Interview with Blue Montgomery

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Some people up in Canada decided, for whatever reason, to start an action sports industry news magazine called The BoardPress.  Their sanity in trying to do this can be questioned, but they sent me a copy of their first print magazine, which came out some months ago. Probably hoping I’d write something about them. It seems to have worked.

They featured an interview with Blue Montgomery, one of Capita’s founders that I highly recommend. I think I’ve met Blue like twice but I’ve never had a long conversation with him.

Most of these stories with brand founders in our media tend to be heroic epics with the goal of promoting the brand. I’m not claiming the people at Capita were unhappy to get the publicity, but the article was way better than the usual stuff.

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SPY’s Results for the Year and Some Thoughts on Their Market Position

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As I’ve written before, I have a lot of respect for how SPY has restructured and repositioned itself. There seems to be an alignment of their corporate culture and market positioning that not only has the potential to differentiate the brand (in their market), but to save money and increase the efficiency of the organization.

Here’s how they put it in the 10K for the year ended December 31, 2014:

“We have a happy disrespect for the usual way of looking (at life) and this helps drive our innovative design, marketing and distribution of premium products, especially eyewear for youth-minded people who love to be outside doing what makes them feel most alive and happy. We feel a primary strength is our ability to create distinctive products that embody our unique, happy, and irreverent point of view, and this has helped us become what we believe is one of the most recognizable action sports and eyewear brands in the world, with a twenty-year heritage in surfing, motocross, snowboarding, cycling, skateboarding, snow skiing, motorsports, wakeboarding, multi-sports and mountain biking. We have a happy disrespect for the usual way of looking (at life) and this helps drive our innovative design, marketing and distribution of premium products, especially eyewear for youth-minded people who love to be outside doing what makes them feel most alive and happy. We feel a primary strength is our ability to create distinctive products that embody our unique, happy, and irreverent point of view, and this has helped us become what we believe is one of the most recognizable action sports and eyewear brands in the world, with a twenty-year heritage in surfing, motocross, snowboarding, cycling, skateboarding, snow skiing, motorsports, wakeboarding, multi-sports and mountain biking.”

So is irreverence really an attribute that can provide a competitive advantage? Think about that and we’ll get back to it after going over the numbers.

For the year, sales rose 0.9% to $38.1 million. Below is the breakdown of those sales by product line.

spy 12-31-14 10k image 1

 

 

 

 

 

 

The sales increase was due to increases in prescription frames and goggles. Sunglass sales fell by 5.7%, or $1.5 million. They say that decline was “…principally attributable to an overall decline in the consumer market, particularly during the second quarter of 2014, coupled with several key retailers currently holding lower levels of inventory, lower closeout sales of our sunglass products and the loss of a key account.”

I’d note that SPY gets 64% of revenues from the very competitive sunglass category (down from almost 69% last year. 16.5% of revenue internationally is low compare to a lot of other companies, but that may turn out to be a good thing given the strength of the U.S. dollar. A strong dollar means that SPY’s product cost falls (same for all internationally sourcing companies). But it also means that the dollar value of their internationally sold product comes down when translated. The more international sales you have, the bigger the currency related decline in those sales.

Gross profit margin rose from 49.9% to 50.6%. The increase was due to purchasing more product from China (instead of Italy) and having lower closeout sales, which fell from $2.8 to $2.0 million.

Sales and marketing spending grew by $0.2 million to $11.5 million. I see they spent more on marketing events and promotions. Good. Advertising expense rose from $394,000 to $540,000. Also good.

Meanwhile, SPY cut general and administrative expenses by 6.9% to $5.7 million. They did it by reducing bad debt expense $0.3 million through better collections and consulting and outside services by another $0.3 million. They took a chunk of those savings $0.4 million) and invested them in salaries. I assume for people who are doing productive things for the brand.

The result was operating income that grew from $399,000 to $890,000.

Below the operating line, there’s that inconvenient line “interest expense.” It declined from $2.97 million in 2013 to $2.5 million in 2014. Remember the interest rate was reduced significantly during 2014 and you’ll see that impact even more in 2015.

Largely as a result of that interest expense, SPY reported a loss for the year of $1.9 million, an improvement from the loss of $2.9 million the previous year.

In terms of revenue, the fourth quarter was stronger than last year’s quarter, with revenue rising from $8.6 to $9.8 million. The net loss was $423,000 compared to $1.265 million in last year’s quarter. That explains most of the improvement in the bottom line over the whole year.

Over on the balance sheet, there’s still that note payable to shareholder of $21.6 million, but it’s up only very slightly from $21.5 million at the end of the previous year. However, the line of credit rose from $4 million a year ago to $6.8 million at the end of this year.

The current ratio has fallen a bit from 1.6 to 1.3. I see that receivables rose 9.6% with sales up just 0.9% and their mention of collecting receivables better. And I see yearend inventory up 31% to $7.7 million. I wonder if that might not have something to do with lousy snow conditions up and down the West coast making it difficult to sell snow goggles.

If so, SPY is hardly the only company with that issue. I see they’ve increased their allowance for returns from $1.6 to $2 million, so maybe I’m on to something.

As we transition from the financials to strategy, I want to remind you of the licensing deal SPY signed. Here’s how they describe it:

“In December 2013, we entered into a merchandising license agreement, pursuant to which we licensed the SPY IP [intellectual property] to a third party…The agreement provides that the licensee shall develop, introduce, market and sell certain licensed products incorporating the SPY IP, including men’s and boy’s apparel, bags and luggage, consumer electronics, protective cases, and other unisex accessories, throughout North America through certain distribution channels, other than deep discount retail channels.”

They expect those products to start generating revenue this quarter, but don’t offer any clue as to how much. Wish I knew what SPY’s definition of “deep discount retail channels” was. I also wonder if these products will get sold into any existing SPY accounts and how that will get managed.

To get out of its balance sheet hole, SPY needs more bottom line earnings. Perhaps these royalties will make a meaningful contribution to that. Meanwhile, SPY is a small company in a market of some big companies with much greater resources than SPY. The traditional response of smaller companies in this situation is to position itself as a niche company, and I’d say that’s what SPY has done.

Here’s how they describe it:

SPY “…is a creative, performance-driven brand that is fueled by collaborative efforts across various facets of youth culture, including competition, art, music and day-to-day athletic performance. We strive to ensure that our in function and design, as well as style. We do this, in part, through partnerships with our world class athletes who help us design, then wear and test our products during training and competition. We believe that the intimate knowledge of our customers’ lifestyles is what helps us develop a stronger, more relevant product offering for our market. We reinforce our irreverent brand profile through unique and disruptive marketing, using traditional and non-traditional means to convey our branded point of view to both entertain and edify people…”

You can’t have intimate knowledge of your customer’s lifestyle if that customer base is very broad- especially as a small company. This is a bit of a conundrum for SPY, and for similarly positioned companies. You need growth, but as you move to broaden your existing market, you may start to lose the thing that has made you special to the existing customer base without attracting the new customers.

What I think may happen is that the attitudes and lifestyles of the millennial generation (larger than the baby boomers) may reduce this challenge. Facilitated by mobile/internet/omnichannel/ecommerce, etc. certain traditional issues of segmentation and perhaps demographics are, I think, going to become less important.

That’s where SPY’s opportunity may lie.

Billabong Turns a Profit; But There’s More Work to Do

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Wow, this is going to be way shorter than most of my previous Billabong articles. Where’s the drama, the kind of hard to get your head around accounting, the recapitalizations and explanations thereof, the endless list of “significant items” I always complain about?

Gone. Mostly. Well, not all the significant items. Billabong is implementing their plan and running their business. The watch word that ran through the conference call was “transparent” and the call and documents really were.

We’ll get to the numbers. First, I want to show you and discuss a few quotes from CEO Neil Fiske.

“I think we’re getting better at running our operations, sometimes at the expense of pumping up top line sales, but with better margins…We tried to maintain a full price brand building, equity building business, and not chase volume for the sake of volume, where we’d dilute our margins.”

Long time readers know I’ve been recommending a focus on operating profit over sales growth (not specifically for Billabong) since sometime in 2008 when the Great Recession hit. You certainly leave the financial documents and conference call with the sense that Billabong has the chance to grow sales, but I suspect as they get more of their systems/supplier/logistics/ changes done, we’ll see efficiency improvement that will also help their bottom line.

Speaking of that, here’s the link to the Billabong investor page. You can review all the documents from the half year report and see the conference call transcript and presentation. If you want to. If you don’t, at least open the transcript and start reading two thirds of the way down page five with the paragraph that starts “Ultimately.” Read about two pages from there and see what they are doing with their systems, suppliers, and logistics.

What they are doing is really hard, really disruptive, really complex, and really necessary. Good for them.

“For the first time, we will have one system capable of supporting all our channels in all our regions, including brick and mortar, retail, catalogue, digital commerce, wholesale accounts and licensed stores.”

The goal is deploy the new platform in 12 to 15 months. That’s just one of the systems they are working on. They are also in the process of “…reducing our global vendor list from over multiple hundreds of suppliers to a much smaller group of preferred vendors.”

This is not just about buying some computers and software. That’s the easiest, though not easy, part. It’s aligning the people and processes to get the most out of those systems that’s hardest.

Those processes include “…tighter integration between merchandising and sales and marketing in our go-to-market calendar…” Neil notes that they are “Going to market with a point of view about what’s important, what we stand for and what we want them [the retailers] to get behind.

All things being equal, I’d expect these changes to offer opportunities to both increase revenue and cut costs as they come on line.

The Numbers

Let’s start with the “as reported” numbers. All numbers are in Australian dollars. As we do that, keep in mind they sold West 49 in February 2014 and SurfStitch and Swell in September of the same year. We’ll look at the numbers without them in a bit.

Revenue from continuing operations for the six months ended December 31, 2014 fell just slightly from $527.2 to $525.8 million. Gross margin rose from 44.8% to 45.2%. SG & A expense was down 1.85% from $217.2 to $203.2 million. The result was an operating profit from continuing operations of $12.5 million, a big improvement from a loss of $34.9 million in the pcp.

Net profit was $25.7 million, up from a loss of $126.3 million in the pcp. $71.4 million of that improvement comes from a change in income tax expense and has nothing to do with how the business operated. Interest expense fell from $57.2 million to $16.2 million as a result of the restructuring. Discontinued operations contributed an after tax profit of $10.5 million compared to a loss of $23.1 million in the pcp.

If you add up the changes in income taxes, interest expense and discontinued operations you’ll find that the improvement in net income as reported was only about $6 million excluding those items. It’s not quite as simple as that, but you can see what I mean.

Obviously, there was a lot going on and Billabong has helped us to isolate that so we can see how the business is doing. You know what the discontinued operations represent. The “significant items” generated income of $13.5 million in the most recent period. They were an expense of $65.6 million in the pcp. They are restructuring costs, deal costs, inventory write downs, and a host of other stuff. See footnote 4 in the financial statements if you’re interested.

We could have a long conversation about which of these should be included or excluded. Every company seems to have some new significant items or extraordinary events or one time charges pretty much every year. They have an impact on the bottom line. Some, I’m okay with excluding for the operating analysis. Others, not so much. Anyway, let’s just acknowledge that there’s a certain amount of art in this and move on.

Below are the segment revenues and EDITDAs including the items and discontinued operations.

Billabond 12-31-14 results chart 1

 

 

 

 

 

Next, from the presentation during the call, here’s a breakdown of revenue and EBITDA by geographic segment that excluded the significant items and sold businesses.

Billabong 12-31-14 results chart 2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

You can see that revenues fell slightly as did EBITDA. The gross margin for the continuing business was 54.9%, down from 55.4% in the pcp.

In the Americas, Billabong and RVCA grew 9.5% and 5.7% respectively. There was weakness in the Canadian market and Element brand. There was $6.1 million less in wholesale business from West 49, who is now a wholesale customer. CEO Neil Fiske makes the interest comment that “…when we owned this business [West 49], we were pushing our family brands hard. Arguably with too much inventory and too little regard for the natural level of consumer demand.”

Comparative store sales were down 3.5% in the Americas, but only 0.4% in the U.S. The number of stores fell from 173 to 68 mostly due to the sale of West 49.

The good news in Europe is the strong performance of Element (we aren’t told exactly what that means) and the improvement in the gross margin from 49.4% to 55.9% after adjusting for the divestments. It was even a little better as reported. You can see the result above in the improved EBITDA. Neil says the improved margin was “…driven by better inventory control, improved merchant planning, margin management and a focus on higher quality distribution.” Comparative store sales were flat but store margins rose 1.7%. The number of stores, at 111, was down from 112 in the pcp.

Asia Pacific suffered from soft Australian retail sales.

It’s interesting that we still don’t hear much about their other brands. They do mention opening some Tiger Lily shops, but that’s it. I’d be curious to hear what’s going on with Sector 9 and Excel, among others. I still wouldn’t be surprised to see the sale of some other brands.

The balance sheet has strengthened enough as a result of the recapitalization that I’m going to pay them the compliment of not spending much time on it. Non-current liabilities have fallen from $512 million a year ago to $268 million at the end of December 2014. Equity has risen from $194 million to $311 million. If I wanted to pick around the edges a little, I might ask why receivables were actually up a bit given the decline in revenue. Maybe because of the growth of the wholesale business. Cash flow from operations was a positive $13.7 million for the six months compared to a negative $27.3 million in the pcp.

So “stabilizing,” the word Neil Fiske uses, is the right one to describe the continuing business. The profit turnaround is more about the taxes, interest and discontinued operations. However, a chunk of that represents benefits Billabong will continue to see- especially the interest expense reduction. The plan they are pursuing is the same one Neil announced when he took the CEO job, and it looks like they continue to move forward.

 

 

 

 

Berrics Consumer Report

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You know, I always assumed/took for granted that skateboards you bought at Walmart or other large discount chains were not too good. I have to admit though that sometimes I thought to myself that maybe they weren’t a bad idea for a first deck if somebody was starting out.

To be clear, I’m way too old to fall on concrete or asphalt, so I didn’t test that hypothesis myself. Happily, The Berrics Consumer Report has.

I can’t help but remind you that it’s basically one guy testing a couple of boards and that he’s doing things some skaters never do.  But the results seem so compelling that even I, who believe in large sample sizes, statistical validation, comparisons against a norm, and all sort of statistical stuff took notice.

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Kering’s Annual Report and Some Thoughts on Volcom’s Role.

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Kering, the owner of Volcom and Electric, presented its annual results for 2014 last week and held the usual conference call. As regular readers know, I was impressed at the job Volcom did selling itself to Kering (then PPR) both in terms of the price they achieved and their timing. The deal happened almost four years ago.

Following the acquisition, I chronicled (as best I could given the limited information Kering provided on the separate performance of Volcom and Electric) what I’d call some apparent difficulties with integration and performance by the brands that I thought didn’t live up to Kering’s expectations given the price they paid ($607 million). It felt a little like Deckers’ purchase of Sanuk.

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The Abercrombie & Fitch Story. What Went Wrong?

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You have heard me say from time to time that companies get into trouble due to denial and perseverance in a period of change. I’ve also noted that it’s typically not the founder or executive who’s been in charge for a long time who can fix the problems.

Their perception of the organization, relationships with the people (employees and other stakeholders) and, ultimately, responsibility for the problems, or at least for not addressing them effectively, makes it difficult for them act as a change agent. Often even recognizing, until things get really tough, the need for the change is hard. The arrogance that successful entrepreneurs justifiably have (or they would never have succeeded in the first place) can get in the way as well.

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Deckers Has a Pretty Good Quarter. Sanuk, Not So Much.

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The overall numbers for Deckers for the quarter look pretty good. But some of the comments left me a bit perplexed. Meanwhile, Sanuk is still not performing the way Deckers must have expected when they bought it.

Overall Results

In the quarter ended December 31, Deckers’ revenue rose 6.6% from $736 to $785 million. The gross profit margin rose from 51.1% to 52.9%. Part of the increase was due to their acquiring their German distributor. Net income was up 11.2% from $141 to $157 million. It would have been stronger, but revenue came in 3% below expectations.

CEO Angel Martinez explained the revenue miss in the conference call.

“As temperatures turned colder across the U.S. with the exception of the West Coast, which has remained unseasonably warm, demand for our weather collections spiked. We experienced strong gains in technical boots, fashion waterproof boots and boots with rain application. In total, sales of our weather offerings grew over 70%.”

“In many instances, demand for casual and weather boots [due to early cold weather] exceeded our inventory investments . As a result, we believe we missed nearly $7 million to $10 million in sales from domestic wholesale reorders as we were unable to fulfill 100% of the demand for these collections. We also believe that we missed approximately $2 million in online sales due to sellout of weather and casual boot product.”

“This shift to expanded categories has highlighted the need to further improve our ability to plan and manage our product and inventory strategy against these consumer purchasing trends. This also requires some adjustments in our product and marketing strategies at both wholesale and in our DTC channels, which we are currently implementing.”

This is a little confusing to me. If they were projecting revenues 3% higher, I would have expected them to have the required inventory on hand. But above he’s saying they missed $9-$12 million in revenue because they didn’t have inventory. Is that on top of the 3% miss?

At some level, this is a great problem to have as a CEO. Sure, we can all stand to work on improving our flexibility in getting the right product to the right market at the right time and to respond more quickly to changing market conditions. But I doubt either Mr. Martinez or any of Deckers’ other executives are going to get any better at predicting the weather.

Meanwhile, the gross margin rose and, as I’ve argued a bunch of times before, I bet a little scarcity wasn’t completely a bad thing for the brand. I might even connect some of the gross margin improvement with the scarcity. We do learn that, “…closeout sales decreased as a percentage of overall sales and had higher margins compared with the same period last year.”

But then he goes on and confuses me some more.

“Classics had a very good second quarter, both from a sell-in and sell-through perspective, which created some bullish expectations among our retailers and internally for the third quarter. This was the main driver behind our decision to raise guidance on our last earnings call. Unfortunately, most of November, with the exception of Black Friday and Cyber Monday weekend, was below plan, which we believe was a result of mild temperatures in certain markets and weak store traffic trends across the industry. Sales trends accelerated as the quarter progressed. However, it wasn’t enough to offset the slow start, which eventually led to some cancellations primarily in our domestic wholesale channels in December.”

You can, I think, see my confusion. On the one hand, Deckers missed some sales because of cold weather. On the other hand, they missed some because of warm weather. And all in the same quarter. I guess they are talking about different geographic markets and products, but a little clarity would be nice.

The UGG brand is branching out. You might check out their web site and note the UGG branded products under categories such as loungewear, handbags and home.

$402 million of the quarter’s revenue, or 51%, came from the UGG wholesale business. But that was up only half a percent from last year’s quarter. Total wholesale business for the quarter was $445 million, up from $441 million in last year’s quarter.

But revenues from ecommerce rose 25.2% from $117.3 to $146.9 million. And retail store revenue was up 8.3% from $178 to $193 million, though comparative store sales declined in the high single digits. They are working on improving store performance, but in the meantime have “…decided to moderate and assess the pace of new store openings.”  They ended the quarter with 138 stores worldwide.

Sanuk

Sanuk’s total revenue for the quarter came in at $20.5 million, down 7.9% from $22.2 million in last year’s quarter. Sales for nine months rose 6.7% to $75.4 million from $70.7 million in the same nine months last year. Happily for Deckers, Sanuk’s revenue represents just 2.26% of the quarter’s total.

Its wholesale revenue for the quarter fell 11.1%, from $19.97 to $17.76 million. For nine months, wholesale revenues have risen slightly from $64.4 to $66 million.

“Wholesale net sales of our Sanuk brand decreased primarily [for the quarter] due to a decrease in the weighted-average wholesale selling price per pair as well as a decrease in the volume of pairs sold.” Volume and price both down. Not so good.

Sanuk’s operating profit from wholesale revenues for the quarter fell from $1.085 million to a loss of $282,000. For the nine months period, it’s down 17.1% from $11.2 to $9.3 million.

The last piece of the earn out for Sanuk has to be paid by Deckers based on 2015 results and equals 40% of the total gross profit Sanuk earns in calendar year 2015. As of December 31, Deckers is estimating that amount to be $27.7 million. That’s down from $30 million at the end of March, 2014. If you knew what Sanuk’s gross profit was, you could pretty much calculate Sanuk’s projected sales this year, though that calculation is complicated by the fact that the estimated earn out is discounted at 7% to allow for the time value of money.

Oh hell, I can’t resist, but I’m going to ignore the 7% discount rate. If GP is Sanuk’s total projected gross profit for 2015, then .4 x GP = the earn out, or $27.7 million. Dividing both sides of the equation by 0.4, we see that total projected gross profit for Sanuk in 2015 is $69.25 million.

We know that Sanuk did $102 million in all of 2013. In nine months of fiscal 2015, it’s had revenue of $75 million (Deckers changed its fiscal year to March 31 last year).  In the first calendar quarter of 2014, Sanuk’s revenues were $30.7 million. If it did the same in this quarter, total Sanuk revenues for the fiscal year ending March 31, 2015 would be $105.7 million.

And just to finish up this little exercise in speculative financial analysis, if sales did come in at $105.7 million and gross profit were $69.25 million, the Sanuk gross margin would be 66%. Wow.

But how can that be with a $660,000 operating loss for the quarter on Sanuk’s wholesale business when ecommerce and brick and mortar sales of the brand total only $2.7 million? Perhaps the quarter isn’t indicative of business for the year.

Okay, I have got to stop this. But this is what happens when I get curious about something and there’s no information provided; I try to figure it out from what I’ve got.   See, the 10Q shows business segment assets for the Sanuk wholesale business of $208.8 million. The similar number for UGG wholesale is $334.9 million, or about 1.6 times Sanuk. But UGG’s wholesale revenues were 22.6 times greater than Sanuk’s during the quarter.

This is the best I can do with what I’ve got, but it doesn’t completely make sense to me. Perhaps some of you wise people out there can help me out?

Based on Sanuk’s performance since the acquisition, it’s pretty clear they overpaid for the brand and I wonder if that might have to be acknowledged by one of those noncash write downs of intangible assets.  We’ll see.

Anyway, Deckers has a strong balance sheet, they grew revenue and profit, and I’m intrigued by some of the brand extensions they are doing with UGG. We’ll see how that works out as we follow Sanuk.

Mobile! Mobile! Mobile!

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In some recent speeches and articles, I’ve been highlighting the growing importance of mobile to brands and retailers. I thought I’d been pretty aggressive in suggesting how important it has become (and is increasingly becoming), but I think I’ve probably been understating the case.

Now, I’ve stumbled (thank you fabled research department) on an article/presentation from Internet Retailer that not only highlights just how important mobile has become, but that asks some questions around what to do about it I probably would never have thought of. Actually, I know I would never have thought of them.

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Intrawest’s Quarter; Business as Usual. Mostly In a Good Way

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You may recall that Intrawest got in an avalanche of unmanageable debt when the Great Recession took down the resort real estate market.  They solved the problems of an unpayable interest bill by getting their primary debt holder to convert a big chunk of its debt to equity and taking Intrawest public. I wrote about their predicament before they went public.

Intrawest, to refresh your memories, owns and operates Steamboat, Winter Park, Mont Tremblant, Stratton Mountain, Snowshoe and Blue Mountain. Let’s start with their income statement for the quarter ended December 31. This is prepared according to generally accepted accounting principles- just the way I like it. You can review the entire 10Q here if you want. Unless otherwise noted, all the numbers in this article are in thousands of U. S. dollars.

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Tradeshows, Millennials and Other Hopefully Related Topics

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SIA’s show in Denver last week was the third trade show I’ve been to this year (the only three I’ve been to, and that’s quite enough) where the millennial generation was discussed and analyzed and their importance acknowledged.

You should know I was one of the people discussing them at a speech I made in Denver. In my defense, I acknowledged that while I was willing to offer some conjecture as to their circumstances, motivations, importance and impact, I really didn’t have much of a clue about what a group of 18 to 34 years olds wanted or thought.

This was driven home too me when I had lunch with a client. He’s 32, and described reading about how some 18 year olds were using certain apps and/or social media. He said he had no idea what they were talking about. What, then, is my chance of “getting it.” Or yours if you’re even within a decade or two of my age.

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