Volcom Quarter & Nine Months Ended 9/30/09

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Volcom’s Quarter and Nine Months Ended September 30

Back on October 29th Volcom released a press release with its third quarter results and hosted a conference call on those results. Everybody read, and listened, and analyzed, and wrote stuff.
On November 9th, with no press release, they filed their 10Q for the same time period. Nobody seems to have noticed, and maybe nobody cares. But I do.
I don’t think there should be a conference call until the 10Q (or annual 10K) is out and people have had a chance to review it. The numbers in the press release and conference call are of course the same as in the 10Q. But there’s more detailed information in the 10Q, but some of those numbers only come out orally in the conference call and you have to write really, really fast to get it down. Either that, or listen to the replay fourteen times which isn’t any fun.
Then there’s the part where the analysts ask questions and request some additional “color” on an issue. You do sometimes get some good information this way and “color” can mean more detail. But it can also mean interpretation, estimate, evaluation, etc.
I read the press release and listened to the conference call. But here’s what I got out of the actual, uncolored numbers and management discussion from the 10Q.
The balance sheet is very strong, with about $90 million in liquid assets and no long term debt. It’s strong enough that we don’t even have to discuss it.
At the conference call, Volcom management said that the third quarter results had exceeded their expectations “primarily driven by revenue that was above plan in all three of our business segments. “ It was $9 million higher than the high end guidance provided at the last conference call.
That I suppose is a good thing, though another interpretation might be that they did a lousy estimating at the last conference call. I guess the worse you estimate one quarter, the better you can look next quarter. Oh well- a lot of that going around in this economy. Companies are justifiably cautious.
The conference call message is that they did a lot better than their last estimate but the 10Q tells us that revenue for the quarter fell 15.9% to $93.9 million, and net income was down 18.5% to $13.3 million. For nine months, revenues are down 18.2% to $216.5 million and net income fell 39.8% to $18.3 million. Net income as a percentage of sales fell from 14.6% to 14.1% for the quarter and from 11.5% to 8.5% for nine months.
Volcom reports their results for three segments; United States (which includes most of the world except Europe), Europe, and Electric. For the quarter and for nine months, revenue and gross profit were down in all three segments. Operating income for nine months was also down for each of the three segments. For the quarter, it fell in the United States and Europe, but rose in Electric.
They also report revenue for eight product categories; means, girls, snow, boys, footwear, girls swim, Electric, and other. For nine months, all the categories but snow were down. It rose from $23.3 to $23.9 million. For the quarter, everything but snow and girls swim was down. Snow rose from $22.9 to $23.1 million and girls swim from $110,000 to $156,000.
You can see the detailed breakdowns for the segments and product categories on pages 14 and 15 of the 10Q here. http://www.sec.gov/Archives/edgar/data/1324570/000119312509229368/d10q.htm.
Volcom believes that “…our overall decline in revenues was driven primarily by the deteriorating global macroeconomic environment and the decline in discretionary consumer spending worldwide.” I agree with that and it’s true for most, if not all, industry companies. The trouble is that nobody can do anything about it except protect your brand, control expenses, and take advantage of competitors’ weakness.
The discussion of Volcom’s relationship with PacSun was interesting, and I’m going to quote here what they said.
“Sales to Pacific Sunwear decreased 42.4%, or $17.6 million, for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008. We currently expect a significant decrease in 2009 revenue from Pacific Sunwear compared to 2008. It is unclear where our sales to Pacific Sunwear will trend in the longer term. Pacific Sunwear remains an important customer for us and we are working both internally and with Pacific Sunwear to maximize our business with them. We believe our brand continues to be an important part of the Pacific Sunwear business. We also recognize that any customer concentration creates risks and we are, therefore, assessing strategies to lessen our concentration with Pacific Sunwear.”
It’s almost schizophrenic, isn’t it? ‘Well, the business is going to be down. But it’s important to us! We aren’t quite sure what this business will be in the future, but we want to maximize the business with them. But you got to be careful about customer concentration!’
This is indicative of the same old problem that companies in this industry face every day- especially when they are public. You have to find growth, but you can’t do it in such a way that it damages your distribution and, potentially, your brand equity.
Volcom is also in 105 Macy stores, they pointed out in the conference call.
Volcom managed to increase their gross margin from 49.4% to 51.6% for the quarter and from 49.9% to 50.5% for nine months. This is a good result that they attribute to limited discounting, better inventory management and an increased margin from Japan after they acquired their Japanese distributor in November, 2008. Total gross profit, of course, was down consistent with the decline in revenues. 
Acquiring your distributor increases your gross margin, but also increases your selling, general and administrative expenses. For the quarter, these grew from 27.1% to 30.7% of revenues and for nine months, from 32.5% to 38.3%. This percentage increase was also the result of having to spread costs over a lower revenue base, increased bad debt write-offs, and incremental expenses for retail stores. In dollar terms, these expenses fell in the quarter from $30.3 to $28.9 million. For nine months, they were down from $86 to $82.7 million
The decrease during the quarter was due to reduced commissions because of lower revenues, decreased amortization, bad debt declining by $400,000 and a $1.5 million decrease in other categories including tradeshow, warehouse and legal. A lower exchange rate also helped. These declines were offset by a $1.5 million increase associated with the Japanese distributor.
Volcom is of a good size and in a good market position to take advantage of other brand’s problems and rebounding consumer spending, whenever that happens. In the meantime, they are controlling expenses, trying to source better, managing inventory and doing everything else they can do to maximize those gross profit dollars. Every company should be doing all those things all the time- not just when the economy is lousy.
But there’s a limit to how much good operational management can improve your bottom line. You can’t cut expenses and reduce inventory forever.   Ultimately, I expect Volcom to be one of the strong brands that benefit from the impact of the recession. But where will growth come from, and when will it begin?  

Zumiez’s Fireside Chat

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Rick Brooks, Zumiez’s CEO and CFO Trevor Lang held a half hour question and answer session today at the Thomas Weisel Partners Consumer Conference in New York. Previously, Zumiez had announced on September 2nd that “…total net sales for the four-week period ended August 29, 2009 decreased 2.9% to $51.7 million, compared to $53.2 million for the four-week period ended August 30, 2008. The company’s comparable store sales decreased 12.1% for the four-week period, versus a comparable store sales increase of 0.2% in the year ago period.” Their comps for September were positive.

They started by defining themselves as an action sports lifestyle retailer (duh) and went on to explain what you had to do to be one. To Zumiez, that means you have to carry hard goods and all the brands (not only in hard goods) that you find in independent shops. They characterized their customer as “very smart” and as knowing what’s authentic and what’s not. Those customers are 12 to 24 years old and more male than female.

They focus on making their employees people who are living the lifestyle and they try to build a distinct culture that empowers these young people to localize product for their stores and create a vibe around it.
 
Their description of their business makes perfect sense. It also leads me to two questions. The first is what does it mean to be an action sports company? That’s a strategic question for every brand and retailer in this industry and one, I have to admit, for which I don’t have a good answer. That label, which has been around a long, long, time, might be seen to suggest that we are the same industry now that we were 15 years ago. But we’re not. If only because of the breadth of distribution and the number of non participants who buy our products we’re a lot different. I guess I’m not against the term as long as you don’t fall into the trap of thinking it means the same now as it did then.
 
The second question is more focused on Zumiez, but not only for them to think about. As they create this focused culture of cool kids who are committed to and invested in the lifestyle, are they defining themselves in a way that might restrict their growth or their attractiveness to certain consumers?
 
The answer, of course, is yes, they are. But every company decides who they want their customers to be and what they want to mean to them. Or at least they should. And any company that tries to be meaningful to everybody probably ends up meaningful to nobody. Unless, I guess, they are an electrical utility, for example. Interestingly, I wonder if Zumiez hasn’t helped themselves manage this issue by being mall based.   They can work to make their stores what they consider core while at the same time exposing themselves to a much broader spectrum of potential customers in an environment that is not intimidating to those customers.
Zumiez noted that their smaller brands are continuing to gain share and specifically that brands need to be careful with distribution and how quickly they grow. They indicated they hadn’t seen any bankruptcies from any of these brands and hadn’t had to do anything special for any of them because of financial difficulties.
 
I have been arguing for a while now that current economic conditions represent an opportunity for new and small brands. It appears Zumiez agrees with me.
 
One of the questioners noted that Zumiez use to talk about an operating margin target in the low to mid teens and asked if that was still a reasonable objective. Zumiez indicated it was, though not in the current environment. They said they were growing selling, general and administrative expenses at half the rate they had been before and spending $85,000 less on each store. Because of these adjustments, they think they can get to those margins with less sales per square foot, but not until sales turn around.
To me, that sounded like an acknowledgement that they have no expectation of sales returning to previous growth rates in the foreseeable future, an assumption I agree with.
 
Zumiez’s growth plans are somewhat restricted right now, and management pointed to the failure of landlords to be more realistic about the rents they could expect as a major reason for this. My belief is that the commercial real estate market is going to get worse before it gets better, and I expect Zumiez will eventually get the cooperative landlords it needs to open more stores. They seem to think so too, as they acknowledged the “capacity rationalization” (what a benign sounding term for something that can be so difficult) that was going on not just in action sports but in all retail sectors. In other words, we’ve got too many retailers and too much retail space
.
The last thing I’ll mention that really caught my attention was their description of how they were working with individual brands on strategies that were appropriate for them. They might, for example, ask a brand to explore a new product or category where Zumiez saw an opportunity. I don’t know how much of that they’re doing, but that guidance could be really useful for a smaller brand and might explain why Zumiez is having success with such brands.

 

 

Nike’s 8/31/09 Quarter, Their Impact on the Industry and Quips on Conference Calls

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Nike put out a press release on its quarterly earnings two days ago and held a conference call on their results yesterday. This has all happened before the actual 10Q with all the detailed information and footnotes is available. So on the one hand, I’d like to be timely and have this done before everybody loses interest, but on the other hand I’d like to have the best information I can have before expressing an opinion. There’s a concept!
 
The prepared comments that started off the conference call had a sort of “Aren’t we wonderful? Didn’t we do just what we said?” feel to them. From a business point of view I suppose they are and I guess they did. Still, I’d like to do my own analysis and not be lead by the hand to my conclusions. That’s why I’d like the 10Q to come out before the press release and the conference call.
 
Then come the questions from the analysts that work for the investment banks.  The questions are usually preceded with some form of “Hey, how are you guys today?” Great Ralph/Sally/Fred! Good to talk with you again!” There’s a collegial sense to the conversations that seems to preclude tough questions.
 
To be fair, I’m not sure there are a lot of tough ones you could ask about Nike, but it still feels a bit like an attorney questioning his own witness at a trial. This isn’t an issue just with Nike. At the last Quiksilver conference call, nobody asked, “Where are you going to get revenue growth from?”   As I’ve written, I think that’s the key issue they have to address.
 
There was one question from a guy named Brian on the Nike call whose last name I couldn’t quite hear from a company called Research something and I couldn’t hear the end of that either. I’m thinking he might not be an investment banker. Nike had announced that they were changing their primary profitability measure from pre-tax income to earnings before interest and taxes, “…which is the primary measure used by our management team and board to make decisions about resource allocation and to evaluate the performance of individual operating segments.”
 
Now, I see Nike’s point from a management perspective. But if I were an analyst concerned with the stock price, I’d know that net income is the primary determinant of stock performance over anything but the short term, and that’s what I care about when I look at a stock. Not pre-tax income, not earnings before interest and taxes, not proforma income, not earnings before extraordinary items, not even EBITDA- earnings before interest, taxes, depreciation and amortization. Call me old fashioned, I guess.
 
So my hero Brian steps up and asks, “Will the change to EBIT change the company’s focus on how you deploy capital?”  I don’t think I have his questions exactly as he asked it, but the implication was that it wasn’t clear if the change was conducive to focusing on bottom line earnings. Nike, you’ll be stunned to learn, said that of course they would continue to be focused on bottom line earnings. They went on to explain that this didn’t change the way top management was measured and incentivized and that among the things they were measured on was stock price and earnings. Good answer I thought. Also the only one they could reasonably give.
So Brian, if you’re out there, thanks for asking a great question and keep up the good work.
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Anyway, in the quarter ended August 31, Nike’s revenues fell 12% to $4.8 billion. Gross profit fell 14% to $2.215 billion. Gross profit percentage fell from 47.2% to 46.2% as a result of currency fluctuations and mark downs. Selling and administrative expense was down 17% to $1.546 billion. It actually fell as a percentage of sales from 34.2% to 32.2%, which is a good job with sales also down.
Because their income tax rate fell from 28.5% to 24.7%, they were actually able to increase net income by $3 million to $513 million.
The balance sheet is strong, to say the least. I guess their biggest issue is what they are going to do with $3.6 billion of cash and short term investments. That can’t be earning much given current interest rates, and I’m sure they’d like to see it deployed.
 
Revenues in all their categories (footwear, apparel, and equipment) declined in North America, Western Europe, Central and Eastern Europe, and greater China. Japan managed four and five percent increases in footwear and equipment respectively. The “Other Businesses” group includes Converse and Hurley. We learned in the conference call that “Converse grew revenue by 10% and delivered its most profitable first quarter ever, up 13% over last year.”
 
“Hurley delivered its 2nd biggest revenue quarter ever.” Nike reported that it “…gained share in the Action Sports Industry,” and “…continued to grow at a double-digit rate with market share gains while the rest of the industry declined.”
Overall, Nike’s action sports business grew 25% in the first quarter. Without giving any numbers, they noted that the direct-to-consumer business saw record revenue in the quarter. Online business was up 19%.
 
The interesting thing about Nike, of course, is that we’re even talking about them. I’m guessing it was only six or so years ago that nobody in action sports even cared about Nike. We’d go to their parties, drink their beer and laugh at their failed attempts to break in. They now seem to have figured it out. Partly that’s because they learned from their mistakes- always a good thing to do. But it’s also because being big in this industry is no longer a sin that automatically costs you credibility.
 
Too much analysis of their numbers is, frankly, kind of a waste of time. Their numbers are big and good. Complaining, as some have, that it’s somehow wrong for them to use their size and financial strength to push their action sports business at a time when other companies are weaker is a waste of time. I’d do the same thing in their position. So would you.
 

The question isn’t how Nike is going to run their business. I imagine they are going to do just fine, thank you very much. The question is how you are going to run yours, big or small, given what their success represents to the evolution of the industry.

 

Quiksilver’s Quarter and Nine Months Ended July 31, 2009

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I’ve read the press release and listened to the conference call, and here’s what I found out.

Quik’s total revenue for the quarter fell 11.2% to $501.4 million from $569.9 million for the same quarter the previous year. Their gross profit margin fell from 50.4% to 46.7%. Selling, general and administrative expense was down 9.1% to $211.8 million. Interest expense rose 30% to $15.3 million. Instead of a foreign currency gain of $1.2 million, they had a loss of $3.5 million.

After taxes, they had income from continuing operations of $3.4 million compared to $33.1 million in the same quarter the previous year. Those numbers exclude Rossignol.
 
The loss from discontinued operations (Rossignol) was $2.1 million this quarter compared with $30.2 million last year. Net income this quarter was $1.35 million compared to $2.85 million last year. That’s $0.01 per share compared to $0.02 last year. Income per share from continuing operations was $0.03 compared to $0.26 in the same quarter last year.
 
The numbers for the nine months ended July 31 show a decline in revenue of 13.2% to $1.44 billion compared to the nine months the previous year. Gross profit margin fell from 50.0% to 46.9%. There was a net loss from continuing operations of $57.5 million compared to a profit of $79.4 million for nine months the previous year. Net income, including the impact of Rossignol, was a loss of $190.3 million this year and $225.3 million last year for nine months.
 
We learned in the conference call that footwear sales have finally softened, and that weakness in the junior’s market is having some impact on Roxy. They are in the process of implementing structural changes and expense reductions that should improve profitability by $40 to $60 million over a full year once implemented. About half of this amount will come from margin improvement, and the restructuring has been extended to include DC Shoes once it was clear that the brand was not going to be sold.
 
They are using what Chairman and CEO Bob McKnight characterized as “More measured and creative approaches to marketing and advertising.” He cited as an example a reduction of 75% in trade show expense achieved by utilizing buses outfitted as booths that are driven into the show and then surrounded by pop up tents. I like it and look forward to seeing it.
      
Over on the balance sheet, total assets fell from $2.34 billion at July 31, 2008 to $1.88 billion at July 31, 2009. That includes a $67 million reduction in trade receivables and a $25 million decline in inventory, both of which you’d expect as part of managing through a recession. Most of the reduction came from current assets held for sale falling from $358 million to $2 million with the sale of Rossignol. There was also a decline of $96 million in goodwill.
 
Total liabilities fell $204 million to $1.435 billion. This was almost exclusively due to the reduction in current liabilities. Long term debt fell only $10 million to $734 million. That’s not a surprise as the debt restructuring Quik has been working on (the last piece will close this month) was meant to spread out maturities, not reduce debt. 
 
The current ratio, at 1.65 has declined only marginally from 1.71 last year. Total liabilities to equity has grown from 2.34 times to 3.26 times, largely as a result of stockholders’ equity falling from $700 million to $441 million. To me, this highlights the fact that Quik still has some work to do in improving its balance sheet, but with Rossignol and the restructuring behind them, they can do it by running their business well. 
 
Quik expects its fourth quarter revenues to be down in the mid teens on a percentage basis compared to the same quarter a year ago. It anticipates a loss per share, on a fully diluted basis, in the mid-single digit range. Earnings will be impacted by the higher interest expense they will incur as a result of the restructuring. They reduced their projection of that expense by $10 million to $100 million and pointed out that $30 million is non cash. Interest expense in their last complete fiscal year was $45 million. They expect interest expense of $21 million in the fourth quarter, and further gross margin contraction of 150 basis points (1.5%) 
     
Quik’s profitability improvement plan should just about make up for their increased interest expense. After all this good work in restructuring and managing expenses, the question is where do sales increases come from? In that regard they have the same issue as every other brand; “The company indicated that longer term visibility into revenues and earnings remains limited due to global economic conditions.” 

 

 

Billabong’s Annual Report for Year Ended June 30, 2008

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I’m supposed to crunch a bunch of numbers when I do these things, but first I’d like to highlight Billabong’s Operating Principles from its Corporate Governance Statement. There are eight of them and they are:

1.       Lay solid foundations for management and oversight.

2.       Structure the board to add value.

3.       Promote ethical and responsible decision making.
4.       Safeguard integrity in financial reporting.
5.       Make timely and balance disclosure.
6.       Shareholder communication.
7.       Recognize and manage risk.
8.       Remunerate fairly and responsibly.
 
They discuss in some detail how they try to accomplish each of these. You can see the discussion on pages 30-36 of their financial report here. http://www.billabongbiz.com/documents/20090821_Appendix4EFullFinancial_ReportWebsite.pdf
I’m sure it’s not easy, and I imagine you’re always working to get it right, but you can’t go too far wrong in running your business if you follow those eight principles.
 
Net profit fell from $176.4 million to $152.8 million Australian Dollars. That includes a noncash after tax impairment charge of $7.4 million on retail assets (all numbers in this article are in Australian Dollars unless otherwise noted. At June 30, 2009, it took 1.243 Australian Dollars to buy one U.S. Dollar). The profit decline came on a 23.6% increase in total revenue from $1.354 billion to $1.674 billion.
 
Sales grew by 9.1% in constant currency terms (that is, assuming the exchange rate was the same all year). Without the Dakine acquisition, constant currency sales grew only 2.8%. The date of the Sector 9 acquisition was July 1, 2008 so it was included in the results for the whole year. Billabong is projecting net profit after taxes to be flat in the fiscal year ending June 30, 2010. What happened? The recession, particularly in the United States, happened.
 
“Excluding the acquisitions of DaKine and Sector 9, as well as the Quiet Flight retail business which was acquired in June 2008, sales in North America were down approximately 13% in USD terms.” This was the result of generally poor economic conditions and retailers changing their traditional buying patterns to minimize inventory risk, as well as the company’s decision to hold prices.
“…sales to chain retailer Pacific Sunwear continued to decline and accounted for less than 10% of the Group’s sales in the Americas. This followed the Group’s reluctance to endorse Pacific Sunwear’s shift into a value price driven retail offer.”
 
Gross profit margins were 53.2% compared to 54.9% the previous year. Their ability to hold the margin decline to 1.7% reflects the company’s strategic decision to minimize discounting with the goal of maintaining brand equity. What discounting they did was mostly in the U.S. The margin decline also reflects Dakine’s and Sector 9’s use of third party distributors.
 
The sales increase means that gross margin dollars earned rose from $746 million to $894 million, but increasing expenses below this line meant that pretax profit fell 16% from $246 to $206 million. Selling, general and administrative expenses rose $126 million, or 31.6%, from $399 to $525 million. $75 million of that increase was employee benefit expense. The Sector 9 and Dakine acquisitions were going to increase those expenses. As percentage of total revenues, it rose from 29.5% to 31.4%.
 
Company owned retail was responsible for approximately 21% of revenue during the year. EBITDA (earnings before interest, taxes, depreciation and amortization) for the retail sector fell from 10% to 10.2% “…due to a marked decline in comparative store sales from October 2008 to the end of the financial year.” At year end, Billabong had 335 company owned stores.
 
The most important thing that happened over on the balance sheet was the raising of $290.8 million in new equity (before transaction costs) last May. As a result, net debt decreased by 36.6% to $225 million. Interest coverage is 7.1 times, down from 11.1 the previous year.
 
The new capital improved Billabong’s current ratio from 3.07 to 3.30, and its total liabilities to equity improved from 1.04 times to 0.89. It’s an especially good time to strengthen your balance sheet.
 
Intangible assets rose from $800 million to $1 billion, representing 45% of their total assets. That includes a $117 million increase in goodwill mostly, I expect, as a result of the Sector 9 and Dakine acquisitions.
 
During the conference call on the annual report, management noted that they were dealing with 10% less accounts than in the previous year because the account was no longer in business or due to credit risk. Receivables over six months past due have risen from $11 to $21 million. They noted that they were working hard on collections, and had slowed their payments to suppliers to compensate for their customers not paying them.
 
They indicated that they expected to see some product shortages during the holiday season due to retailer caution in placing orders. They have been meeting with retailers to discuss the product cycle and make it clear that while Billabong will do everything it can to respond to retailer and customer requirements, production times (especially for technical, seasonal products) can only be reduced so much.
 
Billabong has done a lot of things right. They have bought good brands (the only kind to own these days) at fair prices. They have managed their inventory and expenses in response to economic conditions. They have resisted discounting to maintain brand image and retailer support. They are reducing sales to customers who can’t support that brand image and the pricing it implies. They have raised capital to build their balance sheet. The decline in income (they still had a 15% return on equity) is in line to better than what other brands are experiencing and they are certainly well positioned for a recovery, though of course it depends on what form that recovery takes.
 
But you know what? The most important thing I’ve talked about in this article is probably those eight principals. If you do that, the rest will probably fall into place.  

 

 

Volcom’s Quarter Ended June 30, 2009

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Volcom filed their 10Q in the last couple of days. There’s some good news here, though of course Volcom’s income statement for the quarter and six months reflects the impact of the recession. And the issue of how to manage their PacSun business is an interesting one.

Let’s start with the balance sheet. The filing includes balance sheets for June 30, 2009 and December 31, 2008. I went back and plucked out the June 30, 2008 balance sheet to make a better comparison to June 30, 2009.

I should start by saying that their balance sheet was already strong last June, and it’s strengthened further. Cash and short term investments rose from $71 to $96 million. Accounts receivable and inventories fell by 20% and 18% respectively. Accrued payables and expenses were down 18% from a year ago. Those changes are consistent with the recession and how you manage in it.
 
Volcom’s current ratio rose from 4.78 to 6.22 while total debt to equity fell from 0.20 to 0.15. Those are both good things. They had no drawings under their line of credit (though $1.6 million in letters of credit were outstanding). Availability under the line was $38.4 million. Volcom has a balance sheet that allows it to continue to pursue its strategy and take advantage of competitor weaknesses during a tough economy. I may have mentioned a time or two that having a strong balance sheet right now is a real advantage for any company.
 
Revenues, to nobody’s surprise, declined. They fell 25% for the quarter to $54 million and 20% for six months to $123 million. Gross profit margin for the quarter actually rose from 48% to 48.6%. For six months it fell from 50.3% to 49.6%. Selling, general and administrative expenses fell 7.4% for the quarter, reflecting careful management of expenses and compensation. I’d note that these declines are not as dramatic as I’ve heard about in some other companies. Again, Volcom has the balance sheet to maintain its initiatives.
 
Net income, however, fell 82% in the quarter from $4.8 million to $872 thousand. For six months, it was down 64% from $14.2 to $5.1 million. Revenues and gross profit dollars were down for the quarter in Volcom’s three operating segments- United States, Europe, and Electric.
 
 Volcom reported that sales to PacSun decreased 23.7%, or $5.4 million, during the six months ended June 30, 2009 compared to the same six months the prior year. $5.4 million is approximately 18% of their total sales drop of $30 million from the first six months of 2008 compared to the first six months of 2009. They don’t say what the drop was for the quarter ended June 30 compared to the same quarter last year.
 
They say that PacSun represented 16% of product revenues in 2008 (I assume they mean the whole year), and 14% for the six months ended June 30, 2009. That would be $17 million.
    
Let’s try playing around with the numbers a bit more. If $5.4 million is a 23.7% drop, what were total sales to PacSun for the six months of the prior year? A little less than $23 million. That’s about 15% of total sales during that period.
 
Volcom “…expects a decrease in 2009 revenue from Pacific Sunwear when compared to 2008.” They go on to say, “Pacific Sunwear remains an important customer for us and we are working both internally and with Pacific Sunwear to maximize our business with them. We believe our brand continues to be an important part of the Pacific Sunwear business. We also recognize that any customer concentration creates risks and we are, therefore, assessing strategies to lessen our concentration with Pacific Sunwear.”
 
How can Volcom maximize their business with PacSun while lessening their concentration with them? Can you maximize your business while you decrease it? They seem to think so since 2009 revenue from PacSun will be less than 2008. You can lessen concentration either by selling PacSun less or by selling everybody else more. Those are the only two choices I can see.
 
Only from public companies who are required to focus on quarterly results can you get these kinds of semi-contradictory statements. Volcom has to figure out how to replace sales from PacSun in an environment where finding sales growth isn’t easy. They are “assessing strategies” for accomplishing this but don’t have it solved. Oh well- not even the best companies are having an easy time right now. 

 

 

Boardshorts from a Vending Machine

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If you read this http://www.nbcnewyork.com/blogs/the-thread/Swimsuit-Vending-Machines-to-be-Stocked-in-Hotel-52089002.html you’ll see that Quik has partnered with Standard Hotels to sell cobranded swim suits at boutiques and poolside vending machines for $75 a pair.

I’m not writing this to express an opinion (though I’m usually not loathe to do that) but just to let you know it’s happening and to talk about the general implications.

Just when you think there are no new distribution channels, up pops another one. I don’t know where the next one will come from, but I know it will appear. Is it at the expense of some other distribution channel? Sure. To some extent. But might it also create some new customers? Sure. To some extent.
 
Sales at resorts or hotel shops and pools are often to people who need something they need right now. I’d say you fit into that category if you want to swim and don’t have a suit.
 
Every time you choose a new way to distribute your product- each time it can be found somewhere different-, you change your customer base and the market’s perception of your brand. To some extent. Can you manage that so you get more customers than you lose? How many different distribution channels, partners, products and price tiers can you have before your brand evolves from what it started as to what it needs to be to attract those new customers you need for growth? Can you keep the old customers? To some extent. Figuring this kind of stuff out is what the best executives do.
 
I lied. I do have an opinion. I might not go as far as the writer of the linked article and say its “brilliant,” but I think it’s a good idea which might grow and is consistent with how Quik has evolved their brand. Even if it grows, it doesn’t feel like it will have much downside for other parts of their distribution. I imagine there are some specialty retailers already shell shocked by the recession and distribution issues that might disagree. But Quik, like all brands and all retailers, has to do what it perceives to be in its own best interest. I think they made a good decision.                           

 

 

Spy Optics’ 3/31/07 Quarterly Report: Lemonade Out of Lemons

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Until recently, it’s been kind of a tough road for Spy Optics (publically traded under the corporate name of Orange 21). Though sales grew from $22.3 million in 2002 to $42.4 million in 2006, profits of $911,000, $500,000, and $807,000 in 2002 through 2004 gave way to losses of $1.7 and $7.3 million respectively in 2005 and 2006. Gross profit, at 51% in 2002, had fallen to 41% in 2006. In addition, there was the expense of being a public company, the distraction of a shareholder lawsuit, and the usual stresses associated with an acquisition- in this case their primary manufacturer located in Italy.

Apparently the Board of Directors got tired of this and over the last year a number of positive things have happened. The lawsuit was settled in early May. There have been a lot of personal changes over the last year or so. Mark Simo, the Chairman of the Board and former CEO, has stepped in as CEO, replacing former CEO Barry Buchholtz who was sent over to run the Italian operation (Hmmm. Feels a bit like, “You bought it, you go run it!”) Fran Richards, formerly of Transworld and Future USA came in as VP of Marketing in April of 2006. The old CFO resigned (I don’t quite know if that should be in quotes or not) and was replaced by Jerry Collazo in August of 2006. He’s a CPA with 20 years of diversified financial and accounting experience. They hired Jerry Kohlscheen as Chief Operating Officer giving them another 20 years of experience in manufacturing and operations.
 
So, what has all this high powered talent been doing exactly? A lot, I’d say judging from their recent quarterly releases.
 
 They must be making a lot of money now, right? Nope. Still losing it. Almost $1.8 million in the quarter ended March 31, 2007 (they were late filing the report) on sales of $9.4 million. But I am impressed with the way they are losing it. Okay, there’s no good way to lose money. But a lot of what they are doing, which is costing money, has the feel of getting their house in order. Let’s look.
 
They reported that gross profit increased to 52.2% from 48.1% in the same quarter the previous year. It was indicated that the increase was “primarily due to sales during the three months ended March 31, 2007 of some inventory items that were previously written down and efficiencies achieved at LEM S.r.l.  LEM is the acquired Italian manufacturer.
 
This particularly increase in gross margin may be partly a onetime event, but it shows that they are getting their inventory in order and improving operations at LEM.
 
Sales and marketing expense was up 9% while sales didn’t budge. But two-thirds of this increase was the result of additional depreciation on point of purchase store displays. Why is this good? First, it’s a non cash expense. More importantly, it implies a realistic approach to their numbers and balance sheet values much like the inventory write down mentioned above. That’s great to hear. Ever try and run a business without good numbers?
 
General and administrative expenses were up 17%, or $400,000. But half of that was employee related compensation in the US. Yes, these new people who are going to do wonderful things want to be paid. $100,000 was severance for employees at LEM- part of getting that operation working efficiently I assume. Another hundred grand was getting some new systems up and running. Like I said, you can’t run a business without good numbers. They also cut their legal and audit fees by $300,000 but had some additional expenses for depreciation and bank fees related to a new loan agreement.
 
See the trend here. Higher expenses- yes. But spent on the right things.
 
This continues when they talk about warehouse expense being higher because of air freight resulting from manufacturing delays. Well, nobody likes to pay air freight, but the only thing worse it not getting the product to the customer on time.
In the words of their Chairman, Mark Simo, “We continue our efforts to stabilize the business and position it for long term growth.” That’s what it looks like to me.

 

 

K2’s 2006 Annual Report

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      For the longest time, I thought about K2 as a ski and snowboard company. But that’s ancient history. They call themselves a “premier branded consumer products company” and divide their business into four segments: Marine and Outdoors ($407.6-million in 2006 sales), Action Sports ($421.4-million), Team Sports ($383.4-million), and Apparel and Footwear ($182.3-million). That’s a bit over $1.3-billion in total 2006 revenues.

      Snowboarding, obviously, is included in the action-sports segment. And now, going directly to the discussion of that segment, I’m going to tell you exactly how each of their four snowboard brands are doing, right?
      Not hardly. They don’t provide a breakdown beyond those four segments. The only piece of information I was able to find was in footnote thirteen of the financial statements on page 92 of their 10K where they note that one-third of the action-sports segment (around $140-million) was snowboarding. They also note that one-third of the apparel and footwear segment revenue ($61-million) was skateboard shoes, apparel, and accessories.
      If only fifteen percent of K2’s 2006 revenues were in what we would all call action sports, why am I writing about them? Two reasons. First, $200-million still isn’t small potatoes in the action-sports industry as it has traditionally been defined. Second, in discussing their business, they say a number of insightful things about their strategy and the industry’s evolution that are worth highlighting.
      Let’s start by remembering what K2’s product lines include. Snowboarding and skate we’ve already mentioned, and we all know about their ski business. But they are also selling snowshoes, paintball products, baseballs and gloves, softballs, fishing kits and combos, fishing rods, personal flotation devices, hunting accessories, all-terrain vehicle accessories, inline skates, Nordic skis, and snowshoes. I think that covers it.
      K2’s management thinks that “the growing influence of large format sporting goods retailers and retailer buying groups, as well as the consolidation of certain sporting-goods retailers worldwide, is leading to a consolidation of sporting-goods suppliers.” As a result, they expect retailers to buy increasingly from fewer larger suppliers. This, according to K2, will allow those retailers to operate more efficiently and cut their costs. Those few larger suppliers will be “those with greater financial and other resources, including those with the ability to produce or source high-quality, low-cost products and deliver these products on a timely basis to invest in product development projects and to access distribution channels with a broad array of products and brands.”
      In its market, including the action-sports business but obviously going far beyond it, K2 thinks size matters. Their general strategy of improving operating efficiency, maximizing how they utilize their distribution channels, leveraging existing operations and “complementing and diversifying its product offerings” reflects this. 
      The second part of this strategy is making acquisitions “of other sporting-goods companies with well-established brands and with complementary distribution channels.” So far, they have made two in 2007. There were three in 2006 and two others in 2005. They note that much of their revenue growth in 2006 came from acquisitions made in 2003–2006.
      There are two things they don’t talk about—opening retail stores and expanding into the fashion/apparel business. K2 is largely a hardgoods (I think a baseball glove is a hardgood) company that believes an increasing percent of its sales and profits will come from large retailers and that those retailers will control more and more of the market. Fifteen percent of its sales were to Wal-Mart in 2005 and 2006. Given their strategy and analysis of how the market is evolving, that makes perfect sense.
      And now, three weeks later, after this story is long gone to the editors and basically out of my memory, but about one day before it was too late to do anything about it, K2 goes and sells itself to Jarden , who had revenues of $3.8 billion in 2006 (see the related story in this issue). Jarden is a “leading provider of niche consumer products used in and around the home.” They have a huge stable of brands, many of which we all recognize.  They divide their business into three segments- branded consumables, consumer solutions and outdoor solutions. K2 will become part of their outdoor solutions and snowboarding will become an even smaller piece of the whole pie. Jarden’s growth strategy “is based on introducing new products, as well as on expanding existing product categories which is supplemented through acquiring businesses with highly recognized brands, innovative products and multi-channel distribution” Go back and review K2’s strategy and market analysis and you’ll see why the two companies thought it made sense to get together.
 
      I’m not sure our comfortable little action-sports niche is still little, or comfortable, or a niche, but sitting in it we have tended to make fun of in-line skates, team sports and, not very long ago, skis. K2 doesn’t care. They’ve just looked at where they think the industry is going and have devised a strategy to respond to that evolution—which, as far as I know, is what management at any company is suppose to do.
      Okay, you’re not K2. There is no sale of fishing poles in your future. But if you think their analysis of the broader sporting-goods market and its retailers is valid, what does it mean for your brand? Snowboards, skateboards, and surf boards are, I’m afraid, sporting goods. They are not isolated from these trends.

 

 

Billabong’s Half Year Results- 12/31/06; The Impact of Acquisitions

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I love reading Billabong’s reports. No, wait, I hate it. Actually I’m hopelessly conflicted. On the one hand, being traded in Australia, they don’t have to comply with the U. S. Security and Exchange Commissions filing requirements. There’s less small print and less mind numbing and sometimes superfluous information. But there’s also less information in general. Still, though they are allowed to take a bit more, let’s say, poetic license, they do a pretty good job of presenting the critical information.

 
And it’s not like they have anything to hide.
 
In the six months ending December 31, 2006 they had revenue in Australian Dollars of $614 million (all these numbers are in Australian Dollars). Today, February 27th, there are about 1.2712 Australian Dollars to a US Dollar.).
 
Oh, and while I’m thinking about it, here’s the link to the reports themselves in case you want more detail than I can provide here. http://www.billabongbiz.com/investors-reports.php
 
Anyway, that six month revenue number was up 25.3% from $490 million in the six months ending December 31, 2005. I’m just going to refer to those two six months period as 2006 and 2005.
 
2006’s net profit was 90.5 million compared to 79.5 in 2005. Now, EBITDA stands for earnings before interest, taxes, depreciation and amortization. It’s kind of a measure of operating income. Below, I show you their comparative revenues by geographic segment and the EBITDA associated with those segments, along with a couple of other numbers. This table is taken directly from their report. Billabong has allocated its corporate overhead to each of these segments based on sales. 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
You can see that Australasia sales grew 13%, the Americas by 31%, Europe by 39% and the rest of the world’s sales fell by 28%, but the last number was small to start with. EBITDA for the whole company was up around 11.2%, though it fell in Australasia by 6.8%. My favorite number in this whole report is the gross margin of 53.7% for 2006, more or less the same as the 53.8% in 2005.
 
Okay, you might wonder, is all this about just growing their existing business? Let’s start to answer that with a little side trip to the balance sheet.
 
It’s a strong balance sheet. Current ratio (current assets/current liabilities- a measure of liquidity and the ability to pay operating expenses) is 3.48. The debt to equity ratio is less than one.
 
Long term debt grew 110% to 332 million. The table above showed interest expense up from 1.7 to 7.7 million, so that’s no surprise. Inventory grew 42%. Property, plant and equipment were up 76% and the ever popular intangible assets grew from 542 to 662 million. The balance sheet’s close relative, the cash flow, shows big increases in receipts from customers and payments to suppliers and employees, and a payment of 23 million for property, plant and equipment. 
 
These balance sheet and cash flow changes don’t occur just because of the sales increase, so it’s off to the footnotes we go to find out what happened.
 
Note 6, Business Combinations, seems a likely candidate for some explanatory information. On November 1, Billabong acquired the Amazon Group, and paid cash of 21.146 million. That’s mighty close to the 23 million payment for property, plant and equipment shown in the cash flow.
 
Amazon, by the way, is a 19 store multi-branded retail business in New Zealand. As of December 31, 2006, Billabong “international retail presence lifted to 144 stores (up from 110 at 30 June 2006) and contributed more than 16% of the Group’s global revenue for the first half of the financial year. Retail EBITDA margins were above those achieved by the Group” (italics added).
 
I’m guessing we can expect more retail growth from Billabong, if only because they say, “Further store openings are planned in the second half in Europe.”
 
We also learn that in October of 2005, they acquired 60% of the assets of Beach Culture International and in November, the Pacific Brands Retail group, “which had been operating Billabong outlet stores under license.” Also during this period, “The previously licensed Billabong operations in Singapore, Malaysia and Indonesia were integrated into the group.”    Just to finish the list, Nixon, acquired in January, 2006, now accounts “for approximately 6% of the Group’s global sales.”
 
You can see where the balance sheet changes came from when you think about the impact of these acquisitions. Some new assets came into the balance sheet. New sales, and new expenses also showed up, in some cases in place of royalty payments. Nixon’s numbers don’t show up in the six month comparison because they were acquired in early 2006. The debt? Well, Billabong had to pay for all this stuff.
 
You also get a glimpse into the company’s strategy. They’ve told us to expect more retail and I wouldn’t be surprised to see more acquisitions. If, like most brands, they are interested in expanding into the broader fashion/apparel market (because how else can they continue to grow?) look for brand extensions, and maybe advertising and promotions that start to position the brand in the broader market.
 
How about B for Billabong? Oh, wait, never mind. Somebody already did that.