American Skiing Sells Steamboat; Leverage and Seasonality- a Tough Combination

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How many of you were with me in nineteen ninety whatever at the Transworld Snowboarding Industry Conference when then American Skiing Company (ASC) Chairman Les Otten stood up and thanked the snowboard industry for saving the ski resorts? Apparently we didn’t do enough- at least not for ASC. Its last ten years have been largely a process of trying to deleverage itself after an aggressive expansion left it, judging from its reported results, with an untenable financial model.

The sale of Steamboat to Intrawest for $265 million in cash was announced on December 19th, 2006. At that time it was expected to close on or before March 31, 2007. The sale was the result of a review of ASC’s strategic options that it initiated in July.
 
What are they going to do with all that green stuff? “It is anticipated that net proceeds from the sale will be used to repay all existing senior debt and outstanding revolver balances under ASC’s senior credit facility and certain other indebtedness.”
 
ASC is going to pay down debt, which is what they’ve been doing for a long time. A little bit of historical financial data is instructive. The numbers below are in millions of dollars and are for fiscal years ended July 30th.
 
 
 
 
 
2000
2001
2002
2003
2004
2005
2006
Net Revenue
 
$372
$373
$272
$265
$284
$276
$308
Operating Expenses
 
$377
$441
$385
$262
$274
$269
$289
Interest Expense
 
$36
$53
$50
$47
$88
$82
$87
Net Loss
 
 
$52
$142
$207
$82
$29
$73
$66
 
 
 
 
 
 
 
 
 
 
Total Assets
 
$927
$807
$522
$475
$431
$423
$383
Total Liabilities
 
$540
$538
$416
$414
$671
$737
$763
Shareholders’ Equity
 
$185
$45
($155)
($237)
($241)
($314)
($380)
 
I recall thinking back when this all started that ASC was counting on no bad snow years and very optimistic growth projections. You can see that their revenue has trended down. But so have their operating expenses, which they worked hard and effectively to control. For the last four years, in fact, they managed to show a small operating profit.
 
But it didn’t matter, because that was overwhelmed by their interest expense which grew from $36 to $87 million in six years. Notice the decline in total assets as ASC sold other assets to try and get out from under their debt and interest burden. In spite of their actions, total liabilities grew and shareholders’ equity fell.   
 
There were various kinds of creative financings and refinancings where, to use one example, preferred dividends were accrued, rather than being paid in cash. Why? Because ASC didn’t have the cash to do it any other way.
 
They could do everything right- hell, I think they did do a lot of things right- they were at the forefront of some of the reengineering of ski/snowboard schools and rental programs that took place- and it just wasn’t enough. Even if the snow was good every year and they grew regularly I don’t think they could have gotten out from under their growing mountain of debt without asset sales. It’s interesting to note, for example, that ASC’s resort revenue per skier visit grow from $64.92 in fiscal 2002 to $73.87 in the year that ended last July.
 
Look at the chart again. Consider what happens when too much leverage and seasonality are mixed with some bad luck and perhaps a little too much optimism. Still, I don’t criticize ASC for trying. If nobody ever took a calculated risk, we wouldn’t get in our cars in the morning to drive to work.
 
Look at your seasonal business and your growth plans. How much leverage is enough and how much is too much? Are you going to constructively use debt or is it going to use and abuse you?               

Zumiez’s 10/31/06 Quarterly Report: Pretty Much Nothing But Good News

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Well hell, this is a lot more fun when there’s something negative or at least controversial to gossip about. All I’ve got to go on is the 10-Q for the quarter ended October 28th and things seem awful solid. No executives fired. Sales growing, margins holding up, no interesting litigation. You might as well go read another article.

Net sales for the quarter were up 43.3% to $82.3 million. Comparable store net sales were up 10.7% compared to being up 9.8% in the same period the previous year. So not only are same store sales growing, but they are growing faster than they were in the same quarter last year.
 
Gross margin fell from 37.3% in same quarter last year to 36.8% in the quarter ending October 28th this year. For nine months, it’s up to 34.6% from 33.8%. They explain the fall in gross margin for the quarter as being “due primarily to occupancy costs related to the 32 new stores we added in the three months ended October 28, 2006 compared to 14 stores added in the three months ended October 29, 2005.”
 
That’s easy to quote. What does it mean? You open all these stores. The occupancy costs begin immediately. Landlords are funny. They want to be paid every month no matter what you sell. On the other hand, the customers may not rush in quite as quickly as you want. If, therefore, you include certain occupancy costs for new stores as a cost of goods sold, you are going to reduce your gross margin a bit if you are opening a lot of new stores.
 
Interestingly, Zumiez states that the way they calculate cost of goods sold may not be the same as the way other retailers do it. They kind of go out of their way to do that. If you know much at all about accounting, you know that while there are rules, there are often choices, or maybe judgments is a better word, to be made about how to account for things.
 
I have the perception that Zumiez has been mindful and focused on the choices they have made when they set up their accounting system. I’m guessing it’s contributing to their success. We can tend to look at our accounting system as a necessary inconvenience and generally a pain in the ass. A good system that gives you the management information you need to make decisions is as important as your brand image. No, I don’t think I’m overstating that.         
 
They also said their gross margin had been reduced by their “stock based compensation expense.” That is, the value of certain stock options has to be included as an expense. This is the first October quarter in which accounting standards have required that be included as an expense.
 
These costs that reduced gross margin were partially offset by an increase in margin because their larger purchase volume allowed them to get better prices from vendors. I’m sure we’re all stunned to hear that.
 
They also said gross margin was positively impacted by lower markdowns because of less aged inventory (an indication of good purchasing) and “our ability to leverage certain fixed costs, such as distribution, and product teams over greater overall net sales.”
 
The balance sheet is strong, though their cash and marketable securities have declined and inventory has grown, consistent with their growth including the acquisition of the twenty Fast Forward stores.   I mean, financing growth is what they had those liquid assets sitting there for.
 
Net income for the quarter grew 29.3% to $6.83 million, or from $0.19 to $0.25 cents a share before dilution. Net income as a percentage of sales was 8.3%, down from 9.2% in the same quarter last year. 
 
I’ll be waiting to see Zumiez’s filings in the next couple of quarters. It will be interesting to see if any of the issues impacting other public action sports companies will affect Zumiez. Right at the moment they are kind of in their sweet spot in terms of their size and growth. Hopefully, they can continue that.

 

 

PacSun Quarter and 9 Months Ended 10/28/06- Good Tactics. What’s the Strategy?

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         Pacific Sunwear’s (NASDAQ: PSUN) official SEC filing isn’t out yet (I’m writing this November 26 because I love working Sundays), but I’ve read the press release, reviewed the associated financial statements for the quarter and nine months ended October 28, and listened to the conference call. Let’s look at the numbers first, and then talk about the conference call.

 The Numbers
        The quarter showed a slight decline in sales from $377 to $375 million. But gross margin fell from $144 to $106 million—or from 38.2% to 28.3%. Selling and General and Administrative expenses rose from $81 to $93 million. Net income fell from $40.5 to $9 million or from $0.54 to $0.13 per share on a fully diluted basis.

         On the balance sheet, the current asset fell from 3.45 a year ago to a still strong 2.34 at the end of this October. The only other thing I’d note from the balance sheet is that, even after a write down, inventory—at $253 million—was still nearly $10 million higher than a year ago.

         In the mix was a same-store sales decrease of 6.7% and the ten cents a share inventory write down—primarily for footwear and accessory categories. The CEO resigned and was replaced by Company Lead Director Sally Frame Kasaks as interim chief executive officer. At different times in her career, Ms. Kasaks was Chairman and CEO of Ann Taylor Stores, President and CEO of Abercrombie & Fitch, and Chairman and CEO of Talbot’s, Inc. I think we can conclude she knows a bit about specialty retailing.

         With financial results like that, the stock must have cratered, right? Nope. The press release was dated November 9. The stock closed that day at $17.27. The next day it rose to $18.56—a 7.47% gain on volume that was 3.76 times the average volume. The company’s most recent closing price as I write this was $19.48. The conference call was held on the November 10 at 5:30 in the morning Pacific Time. No, I did not listen to it live.

       Clearly some people were pleased with what they heard on that call, and maybe had been expecting quarterly numbers that were worse than they were. But what made them so happy?
 
The Conference Call
        I wish they made transcripts of conference calls available or—if they do—I wish I knew where I could get them. Trying to write down all the good things Ms. Kasaks said they were doing as quickly as she was talking was a real pain in the butt. I kept trying to stop and restart the replay, but Media Player isn’t built for rewinding fifteen seconds. And another thing, left-handed people with lousy writing should not be allowed to own fountain pens—much less try and take fast notes with them. Uh, I seem to have gotten off track.

         Anyway, Ms. Kasaks highlighted three key big ideas for Pac Sun to focus on. They were:
      1. A commitment to build the juniors business to increase sales and store productivity.
      2. A focus on improving the in-store presentation of merchandise.
      3. A strategic assessment to understand how they can reconnect with their customers.
 
These three big ideas followed a list of initiatives Pac Sun was undertaking. I want to quote one of those initiatives: “Put more focus on transitional merchandise with the implementation of our spring floor set at the end of January. This will insure that our spring product is presented earlier than last year while being merchandised with more wear now product than in the past.”

         I thought this initiative required a little explanation and discussion.
 
Transitional merchandise is product that’s brought in during one season (winter in this case) and can be worn in that season, but can also be worn during the upcoming season (spring). Sweaters in spring colors might be an example. You sell it now and wear it now—but they carry over into the next season.
         The reason you do this is that it has the potential to improve your sales in the existing quarter. The danger is that if you don’t do a really good job in selecting merchandise, picking the right quantities, and merchandising it well, you may get to the next quarter with assortments that are old.
         In other words, at the extreme, you could theoretically end up just transferring sales from one quarter to an earlier one. PacSun spent some time on its conference call discussing some issues in just these areas, so it will be interesting to watch them implement this initiative.
         I think there were seven initiatives in total, including the one I quoted above. Somehow, I’ve managed to write down nine. I was either listening too slowly or writing too quickly. They included a review of the company’s customer communications program and in-depth customer research. Other initiatives will focus on inventory and in-store presentation. They want to reduce inventory density in their stores “to provide assortment clarity and in store presentation.” They noted a decline in their sneaker business and have plans to improve their assortment.  They will review it “to be in line with customer preferences.”
         They have plans to improve their merchandise presentation “without undertaking a major investment in time and capital.” They are utilizing something they called a “refresh” format that involves certain new design and layout elements. And they’re trying to improve the process by which they update their monthly floor sets.
         Due to time and cost constraints, you can’t wave a magic wand and have all 1,169 stores (835 are PacSun) updated. They are working to figure out what seems most likely to work and to implement the changes as time and capital permit. They are developing a new logo and new layout that provides what they characterized as a much more sophisticated look, and expect to do 30 to 40 remodels utilizing this concept next year. Sounds like the right direction and right process to me.
         That they are doing this isn’t a surprise to anybody who has been in a PacSun, Zumiez, and Hollister store lately. In Hollister, there’s a certain calmness that makes you feel like you’re on the beach. Their attempt to connect to the surf market—and they seem to do it pretty well—is clear. Zumiez carries hard goods. That has given them credibility in the market even as their store numbers expand. PacSun has the right brands and competitive prices but needs, in the words from the conference call, “To understand how they can reconnect with their customers.”
         During the conference call, Ms. Kasaks acknowledged that she doesn’t think PacSun can be authentic at their size. While that may cause a gasp of dismay and prognostications of their demise in some action-sports circles, I found it refreshing. It’s inevitably true for a company with this many stores. So you recognize it, work on evolving your inventory and your look, and undertake a strategic reassessment.
         So what’s the strategy? That’s what PacSun management is figuring out. They’ve done an awful lot in three months. They’ve been open about their issues and have moved to implement tactics that address them. I can’t wait to walk into one of their remodeled stores and see where the strategic reassessment came out. In the meantime, we’ll all keep watching PacSun as a barometer of what’s happening in the broader lifestyle market and worry about how their initiatives impact orders and sales of our brands.

 

Globe Annual Report and the Pacific Brands Deal

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Being traded on the Australian Stock Exchange, Globe doesn’t have to file the usual reports with the Securities and Exchange Commission here in the U.S. But they did file an annual report (109 pages, but happily for me full of pretty pictures and big type) and, in conjunction with the announcement of the pending sale of its Australian and New Zealand street wear apparel division to Pacific Brands for a maximum of $42 million Australian Dollars, it was worth taking a look at.

 
By the way, all the numbers in here are in Australian Dollars. Currently, an Australian Dollar will get you about $0.76. Do your own math. Oh, and just so I don’t have to say it continually, Globe’s fiscal year ended June 30, 2006. The annual report was released October 13th.
 
The first thing I want to say is that I like these guys. I mean, thanks to them, I now know how to bounce quarters into a glass. You know who you are. Maybe more importantly is that I love any management that starts off its annual report directly and honestly with the Chairman and CEO saying, (I’m paraphrasing here) the first quarter in North America really sucked, but the brands are in better shape and we’ve got our financial and management ducks in order, but we didn’t make as much money this year as we’d hoped. All you can ask of any management is competence, honesty and integrity.
 
Sales fell in 2006 from $204.5 to $197.3 million. Net Income dropped from $3.3532 to $0.471 million. There’s no way to make that look like a good result. However, the improvement they talk about in the annual report is better seen in the cash flow. There we see that in 2005, operations used $7.381 million in cash. In 2006, operations generated $2.780 million. And that is almost entirely the result of increased receipts from customers. That’s a good thing, and suggests they are doing all the appropriate management things that a company has to do when things aren’t going its way- controlling inventory, collecting receivables, being tough on spending. Let’s see if the balance sheet bears that out.
 
Inventories and receivables both down a bit. Good. Payables down almost $10 million. Great. Current ratio went up from 2.43 to 2.83, a 16.5% improvement. That’s a strong current ratio. My only caveat is that a current ratio is as of a moment in time (June 30 in this case) and seasonality, to the extent Globe has it, can wreck havoc with that. As a former President of a couple of snowboard only brands, I am justifiably paranoid about that.
 
Meanwhile, back on the cash flow, I see that Cash Used in Financing Activities fell from $11.1 to $0.3 million. Of course, $8.3 million of those savings came from not paying dividends in 2006 that they paid in 2005 and I suppose the people who use to get those dividends aren’t that thrilled, but I imagine it was the right thing to do.
 
The bottom line is that while they used $22.2 million in cash in 2005, they used only $3.0 million in 2006. The conclusion? They responded appropriately to their business conditions, but now they have to improve their bottom line by selling more at better margins.
 
There’s a limit to how much you can accomplish that by controlling spending. So they are taking the strategic step of making the apparel sale to Pacific Brands. The brands being sold “…include Mooks, M-ONE-11 and Australia and New Zealand licensed brands together with eight concept retail stores in Melbourne and Sydney and two Direct Factory Outlets stores,” according to the Melbourne newspaper The Age. The same article says these assets represent about 35% of Globe International’s group revenue.
 
Certainly, this sale gives Globe some additional resources to use in focusing on its core brands. Apparently, it’s the result of the strategic review that Globe announced it would be conducting last February.
 

The interesting thing to me is that this leaves Globe with a bigger percentage of its revenues in skate hard goods- a tough market for anybody. Hopefully, the tighter focus and proceeds of the asset sale will help them improve their performance there.   

 

The Last Intrawest Annual Report: One Benefit of Being Bought

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I’ve always admired Intrawest’s ability to combine and coordinate its real estate activities with the development and management of its mountain resorts. It always seemed like they managed to choreograph the two to maximize the value of both. That didn’t mean, however, that I looked forward to reading their annual  Form 40-F filing with Security and Exchange Commission and now that they are about to be acquired by Fortress Investment Group (probably a done deal by the time you read this) I guess I won’t have to do it any more.

 
But I’m a sentimental kind of guy. Just for old time’s sake, I decided to slog through the last one when it came out. And as long as I was being sentimental, I thought I might as well try and figure out exactly why Intrawest decided to sell to Fortress.
 
This all began with a February 28, 2006 press release in which Intrawest announced “…that it had initiated a review of strategic options available to the company for enhancing shareholder value…” Intrawest Chairman Joe Houssian is quoted as saying, “It makes sense for us at this time to evaluate all of the different ways in which we can capitalize on the opportunities in front of us for the benefit of shareholders, and to ensure that we have the bets possible capital structure in place.” Here’s a link to the Intrawest site where you can click through to see the press release: http://www.integratir.com/newsrelease.asp?ticker=IDR
 
Okay, well enhancing shareholder value is a fine thing. Who could argue? But my question was why they thought they had to go through this process to do it. Couldn’t they just run the business themselves? Did they need more capital than they could raise on their own? Were they concerned about softness in the real estate market? Did the diversification of their business (only 32% of revenue now comes from mountain operations) require a different kind of support? The release didn’t say.
 
By way of background, Intrawest went public in June of 1997 at $16.75 a share. The stock bounced around for some years, closing at $18.94 at the end of September, 2004. From there, it moved up smartly, closing at a high of $37.60 the week of May 5, 2006. It then reversed course and went down for eleven of the next thirteen weeks, closing at $26.70 the week ending August 4th. Then the sale of the company was announced and the stock rocketed up to $34.50 ($35.00 a share is the purchase price) and has stayed near that price since.
 
The June 30, 2006 balance sheet is hardly changed from the previous year and the changes are positive. Total assets are almost identical, while liabilities are down and equity is up.
 
Net income rose from $33 to $115 million. The contributions from resort and travel operations fell 11% to $89 million. Management services contribution fell 14% to $37 million. The real estate contribution, however, more than doubled to $143 million. That component of Intrawest’s income can swing around a lot from year to year. I guess it’s normal for that business, but it makes year to year comparisons a little difficult.
 
I thought a telling section of their Form 40-F was the section called “General Development of the Business. It listed what they consider to be “key developments” during the last three fiscal years. There were thirteen accomplishments listed and every single one of them was raised money, sold this, bought that, refinanced this, retired that debt, started our review of strategic options. No doubt these were key developments, but I thought it was interesting that not a one was focused on running and improving the core business operations. I mean, they must have done some good things in those areas. They’ve been doing them for years. 
 
You read the press releases, scour the documents, and listen to the conference call. You still don’t get a specific and satisfying explanation for why Intrawest sold.
 
But if you go to the web site of the Fortress Investment group (http://www.fortressinv.com/) and spend just a few minutes reading about it, you will learn that they are a large, diversified organization with access to capital and the ability support companies in putting in place financial structures that allow those companies to take maximum advantage of their opportunities. Whatever Intrawest can accomplish on its own, it can do more with the support of Fortress. With the support of Fortress, management’s time won’t have to be focused on refinancing, buying, selling and restructuring. They can worry about running the business.
 
If you read a bit about Fortress, the apparent generalities which Intrawest used to explain the motivations for the transaction make a whole lot more sense.       

 

 

PacSun’s Quarter Ended 7/29/06; Numbers and Industry Implications

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I guess if you’re going to talk about a quarterly earnings release, you have to mention the numbers. Okay, fine. PacSun’s net income for the quarter ended July 29, 2006 was $0.14 a share compared to $0.28 a share for the same quarter the previous year. For the six months ended the same date, it was $0.30 a share compared to $0.51 for the same period the previous year. Those are drops of 50% and 41% respectively. Sales for the quarter grew only 1.3% from $309 million in the same quarter the previous year. Sales for the six month ended July 29, 2006 were up only 4.2% to $614 million.

 
What happened? Gross margin fell and expenses rose while sales were flat. That will put the kibosh on the old bottom line every time. On August 31st, PacSun announced that August sales were down 4.0% from August of last year and that same store sales for the period were down 9.4%.
 
If you’ve ever looked at PacSun’s stock chart, you maybe weren’t all that surprised by this. The stock fell about 10% the day after the announcement of the quarterly results, but the trend had been down for a while. The stock peaked at $29.05 way back on March 7, 2005. It fell as low as $20.33 on May 12, 2005, rallied back to almost $28 in November and has been mostly falling since. People who study this stuff tell me that a stock’s chart often shows weakness before the company’s fundamentals turn over. Speaking more generally, the stock market often leads the economy.
 
I hasten to add that PacSun’s chart doesn’t look much different from some other industry public companies, which is maybe a good way to move on to implications for our industry.
 
In its conference call on the quarterly results, PacSun acknowledged that business was tough, and that they were taking the usual and appropriate measures to respond. These included watching costs closely, controlling/reducing inventory and being cautious about their orders. Well, what would you expect them to do? They sounded like a competent management team in touch with reality. I imagine that’s because they are.
 
They also talked about meeting with the leading brands more often and earlier because of the challenging environment. They said they were trying to be “more responsive to their [the brand’s] insights around product.”
 
They talked about weakness in branded fashion denim sales, with the exception being Levis. They indicated they had added a specially designed selection of Levis for back to school in 200 stores and that the results had been “very positive.” They also talked in general about adding new brands for back to school.
 
This caused one analyst to ask whether PacSun was expecting to transition its business away from the core skate/surf brands. I seem to recall a reference to Volcom in the question.
 
PacSun’s answer was that the addition of new brands was a normal, ongoing, practice, that orders had been reduced consistent with the decline in business, and that they had no intention of transitioning the business away from the core brands.
 
But I think the analyst’s question went, or should have gone, deeper than that. What they were really asking was, “PacSun, what are you? Are you a skate/surf/lifestyle brand committed to the same market you’ve always focused on, or will a slowdown in that market’s growth and a saturation of its selling opportunities require that you expand your appeal? If so, how do you do that without losing your original, and very successful, franchise?
 
I think it was four years ago at the Surf Industry Conference where Bob McKnight warned us that the uptrend wouldn’t last forever. If the trend has stopped upping, is it a hiccup, or the beginning or a new kind of market? I don’t know. PacSun, and hopefully lots of other companies, are taking the appropriate tactical steps to manage it in the short term. But the longer term question is the one the analyst may have meant to ask but didn’t quite- What are you?

 

 

Volcom’s Quarterly Conference Call: It Didn’t Sound 29% Bad to Me

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         I’m just back from two years In Ireland, where I made a futile attempt to have one pint in every pub in Dublin. I’ve missed a bit, but I did hear about Volcom’s quarterly conference call last Friday, the 29.4% decline in its stock that followed, the industry discussion that has ensued about the reduction in Volcom’s projected third quarter sales at PacSun, and the apparent concern over the ability of industry companies to sell their denim and other brands if PacSun was to change its branding strategy. 
         So I listened to the conference call. All one hour, 32 minutes, and 19 seconds of it. Moan. Volcom beat estimates for its second quarter, held to its guidance for the year, and announced what I took to be some very positive developments in new products, distribution and retail.
         But Volcom reduced guidance for the third quarter from 45 to 38 or 39 cents and said it expected sales to PacSun, its biggest customer representing 29 percent of last year’s revenues, to decline in the third quarter.
         When asked for some specifics about why this was happening (some “color” as the analysts call it) management just repeated the same non-specific answer about how they had a great relationship with PacSun, considered them an important customer, looked forward to a continued good working relationship with them and were all over it.
         I didn’t think much of it at first, but by the fourth time they gave that answer and no details I was wondering if there was something more to this. (Apparently, judging from the stock’s performance, so does the stock market.) Is there? I have no idea. But I might have approached the issue a bit differently.
         Before I tell you how, go check out a daily stock market chart for Volcom and some of the other publicly companies in our industry. Notice that many of the prices aren’t exactly up. They are kind of unup. Well, actually they are down and it’s hard to put a positive spin on that.
         Is it industry related? Maybe. But the whole stock market has been in a downtrend since early April. Investors Business Daily regularly points out that three out of four stocks follow the market direction. So anybody who might be concerned that any of Volcom’s comments (or lack of comments) with regards to PacSun caused a decline in industry stocks needs to look at the longer-term trend and general market conditions as well.
         If you’re a public company and the analysts think you didn’t quite provide a good answer to a question they think is important, and you reduce your guidance for the coming quarter, your stock goes down. But not, one would think, by 29 percent when you have some good news as well. If I were Volcom, I might have suggested that questions about PacSun’s brand strategy be directed to PacSun.  I might have suggested that if PacSun was going to focus on brands like Levi (and its own brands for that matter—not news) that over time Volcom’s sales to PacSun might, in fact, become less important given Volcom’s distribution strategy, which they characterized (correctly, I think) as cautious. And I would have focused on all the other positive initiatives Volcom highlighted and how they might, over time, reduce the company’s dependence on PacSun.
         If you’re a public company, then you are to some extent a prisoner of the quarterly filing cycle. That’s life. But it seemed to me that a reduction of Volcom sales (at least as a percentage of total sales) to PacSun could be seen as strategically positive if PacSun is changing its brand strategy in a way that’s not consistent with Volcom’s market positioning.
         And (of course) if it’s not too big a reduction. No matter what your strategy is, it’s damn hard to get profit growth without an overall growth in sales.
         Somehow, all the good things Volcom had to say were overshadowed by the implications of the third-quarter decline in sales to PacSun and the possibility that there was more to it than Volcom explained. I just wonder if the question couldn’t have been answered so that the decline in the stock wasn’t so dramatic.
         Unless of course, there was more to it than Volcom explained.

 

Well, At Least It Can’t Be Any Worse Next Year; The Trade Show Schedule

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The box on this page contains, as most of you are no doubt painfully aware, this year’s trade show schedule. Pretty intimidating. But of course it doesn’t include any key account presentations suppliers might have to make. Or regional shows. Or shoe shows, or bike shows, or toy shows or whatever other shows some suppliers and retailers might need to attend. And when’s that new ASR back to school show? When’s MAGIC? Granted, these aren’t all winter sports shows, but basically all retailers and many suppliers aren’t only in the winter sports business.

  
Show                                                 Date
 
Outdoor Retailer                               January 5-6
NBS                                                    January 10-13
Supershow                                       January 19-23
Winter Sports Market                       January 27-28
SIA                                                      January 29- February 2
ASR                                                    February 2-4
ISPO                                                   February 2-5
NSIA on snow                                  February 7-8
NSIA show                                        February 10-13
SBJ (Japan)                                      February 28-March 3
 
 
Now, I guess no single person actually has to go to all of these. Well, wait a minute. I can think of one guy. The guy who gave me this schedule actually. Maybe I can talk him out of some of his frequent flier miles. He can’t possibly use them all.
 
I started writing this sometime in mid January and, at that point, it was something of an abstraction to me. Now, sitting here in Long Beach for ASR in my hotel room on a Sunday evening in early February, it’s all too real. Tomorrow will be my seventh straight day of trade shows, and I don’t even have to fly to ISPO. I had a moment of clarity as I walked into the ASR show this morning and one of the security guards looked at me and said, “Don’t worry, you’ll get through this.” Apparently, I had a bad case of trade show stare.
 
What the hell happened? How did we find ourselves in this position? What can we do about it? This number of shows of this duration this close together can’t possible be argued to be in the interest of retailers or suppliers.
 
Apportioning Guilt
 
In that great American tradition, I guess we should start by finding somebody to blame. Can’t be our fault we’re in this mess. I know- let’s blame the associations that put on all the shows.
 
I think pointing a finger there is at least partly appropriate. It’s not that all the show producers got together and decided how to make us all broke, jet lagged and exhausted. All of them, I imagine, know in their heart of hearts that there are too many shows, but it’s unlikely that any of them are going to volunteer to close themselves down. Organizations are almost organic in their tendency to survive and grow whether they should or not.
 
In a weaker economy with, as I perceive it, fewer retailers going to fewer shows and staying fewer days, the trade organizations find themselves competing with each other for “market share.” It’s no different than any other industry. In the computer industry, or the snowboard industry for that matter, too many companies fought for market share and many of those companies didn’t make it. But in the process of that fight, the customer got a constantly improving product for less and less money.
 
The customers of trade shows, of course, are the suppliers and, to a lesser extent, the retailers who attend the shows. But it’s the suppliers who pay whoever puts on the show to be there, in addition to costs for building, transporting and staffing their booth. Retailers pay to attend too, but they don’t have to build a booth or pay for space.
 
In most industries, the customers don’t rush to pay for and use more of something than they really need, want, or can afford. In the snowboarding business, where marketing is critical and many companies try to look bigger than they are, competitive pressures can make suppliers show up at trade shows, do more, and stay longer than they really want to. If they aren’t there, or their presentation isn’t what’s expected, the rumors start flying. Let’s call it the lemming affect- we all scurry in the same direction.
 
The longer shows are and the bigger the booths, the more money the organization sponsoring the show makes. Talk about a potential conflict of interest with your customers. Competition among trade show promoters doesn’t seem to result in the trade show customers getting a better, more affordable, product.
 
To the larger players, the cost, hassle, duration and number of trade shows may be a pain in the butt (an expensive pain in the butt), but it doesn’t threaten their ability to compete and survive. For smaller companies, or brands just trying to get off the ground, the need to make their presence felt at shows can be a formidable barrier to success. They just don’t have the people, booths and money to be everywhere.
 
In an industry that could use some fresh new products and brands, that’s too bad.
 
Hey, wait a minute! We can blame the economy and snow conditions. Well, that doesn’t really work. It’s true that if the economy was stronger and it was cold and dumping everywhere we might not complain as much. Cash flow covers up a variety of sins. But it wouldn’t change the existing issues with the trade show schedule.
 
This is inconvenient, but at the end of the day, I’m afraid we’re going to have to look into the mirror and accept some blame ourselves. We are, after all, the ones who show up and nobody exactly puts a gun to our head.
 
SIA and What To Do
 
Vegas is our trade show run by our association. But, as I’ve made clear above, many suppliers and most retailers have trade show responsibilities and concerns that go beyond winter sports. It’s the interplay of all the trade shows and their schedules-not just winter sports- that really creates the problems. SIA can’t fix all those problems. What might they do?
 
SIA has a board of directors run by suppliers who are also Vegas exhibitors. They are responsive to our concerns because they are us, though they may not act as quickly as we’d like. Shows like Vegas get planned and contracted years in advance, so perhaps that’s inevitable. We’re the shareholders, so money SIA takes in goes to programs that help winter sports and, according to SIA, Vegas costs us less than a comparable show put on by a for profit organization. That’s all good.
 
This year in Vegas, the number of buyers was down 10.8 percent. Given the new dates, the economy, and, maybe most importantly, a Superbowl weekend, that wasn’t too surprising. The question for me, however, isn’t how many buyers were registered. What I’d like to know (and I guess we don’t have a way to get this number) is how long they stayed. That is, if you take all the buyers who showed up, and add up the days each stayed, how many was it and how does that compare to previous years?
 
My guess is that the total number of buyer days was down and by more than the number of buyers. That’s fine because this is now a preview show. The first thing I’d like SIA to do is cut the show down to three days. That’s a number most people I spoke with seemed to think was reasonable. I understand we’re down to four days next year from January 24th through the 27th,  I further understand that existing commitments can’t be arbitrarily changed. But three days seems about right. On day four I was there and it was very quiet. On days five, I was gone but I’m told that deserted might not be too strong a term.
 
Does that mean less income for SIA? From both a financial and a management point of view, I expect suppliers would rather pay higher dues than spend two more days in Vegas.
 
Next, let’s see if SIA can merge with Outdoor Retailer. Those discussions are apparently ongoing. When OR’s numbers came out, the gossip was that SIA was in the catbird’s seat for the negotiations. At Vegas, as it became clear that show attendance would be down, the handicappers seemed to give OR the edge. If SIA had been before OR, I’m sure the opposite would have happened.
 
Anyway, I think that merger makes sense though I can imagine that reaching an agreement between a for profit and a non-profit organization will require some creative structuring.
 
OR’s on snow is January 28th and 29th next year. Their show is January 30th through February 2nd. For those who have to be at both, that’s tougher than this year unless through some miracle there’s a merger that’s effective for next year’s shows.
 
Speaking of scheduling, I hope and assume that SIA does everything it can to keep Vegas from overlapping with ISPO and ASR. In fact, ISPO is February 1-4 next year, so that’s an improvement from this year for people who want to attend Vegas and ISPO. ASR, on the other hand, is January 23rd through the 25th, offering a two day overlap with SIA compared to one this year. I’d guess that most suppliers who go to SIA don’t exhibit at ASR as well. But there are a lot of retailers who would want to go to both. They have a problem
In Vegas, I saw bigger booths. Never in my wildest dreams did I imagine I’d see that this year. In this industry, at this stage of its development, are there still companies that think that booth size correlates with sales? Maybe, and I’m only half kidding, SIA should limit booth size. Of course, that would cut into their revenue and be in the interest of the smaller companies…… Personally, I think snowboarding could stand to see success by new, fresh, smaller companies, though a viable financial model is a hard thing to achieve.
 
I just got a phone call from somebody I respect who said he thought Action Sports Retailer would start approaching the snowboard companies. In the far distant past, they all went to ASR anyway. The timing’s more or less the same as Vegas, it’s just three days, most of the retailers will be there as they also tend to do either skate or surf, and in terms of the lifestyle and demographic, snowboarding belongs with skate and surf more than with ski. Interesting idea.
 
At the end of the day, the interest of trade show producers, on the one hand, and suppliers and retailers, on the other, aren’t necessarily the same. Perhaps SIA is an exception, at least in part. Change will happen because enough attendees, at whatever show, make it clear they won’t show up if things don’t change.
 
Wouldn’t it have great if five major companies at SIA had put big tarps on their booths at the end of three days with signs that said, “We’re Done. We’re Gone.”

 

 

Good News And Bad News; Ride Reports Third Quarter and Preseason Orders.

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            It must suck to be the only public, pure snowboard company left standing. All the other snowboard brands are suffering from some of the same industry issues as Ride, but they can equivocate about it with impunity.

 
            But Ride’s management wouldn’t want to do that anyway. Like the title says, there’s good news and bad news. The good news is the improvement in the income statement and the preseason orders (up 26 percent). The bad news is a weak balance sheet and a capital structure that needs, well, restructuring.
 
            The income-statement result and preseason-order growth is all the more impressive given the balance sheet Ride has had to work with and the constraints placed on what the company can do. A weak balance sheet means the CEO spends all his time managing cash, assuaging banks, and trying to raise capital. Who knows what Ride—or any other snowboard brand for that matter—could accomplish if the management team could actually focus on running the business?
 
The Income Statement
 
            Sales for the nine months ending March 31, 1999 are up 14.2 percent to 38.1-million dollars over the same period last year. Ride’s loss for those nine months was 1.389-million dollars compared to 14.645-million dollars last year. The improvement isn’t as spectacular as it seems at first glance. Last year, the company took an 8.6-million-dollar write-down for impairment of goodwill. In other words, given market conditions at the time of the write down, it had some assets that were worth a lot less than what Ride paid for them.
 
            Nine-month selling, general, and administrative expenses have been more than cut in half, but that includes the 8.6-million-dollar write-down. If you take that out of the equation, the expense reduction is still 19.7 percent—which is pretty impressive. According to Ride, and excluding the impact of the 8.6-million-dollar write-down, the expense reduction “ … was primarily due to staff reductions and lower executive salaries.”
 
            Gross margin over nine months was up to 27.4 percent, an increase of 1.3 percent. May not sound like much, but 1.3 percent of Ride’s nine-month sales is half-a-million bucks, which would buy a lot of beer at Vegas. Perhaps you recall, many years ago, when having your own factory was the Holy Grail of the snowboard industry because “it would let you have a really great gross margin.” Numbers like 45 percent were once thrown around. Too bad everybody had the same idea.
 
The Balance Sheet
 
            Ride’s receivables at March 31 were 6.5-million dollars net of a bad-debt allowance of 750,000 dollars. That would be bad if those receivables represented uncollected accounts from last season. But according to Ride President Robert Marcovitch, those receivables represent early 1999 sales of last season’s product that will be collected this fall.
 
            The 10Q confirms this, stating, “The company made the decision to move our closeout inventory at prices lower than would normally be the case in order to gain quick sales and hence borrowing availability.” Translation, we needed the cash!
 
            If it isn’t getting paid until fall, how does that get the company any cash? The bank line from CIT allows Ride to borrow a percentage of eligible inventory and receivables. Ignoring the issue of what’s “eligible” and what’s not, the percentages for Ride are 55 and 85 percent respectively. Let’s say you’ve got a million bucks in inventory. You can borrow 55 percent of that, or 550,000 dollars assuming it’s all eligible. If you’ve got a million in receivables, you can borrow 85 percent or 850,000 dollars. Because I went to business school, I know that 850,000 dollars is better than 550,000 dollars, so Ride sold at lower prices to create receivables. 
 
            Inventory of 7.3-million dollars on March 31 gives you pause for a moment. But the footnotes in the 10Q tell us that 2.5-million dollars of that is raw materials and work in progress. That will turn into next season’s product. The remainder is finished-goods inventory. According to Marcovitch, almost all of the finished goods are product for the coming season. Not only do we know from this that the inventory is good, but it suggests that however tight cash is, Ride is finding enough dollars to run its factory efficiently. That is, it’s getting materials from suppliers and not having to start and stop the plant because of material or cash shortages. The major liquid assets then—inventory and receivables—are more or less worth what the balance sheet says they are. And, in the normal course of business, when Ride ships that inventory to customers it will turn into receivables (and, hopefully, someday cash), that will be worth substantially more than the current inventory value.
 
            Meanwhile, down on the liability side of the balance sheet, we find current liabilities of 15.1-million dollars broken down as follows:
 
            Accounts Payable: 4,247,000 dollars.
            Accrued Expenses: 2,383,000 dollars.
            Short-term Borrowings: 8,484,000 dollars.
 
            The short-term borrowings include three million dollars owed to U.S. bank and a note for 1,725,000 dollars payable to Advantage Fund II, Ltd. The remainder is owed to CIT Group/Credit Finance, Inc. under Rides’ revolving line of credit. Accounts payable and accrued expenses are moneys owed to the phone company, materials suppliers, insurance agents, employees, and everybody else Ride needs to get goods and services from to operate its business. Ride’s current ratio (its current assets divided by current liabilities) is 0.98. The current ratio is a standard financial measure of a company’s ability to meet its ongoing operating expenses. The lower
the number gets, the tougher things are. You can’t continue to operate with a current ratio under 1.0 for too long.
 
            Let’s put that in a little perspective. In a highly seasonal business, in the part of the season where the cash is drying up (like the end of March for example) no snowboard company has a great-looking balance sheet and is rushing to pay all its bills. Nevertheless, Ride’s current ratio is symptomatic of the need for a balance sheet restructuring and additional working capital.
 
Preseason Orders
 
            Up 26 percent to 43-million dollars. Wow. Any other snowboard company that had a bigger increase, step up and claim it. I won’t be holding my breath. The only category that’s down is “OEM, wakeboards, and other.” That’s only down, according to the press release, because it chooses not to accept certain OEM orders, which is probably a correct strategic move.
 
            What I like even better are the categories the increases came in. Boards are up nineteen percent. However, boots, bindings, and apparel and accessories (excluding SMP) are up 38, 33, and 58 percent respectively. That is, higher margin products represent an increasing percentage of total sales, which should bring the whole margin up.
 
            Some of these sales may get shipped before June 30. But just for fun, let’s say Ride sells that 43-million dollars, and nothing more, in the nine months of their next fiscal year. Let’s assume the company’s gross margin stays the same. Its gross profit will be 11.78-million dollars.
With the preferred stock dividend eliminated, that increase in gross profit by itself will bring Ride to break-even. A restructuring should reduce the company’s interest expense from 798,000 dollars, if only because Ride is paying punitive interest rates right now. Margins should go up a point or two just based on the change in the product mix. Obviously, the quarter ending June 30 isn’t a strong one, but for the twelve months ending June 30, 2000 Ride ought to earn a few bucks just from what’s in place right now. That is, if Ride management can get the restructuring done.
 
Restructuring
            The U.S. Bank facility is a term loan for three million dollars that is due and payable August 31, 1999. That loan, according to the 10Q, “ … is secured by promissory notes from Global Sports, Inc. in the original aggregate amount of 1.8-million dollars. Additionally, the facility is secured by the personal guarantee of one of the Company’s outside directors, including certain real-estate property owned by the director.”
 
The note for 1.725-million dollars, also according to the 10Q, “ … has a term due date of June 30, 1999 which date is automatically extended to September 30, 1999 in the event the company has executed a letter of intent for a transaction which would raise capital sufficient to fully redeem the note.”  The note’s interest rate is ten percent, but it has a default rate of
eighteen percent. The CIT line of credit expires August 30, 1999.
 
            So, there are a lot of critical deadlines coming up, and the 10Q is replete with the usual statements companies in these circumstances make about dire consequences if Ride can’t meet some of these deadlines.
 
            My guess is that there will be a successful restructuring. The improvement in operating performance and increase in preseason orders makes me believe that. Its likely shareholders will be hit by additional dilution as a result of the restructuring. Concern over that dilution is probably the reason the stock price didn’t go up significantly in the wake of Ride’s healthy preseason order numbers.
 
            Ride has hired Ladenburg Thalman & Co. “ … as its financial advisor to provide advice regarding potential strategic alternatives available to the company,” says the 10Q. Negotiations are ongoing.
 
The Bottom Line
            If Ride had paid maybe two-million less for its factory, not hired quite so many people so quickly, and had paid some of them less, and not built the Taj Mahal in Preston, Washington, I suspect the managers at Ride would be smiling and looking forward to closing out their fiscal year June 30 with a twelve-month profit. But that’s not how it happened, and Ride was hardly the only snowboard company seduced by perceived endless growth.
 
            Ride’s market position seems sound and the product line complete and well received. Management and employees are industry experienced.          I still have some trouble with the financial burden of owning a factory, but Ride management has made its a marketing asset. So, strategically the brand seems positioned to succeed. By the time you read this, we’ll probably know if Ride’s managers pulled off the financial restructuring that will allow them to do it.

 

 

Chasing the Demographics; Pacific Sunware Focuses on Youth

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There’s got a way to make this story exciting. Oh the injustice of making me write about a company with a strong balance sheet, growing revenue and earnings, no meaningful litigation, and an experienced management team with a clear strategic focus. I’ve got to stir up some drama somewhere if there’s to be any hope that people will make it all the way to the end of the article.

The drama is in the execution of the strategy. Pacific Sunware started out as the store where young, white males could get the trendy, casual brands they wanted. Now, twenty two percent of their sales are to females. The new d.e.m.o. stores are focusing on cross cultural trends. Pacific Sunware sells snowboard clothing. They are selling their own private label brands.
 
Can they expand their target market, but keep their focus and their niche? Can they keep the loyalty of a notoriously finicky customer group? Inquiring minds want to know. But first, the boring stuff.
 
SIDEBAR
 
Pacific Sunware: A Snapshot
 
As of the fiscal year ended January 31, 1999, Pacific Sunware (PacSun, as they seem to want to be known) had 342 stores in 42 states. Their customers are young men, and increasingly women, between the ages of 12 to 22 who prefer a casual look. Revenues have grown from $85 million in 1994 to $321 million for the year ended January 31, 1999. Net income has climbed from $3.9 to $23.5 million during the same period. They had 4,058 employees of whom 3,822 were store employees. Of the store employees 2,700 were part time. Management is mostly in their 40s. Most of the team has been with the company since 1994 or before.
 
END OF SIDEBAR
 
 
PacSun by the Numbers
 
At May 2, 1999, the balance sheet was, well, boring. There’s eleven million dollars of cash and a current ratio of 3.16. There’s basically no long-term debt, and the total debt to equity ratio is 0.25. The piece of information I would like but don’t have is a way to judge the quality of the forty six million dollars of inventory. Obviously, when you’re selling trendy goods to young people, you’d better be right on your inventory selection. On the other hand, even if a chunk of that inventory were obsolete, this balance sheet would still be strong.
 
One caveat on evaluating the balance sheet of any fast growing retail business- comparisons from one balance sheet date to the next are difficult due to both growth and seasonality. Ratios will tell you the strength of the balance sheet, but getting a handle on operational efficiencies using the balance sheet is tough when, for example, inventory goes up a bunch, but so did the number of stores.
 
For the thirteen weeks ending May 2, 1999 sales were $81.4 million, up 33 percent from the same period the previous year. Income grew forty percent to $4.04 million. Gross profit margins were essentially constant in these two periods at 32.1%.
 
Similar trends can be seen in comparing the two years ending January 31, 1999 and February 1, 1998. Sales grew 41.4% to $321 million. Net income was up 43.7% to $23.5 million. Gross margin fell two tenths of a percent to 33.7. Operating expenses as a percentage of sales fell from 22.5 to 21.9 percent, largely as a result of the rapid growth in sales.
 
Also important to note is that the average inventory between these two dates was $37.3 million. They did $321 million in sales. So they turned their inventory 8.6 times, and that is a great place to move into how the PacSun’s market strategy and how it dovetails with their financial and operational strategies.
 
Setting the Stage
 
PacSun either figured out or fell into the fact that it’s not just surfers that buy surf wear, snowboarders that buy snowboard clothing and skateboarders that buy skate clothing anymore. The specialty markets are crossing over each other. Fashion and lifestyle are as important as participation in the sport that originally spawned the apparel. If it were just surfers who wore surf apparel, the company wouldn’t be planning to increase its square footage by forty two percent this fiscal year.
 
So Pacific Sunwear has positioned itself, it hopes, at the cross roads where everybody passes through but nobody is confused or put off by seeing surf/skate/snow in one place. The theory is that you aren’t selling out anymore as long as you’ve got the cool stuff to sell.
 
Trouble is that somebody keeps changing the road signs at the crossroad. Fashions come and go as fast as commemorative postage stamps. Faster, probably. How does Pacific Sunwear hope to keep its road map accurate?
 
Real Marketing!
 
It’s my personal observation that most action sports companies think advertising and promotional tactics are marketing. Pacific Sunwear doesn’t seem to suffer from that delusion. Chief Financial Officer Carl Womack described the two-hour focus groups they do each year in half a dozen cities and have been doing for seven or eight years. He explained that their on-line inventory reporting allowed them to see what was selling and what wasn’t on a daily basis.
 
“Not only does this allow us to manage our inventory on a day to day basis, but it helps us anticipate trends so we can respond on a timely basis.”
 
He emphasized the close relationships they had with suppliers as a critical source of market trend data. They share ideas regarding fashion trends and merchandise self through with their vendors. “We always pay our suppliers on time- sometimes even early if they need it,” he indicated. That ought to go a long way towards creating good working relationships.
 
They experiment with new colors, styles and items by ordering small number (maybe twelve dozen) and seeing how they sell.
 
To sum it all up, it seems that marketing (that is, figuring out what the customer wants) is institutionalized at Pacific Sunware. Everybody thinks about it all the time and is required, as described below, to react to what they learn.
 
Running the Business
 
So PacSun’s success depends on their ability to respond to the dynamic fashion whims of young people aged twelve to twenty-two. How do they run their business to accomplish that?
 
All the stores of a given class are the same in terms of size, fixtures and inventory. Nobody has to do a study to figure out how build out and stock a new store. It’s a good thing, since they plan to open 108 new stores in fiscal 1999. Sixty-seven are planned to be Pacific Sunwear stores, sixteen Outlet stores, and twenty-five d.e.m.o. stores.
 
Though stores have the same inventory selection, the timing of inventory receipt will vary according to store locations. It gets colder some places earlier in the year than in others.
 
The company manages inventory through what CFO Womack called “permanent markdowns.” Every two weeks, based on the daily sales data, the store managers get to work to find the markdowns already downloaded into their store registers. All they have to do is put up the “On Sale!” signs. No slow moving inventory is allowed to linger in the hope that it will suddenly become hot. The inventory turns quickly, and the customer doesn’t wait for big sales promotion before coming into the store.
 
Stores have daily, weekly and monthly sales goals against which performance is measured. Feedback is immediate, as are bonuses for meeting monthly goals. Yet the store managers have no involvement in the actual selection of merchandise, though of course their input and ideas are solicited.
 
So what’s going on here? Pacific Sunwear’s systems and operating procedures dovetail nicely with their marketing imperatives. Need to have the right inventory? Better have the systems to know what selling so you can move what’s not. Want to grow quickly? The stores better be more or less the same. Want to be on top of trends? Better get along with your suppliers. The financial results are good expense control, minimizing writedowns and inventory levels, and high margins.  And a strong bottom-line.
 
Notice how all the pieces work together. There seems to be a company wide strategic focus that makes it immediately clear to management when something is “right” and when it is “wrong.” I’m usually not this gah-gah over a company. What could go wrong?
 
I’d focus on three things. First, management could lose touch with trends. Age does that no matter how good your systems and marketing are. Second, defections from a management team that has been together this long could be a problem. I hope the golden handcuffs are reinforced with titanium, and I hope the district and regional managers have a lot of input. Finally, fast growth can cause problems all by itself, but that’s a risk it looks like we’ve going to have to live with.