is in current assets, and those changes are appropriate to their changing sales level and the overall business environment.
Cash has grown from $413,000 to $717,000. Inventory and receivables are down almost $8 million in total. You’d expect that. Deferred taxes have fallen $1.25 million to $0.00.
Total liabilities, of course, are also way down from $20.3 to $$13.8 million, a decline of 32%. Most of that decline is in current liabilities, down from $18.8 to $12.1 million. The line of credit outstanding, at $2.1 million, is less than half of what it was a year ago. Accounts payable and accrued expenses are down a total of $3.1 million.
The current ratio is basically the same, having fallen only very slightly from 1.31 to 1.26.
Stockholders’ Equity is down 69% from $21.1 to $6.6 million. As a result, total debt to equity has doubled from 0.96 to 2.06.
Net sales for the quarter fell 27% from $12 to $8.8 million. For nine months, they were down from $37.6 to $25.3 million, or 32.7%. The gross margin percentage for the quarter fell from 49% to 33%. The biggest reason for the decline in the quarter’s gross margin was “…a $0.7 million increase in inventory reserves for slow moving and obsolete inventory…” For nine months, it was down from 49% to 42% in the same period the previous year. Expenses in the quarter fell from $5.9 to $4 million, or 32%. The percentage decline was about the same for the nine months, from $19.1 to $12.9 million.
Sales and marketing expenses as a percentage of net sales fell from 25% to 20% in the quarter compared to the same quarter the prior year, and from 25% to 22% for nine months. Those percentages do need to come down, but you’d rather see it happen because of rising sales. Half a million of the decline during the quarter was from reduced commissions due to lower sales. 
In last year’s quarter ended Sept. 30, Orange 21 made $6,000. In the same quarter this year, they lost $1.136 million. The numbers for nine months are a loss of $2,194 million this year compared to a loss of $1,118 million in the nine months last year.
Orange 21 thinks “…its cash on hand and available loan facilities will be sufficient to enable the Company to meet their operating requirements for at least the next 12 months.” If the economy gets worse, or doesn’t improve, there may be a need for some additional capital. I guess we all have that problem.
Orange21 will have a hard time prospering with its existing sales levels and a 33% gross margin. One or both of those just has to improve. As I said, the low gross margin is at least partly the result of writing down some bad inventory, and that impact will go away.
The sunglass business, as we all know, has attracted a lot of competitors because of the historically high gross margins that have been earned both by brands and retailers. Even ignoring the impact of a lousy economy, those high margins didn’t persist in skate shoes or snowboards, and I can’t imagine why they would persist in sunglasses and goggles. But Orange 21, as a smaller company with a 100% focus on sunglasses and goggles, may have some advantages in the market over large companies that look at these products as accessories. Let’s hope that works for them.