Portfolio Theory at Work at VF; Their Quarterly Results.

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VF’s 10Q for the quarter ended September showed another strong result. You can see the 10Q here. However, as with recent quarters, the good news was pretty much limited to their outdoor and action sport segment (OAS). I want to talk a bit about what that might mean, but first, let’s lay out the numbers.

VF’s revenue grew 6.8% from $3.3 to $3.52 billion. Gross margin rose from 47.6% to 48.3%. OAS has the highest gross margin of any of the company’s segments.

SG&A expense rose 8.1% from $0.989 to $1.069 billion. Operating income was $633 million, a 6.2% increase over the $580 million in last year’s quarter. At $20.7 million, net interest expense was almost unchanged. Net income rose from $434 to $471 million.

Okay, let’s break it down a little. Below is the chart from the 10Q that shows revenue and operating profit by segment- by coalition as they call their segments. I’ve included the information for both the quarter and the nine month period.

Untitled

 

 

 

 

 

 

 

 

 

What do we see when we evaluate this chart? First, note that OAS revenues were up 10.6% for the quarter. Remember that total quarterly revenues for the whole company rose by 6.8%. That translates into a revenue increase of 1.1% for all the segments combined excluding OAS. So OAS saved the day for VF.

OAS represented 62% of total revenue for the quarter, up from 60% in last year’s quarter. And it generated 67.5% of all operating profits, up from 64.5% in last year’s quarter. OAS operating profit rose by 12.8% from $421 to $475 million, or by $54.2 million. Operating profits in all other segments combined actually fell slightly from $232.4 million to $228.9 million. That’s not good.

OAS, and especially The North Face, Vans, and Timberland, are the engines pulling this train right now. Their revenues grew by 9%, 12% and 15% respectively during the quarter. OAS revenues in the Americas, European and Asia Pacific regions were up, respectively, 11%, 10% and 13%. Direct to consumer (online and their own retail stores) rose 20%. Wholesale revenues were up 8%

Here are some comments from the conference call on brand performance. For The North Face, “In the Americas revenues were up at a low double-digit percentage rate with almost 30% growth in D2C and high single-digit growth in wholesale.”

In Europe, “…The North Face revenues increased at the low single-digit rate. Our wholesale business was essentially flat due to a combination of a sluggish outdoor retail environment and a shift in the timing of product shipments into the fourth quarter. However our D2C business was up nearly 30% in the quarter…” In Asia, North Face revenue rose “…at the mid-single digit rate.”

Now for Vans. “In the Americas, revenues increased at a high single-digit rate.” In Europe, “…revenue grew at the mid-teens rate with D2C growth of 25% and low double-digit increases in the wholesale business.”

“In Asia Vans revenue grew nearly 40% with China increasing more than 40%…”

And finally, Timberland. “Third quarter global revenues were up 15% driven by 18% wholesale growth and a 6% increase in D2C.”

“In the Americas, revenues were up 22% driven by more than 30% growth in the wholesale business. This growth, similar to the second quarter was very balanced across all products and channels…On the apparel side we continue to expand our distribution and see strong sell-through as our fall 2014 collection hits retail floors across our own and wholesale partner doors.” My guess is that Timberland has quite an opportunity in apparel.

“Timberland’s revenues in Europe were up 15% in the third quarter with balanced growth in both D2C and wholesale… In Asia, third quarter revenues increased at the low single digit rate.”

Not a word about Reef. That never surprises me, but I’m always disappointed.

For the whole company, direct to consumer revenues grew 16% quarter over quarter. VF ended the quarter with 1,333 retail stores with direct to consumer revenues representing 22% of total revenues. They expect add around 150 stores a year “…over the 2017 planning period.”

Here’s a quote from the 10Q about the company’s overall business. “VF reported revenue growth of 7% in both the third quarter and first nine months of 2014 [was] driven by growth in the Outdoor & Action Sports coalition, and continued strength in the international and direct-to-consumer businesses.”

I guess if I took the obverse of that, or maybe I mean the converse, it sort or says, “Our wholesale business in the Americas outside of OAS wasn’t specifically too good.”

The balance sheet is fine, and I won’t even risk putting readers to sleep by analyzing it. Current ratio, at 2.0, was the same as a year ago. I would note that inventory was up just 4%- less than the increase in sales. There’s a whole lot of money to be made in good inventory management and not just for VF. It is also, in my judgment, an important part of differentiating and building your brand.

All’s fine with VF as long as all’s fine with Vans, The North Face and Timberland. Some other OAS brands are doing fine we’re told, but those three are responsible for most of VF’s revenue and profit growth right now.

VF has 35 brands in total. They are interested in further acquisitions (because they’ve told us so in the conference call) and have been willing to sell brands that didn’t seem to have the potential they were looking for (most recently, John Varvatos in 2012). They are focused on OAS, they tell us, because that segment represents the best opportunity to increase revenue and gross margin.

The numbers we’ve reviewed above tell us there are some issues with certain brands in other of VF’s segments, though we can’t know exactly which brands. The 24 brands that are not part of OAS did not all grow revenue at 1% during the quarter. Some did better, some worse.  It’s the nature, in fact the justification, for having a portfolio of brands that the overall portfolio can do well even when some brands aren’t performing.  Over time, you can expect different brands to perform at different levels.

I’m wondering if VF, especially if they can find some attractive OAS acquisitions, might not consider selling some of these other brands that are apparently not performing.

Strategically, that’s what I’ll be watching at VF.

Lowe’s New Customer Service Representatives and the Minimum Wage

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Lowe’s new in store service representatives won’t need bathroom breaks, vacations, or retirement account. They won’t get sick. Hell, you don’t even have to pay them a salary. And what’s even better, or maybe worse- I’m not quite sure- is that they may be able to help me find the esoteric piece of hardware I need better than the current human ones. And they will be able to do it in as many languages as are necessary.

They’re robots, and you can read about them here. Make sure you watch the video. Read more

Peak Resorts IPO; If, At First, You Don’t Succeed……………

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Peak Resorts has filed to do an initial public offering again. Here’s the link to the new S1.   They first filed back in April of 2011. After a serious of amendments to their S1 filing, they withdrew it due to poor market conditions for IPOs. I analyzed their situation and initial filing back in October of 2011. Here’s the link to that original article.

In the newest filing, they describe the company this way:

“We are a leading owner and operator of high-quality, individually branded ski resorts in the U.S. We currently operate 13 ski resorts primarily located in the Northeast and Midwest, 12 of which we own. The majority of our resorts are located within 100 miles of major metropolitan markets, including New York City, Boston, Philadelphia, Cleveland and St. Louis, enabling day and overnight drive accessibility. Our resorts are comprised of nearly 1,650 acres of skiable terrain that appeal to a wide range of ages and abilities. We offer a breadth of activities, services and amenities, including skiing, snowboarding, terrain parks tubing, dining, lodging, equipment rentals and sales, ski and snowboard instruction and mountain biking and other summer activities. We believe that both the day and overnight drive segments of the ski industry are appealing given their stable revenue base, high margins and attractive risk-adjusted returns. We have successfully acquired and integrated ten ski resorts since our incorporation in 1997, and we expect to continue executing this strategy.”

Peak Resorts had about 1.8 million visits in the 2013/14 season. By all accounts, this management team knows how to operate mountain resorts. They’ve been doing it for long enough.

The original filing had financials up to the fiscal year end in April 2011. For the year ended April 30, 2014, reported in the new filing, they had revenue of $105.2 million and a loss of $1.5 million. In the previous year, they had a profit of $2.7 million on revenues of $99.7 million.

Some of you may be relieved to learn that I am not going to my usual deep (and admittedly, sometimes a bit pedantic) dive into the S1 filling. Go back and read the article I wrote in 2011 if you’re that interested. All I want to note is that in the most currently complete year, they had interest expense of $17.3 million, up from $12.7 million the prior year. Long term debt at April 30, 2014 was $175 million.

Compare net income in the last two years with interest expense. I suspect, like me, that you’ll spot an opportunity for improvement.

They are going to try and raise around $100 million. About $76 million of this amount will be used to pay down that debt, with an immediate favorable benefit to their interest expense and bottom line. They will also have to pay a $5 million fee to their lender to get them allow to pay this off. Apparently, no prepayments were allowed.

There a couple of other interesting things. Three of the four largest shareholders in Peak Resorts are Tim Boyd, Steve Mueller, and Richard Deutsch. They own, respectively, 32.0%, 12.3%, and 12.1% of shares outstanding before the IPO. When the deal is done, the lender (EPR Properties) will release them from their personal guarantees. It is good not to have to provide personal guarantees.

I also noted that the shareholders are not selling any of their personal shares as part of the offering. That is, there’s no “taking the money and run” going on.  No way to know if that was a condition of doing the deal or not.

Finally, they note that they are going to start paying a quarterly dividend. They don’t say now much. Like most initial filings, there are bunch of financial holes in this one. Vail pays a dividend (current yield 1.97%) but Intrawest does not. Dividends can be highly problematic in one season businesses due to cash flow considerations. But it occurs to me that we may see larger mountain resorts paying them as they continue to turn themselves into year around operators.

I don’t know if Peak Resorts will succeed this time around, but I can certainly see why they want to get it done. Proven experience as operators, a diversified resort base, an industry that’s ripe for more acquisitions at good prices, the ability to integrate new properties, and growing year around revenue are things they will be able to take advantage of once debt reduction improves their cash flow and net income.

Et Tu, Nordstrom?

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Okay, I don’t precisely feel like Julius Caesar when he was stabbed by Brutus (Hey, at least his problems were over!). But I was initially kind of surprised by what my ever vigilant research department fed me from Nordstrom’s web site.

I’ve written about the tough retail environment. Among the topics I’ve highlighted are how over retailed the country is, the difficulty in getting sales growth, how hard it is for independent specialty retailers to compete, that consumers are increasingly in control, the impact of online and mobile and probably other stuff I just don’t remember.

I’ve never claimed to have “the answer.” But I’ve suggested that part of the response of brands and retailers has to be to manage distribution, control inventory and have systems such that you can hope to improve your bottom line even when sales aren’t growing as quickly as they used to. And know your customer and market position. Yeah, easy for me to say in two sentences. Not so easy to do. I know.

So when my wife- uh, I mean my research department- showed me this link from Nordstrom’s web site, I glanced at it but didn’t think much about it.

My wife likes Eileen Fisher, but this was available only in plus sizes so it was no sale. I couldn’t figure out why you’d want to boil perfectly good wool. Fermenting hops and barley I understand, but boiling wool?

Anyway, I said something like, “Nice coat.” She urged me to look again and showed me what had just popped up.

Nordstrompricematch

 

To be clear, she hadn’t found a lower price herself and requested a better deal. Nordstrom found it for her and offered a lower price.

This is Nordstrom. As far as I know, they compete on quality, service and ambiance. You don’t go there for the best price. You go there because it’s Christmas or your wife’s birthday and you want to pick out something nice in clothing, but you know if you do it yourself it won’t be right and at Nordstrom, some nice woman will talk you down and help you figure out what size your wife is and not say you should have checked in her closet before you came and help you pick out something that your wife might actually like and you don’t care what you have to pay for it. At least that’s what I’ve heard.

How does their business and expense model support price matching?

Okay, here’s how it works. This is from their web site.

“Price Matching”

“We are committed to offering you the best possible prices. We will meet similar retailers’ prices if you find an item that we offer available elsewhere. We’ll also be happy to adjust the price of an item you’ve purchased if it goes on sale within two weeks of your order date. Please note that price matching only applies to items of the same size and color. Designer items can only be matched when purchased at regular price.”

“We are unable to match prices from auction and outlet stores or their websites, or other retailers’ discount promotions, shipping offers and gift card offers.”

I feel a little less aggrieved after reading that. This is carefully controlled and managed and focused only on retailers that Nordstrom perceived to be their direct competitors.

This is a tactic by Nordstrom that probably just formalizes what’s going on anyway, so I’m now feeling less flummoxed. Nordstrom controls who they compare prices with. It’s not Kohl’s. It’s only retailers who have what I expect are cost structures similar to Nordstrom. And apparently, they don’t price match if the other retailer has it on sale. Wonder exactly how they program for that? How do you decide how much lower the other store’s price can be before that product is “on sale” and you no longer offer the price match? There are some interesting issues here. All part of figuring out the omnichannel I guess.

Perhaps this discourages some shoppers from doing their own price shopping while at the same time limiting the discount and making the shopper feel that Nordstrom is looking out for them. Maybe price matching only happens if you are slow to put the item in your cart, or leave it and then come back.

And as long as we’re on Nordstrom’s web site looking at women’s coats, check out this page. Look at the list of featured brands part way down on the left. Notice that The North Face is the only brand we’re likely to recognize as part of our industry. They are also the first brand listed even before you click through to see their offerings and their page has 53 coats.

The reason you might reflect on it is that VF owned North Face has somehow navigated the branding and positioning wars so that it’s fine for it to be an outdoor brand and a fashion brand among other fashion brands that are clearly not outdoor brands. My perception is that somehow The North Face’s credibility as both an outdoor and a technical mountain product has been translated so it provides credibility as a fashion brand.

We’ve watched and are watching lots of industry brands struggle with this. What is VF doing with The North Face (and Vans) that other brands don’t seem able to do? No magic wand I’m afraid. It’s VF’s processes, operational discipline, and strong balance sheet that make the difference.

Quiksilver Gets a Letter from an Unhappy Investor

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A reader sent me an article I imagine most of you have already seen, though I haven’t seen it covered in industry media. It tells us that Ryan Drexler of Consac, an owner of 2 million Quiksilver shares, has sent a letter to Quik Chairman Bob McKnight and CEO Andy Mooney stating that the company’s turnaround strategy has failed and that they should look to sell the company. Here’s a link to one of the articles that was published. A simple Google search will lead you to others.

And look what I just found! If you go here and click on the small document in the center of the page, the actual letter will open as a PDF. God, I love the internet.

He says, in part, “The 11-point turnaround plan announced by Andrew Mooney 16 months ago has thus far failed to deliver the desired results and, based on the deterioration in the company’s core brands since that time, has in actuality had a profound detrimental effect on the financial position and operating performance of the company, in my opinion.”

Mr. Drexler is known in some circles as an activist investor, and this isn’t the first company with issues he’s approached this way. There is a certain rhythm/process/ that happens when an investor does this, and the letter reflects it. I am not prepared to say, as Mr. Drexler does, that Quiksilver’s turnaround plan has failed. But I will continue to say what I’ve been saying; there’s a certain conflict between being a public company and Quiksilver maximizing the value of its brands, and the company’s weakening balance sheet limits the time they have to reinvigorate those brands.

The performance of the stock, as Mr. Drexler points out, suggests that he isn’t the only one with concerns. I’ve also become aware that certain of Quicksilver’s European debt is trading at $0.60 on the dollars. Actually, that’s on the Euro. The CUSIP is Z4840DAB6 if you want to check yourself.

I don’t know what’s going to happen, and maybe this is the last we hear from Mr. Drexler. On the other hand, it may be the start of a process. Quiksilver is on a shortening financial leash. At one time, I thought the solution might be to take the company private by doing a tender for the shares, but I no longer think that can happens. Even if you paid $0.00 for the shares, you’d own a company losing money with $900 million in debt and be faced with the same problem current management has.

I guess Quik’s board will have to respond to Mr. Drexler and perhaps we’ll see that response. The company’s next quarterly results are due to be released in early December. I’ll probably have more to say about their options when I see those. I mostly like Quik’s strategy. But I‘m becoming worried that they don’t have the time or money to pull it off.

About a year ago, a reader reminded me, I wrote this article relating some of Quiksilver CEO Andy Mooney’s comments in a conference call to the broader market and conjecturing on what some of Quik’s challenges might be. I don’t think I’d looked at since I posted it (I tend to be really, really, tired of articles by the time they finally make it on my web site), but it seems to have held up pretty well.

Learn to Ski and Snowboard Month; Can’t We All Do Just One Thing?

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Last week or so, SIA President David Ingemie sent out an appeal for support for the Learn to Ski and Snowboard Month bring a friend initiative. Check out the web site. Look under “The Challenge.”

While I’d love to say something strategically brilliant about the program and give you some blinding insights into its value, that should be pretty obvious. I’m afraid this is going to turn into a short commercial for the program.

If you take just a few minutes to wander around the Learn to Ski and Snowboard web site, you’ll probably figure out what I figured out- that’s there’s no reason a person planning a trip to a winter resort wouldn’t use this site. It’s full of deals and good information. Looks to me like you can pretty much plan your whole trip here.

I wonder if retailers point their customers to this site while they are in the store. Maybe they don’t like the deals on equipment part. It just seems to me that a retailer who can not only sell stuff but help the customer plan when and where to use it might have leg up. Kind of like scuba diving retailers acting as travel agents for diving trips. Of course, they make money on that.

As you all know, the snow sliding business faces the challenges of dependence on aging baby boomers, stagnating middle class incomes, an economy which, while strengthening, isn’t likely to go back to the way it used to be for a while, global warming, competitive from other leisure time activities, complete transparency (for better or worse) of pricing and costs, and the fact that our activities just don’t seem to be perceived by our potential customers (of which there are a lot) to be as cool as they once were. We aren’t alone. Other industries face some of these same challenges.

Meanwhile, among the good news I see from the winter resort is the extent to which those resorts are managing to sell summer products- hiking, mountain biking, golfing, water slides, zip lines, etc. You have no idea (well, some of you do) what a difference just getting 10 percent of your revenue during the summer makes.

Summer activities relate to winter ones because getting somebody to come to your resort in winter is a chance to convince them to come back during the summer.

There’s no magic bullet. Neither SIA nor any organization is going to “fix” the participation problem. What we’re facing, and have been facing, is a multiyear, and I am comfortable saying multidecade, ongoing issue that we can never resolve, but always work to improve. Wait- maybe I did just say something strategic.

And that’s where programs like the Learn to Ski and Snowboard Month come in. It won’t “solve” the problem. But every time this program and others like it get somebody to the hill for the first time, they create a potential customer for life. And every time a resort or a retailer makes sure the newbie has a good time and easy experience, they help do the same.

So look at the web site and think about what you can do for one person that might help get them on the hill.

Zumiez’s Quarter and Omnichannel Insights

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Zumiez reported a 12% increase in revenue for the quarter that ended August 2nd to $177 million from $158 million in the same quarter they last year. Their net income was up 57.3% from $4.74 to $7.46 million. Naturally, with that kind of good result, the stock fell 18.8% the next trading day from $32.4 to $26.31.

I don’t think I’d make it as an analyst on Wall Street. It’s not that I’d only focus on the current quarter’s results. The analysts also had some concerns about the rest of the year and those aren’t unreasonable. But if they took any kind of longer term perspective (which I’m beginning to think isn’t allowed if you’re an analyst) they might have focused on Zumiez’s efforts with the omnichannel stuff a bit more. I’ll get back to that, but first let me do what I always do- the numbers.

Zumiez ended the quarter with 535 stores in the U.S., 33 in Canada and 14 in Europe. They expect to end the year with 18 European stores. The sales increase was the result of having a net of 53 more stores open in this year’s quarter as well as a 3.4% increase in comparable store sales. Remember they include ecommerce in their comparable store sales (as I think they should). Interestingly, the 3.4% increase includes a 22.2% increase in ecommerce and only a 1.4% increase in comparable brick and mortar sales. Total ecommerce sales were 9.6% of total sales ($17 million) compared to 8.8% in last year’s quarter.

North American sales rose 10.1%. European sales were up 57.6% to $9.5 million and represented 5.4% of total sales.

The gross profit margin fell from 34.9% to 34.5% mostly due to a 0.6% decrease in product margin. SG&A expenses rose from $47.3 to $49.3 million. They fell as a percentage of revenues from 30% to 27.9%. 0.70% of the decline was because Zumiez didn’t need to accrue any additional cost for the Blue Tomato earn out.

The balance sheet is in good shape. I would note that for the six months ended August 2, net cash provided by operating activities was $30.5 million compared to $9.9 million in the same six months last year. I like cash.

Okay, now for the fun part. Here’s the first risk factor Zumiez lists. “Our ability to attract customers to our stores depends heavily on the success of the shopping malls in which many of our stores are located; any decrease in customer traffic in those malls could cause our sales to be less than expected.”

I don’t necessarily take risk factors too seriously, but I don’t ignore them either. This one caught my attention because it was listed first, I didn’t recall seeing it before, I posted something about the future of malls recently, and I think the trends in malls have a strong relationship to the evolution of a retailer’s omnichannel strategy. Or maybe I mean that omnichannel strategies are causing some of those trends.

It’s all kind of a big mish mash of trends, possibilities, experiments, false starts, new ideas, and unexpected relationships. I don’t know the answer. Neither does Zumiez. But they do seem to know they are stuck with it and are working hard to find out what works and what doesn’t.

Let me quote CEO Rick Brooks a few times. Please keep being quotable Rick. I love it when I can write these things by cutting and pasting.

“…we view really what we are doing- the integration of building a channeless retail experience for our customers- as a never ending job because the customers are in charge, they are the ones that have the power in today’s world because of smart technology, we need to go where they want to go, however they want to do it, we’re going to be there to serve them and we don’t know exactly what that’s going to look like again. I tend to think with their early stages of this transition not the latter stages.”

“So we’re going to try all sorts of things, we’re going to measure what happens when we close stores and markets, what happens to the integrated omnichannel business. Well we already know it’s a huge list when we open stores in markets. But so we’re going to continue and to really experiment with these ideas and measure where we’re going to be.”

“As we continue to expand our omnichannel capabilities and bring our highly differentiated and lifestyle relevant product and perspective to the marketplace, we believe that we can maintain strong merchandise margins through full price selling.”

“We also strongly believe that the enhanced connection with our consumers that is enabled by heightened omnichannel presence will be a key point of differentiation in the rapidly evolving retail landscape.”

I’ve written a few times that the biggest risk was taking no risk at all, and I’m guessing Zumiez’s management team would buy into that. They don’t know how this all going to work, but they know it’s happening and if they aren’t part of it, they will not prosper.

I’ve quoted CEO Brooks enough, but also interesting was his discussions about opening (or closing) stores. The goal is not to open stores. It’s to have the right kind and size of stores in the right place supported with the correct omnichannel presence and activities. Whatever you do with stores, you do it to meet a customer requirement. Maybe there are some places where you would have opened stores in the past, but now you won’t and not opening will be net positive for your bottom line.

If I could get Mr. Brooks and members of his team in a bar and get a few drinks into them, I’d love to find out how their organizational structure is evolving in response to the omnichannel and retail evolution. To me, it seems like every function is connected to and influenced by every other function in ways they haven’t been before. At least for me (a closet organizational dynamics junkie) this is going to be fun.

You can see where a strong balance sheet comes in. Whether you’re a brand or a retailer, you need to be paying attention. You’re going to spend some money on things that aren’t going to work, but that has to be okay.

The Future of Malls and Impact on Industry Retailers

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I have in front of me the pleasant task of reviewing the quarterly fillings of a bunch of our favorite retailers. But before I get to that, I thought I might point you at this article that talks about the future of malls in the U.S. It may have something to do with the evolution of retail.

Like me, you know that we’ve got way too much retail space in this country across all industries. But when the article tells us we’ve got 50 square feet for every man, woman, and child and Great Britain (which may be less great by the time you see this depending on the Scot’s independence vote) comes in second with 10 square feet, you began to get a sense of just how big the problem is.

The article (go read it) talks about anticipated mall closings, how no new malls have been opened since 2006, and that’s it’s only the high end malls that can expect to prosper. He also makes the rather obvious point that online is cannibalizing, brick and mortar sales.

Most of the retailers I follow, of course, are opening new stores. Those new stores are a critical part of their long term growth strategy. As they open these stores, they chant, “Omnichannel! Omnichannel!” like it’s a protective talisman with mystical powers.

For some I guess it will be. They will the ones who figure out how to integrate brick and mortar with mobile and online to generate enough incremental operating income to pay for all the costs they incur in the process. I’ve pointed that out before.

But that additional operating income won’t all come from more revenues. It will come from smaller stores, configured and merchandised differently. It will come from lower inventory levels as more sophisticated systems and increasing comfort with getting it next day or the day after means customers can be satisfied without having every piece in all sizes and colors in each store. I also think it’s going to come from increased U.S. manufacturing, resulting in shorter lead times.

Finally, and most importantly, it’s going to come from an increasing understanding of how mobile and online relates to brick and mortar.  That is, the decision as to where and what kind of store to open will be influenced by the online/mobile activities and demands of customers in the area, or potential area, of the store.

And, by the way, I’m not quite sure I know what “store” is going to mean in the future. Larger or smaller? Permanent or temporary? What will location criteria be? How will they be fixture and inventoried? Will they sell the actual product or maybe just let the customer see the product then download the specs to be used at home on their 3D printer? You might want to listen to this Ted Talk on the subject. Consider the implications for manufacturing and supply channels.

Remember this is all going to be happening while brands stop telling customers what they should buy and have to ask customers what they want to buy and give it to them- quickly. I don’t know how this is all going to work out, but it should be fascinating. And it’s not all going to happen in malls.

Quik’s July 31 Quarter: Restructuring Results Slow to Appear.

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You know, maybe it’s a delusion, but an awful lot of corporate reports for the companies I follow are starting to sound the same. I need to read something else. Most of them say some variation of we’re trying to figure out how to integrate brick and mortar with online, sales growth is hard to come by, we’re rationalizing expenses and improving efficiencies, we’re reducing SKUs, we’re improving systems to get the right inventory to the right place at the right time, we have some constraints caused by our balance sheet, the U.S. market is especially tough, we’re pinning our hopes on Asia/Pacific, we’re trying to improve product, we’re focused on building our brands and managing our distribution, and the market is very promotional.

I think that covers it, and now I have to somehow relate that introduction back to Quiksilver. I guess I can do that by saying they are dealing with most of these issues.

Sales for the quarter ended July 31, 2014 fell 18.9% from $488 million in last year’s quarter to $396 million. Sales declines in the Americas, EMEA and APAC respectively were 26.8%, 12.8% and 1.8%.

The gross profit margin was down from 49.1% to 47.8%. The Americas gross margin fell from 41.9% to 40.2%. In EMEA it went down from 58.4% to 55.6%. In APAC it rose from 51.4% to 56.8%. The decline in gross margin “…was primarily due to increased discounting in the wholesale channels of North America and Europe (320 basis points), partially offset by net revenue growth from our higher margin direct-to-consumer channels (160 basis points).”

SG&A expenses were down just 1% from $215 to $213 million, but as a percentage of sales they were up mightily, from 44% to 53.8%. They reduced athlete and event spending by $5 million, but had a gain on the sale of a building of $5 million. Employee compensation fell $4 million because they didn’t have the severance costs they had last year. They spent an additional $5 million on marketing other than athletes and events, had $3 million more in bad debt expense and $2 million in higher depreciation.

Operating profit went from a positive $23 million to a loss of $206 million. However, that includes noncash goodwill impairment related to European assets of $182 million. Remember, however, that even though it’s noncash, it’s indicative of lower expected future cash flows from the assets being written down.

Ignoring all the noncash charges in this year and last year’s quarter, operating income fell from a positive $25 million to a negative $24 million, so it’s hardly good news. Interest expense was about $19 million compared to $20 million last year. There was a bottom line net loss (including the write down) of $222 million compared to a profit of $1.8 million last year.

Here’s the chart from the 10-Q that lays it all out for you by segment. You can see the 10-Q here if you want, though I doubt anybody ever goes to look. The Americas segment is just what you’d think it is and most of its revenue comes from the U.S., Canada, Brazil and Mexica. EMEA is Europe, the Middle East and Africa, but mostly the revenue is from Great Britain, continental Europe, Russia and South Africa. APAC (Asia and the Pacific Rim) is mostly Australia, Japan, New Zealand, South Korea Taiwan and Indonesia. Notice how China does not make the top six yet.

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Quiksilver, by the way, ended the quarter with 658 company owned stores. They are on pace to open a net of 60 new stores by the end of this fiscal year.

Please note that APAC’s operating income rose $3 million on a small decline in sales. Ain’t nothing like raising that gross margin.

In the Americas, “This net revenue decrease was primarily due to lower net revenues from our DC brand in the wholesale channel of $47 million driven by reduced clearance sales, narrowed product distribution to mid-tier wholesale customers, and the licensing of DC children’s apparel. In addition, net revenues decreased in the Quiksilver and Roxy brands by $14 million and $7 million, respectively, in the wholesale channel due to licensing of Quiksilver children’s apparel, lower customer demand, and less effective order fulfillment compared to the prior year. Americas segment net revenues decreased 28% in the developed markets of North America, but increased 9% on a combined basis in the emerging markets of Brazil and Mexico.”

The licensed kids business was responsible for $11 million, or 16% of the decline in the North America wholesale business.

I want you to specifically note that they are pulling back DC’s distribution with the goal of strengthening the brand. It’s about time. In this case at least, they are giving up some sales in a good cause.

There isn’t much good news about revenues in AMEA. The decline is “…due to lower revenues in the wholesale channel across all three brands driven by lower customer demand as a result of poor prior season’s sell through, and less effective order fulfillment compared to the prior year. These decreases were partially offset by double-digit percentage growth in the e-commerce channel … ”

Lower demand, poor sell through, and troubles with order fulfillment is quite a triple whammy.

In APAC, wholesale revenues were down but that was offset by growth in retail and e-commerce.

Here’s revenue for the quarter by brand.

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The decline in the Quiksilver brand “…was primarily due to reduced net revenues in the Americas and EMEA wholesale channels of approximately $14 million and $15 million, respectively. A portion of the decrease in Quiksilver brand net revenues ($6 million) was due to the licensing of children’s apparel.

The Roxy decline “…was primarily due to lower net revenues in the Americas and EMEA wholesale channels of approximately $7 million each, partially offset by increased revenues in the e-commerce and retail channels.” Roxy was not licensed for children’s apparel.

DC’s decrease in revenue “…was primarily driven by lower net revenues in the Americas and EMEA wholesale channels of $48 million and $10 million, respectively. The Americas net revenue decrease was driven by reduced clearance sales, narrowed product distribution to mid-tier wholesale customers, and the licensing of DC children’s apparel.” They also reported successfully launching DC’s offering in “accessibly priced canvas footwear market,” and expect a positive impact going forward.

So it seems we can conclude that wholesale in the Americas and EMEA kind of sucks. You can see the problem in this chart showing sales by channel.

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I’d like to point out the relative contribution to revenue of wholesale compared to retail and e-commerce. There were gains totaling $7 million in retail and e-commerce and a decline of $100 million in wholesale. E-commerce revenues were down 9% in the Americas by the way. Global comparative store sales were up 1% during the quarter. So when Quik talks about retail and e-commerce offsetting wholesale, it’s not much of an offset overall.

Looking at the balance sheet, you’ve got a current ratio that improved from 1.73 a year ago to 2.46 as of July 31. Long term debt is up slightly from $808 to $812 million. Total liabilities to equity have vaulted from 2.97 to 10.6 times. Liabilities fell significantly from $1.64 to $1.2 billion, but equity was down from $553 to $114 million.

Quiksilver notes that they are updating their profit improvement plan “…based upon recent difficulties within the wholesale channels of our Americas and EMEA segments. As part of updating our PIP, we will establish additional SG&A reduction objectives and allocate capital to our emerging markets, e-commerce and retail channel growth plans.” So more expense cuts to come.

In a short section on page 29 of the 10-Q called “Known or Anticipated Trends,” Quik gives us a look at what the future looks like. Over the next few quarters they expect net revenue comparisons will be “unfavorable.” That means they will be lower when compared against the previous year’s quarter. For the year they expect them to be “unfavorable” in North America and Europe wholesale but favorable in emerging markets and e-commerce. Didn’t say anything about retail.

“Unfavorable” is such a benign sounding word for such an unfortunate result, speaking of benign words.

They also tell us that the adjusted EBITDA for the year that ends October 31 will be lower than for the previous year. I tend to believe that if the adjusted figure is worse, the as reported will be even worse. Maybe I should have said “unfavorable.”

There’s a lot going on. Some of the things I think Quik is doing right have caused what I hope are short term difficulties. Reducing DC’s distribution is absolutely critical to the brand’s success, but in the short term costs revenue. They’ve stopped or at least reduced discounting on their web sites. Again, a possible short term revenue hit, but good for the brands. Just as a guess, I expect core shops to like that.

In the conference call, CEO Andy Mooney announced, as part of their positive accomplishments, that “…we moved a large number of small independent accounts to a B@B service model.” I understand the financial rationale for doing that, but I have reason to believe you shouldn’t expect those accounts to see it as positive.

And literally as I write this, I got an email telling me that Quik is reorganizing its marketing function to help give it a better connection to the core.

They also decided not to order any products in quantities below production minimums because of the additional cost. That eliminated some orders, but helps gross margin. Some late deliveries were the result of changing from regional to global demand planning, but it’s a good thing to do anyway.

There was also some discussion about the previously announced program to selectively reduce prices. They don’t expect it to reduce margins given the other efforts they’ve taken to reduce SKUs and rationalize production.

Quik is making changes in every facet of their operations. That some of them didn’t quite go according to schedule isn’t a surprise. I just heard from a client that they’ve got a container held up in customs because of an “invasive moth.” God, you just can’t make this stuff up and to some extent it happens to every company every year.

But Quiksilver doesn’t have the luxury of time. Its brand building (rebuilding?) has to be successful sooner rather than later. Its balance sheet can’t continue to deteriorate, but it sounds like we can expect further losses in the next few quarters. For all the things I think they are doing right, there’s a time limit here that’s gotten shorter as a result of a couple of tough quarters.

The Issue Continues to be Competitive Positioning: PacSun’s Quarter

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Back in its glory days, PacSun was a destination for its young customers and expanded to around 900 stores. It lost its way for reasons that included too much growth and overexposure, unattractive stores, problems getting the right product to the right stores at the right time, thoughtful, better positioned competitors, and a weak economy.

I remember Gary Schoenfeld, in his first earnings conference call as CEO, saying something like, “Nobody needs 900 PacSun stores.” By the end of this year’s August 3rd quarter, the company was down to 618 stores. During his tenure, Gary has improved the executive team and in process turned it almost completely over, worked to better merchandise the stores, and invested in systems to get the right product to the right stores at the right time. Well, the list is longer than that, but basically Gary and his team are doing the things a CEO of a large retail chain should be doing.

But the really hard thing here is the competitive positioning issue. When you’ve lost your target customers’ attention- their commitment to come to your store or buy from you on line- how do you get it back in a weak economy that’s over retailed and offers the customer endless alternatives?

Part of PacSun’s answer to trying to reengage its “teen and young adult” target customers is its Golden State of Mind campaign, which I like a lot. My liking it, of course, is irrelevant. I’m a few decades removed from being the target customer, and get strange looks when I walk in a PacSun store. But they’ve put a stake in the ground. They’ve identified what they think is a point of differentiation and are trying to make it work. Good. Here’s how CEO Schoenfeld put it in the conference call.

“We remain keenly focused on differentiating and elevating PacSun through the best branded assortment and specialty retail, continuously elevating our merchandising mix to appeal to our trend and style savvy 17 to 24 year old guys and girls and connecting our customers to the creativity, diversity and as I like to say, the optimism that is so uniquely California lifestyle and synonymous with PacSun.”

As we review PacSun’s numbers, and their discussion of those results, don’t get distracted from the issue of competitive positioning. They can do everything else right but if ultimately they can’t distinguish themselves from their many competitors in a way that makes their target customers want to buy from them, it won’t matter. Just like for every business.

Revenue rose slightly from the same quarter last year from $210 to $211 million. Comparable store sales were up 0.3%. The average sales transaction was up 7%, but the total number of transactions fell by 6%;

The gross margin fell from 29.8% to 29.1%. Remember the gross margin is after buying, distribution and occupancy costs. The merchandise margin fell from 53% to 52.3%

Selling, general and administrative expenses rose from $56.7 to $60.6 million. As a percentage of sales, they increased from 27.0% to 28.6%. 0.8% of that increase is the result of marketing costs that happened earlier than expected. The other 0.8% results from “…consulting costs supporting long-term strategies and store impairment charges, partially offset by a decrease in store payroll and payroll-related expenses.”

This left PacSun with an operating income that fell from $5.9 million to $1 million.

The next item on the income statement is the “(Gain) loss on derivative liability” we get to discuss every quarter. This relates to 1,000 shares of convertible preferred stock PacSun issued to Golden Gate Capital as part of getting a $60 million term loan. The value moves around a lot every quarter and impacts the income statement. In last year’s quarter, it was a loss of $21.2 million. For this year’s quarter, it’s a gain of $10.4 million. That’s a $31.6 million difference from last year to this year.

The bottom line impact is that PacSun showed a $19.2 million loss in last year’s quarter and a profit of $7.5 million in this year’s. Obviously, the big change in the value of the derivative liability distorts that, and will in future quarters. I recommend you look at the change in operating income when you consider how PacSun is doing.

On the balance sheet, the current ratio improved slightly from 1.05 to 1.12. Total liabilities to equity deteriorated from 13.89 to 18.29 times. However, once again we’ve got to point out that derivative liability which is carried as a current liability. It was $50.5 million at the end of last year’s quarter and is down to $19.1 million at August 2nd this year. If that didn’t exist, the current ratio would have declined from 1.47 to 1.28. We learn in the conference call that inventory on a comparable store basis was down 5%.

I want to highlight something they say about operating cash flows. “Net cash provided by operating activities in the first half of fiscal 2014 was $1.1 million, compared to $17.1 million of cash used for the first half of fiscal 2013. This increase of $18.2 million was due primarily to increases in accounts payable and other current liabilities.” One interpretation would be that they are paying their bills a little more slowly. That’s not necessarily a bad thing, as we former cash managers can tell you.

CEO Schoenfeld also notes in the conference call that the overall market is very competitive and specifically points to denim as “…not a very fun business to be in right now.” I think we all know that.

He also makes an interesting comment about how PacSun had, in the last couple of years, moved its non-apparel women’s business “…to a more private label and trying to compete on price with some of the more aggressive fast fashion retailers.” He makes it clear that didn’t work, and they are once again focused on who PacSun is and what it stands for.

That’s where they have to be focused. As I indicated, I like the Golden State of Mind positioning concept, but as they’ve moved into the different competitive environment of the broader fashion business I am waiting to see how that resonates.