Intrawest Officially Trading as a Public Company. What’s the Impact?

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As many of you know, Intrawest, the owner of Steamboat, Winter Park, Tremblant, Stratton, Snowshoe, Mammoth, and half of Blue Mountain, started trading as a public company on January 31. The initial offering price for the stock was supposed to be $15 to $17, but it ended up going public at $12 in a soft stock market where fear of the Fed tapering and its impact on certain developing countries is taking its toll. As I write this Monday morning, the stock is at $11.78 at 9:40 AM Pacific time with the whole market taking another drubbing. The trading symbol is SNOW, which kind of makes sense.

I explained the rationale for the public offering a couple of weeks ago in this article. To summarize, they are great at running resorts, but the real estate crunch did them in. It left them with an untenable debt burden and they are resolving the problem by having most of the creditors agree to convert their debt to common stock. I guess I think they would have preferred another solution, but didn’t have one.
 
When I wrote my initial article, I did it based on an SEC filed S1 which didn’t have all the numbers filled in. That’s standard procedure. Now, with the company actually public, there’s a final prospectus with all those numbers, and I thought I’d point out a few things. You can see that document here.
 
The selling price is $12.00 a share, but the underwriting discount is $0.78 a share, so the selling shareholders get $11.22 a share before the costs of doing the deal.
 
With the deal done, the “initial shareholders” control 65.3% of the common stock. Those shareholders are all controlled by the Fortress Investment Group. For this discussion, you can pretty much think of Fortress as the seller of most of the shares.
 
As part of the deal, Fortress converted about $1.4 billion in debt to equity. Intrawest itself sold 3.125 million shares and will receive about $32 million. The initial shareholders sold 12.5 million shares and are receiving (probably on February 5th) about $140 million. To be clear, that $140 million is not available to Intrawest for operations. It goes to the entities who converted their debt to equity.
 
Let’s see what Intrawest has accomplished financially by doing this deal, starting with the income statement.
 
For the years ended June 30, 2011, 2012 and 2013, Intrawest reported net losses of $499 million, $336 million, and $296 million respectively. Yet in those same years, they had positive cash flow from operations of $21 million, $43 million and $42 million respectively.
 
If you look at the expenses for those years, you’ll see all kinds of noncash expenses for losses on sale of assets and impairments of goodwill, real estate, and long-lived assets. They are particularly big in 2011, and decline thereafter. The loss from operations is $197 million in 2011. It falls to $19 million in 2012 and is a positive $3.5 million in 2013.
 
But below the operating line is interest expense. Here’s the numbers for the three years in millions of dollars.
 
Interest expense on third party debt                     (143,463)             (135,929)             (98,437)
Interest expense on notes payable to affiliates    (160,943)              (195,842)             (236,598)
Total Interest                                                      (304,406)             (331,771)             (335,035)
 
That, I think, can be characterized as a lot of interest and the bottom line, as indicated above, reflected it. What’s the impact of getting rid of it which, after all, is the purpose of Intrawest going public?
 
In a pro forma income statement they provided, which assumes the deal is done (it is done now), interest expense in the year ended June 30, 2013 falls from the $335 million shown above to $48 million. Net income goes from a loss of $296 million to a profit of $5.4 million. Quite a difference.
 
With the assets all written down to a reasonable value and interest expense reduced dramatically, Intrawest can now go about making money running resorts. That’s not a slam dunk, but it’s lower risk than mountain real estate right now. And who knows, maybe there will be a time in the future when those now low valued assets will be worth a bunch again.

   

What Happens If (When?) Apparel Prices Rise?

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We sell a lot of apparel. It’s where we, as an industry, make somewhere between a lot to most of our money. We’ve benefited over many years from apparel prices that have risen slowly if at all, and certainly more slowly than inflation. This article demonstrates that. It further tells us that apparel prices have started to rise and that they may rise more in the future. 

The increase is due to rising labor costs in China, and the cost of inputs, especially cotton. What happens if the cost of getting a garment made continues to rise or even does some catching up with general price levels?
 
We’ll do what we can, of course, to keep that from happening. You are all aware of some movement out of China to lower labor cost countries. However, you’ll note in the article how much apparel still comes from China.
 
We’ll try and pass on some price increases to consumers, but that has its limits. Especially in this economy. Perhaps it’s an extreme example, but you may recall that UGGs tried to pass on a big increase in sheepskin cost to consumers and the consumers wouldn’t accept it.
 
I imagine we’ll cut the number of pieces we make with the goal of increasing volume per style. That’s already happening at some companies and it’s my longstanding recommendation that you take a look at your SKU numbers anyway. There’s money to be made there.
 
We’ll try and substitute cheaper materials without sacrificing quality. We’ll design for easier manufacturing.
 
We can look hard at our customers and try to figure which ones are, or are not, sensitive to price increases and why. Your dream is to have a customer who wants/needs your product so badly that price doesn’t matter. Mine too.
 
You might find yourself taking a hard look at your distribution as price increases can mean that certain products will no longer be competitive in certain channels.
 
I can’t help but notice that these are all good things to do anyway, and I hope they are already part of your normal business processes. Let’s hope apparel prices stay under control though, of course, “hope” is never a valid strategy. 

 

 

A Sustainable Competitive Advantage: The Zumiez 100K

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I have written before about the value of Zumiez’s hiring, training, and promotion process. They take kids with a passion for the activities and brands their stores sell, train them, support them, make them compete with their peers, and promote the ones who succeed. The average age of store managers is something like 23 and pretty much all their district and regional managers started out as sales people in a store. 

This approach to culture and staffing is so important to them that it’s been allowed to impede their growth plans when they couldn’t identify enough good people to staff new stores. In hindsight, I imagine they are thrilled that happened given the way the environment for brick and mortar is evolving.
 
Anyway, it’s easy to read SEC filings and intellectualize about this, but when you walk into the annual 100K party at Keystone, where the company’s best sales people are celebrated, you look up and see a sustainable competitive advantage staring you right in the face. That’s never happened to me.  The fact that I was afraid I was the oldest person in a room of 1,300 only dampened my enthusiasm a bit.
 
A competitive advantage is only sustainable if none of your competitors can duplicate it. I suppose somebody else could do what Zumiez does, but they’d better get started. They’re 30 plus years behind.
 
I’m guessing most of the Zumiez sales people don’t read my column. If they wrote one I’d sure as hell read it to find out what brands were succeeding. If they did read it, I’d tell them how lucky they are to have jobs involved with something they love (hell, maybe just to have jobs), solid support and training, the opportunity to advance based on performance and, if they want it, a career.
 
And finally, I’d tell them what a great thing it is to be part of something that can support and validate them. Without getting too deep into generational history (read this book if you are curious what I’m talking about), let’s just say that this is a group of young people who are going to have to pull together to solve some big problems not of their making. I’m seeing it with my own kids (they don’t work at Zumiez) as they form groups and relationships outside of the immediate family that involve strong personal bonds. I see it where I went to college, where the number of students who return for reunions are much larger than they ever were in my generation.
 
So the environment Zumiez has created not only works for these young people, but for Zumiez as well and is consistent with the way generations turn over and repeat themselves in our society over decades. And it has significant implications for how any brand markets itself today.
 
But, as usual, I digress. Back at the 100K, the introduction of brand founders was particularly interesting. In groups (there’s a lot of them), they march founders out on stage and give each one a chance to say a few words. Somebody told me they’d meant to bring a decibel meter to measure the applause each brand got (or didn’t get). That would have been brilliant. I would love to publish that list with the noise levels listed.
 
Among the brands that got the loudest cheers were brands that are urban, or youth culture, or whatever word you want to use. But they were definitely not action sports brands. Not to say that some action sports brands weren’t well received, but I thought the reception of the various brands was a good indication of how the industry is evolving.

It is true that a deeply imbedded, successful culture can be destructive to a company if the culture resists evolving with the competitive and economic environment. I can’t say for certain that Zumiez (or any other company) won’t someday have that problem.  But Zumiez can minimize that potential by just letting the young sales force that is part of its target demographic drive brand selection and be the arbiter of what’s “cool.”  If they do that I think this competitive advantage can continue to be sustainable.  That’s a hell of thing and unusual in our industry.

 

 

Tilly’s Quarter and the Retail Environment

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Tilly’s quarter ended November 2, though the 10Q didn’t come out until later. I’m late writing this, but I thought there were a few things in it you might want to think about, especially given the holiday results and warnings from industry retailers.

Just to be clear, I believe the country was over retailed even before ecommerce. With its explosion, it’s even more over retailed. Every retailer has to be thinking about where or if they should be opening (or closing) stores. Store sizes probably have to shrink. Inventory has to be managed differently as the coordination between brick and mortar and ecommerce becomes tighter.
 
Let’s start with some of Tilly’s President and CEO Dan Griesemer conference call comments. This first one sounds a lot like other CEOs.
 
“During the quarter, we experienced a continuation of the weak traffic trends that have affected many retailers, leading to lower than expected comparable store sales. Consistent with the past several quarters, consumers continue to focus their shopping into compressed peak periods and pullback during non-peak periods. This trend was consistent across all product categories, real estate formats and store vintages, as well as in our e-Commerce channel; affirming our view that our sales results were primarily driven by external factors.”
 
He seems to be implying that disappointing results are okay because they were caused by things outside of their control. I know a conference call has a high marketing content, but wouldn’t it be better if such results were caused by things they could fix?
 
“While acknowledging that teen unemployment remains high, and that other categories such as electronics and entertainment compete for teen dollars, we know that Tilly’s remains the top destination for the most relevant merchandise and brands important to our action sports inspired customers.”
 
You know if you aren’t a new reader that I don’t think that “action sports” is an adequate description of the market our retailers are in. More importantly, I’ve got a bit of a problem with the idea that Tilly’s is “the top destination.” If he’d said Amazon, well, maybe.
 
“Despite the challenging external environment, we continue to adhere to the proven business strategies that have guided Tilly’s success for over 30 years, including our differentiated business model and our sharp focus on evolving preferences and needs of our customer.”
 
Focus on customer requirements is a good thing and something all retailers are doing. Or should be doing. But I think Mr. Griesemer would agree the competitive environment has changed a bit in 30 years, and I hope Tilly’s business strategies have changed to reflect that. I don’t think any of us are using the same package of strategies we were using 30 years ago.
 
Finally, in response to an analyst’s question CEO Griesemer says, “…we recognize that we have a unique business, a unique business model.” Unique is a pretty strong word. Of course no analyst asked just what he meant by that. I don’t see Tilly’s as unique, and would have loved to hear why he’s comfortable using the term.
 
He talks about a lot of good things they are doing. They are “relentless” in pursuing the brands and styles their customers want. They are keeping the business and inventory clean, with inventory per square foot down 16% from a year ago. That’s a great result. They also talk about having “newness” in their stores multiple times a week. That certainly means with product, but it felt like he meant more, though he wasn’t specific.
 
Those are all good things, but I don’t see them rising to unique. But perhaps some of the discussion below will help us understand what Tilly’s thinks does.
 
Tilly’s balance sheet is solid, and doesn’t require any discussion.
 
Sales for the quarter fell very slightly, from $124.9 to $123.8 million. CFO Jennifer Ehrhardt reminds us that “This reflects approximately $8 million in back-to-school period sales that shifted into the second quarter from the third quarter this year, when compared to the 2012 fiscal calendar.” Ecommerce sales were $13.3 million, up from $12.9 million in last year’s quarter.  Gross margin fell from 33.5% to 30.9%. 2.4% of that decline was due to occupancy costs from new stores. Product margin improved by 0.2%.
 
Selling, general and administrative expense rose from $27.9 to $28 million. Net income was down 33.9% from $9.3 to $6.1 million.
 
They closed the quarter with 189 stores, up from 168 stores at the end of last year’s quarter. They expect to grow their store count by 15% in each of the next several years. “The stores are located in malls, lifestyle centers, ‘power’ centers, community centers, outlet centers and street-front locations.” That’s an interesting mix. If I had to guess, it might be that getting a good deal on the rent was an especially important factor in choosing locations.
 
Comparable store sales fell 2.4%. That includes a 1% increase contributed by ecommerce sales. The average store size at the end of the quarter was 7,788 square feet, but average sales per store were $592,000, down 16% from 705,000 in last year’s quarter. Picture each of their stores being a square that’s about 88 feet on a side. My gut tells me those are low sales for stores that size, and makes me think I’m right about their negotiating well with landlords.
 
I’m wondering if CEO Griesemer would tell me that what was unique about their business model was their ability to make money on lower store sales volumes because of their lower occupancy costs. I’d still have a hard time with “unique,” but I might be okay with calling it a competitive advantage.
 
Tilly’s is facing the same uncontrollable, external, headwinds all retailers in our industry are facing. My expectation is that those will last a while. In addition, rapid change driven by ecommerce has to be managed- maybe harnessed is a better term. The look and roll of brick and mortar is going to be different as a result.
 
Yet most retailers seem to go along opening (more cautiously, I admit) new stores that, from a macro point of view, we don’t need. The assumption, I guess, is that all the bad stuff will happen to their competitors.
 
I would remind you all that unique doesn’t necessarily mean good. Even if your evaluation of your own market advantages doesn’t rise to “unique,” be careful that your confirmation bias* doesn’t have its way with you.
 
* Confirmation bias is the tendency of people to favor information that confirms their beliefs or hypotheses. People display this bias when they gather or remember information selectively, or when they interpret it in a biased way. The effect is stronger for emotionally charged issues and for deeply entrenched beliefs. People also tend to interpret ambiguous evidence as supporting their existing position.

   

Surf Expo from the 10,000 Foot Level- Literally

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Yesterday morning, I was in warm, humid, sea level Orlando for Surf Expo. After 14 hours of travel, I found myself at the cold, dry, and 10,000 feet high Keystone resort for the Zumiez 100K event. Whew. One beer was my limit with dinner last night, and then I went to sleep early. 

Agenda and Surf Expo are two very different shows, with Agenda more urban and apparel and Surf Expo more beach and surf. We need them both but not, if I may say it again, overlapping each other.
 
The thing that almost caused me to keel over at Surf Expo was the stand-up paddle section. I regret not counting the brands. There were a lot. In conversations with a couple of them, I heard that there were perhaps 200 “viable” competitors plus maybe another 100 who just have product made and printed with their label in China. The size, shape, and prices of product varied widely. Incredible number of choices. Amazingly, I was told that the SUP section is about twice this size at Surf Expo’s September show.
 
I know some of you have had the same thought I had- “Oh lord, it’s the SIA snowboard section in Vegas in 1996.” We know how that worked out. Honestly, I expected a consolidation sooner. It was two years ago I saw a $400 SUP board at Costco and there’s never been the manufacturing learning curve and lack of capacity issues we had with snowboarding.
 
The reason we haven’t had a consolidation yet, I hypothesize, is because SUP has a much larger potential market and is easier to learn than surfing or snowboarding. And it doesn’t require a mountain or a wave. There are lots of lakes.
 
I couldn’t help but notice how many people involved in SUP had been through the snowboard business cycle. Hopefully, they haven’t come down with a case of selective amnesia. This time will not be different. There will be a consolidation, margins will drop, there will be too much product and production capacity. I don’t know when, but I recommend that you build your balance sheets and not assume it will only impact your competitors.
 
But damned, it’s great to see a new category with some legs.
 
The skateboard section was intriguing. The skate ramp was packed (I love watching the etiquette that skaters use to keep from running over each other). Volcom was the sponsor, with its booth opening on the ramp. Every kind of skateboard was represented. Long, short, narrow, wide, various shapes, wood, plastic, metal. I particularly liked Beercan Boards, made from scrap aluminum by an auto parts manufacturer from Georgia. They readily acknowledged that they didn’t know anything about the skateboard industry, but they seemed to be having fun. It felt a little like the bike show, where anybody with a new idea is welcome and encouraged to try something different.
 
While one end of the show was dominated by skate, the other end was what I guess I’ll call resort focused gifts, for lack of a better term. I more or less walked the whole show, and found it interesting how the energy built from one end of the show to the other. Kind of suggested that they have it organized right. At first, I found it interesting that beach and surf were separate, but as you walked the sections it became clear why. Their products mostly wouldn’t sell in each other’s channel. Surf industry consumers want technical board shorts. Beach market customers want a bathing suit.
 
Oh- and I want to thank Surf Expo for giving me a badge that said “buyer.” People in booths were nice to me, and I actually had an apparent reason to stop in my tracks and check out the models because, obviously, I was a buyer with an interest in the swimsuit business. My favorite booth had to be a little one with a guy sitting at an unadorned table with some apparel hung on the back wall. The sign over the front of the booth just said “DEALS.” I thought that was refreshingly honest.
 
A company called New Trick Sports was featuring a 45 pound electric wench fitted with an 1,800 foot line that can be easily attached (and detached) from a pickup truck and can pull a wakeboarder. The videos on the web site make it look like it’s plenty fast. I guess one potential inconvenience might be that you have to swim the line out. They are working on a gun that can be used to shoot the line out for rescue purposes, but I doubt that will be available to consumers. Too bad.
 
There were some pretty large booths in the surf section. Billabong, Quiksilver and Vans come to mind. Shades of the old ASR. No second stories though. I understand The Endless Summer showing the first night of the show was a big success, though I didn’t get there to see it due to my being efficient and planning too far in advance. Do something that cool next year and I’ll be there.

 

 

Agenda Show: The New Skate Business Model

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I’m somewhere in the middle of the country between the Agenda and Surf Expo trade shows at 30,000 feet. Before I talk about the sea change in skateboarding I saw at Agenda, I have a request. Will the powers that be at both shows please figure out how to not have the shows overlap? 

Please, no explanations and finger pointing. Not interested. Yeah, yeah, I know. I don’t understand. I’m just a customer (kind of) that thinks it sucks and is inconvenienced by it. And I’m not even the customer you should care about.
 
There, I feel a whole lot better.
 
Okay, skateboarding. An English magazine product guide I picked up at Agenda listed 55 brands of skate decks. Some I knew, many I’d never heard of. And those are only the ones who have enough presence (and money?) to be in that publication. Lots and lots of small skate brands around. At the show, there were a bunch of small deck brands that were new or had only been around a year or two. My perception over two days (shared by others in the industry I asked) was that the newer brands were busier and full of kids while the older brands (guess what – I’m not going to call them the “core” brands) were slower and full of older guys.
 
Many of those older guys will remember a time when they were just kids skating who thought it would be cool to get a few decks made for their friends because they kind of had an idea for a graphic. So somewhere they got 50 decks made and, after selling them to their friends, found they had made a couple of hundred bucks.
 
Of course, it had taken them at least 100 hours of work to get them made and sold (maybe a lot more) so in fact they’d earned about fourteen cents an hour. But who cared. They had a few bucks in their pocket, had a lot fun, and sensed a new found respect from their friends. They were on to something. Next time they’d make a hundred.
 
And the guys who turned out to be pretty good at that (and committed, and worked hard, and had a vision, and managed to raise a few bucks, and were a little lucky) are the guys I spend time talking to at Agenda. I like them, I’ve known them ten or fifteen years, it’s interesting to hear what they think, and they’re my age (okay, not that old, but getting there).
 
As they built their brands, they created a business model based on a high retail priced product carefully distributed (initially) with differentiation based mostly on team riders. High gross margins and big marketing budgets.
 
That business model started to go to hell about ten years ago as skateboarding got big enough to attract outside attention and lacking any kind of product improvement or differentiation not based on marketing. As the skateboard deck became a commodity to more and more skaters, there was no way to sell enough of them at a high price to fund the marketing program. The leading brands in the industry lost their ability to control pricing.
 
But they were stuck with their business model in terms of how they thought about it and because of a corporate structure with committed overhead. And they were getting older- every day, week, month, year- in an industry where the fourteen year old if the arbiter of cool. Maybe the 12 year old. Attitude and reality was (is?) working against them.
 
Meanwhile, the kids with the new brands have discovered what the owners of the core brands once discovered. It’s cool to make 50 boards and sell them to your friends. But they aren’t trapped by an increasingly obsolete business model and overhead structure.
 
Who’s on their team? The kid who did the coolest trick caught on video at the local skate park yesterday. It was up on YouTube, Twitter, etc. and the brand’s web site before his session was over. Hmmm. Maybe web sites don’t even matter like they used to. Tomorrow it will be somebody else. Or it will be the same skater. But there’s no need to create and run a series of ads to build a single skater’s credibility.
 
Marketing budget? Practically zero. Maybe you end up with a “team” of 6,000 composed of a couple of skaters at various skate parks and neighborhoods around the country. Or maybe you don’t. And your “team” will change and you won’t know it or control it. Maybe you cobrand with local shops or skate parks. Some brands and some skaters will rise to the top just like they always have. But there’s not an initial and expensive structure and process required. It will be informal, inexpensive, and inexact. In a word, it will be surprising and the skaters, not the brand, will have a lot of control. I wonder, in fact, if you don’t try and control it at your peril.
 
But how different is this really? The heritage skate brands (Oh god, what an awful thing to call them) aren’t strangers to creating new brands. But the communications process and the cost structure are dramatically different from what they are used to.
 
The heritage brands can’t do a damned thing about this as long as they have to exist within their old cost structure. Maybe one of these brands should rename itself Phoenix and rise from the ashes by severing all ties with the parent and putting a few kids with computers and a travel budget into a small old house somewhere and start over with the same brand name. Don’t you wish you’d done that with longboarding ten years ago? Or maybe you approach half a dozen of the new brands that are thought to be the coolest and you offer each of them $10,000 for an equity stake in the business (actually convertible debt would be better).
 
I keep being told that, according to the numbers we have, skating is declining. But damn, I see a lot of people skating (Of course, that’s what I want to see). And I was reminded at the show that the industry is about due for the next demographic boost. The numbers I’ve seen bear that out.
 
So anyway, when I get to Surf Expo, to the extent they are there, I’m going to spend all my time talking to skate companies I’ve never heard of. Won’t be as much fun, but I have a sense I’ll learn more about where the industry is going.
 
Meanwhile, at Agenda, the coolest thing I saw was the tagged police cruiser with the skateboard through the front windshield and the product displayed in the trunk. That’s the kind of thinking we need. I also saw a really busy show, though not quite as busy on the second day partly, I think, because people had left for Surf Expo.
 
I visited RAEN (because they asked me to) and saw a business model I liked. They’ve got some actual product differentiation, a story to tell, and a price structure that makes sense. I was scared to death I’d break their material when I twisted the frame, but when I worked up the nerve to try, I couldn’t. I also liked the product look, but for all I know, that’s the kiss of death for them.
 
Speaking of old school, I went to Bud Smith’s retirement party thrown by NHS. I’ll miss Mr. Griptape.  Next day, retired or not, Bud was still in the NHS booth. I didn’t stay long enough to see if Denike had to have him removed by security when the show closed.   Hey Bob, maybe you can get him to sell some grip tape for free?

   

Speaking of Brand Retail Strategies…..

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Shortly after I posted my article on Quiksilver’s annual results, a reader of mine sent me this brief article (thanks YKW!). Here’s another article on the same subject with a little more information (don’t be confused because it has the same picture). Basically, what they say is that “Nike and Adidas recently dealt an additional blow to small-scale commerce by severing ties with those accounts unable to sell £25,000 GBP (approximately $41,000 USD) worth of sportswear in a 12-month time frame.”

Apparently the decision, at present, is just for shops in the London area and impacts about 50 retailers. But if Nike and Adidas think it good business strategy for shops in the London area, I’m hard pressed to think of a reason why they won’t come to the same conclusion for other shops in other locations, though perhaps with a different minimum sales number.
On the one hand, I suppose we shouldn’t be all that surprised by this development. We’ve had various brands bemoan the decline of the small shops and the difficulty of working with some of them. It was years ago I pointed out what we all already knew; that as a brand got bigger the financial contribution of small shops to a brand’s success became less significant to the point of being unimportant. And I’ll tell you from personal experience that if you’ve got a shop that orders small and then can’t pay, you don’t make any money from that shop- no matter how cool the shop is and how much you want to work with it.
It’s not like a minimum order is a new development in the industry. They’ve been used in combination with discount structures and order breadth to encourage/require not just larger orders, but a better representation of the brand. The question is whether a $41,000 order is of a size that makes it impossible for a shop to carry a brand. That is, is it Nike’s or Adidas’ intention to flat out exit these smaller shops or is it just that they don’t want to do business with accounts they can’t make money with.
Whatever the financial motivation, more interesting is the market implication. Talking about the United States, I once wrote that there might be 50 “core” shops (and maybe and number is smaller or larger) that every brand needs to be in to be credible with the core market where a brand’s legitimacy comes from. At some level, Nike and Adidas are making a statement that what used to be considered a marketing imperative just isn’t as important any more. For neither brand were the number of dollars (or pounds) they received from the affected shops ever very important, but now the financial considerations, minimal though they may be, seem to trump the market ones.
It’s also true that larger brands now have their own retail outlets and very specifically rely on those stores to present the brand image. This makes the smaller, independent retailer seem less important to those larger brands.
Neither Nike nor Adidas are action sport based companies, so I suppose they can more easily make this decision than some other brands. Nike’s credibility with its larger target market is just fine and Adidas, from my perspective, has never really penetrated the core market anyway.  I always had to smile when I walked past a booth labeled “Adidas Skateboarding” at a trade show. I’ll be sure to get by the Adidas booth at the shows and somebody can tell me why I’m wrong. Actually, I’m going to ask.
I won’t bore you by re-re-re-repeating my thesis that the real action sports market is and always has been pretty small. The internet, lack of product differentiation and a lousy economy are pushing the youth culture market into larger companies, chain retailers, and broader distribution. This announcement is just one small occurrence in an ongoing process. Pay attention independent specialty retailers.

 

Quiksilver’s 10K: It’s Results for the Year and Some Issues of Strategy

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If you haven’t noticed, I’ve been working to not just report the numbers (it’s hard to grab readers attention with the drama of a changing current ratio) but to draw some larger business lessons from company reports and make us all think about the issues. You can think I’m wrong, or you can think I’m right (I’m not always sure). I just ask that you pause and think. 

Quiksilver is giving us the chance to pause and think. I’ll get to the numbers of course, but let’s dive right into some more strategic issues, starting with this quote from their discussion of distribution channels in the 10K (which you can see here).
 
“We believe that the integrity and success of our brands is dependent, in part, upon our careful selection of appropriate retailers to support our brands in the wholesale sales channel.”
 
No kidding. I suspect I’d define “careful selection” differently from Quik management, but then I don’t have to answer to the stock market. As I’ve said, it’s hard to be public and do the right thing for a brand in our space.
 
“A foundation of our business is the distribution of our products through surf shops, skateboard shops, snowboard shops, sporting goods stores, and our own proprietary retail concept stores, where the environment communicates our brand and culture.  Our distribution channels serve as a base of legitimacy and long-term loyalty for our brands. Most of our wholesale accounts stand alone or are part of small chains.”
 
I’m all for communicating brand and culture. But outside of its own stores and certain core shops, it’s tough for any brand to do. Damned near impossible once your distribution gets past a certain point. Perhaps, I’ve argued, even a detriment as some of those further removed customers may know your brand, but not know or care about your story. And then, how are you competing? I’d also love to hear what Quik’s definition of a “small chain” is. 
 
Next, here are some comments CEO Andy Mooney made in the conference call. They are in the order I came to them.
 
“… retail brick-and-mortar sales were very steady and e-commerce sales continued to show robust double-digit gains. And…we continue to see very slow erosion in the specialty core surf and skate chain worldwide, offset by pretty robust growth in emerging markets, particularly for us, Russia, Brazil, Mexico and Southeast Asia, and even Japan this quarter.” 
 
Okay, here’s the next one.   “In the case of Quiksilver, we believe there’s opportunities to take share within the core channel, particularly when we see the current weakness of some of our competitors in the marketplace.”
 
Subject to definitional clarity, I’m wondering just how big the core market is. I’ve suggested it’s not really that large a market overall. I’d be curious what percentage of its total revenues Quik sees as coming from the core market. And if it’s “slowly eroding” how significant to revenue growth can taking share be? It was years ago I first pointed out that even robust growth in the core channel (if by “core” we mean specialty shops) doesn’t really move the revenue and profit needle much once a company is larger.
 
And third from CEO Mooney, talking about their Board Rider stores. “These are very exciting stores that have within them restaurants, bars, barbershops. We offer in those stores a broad range — array of our own products, but also other products that would be relevant to our consumer. So products like GoPro or mophie, the battery charge — battery packs for iPhone, headphones, that type of thing. We think that makes for an interesting environment for consumers that cut across all 3 brands. Those stores are performing very well for us. We’d like to experiment with a few of those stores here in North America in 2014…”
 
A couple of weeks ago, I wrote about Zumiez’s quarter and asked if it really mattered how we defined our industry or if maybe it was up to our customers to define us and our job was just to give them the product they wanted where and when they wanted it. It sounds like that’s how Andy Mooney looks at things given his description of the Board Rider stores. Interesting implications for branding however. Will any of these products carry a Quiksilver brand? How much and what kind of product can you carry before these stores no longer “communicate the brand and culture?”
 
And next: “Well, one of the things that we’ve been doing because we can is we’ve been doing product injections into our retail stores ahead of the calendar that’s required to introduce new product for the wholesale channel…So we’ve got some of the products, the newer products that we want to have in retail in the stores quicker. One of the other kind of really important changes that we’re going through, which again gives us the level of confidence that we can actually go deeper in SKU reductions is that, as an organization, historically, we have designed for wholesale, and retail has been an afterthought. Increasingly, what we’re seeing is, we’re going to design primarily for our own retail stores, our own website and our own key wholesale partners.”
 
I guess I just have to wonder what actual core retailers, which Quik says are a foundation of their business, think when they read this. I am not saying I wouldn’t do the same thing if I were in Andy Mooney’s place. But as a core retailer, it might make me think about my commitment to Quik’s brands. 
 
And finally, just to put the cherry on the whipped cream, Andy notes:
 
“I think our wholesale business is in transition, in that we’re seeing a rotation out of the small independent mom-and-pop operators in surf, skate and snow into other — in some cases, other wholesale players. That could be, in the case of Europe, it could be large multi-outdoor players like Decathlon or it could be pure play e-commerce players like Surfdome in their own stable in Europe, or Amazon, even here in the U.S., or eBay. There’s a lot of activity happening on web for pure-play retailers that clearly didn’t exist before. So you’ve got a rotation out. Definitely, the small independent operators are much more challenged than they’ve ever been, today. And we’re seeing, I’d say, some modest contraction in that channel, but it’s rotating into other channels.”
 
Once again, I think Andy’s perception may be accurate. But where does it leave Quiksilver (and other industry brands and retailers) who get their credibility and legitimacy from having their roots in a sport and lifestyle that, with revenue growth, is less important to a bigger percentage of their customers? How can Quik’s “…distribution channels serve as a base of legitimacy and long-term loyalty for our brands” under these circumstances? 
 
Now, here’s how Quik defines its strategy in the 10K:
 
“In our efforts to increase shareholder value, we have adopted three fundamental strategies: 1) strengthening our brands; 2) growing sales; and 3) driving operational efficiencies.”
 
Those strategies (if they are strategies, and I don’t think they are) offer no competitive advantage or point of differentiation. Everybody who owns a brand is striving to do those three things all the time. Always have been, always will. Granted, they’ve become more important since the economy went to hell. I suppose I expect too much from the information provided in a 10K.
 
We’ll move onto the numbers now.
 
The Numbers
 
Revenue for the year fell 6.8% from $1.942 billion to $1.811 billion “…due to the expected decrease in DC sales.” Argh. Some of you may remember that several years ago I expressed concern that Quik might push the DC brand too hard in a search for revenue. They did. It’s the public market pressure again. You’ll note some more indications of this below where I present more data on DC.
 
Wholesale fell from 74% to 71% of the total. Retail rose from 23% to 25% and ecommerce from 3% to 4%. Apparel was 62% of the total. Footwear and accessories were 25% and 13% of revenues from continuing operations respectively. The Quiksilver brand was 40% of revenues from continuing operations (unchanged from the previous year). DC represented 30%, down one percent and Roxy 28%, up 1%. Other brands were 2%.
 
The Quiksilver brand’s year over year revenue fell 8% as reported from $784 to $721 million. DC was down 9% from $588 to $542 million. Roxy fell 4% from $530 to $511 million. Total wholesale revenues were down 9% to $1.294 million. Retail was down 2% to $447 million and ecommerce rose 25% to $69 million.   
 
I’d note that revenues from continuing operations are surprisingly even over the quarters, with the 1st quarter being lowest at 23% of the total, and the 3rd and 4th highest at 26%. As a finance guy, I love that.
 
38% of this revenue was generated in the U.S. The next biggest single country is France at 12% with Australia/New Zealand coming in at 7% and Canada at 6%. Below is the table that shows net revenues and gross profit by operating segments. Note that revenues were down in all three segments for both the quarter and the year.
 
 
 
For the quarter ended October 31, the Quiksilver brand had flat revenues of $190 million. Roxy stayed the same at $137 million but DC was down $47 million to $139 million. That is a 25% decline. Wholesale revenue fell 12% to $353 million. Same store sales in company owned stores were flat and ecommerce revenues grew 22% to $16 million. The gross margin for the quarter rose 1.4% to 47%. It would have risen 1.9% except for $2 million in restructure related costs.    
 
The gross profit margin for the year was down from 48.5% to 48.2%. The decline was “…primarily due to increased discounting associated with DC brand net revenues within our wholesale channel. We entered fiscal 2013 with a higher level of DC inventory in the wholesale channel than we planned, which resulted in higher discounting to clear this product.”
 
SG&A expenses declined from $227 to $200 million. “The decrease in SG&A was primarily due to reduced employee compensation expenses and event related marketing expenses, partially offset by higher severance and early lease termination costs as well as increased e-commerce expenses associated with the expansion of our online business.” As a percentage of revenue, SG&A rose 1.7% from 45.7% to 47.4% “…primarily due to net revenue declines outpacing any SG&A reductions in fiscal 2013.”
 
Quik spent $93 million on promotion and advertising during the year, down from $118 million the prior year.
 
Asset impairment charges (noncash) were $1.7 million compared to $6.7 million last year. Interest expense rose from $15.3 to $20 million and the loss before taxes and discontinued operations (businesses they are selling) rose from $11.2 to $18.7 million.
 
And then, there was a provision for income taxes of $157.5 million compared to a benefit of $9.7 million the prior year. That left Quik with a net loss from continuing operations of $176.2 million compared to a loss of $1.5 million the previous year. After then taking into account the discontinued operations, we’ve got a net loss of $171 million compared to a profit of $4.4 million last year.
 
I usually stay away from income tax issues, but a charge of $157 million (it’s noncash) requires some respect and a little attention. Here’s how CFO Richard Shields explains it:
 
“The Q4 tax provision includes a noncash charge of $157 million related to taking allowances on the net operating loss carry forward deferred tax assets in France. We have NOLs of EUR 356 million in France, which were created in the Rossignol disposition in 2009. These deferred tax assets were carried on the balance sheet, tax effected, at $157 million. Based upon the cumulative losses we have incurred in France in recent years, we took valuation and reserves against those deferred tax assets. This does not preclude our future use of those NOLs, and those NOLs do not expire.”
 
I’m sure you all understand that as well as I do. My take is that they don’t expect French results to be good enough to let them utilize those assets in the near future, so they might as well write them off now while nobody is expecting much from them on the bottom line. I think that, having written them off, they will have more value if they can be used. One of you CPAs out there want to explain this to us on my web site?
 
The balance sheet requires a little attention. Trade accounts receivable are up like $1 million to $412 million, but with the sales decline, you might have liked to see them go down. I see their allowance for doubtful accounts has increased from $57.6 to $60.9 million. Deductions for bad debts were $2.38 million compared to $7.81 and $9.26 million respectively in the prior two years. The average number of days it took them to collect receivables rose from 85 days to 97 days or by 14%. We can’t tell if that’s because they extended longer terms or had trouble collecting.
 
Total inventories rose slightly from $327 to $338 million. Again, with a decline in sales, you’d like to see that fall. They tell us that, “As of October 31, 2013, aged inventory was approximately 6% of total inventory, a reduction of 100 basis points versus October 31, 2012,” and it was 15% lower than a year ago.   CFO Richard Shields tells us in the conference call that they added $8 million in U.S. retail inventories because they thought they were too thinly stocked.
 
It is, of course, good to see aged inventory falling. But what, exactly, does 6% represent? Is that a good number or a bad number? Is “aged inventory” anything older than three months or three years? Not knowing that, I have no idea how to react to that number. It wasn’t available during the conference call, so nobody could ask. I’ve emailed Quik to ask that question and will let you know if I get an answer.
 
By the way, the receivable and inventory numbers exclude the assets associated with the businesses being sold. Total assets fell from $1.72 to $1.62 billion, largely due to the write off of the tax assets.
 
Current liabilities are up from $357 to $367 million. However, long term debt, net of current portion, rose 12% from $721 million to $808 million. Mostly due to that increase, total liabilities increased from $1.116 billion to $1.233 billion.
 
As a result, stockholders’ equity fell 35.6% from $583 million to $370 million. Total liabilities to equity rose from 1.85 times to 3.18 times.
 
The Profit Improvement Plan     
 
You remember that last May, Quiksilver introduced its Profit Improvement Plan (PIP). Here’s how they describe it.
 
“Important elements of the PIP include:”
 
“• clarifying the positioning of our three core brands ( Quiksilver , Roxy and DC );
• divesting or exiting certain non-core brands;
• globalizing product design and merchandising;
• licensing of secondary or peripheral product categories;
• reprioritization of marketing investments to emphasize in-store and print marketing along with digital and social media;
• continued investment in emerging markets and e-commerce;
• improving sales execution;
• optimizing our supply chain;
• reducing product styles;
• centralizing global responsibility for key functions, including product design, supply chain, marketing, retail stores, licensing and administrative functions; and
• closing underperforming retail stores, reorganizing wholesale sales operations, implementing greater pricing disciplines, and improving product segmentation.”
 
CEO Mooney notes in the conference call that the fall and holiday SKU count is 47% lower than last year. That’s progress. Remember that licensing agreement like the one for children’s apparel and the sale of Mervin and other assets helps with the SKU reduction.  
 
I pretty much agree with all of this and wish Quiksilver, as a company, had started it sooner. I’m sure we all realize that some of these things make sense whether times are good or times are hard.
 
They go on to say:
 
“We expect that the PIP, when fully implemented by the end of fiscal 2016, will improve Adjusted EBITDA by approximately $150 million over fiscal 2012 Adjusted EBITDA, of which approximately one-half is expected to come from supply chain optimization and the rest is expected to be primarily comprised of corporate overhead reductions, licensing opportunities and improved pricing management, along with modest net revenue growth compared with fiscal 2012 results.”
 
I wish they’d tell us what “modest net revenue growth” means. I’m seeing in Quiksilver what we’re seeing in a lot of other companies- not just in our industry. Bottom line improvement is coming largely from expense reduction driven by layoffs and improved efficiency. Top line growth with a solid gross margin is harder to come by. Trouble is, you can’t cut expense and become more efficient forever.
 
The Retail Footprint
 
Quik ended the year with 631 owned retail stores. They had an additional 243 stores licensed to independent retailers around the world for a total of 874 retail locations. Here’s how the owned stores break down by type and location.
 
 
Quik closed 17 retail stores during the last quarter of the year. They see a chance to add “…a few more full-priced stores in developed markets…” and believe “…there’s tremendous opportunity to open stores in emerging markets.” They believe they’ve got a big opportunity in ecommerce, where they “…received 30 million visitors to our own branded sites last year.” But they “…only converted, on average, 1.5% to 2.0% of them.” Part of the PIP is the consolidation of their three independent ecommerce platforms. Good idea.
 
I applaud what Quik is going as part of its profit improvement plan. But I’m going to ask the same question I’ve been asking about Quik for years now. Where will revenue growth come from? Like most public companies with roots in traditional action sports, they are ultimately conflicted by the need to grow revenues but also to manage distribution carefully to differentiate products that don’t have meaningful competitive advantages. You can see that conflict highlighted in some of the quotes and the discussion at the start of this article.
 
Why might Quiksilver be more successful than its competitors? There are three possible reasons. Better management, better brands, and/or a stronger balance sheet. Actually, you need some of all three.

 

 

Why Crocs Might Go Private

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I’ve been holding on to this article on Crocs for a while mostly because I just didn’t have time to do anything with it.  What it says is that Crocs is looking to go private because it’s just not as cool as it was.  Currently, it’s traded under the symbol CROX on the NASDAQ and is at $12.88 as I write this.  Here’s a five year stock chart on the stock’s movement.


You’ll note that the stock is trending down at a time when the market has been trending up. 

In the 9 months ended last September 30th, Crocs earned $77.4 million on revenue of $964 million.  That doesn’t sound so bad.  Okay, but in the same 9 months in 2012, it earned $135 million on revenue of $898 million. Selling more and making less.  If that isn’t a sign of being less cool, I don’t know what is. 

So what have we got here?  The gross margin for the nine months fell from 55.8% to 53.9% and selling, general and administrative expenses rose 18.3% from $350 to $414 million.  Operating income fell from $151 to $106 million.  I’m going to resist the urge to do a complete financial analysis (I hear those sighs of relief).   

My point is simple.  It seems a lot of people still want to buy Crocs, and the company can make money.  What they can’t do is satisfy Wall Street’s endless demands for the growth that makes stock prices rise.  And I’ll bet anything that if they try to do that, their gross margin will continue down and the brand will lose credibility as it tries to push its distribution harder, faster, further.  Remember it would be trying to do that in a poor economy with a lot of competition. 

Is this starting to sound at all like any other companies we follow? 

Some smart person probably said, “Hey, if we weren’t public, we could pull back our distribution, improve our brand positioning and gross margin, cut some expenses (from not being a public company and because our improved distribution would let us reduce some marketing expenses) and maybe make more money with less working capital invested!”  Perhaps they’d consider closing some of their 600 or so stores as well. 

Maybe that would work or maybe, for this brand, it wouldn’t.  But continuing to try and satisfy the requirements of the public market looks like a bad plan.  I haven’t heard that there’s a deal done yet.  I’ll let you know if I hear and you do the same for me.

Does it Matter What Industry We Think We’re In? Zumiez’s Quarter

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For many of us, “action sports” doesn’t really describe our target market anymore. We struggle (or at least I struggle) with words like “youth culture” or “fashion” or “outdoor” to describe it. None of them work very well. They are all correct, but not adequate or complete. 

Maybe Zumiez has helped me figure out why. During the conference call, CEO Rick Brooks said, “…it’s really not about e-commerce, it’s really not about stores, it’s about meeting whatever our customers want and whatever channel they want it, anyway they want to get the product. That’s where we’re trying to play and we’re trying to dominate the market in that arena of integrated multichannel selling.”
 
He’s also talked about the fact that they had reduced their North American store projection over the years from 800 to between 600 and 700, but with no decline in revenue from what they would have expected with 800. That is due to the growth of ecommerce and integrated multichannel selling (also known as the now ubiquitous omni channel).
 
The thought that popped into my head was that Rick probably didn’t care quite as much as he used to whether the customer was best classified as action sports, youth culture, fashion, outdoor, or something else. What he cares about was that Zumiez carried the apparel, accessory, footwear, and limited hard goods brands (because that’s a point of differentiation- for now- for Zumiez) that his teen to young adult customers want.
 
At some level Zumiez, or any other retailer for that matter, isn’t going to define itself quite as rigorously as it used to. Its customer is going to define it. That will happen at least partly through Zumiez’s rigorous and ongoing process of identifying and assisting new brands and integrating them into Zumiez’s selling channels at whatever level they can succeed. They discuss the process of identifying and supporting new brands in the conference call. Here’s part of what CEO Brooks say on the subject:
 
“…we are just laser-focused on trying to be supportive and a really good partner for our small retail brands. And again, we have hundreds of brands today that we’re doing business with, just like we always have. And some of them are just in a few doors, and we want to be the right way for that young brand, and we want to do everything we can to help see them be successful. Maybe it’s just those 10 doors, but we’re hoping that over time — and they have to do their job well, too, of making sure that they have great products. They have to have a great marketing, and product and marketing have to be completely aligned with the unique brand positioning. And then they have to have great retail partners that believe in full price selling.”
 
It occurs to me we’re already seeing the customer define the brand happen in the decline of traditional print and media advertising. Why bother spending money (whose impact was already unclear) to define yourself to a certain customer group when the omnipotent, endlessly connected customer with near perfect information is going to decide for themselves what you stand for? 
 
It certainly changes the roll of the marketing department. It doesn’t have to explain what the company is about. It has to listen to the customer to evolve with them but not, it occurs to me, let that customer pull the company too fast or in a direction which will ultimately be wrong.
 
And yet, in response to analyst’s question, Rick talks about their Ultimate Gift Guide that they are mailing to selected control groups to see what kind of response they get. Maybe the role of print is changing in ways we don’t quite understand yet. I’d love more details on how they see the guide tying into their ecommerce channel.  
 
Zumiez may also have an advantage in this environment in the way they identify store managers and give them a high level of management discretion.
 
So I think I’m going to stop stressing out about what to call our industry. I’ve concluded not only that it’s less important, but that it might be a mistake to worry about it as it could lead to resistance to inevitable change.
 
Meanwhile, back in the financial statements, Zumiez’s revenues rose 6.2% to $191.1 million in the quarter ended November compared to the quarter ended October 27 last year. Ecommerce sales were 11% of the total (10.7% in last year’s quarter). They had a net of 55 more stores open in this year’s quarter (541 in North America at the end of the quarter). Comparable store sales increased 1.5%, “…partially offset by the negative impact of the calendar shift, which moved a week of the back-to-school season into the second fiscal quarter of fiscal 2013 and out of the three months ended November 2, 2013 compared to the prior year quarter.” The impact was $7 million.
 
Comparable store sales include ecommerce sales. They rose 7.9% while brick and mortar sales were up only 0.7%. 
 
The gross margin declined slightly from 37.3% to 37%. “The decrease was primarily driven by the deleveraging of our store occupancy costs and an increase in ecommerce related costs due to ecommerce sales increasing as a percent of total sales. This decrease was partially offset by an 80 basis points benefit due to prior year costs related to a step-up in inventory to estimated fair value in conjunction with our acquisition of Blue Tomato.”
 
Without the Blue Tomato inventory step-up, then, the gross margin would have been 36.2%.
 
SG&A expense as a percentage of sales rose from 25.4% to 26.2% or from $45.7 to $50.1 million. Part of the increase was from “…deleveraging of our store operating expenses.” I might have expected the opposite result with 55 more stores open. No detailed explanation is offered.
 
There was a charge of $1.3 million for settling litigation included, and some additional investments in their ecommerce business. There was a benefit of 0.6% because they reduced the expected earnout payments for the Blue Tomato acquisition. That happens because Blue Tomato isn’t performing as well as they had previously expected. That does not necessarily mean it’s performing badly. Total charge for the Blue Tomato acquisition this quarter was $1.7 million.
 
Operating profit fell from $21.4 to $20.7 million and net income was down from $12.7 to $11.9 million. The balance sheet is fine, and there’s no big change from last year. Inventory is up, but it’s consistent with having 55 more stores. In North America, inventory per square foot was basically flat.
 
I guess I’ll have Rick Brooks help me end this. 
 
“I just view retail in America as over-stored. I think, in particular, teen retail is way over-stored. And that is one of the reasons that there’s such tremendous promotional pressure in the teen retail world. One of the reasons, not all of them. But it is a significant reason, I think, that we see the level of promotional cadence in the teen world that we’re seeing today.”
 
That’s a problem for everybody in this space- not just Zumiez. And it’s a reason why you have to operate well. Sales and margin increases are hard to come by. The winners, I think, will be letting their customers help them determine their market position. I think Zumiez’s management would agree with that.