Rip Curl Financial Results

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Thanks to an alert from a reader, and a follow-up with a journalist who wrote about their results, I was able to come up with a copy of Rip Curl’s financial statements for the year ended June 30. There’s no discussion of operations or breakdown of what’s selling and where like we’d have if they were a public company. But I’ll take what I can get and I thought you’d be interested in their year over year improvement. 

You may remember that the company was for sale earlier this year but was pulled from the market when management decided there was no prospect of getting an offer they considered acceptable.
 
The numbers, of course, are in Australian dollars.
 
Total revenue for the year fell 3.4% from $412.5 to $398.3 million. Revenue from the sale of goods was down 3.7% from $406.8 to $391.6 million. Some may ask how I can characterize that as part of an “improvement.” Obviously, it can’t go on forever or there will be no company left. But long term readers know that I think there are a lot of competitive and financial advantages in being focused on managing your distribution and generating operating margin dollars rather than just sales growth. To be clear, I’m not against sales growth, but it should not be your only engine of profit improvement. 
 
Below is a table from their report that shows some of their expenses during the past two years ended June 30 (in thousands of Australian dollars).  The first column is 2013 and the second 2012.
 
 

  
You can see that they reduced their employee, rental, and selling and marketing expenses in 2013 compared to 2012. They had to take a restructuring charge of $4.5 million last year to do it, but the result is an EBITDA that rose 42% from $26.2 to $37.2 million. Rip Curl’s pretax profit increased from $938,000 in 2012 to about $14 million in 2013.
 
Now, anybody can slash expenses and do better at the bottom line. For a while. I guess we won’t know until next year how this looks as a more cohesive strategy and whether there’s further pay off.
 
That’s partly because the restructuring is still going on. Of the $4.5 million provision they took in 2012, they used only $195,000 in that year. $2.7 million was utilized in 2013 and the rest is expected to be used in 2014 as they complete the restructuring. No further charges are anticipated. The restructuring costs were for “…employee termination benefits, exit costs in closing retail stores, write down of assets no longer required and consulting fees.” None paid to me unfortunately.
 
The balance sheet showed some improvement. The current ratio rose from 1.03 (way, way too low) to 1.93. There was a rise in cash from $10.7 to $14.9 million and a decline in receivables from $85.5 to $77.7 million, which you like to see when sales fall. Inventory went up just a bit from $85.4 to $86.7 million. Overall current assets were down about $3 million to $185 million.
 
The improvement in the current ratio is largely the result of some reclassification of debt. Loans and borrowings classified as current liabilities fell from $111.2 to $32.1 million. But non-current loans and borrowings rose from $3.2 to $32.1 million. So basically it looks like they pushed their payment schedule out, though total loans and borrowings did decline from $114.3 to $94.8 million.
 
Total liabilities fell by 12.9% from $198.8 to $173.2 million. The balance sheet improvement plus profit growth means that equity rose from $66.9 million to $86 million. Total debt to equity improved from 2.97 times to 2.01 times.
 
Rip Curl improved during the year, but it’s still a work in progress. We’ll see what happens next year. I’m getting tired of saying that about industry companies.

 

 

Billabong: Restructuring News and Sale of West 49

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I got four pieces of information for you. If you’d prefer, you can read Billabong’s announcement which came out Monday their time. It’s the first item under “Recent News.” 

The most interesting, which they leave for last, is the pending sale of West 49 to YM Inc., “a leading fashion retailer with a number of highly successful stores including Stitches, Urban Planet, Sirens, Siblings, Suzy Shier and Bluenotes.” They are buying 92 stores for a total of between $9 and $11 million Canadian dollars. Billabong will keep six Billabong and two Element stores in Canada.
 
I recommend you take a few minutes and look over YM’s web site. They say what I think are a number of insightful things about operating and their target market. 
 
YM and Billabong also signed “…an initial two year supply agreement” under which Billabong brands will continue to be sold in West 49 stores. We don’t get any specifics about which brands or how much. At the end of the day, I assume that YM, like any retailer, will choose to carry the brands that sell best at good margins.
 
You will remember that Billabong bought West 49 in the summer of 2010 for $83 million Canadian dollars. At the time, West 49 had 140 store fronts. I can’t tell what the West 49 assets are presently carried at on Billabong’s balance sheet, so I don’t know what the accounting impact of this deal on the income statement will be. But its cash positive and, most importantly, it gets Billabong out from under the lease obligations of those 92 stores. West 49 will now be strictly a wholesale customer, so some margin and revenue goes away, but so do all the operating expenses.
 
We also learn that US$300 million of the previously announced US$360 million 6 year senior secured term loan was received and used pay off the US$294 million term loan and associated interest and fees previously received from Altamont. That gets Altamont out of the picture. 
 
Third, we learn that the seven person board of directors will consist of independent directors Sally Pitkin, Ian Pollard and Howard Mowlem. “The other directors are founder and substantial shareholder Gordon Merchant, Jason Mozingo (nominated by Centerbridge), Matt Wilson (nominated by Oaktree), and CEO Neil Fiske.” The two directors who had represented Altamont are out of there.
 
Finally, we’re told that “Billabong continues to work with GE Capital to provide an asset-based multi-currency revolving credit facility of up to US$100 million. This has been reduced from up to US$140 million in part due to the sale of West 49.”
 
That it’s being reduced because the sale of West 49 reduces their needs make sense. But that’s only “part” of the reason it’s being reduced and we don’t know what the other reason or reasons might be. I’m kind of interested to see that it isn’t done yet and would love to ask why.
 
Billabong’s restructuring and refinancing continues. I’m happy to see it moving forward, but I’m still waiting to understand the results of the customer and brand positioning analysis that started under former CEO Launa Inman. They can restructure and cut expenses till the cows come home, but customers still have to like the brands.

 

 

Kering tells us Almost Nothing about Volcom’s Results

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Kering reported its earnings for the September 30 quarter last week. We learned very little about Volcom and Electric. It’s like trying to find out what’s going on with Ride when we review Jarden’s financials or Reef when we look at VF’s. They just aren’t big enough to require much disclosure. What I do believe is when there’s good news, more time is spent on the smaller brand’s results. To me, the lack of information speaks volumes. Let’s see what we can find out.

Remember that Kering (then PPR) announced the acquisition of Volcom back in May 2011 and paid $608 million. The last time Volcom, as a public company, reported a quarter ended September 30 it was in 2010. Their revenue in that quarter was $105 million. 
 
Volcom is part of Kering’s Sports & Lifestyle Division. That division includes, in addition to Volcom, Puma, Cobra, Tretorn and Electric (acquired with Volcom). That entire division reported revenue of 896 million Euros for the quarter. (If we use the exchange rate at September 30 2013, that’s about $1.21 billion). But Puma represented 825 million Euros, or 92% of the total. So, according to my careful calculations, Volcom, Electric, Tretorn and Cobra together for the quarter had revenue of 71 million Euros. That’s $96 million at the September 30 exchange rate.  That represents a decline of 7.9% from 77.5 million Euros in the same quarter last year for the entire division. 
 
So what do we know?  We know that Volcom, Electric, Cobra and Tretorn together had about $9 million less in revenue than Volcom (including electric) reported during the quarter than ended September 30, 2010.   I have no idea what revenues Tretorn and Cobra had and whether those revenues grew or shrank. Do your own guessing, but by way of example, let’s say they are just $5 million each during the quarter.  That would leave Volcom and Electric combined at $86 million. 
 
We are told in the conference call that Volcom’s revenues were up 2% compared to the same quarter last year so that suggests that Cobra and Tretorn were down. 2% if probably not quite the kind of growth Kering had in mind when they spent $608 million. Kering says Volcom benefitted from the introduction of shoes and “resilience” in apparel. Its sales were “solid” in the North American market. Electric, they say, is “refocusing” on accessories and that impacted its results. Resilience and refocusing are the kinds of words you use when things aren’t going all that well, though how a 2% increase represents resilience beats the hell out of me. 
 
I don’t know if Volcom’s 2% growth includes Electric or not. I think not, but remember that the $102 million Volcom reported in its last September 30 quarter before being acquired does. 
 
When Volcom was acquired I wrote an article that congratulated Richard Woolcott and the Volcom board of directors for selling at the right time and for the right reasons. There’s a lesson there for anybody building a company, and at least one of you is now going to get a call from me this week suggesting it’s time to sell. 
 
The Kering press release does not even include complete financial statements, and many of the numbers are adjusted to reflect a “constant group structure and exchange rates.”   It’s bad enough that in the U.S. they do the conference call before the analysts really have time to analyze the press release and before they see the 10Q. That Kering can get away with doing it before they’ve released complete financial statements at all just amazes me. You won’t be surprised to learn that most of the questions are “strategic,” which in this case means there’s not much else you can ask about. I have no idea why the analysts tolerate it. Conference calls are starting to feel like Kabuki theater. 
 
It looks like Volcom (including Electric) isn’t doing very well based on the few numbers we are provided. Interesting that nobody else has even raised the issue. Certainly they are nowhere near performing up to expectations at the time they were acquired. What happened? Don’t know. I imagine that Kering’s expectations didn’t help things. But I also think, as I wrote at the time, that Volcom had gone a long way towards filling the niche they had positioned themselves in, and growing beyond that has proven difficult.
 
 

 

 

Market Evolution; Things to Think About from Quik CEO Mooney and My Spin on Them

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I wrote about Quiksilver’s quarter maybe a month ago. In the conference call, CEO Andy Mooney had some really interesting things to say about how the market is changing. I set them aside to think about. I felt they were comments that were appropriate to a general discussion of market evolution, rather than the particulars of Quik’s situation, though obviously they apply there as well.

The first thing he says, talking about Europe, is that we’re seeing “…a transition from smaller independent operators to larger big-box formats.” He went on to explain that their management team in Europe saw the decline in the number of independent specialty retailers as normal during a down economy, and that they expected a recovery in their numbers as the economy improves.
But CEO Mooney doesn’t share that expectation. “I’m a little less optimistic than they are because of the impact of – largely of e-comm because I think e-comm in some ways is creating systemic pressure on those smaller independent retailers, which for us is actually somewhat of a blessing because it’s actually less expensive for us to service e-comm retailers – pure play e-comm retailers – than it is to service remote onesie, twosies sub-specialty shops, particularly ones that by definition are kind of undercapitalized, have problems paying their bills, et cetera, et cetera.”
He expects some rebound in the number of specialty shops, but not as much as in past cycles. I also think his analysis for Europe is relevant in much of the rest of the world as well and certainly in the U.S.
However, I don’t think pressure on specialty shops has come only from ecommerce, though certainly that’s a big issue. I’d remind you all of the (apparent) strength of the economy up to 2007 and of the length and depth of the (continuing) recession that followed. Because the good times were as good as we’ve ever seen them, a lot of independent specialty retailers opened that would probably never have gotten off the ground in less favorable economic conditions. That they’ve closed in historically bad economic times and won’t reopen unless things get fabulous again is hardly a surprise and isn’t only about the internet.
One analyst asks if he thinks the action sports market is shrinking globally. Mooney responds, “…It’s not necessarily a contracting market; it’s a transitioning market.” He talks about the impact of ecommerce again, and then goes on to discuss another piece of the transition.
“You’re seeing,” he says, “…fewer more professional players who are allocating their open-to-buy to fewer more professional brands…my viewpoint is that there will be consolidation both in the retail theater, but I think there’ll also be consolidation in the branded theater. It’s that the stronger, more professionally-run companies will continue to gain share in what has historically been a very fragmented industry…what occurs when you’re going through this type of phase is you’ll end up with 4 to 5 major players who will have significant footprints in the specialty channel, and we absolutely intend to be one of those players.”
I assume if he thought it was a contracting market and that Quik wasn’t capable of being one of those four or five major players, he wouldn’t have taken the job in the first place. And, of course, what else is he going to say?
Still, I find his answer incomplete as it ignores a couple of elephant in the room issues that impact all the larger brands in our industry.
First, as I’ve written, the real action sports market is a pretty small market and has always been a pretty small market. Right now, judging from the evidence I have in terms of participation, it is shrinking. So Quiksilver, and any other brand with its roots in action sports of any size, is already competing way outside of action sports in fashion, youth culture, urban or whatever we want to label it as.
The second is that I don’t know what he means by specialty channel. Can‘t believe some analyst didn’t ask that. My assumption is that it includes not just independent specialty shops, but chains up to and including Intersport, Zumiez, Journeys, Tilly’s, etc. It used to be so clear and now it’s not. Is Intersport really “specialty?” I am not sure PacSun is with its new positioning. Maybe it’s correct to say it’s specialty, but in a much broader market. How broad does a market have to get before retailers who serve it are no longer “specialty” retailers?
Andy doesn’t seem to be that concerned about the independent specialty retailers and I don’t entirely blame him from a strict operating and revenue point of view. But some of those shops would say, “Right back at you, Andy.” Quik’s brands are widely enough distributed that I’m not sure shops can really compete with them and certainly they won’t help differentiate shops.
But Quiksilver is certainly a surf based brand. Can you be a “surf based brand” and not be in core surf shops? Can DC not be in core skate shops? Maybe they need to have product in those channels even if they aren’t the fastest growing, most profitable, easiest to work with accounts in the world. It’s not, of course, that Quiksilver isn’t in those shops, but it doesn’t feel like an area of emphasis and it’s fewer than it used to be.
Meanwhile, even if a big action sports brand kills it in the specialty market up to and including the chains I’ve mentioned and their ilk, it’s not going to be enough- especially as a public company. Macy’s, Nordstrom’s, Dick’s, Sports Authority- you can’t decide not to be in them. You can only decide when, with what product, and try to make sure they present you well.
I think Quiksilver, Billabong, and Skullcandy, just to name three, would be much better off if they were private. They’d be able to be more discriminating in their distribution in ways that would benefit their brands and, as a result, I think they’d be more profitable.
From their public discussions, we already know that these three companies are taking steps to improve their operations and become more efficient. Good for them. I have no doubt it will improve their bottom lines. But that doesn’t impact brand positioning (unless it changes distribution?) and leads us to the next elephant in the room.
Who’s the customer? It wasn’t discussed in the conference call.   Brands, we all know, have life cycles. As they grow and succeed, they resonate with a group of customers. If they are lucky enough to be around long enough – not an easy thing to accomplish – they age right along with that customer group. The customers’ lifestyle, shopping habits, priorities and lifestyle evolves. The company evolves with them.
As those customers shop differently, the brand distributes differently. I won’t bore you with specifics you already know, but distribution tends to become broader as brands age. And broader. And broader.
How do you accommodate those customers but be relevant and “cool” enough to attract new ones? Look at the winter resort business. They’ve built facilities and created experiences that appeal to their older, aging customers. But that customer group is only one who can afford that experience. Given the economy and existing resort cost/price structure, who do they replace current customers with as they age out?
When Andy Mooney says it’s “something of a blessing” that they don’t have to deal with so many small shops, I knows what he means. But if a brand doesn’t have product that those stores want to carry and can sell for margin, what does that say about its ability to attract new customers as the old ones “age out?” How, in short, do you follow your customers along their lifestyle curve while still attracting new ones?
CEO Mooney also talks about the product review the company is undergoing and how they are trying to focus on those products where they can differentiate and be a leader. We won’t see the results until 2014, which I’d say is about as fast as we could see the results. I’d expect that is part of their answer to my question.
At some level Vans is the poster child for a brand that seems to be accomplishing this transition. They’ve made their heritage a foundation of growth with new customer groups without, as far as I can tell, alienating the old ones.
It’s important to remember, however, that Vans didn’t manage that without some bumps in the road. They were a $400 million public company in trouble before they were acquired by VF in 2004.
Having the kind of success Vans is now having requires a steady hand, objectivity, and money. The “who’s the customer?” issue has to be addressed early and realistically before pressures from the inevitable market evolution lead to product and distribution decisions that compound the difficulty of making the required changes. This is particularly difficult in public companies, where the correct decisions don’t typically contribute to immediately improving quarterly results. This is why I’m such a fan of what Skullcandy is doing. I think they are doing the right things in spite of the short term impact on quarterly results.
Then there’s the whole ecommerce thing which is changing the playing field in ways we don’t understand yet. At least I don’t. I’ll just say here that I wonder if ecommerce accelerates the traditional brand life cycle- or, alternatively, maybe makes it irrelevant? Can it be that distribution will become less important, replaced by how you connect with your customers at all your touch points with them? Will it still matter if you’re in “specialty” distribution? We’ll all be finding out.
Finally, and still on the issue of who the customer is, Andy Mooney talked, as I noted above, about consolidation in the brands and ending up “with 4 to 5 major players who will have significant footprints in the specialty channel, and we absolutely intend to be one of those players.”
We’ve had a few conversations about consolidation over the years and the path he describes is certainly a familiar one. Snowboarding comes to mind when you think about consolidation. How’s that worked out as far as keeping customers and attracting new ones goes?
Operationally, I understand why CEO Mooney would expect the kind of consolidation he describes. But for me the strategic issue is how a company like Quiksilver, if it becomes one of four or five major players with broad and broadening distribution, positions its brands so that many of the specialty retailers want and need to carry them.
I don’t perceive that has been accomplished very often in the past. I hope in future conference calls (Not just Quiksilver’s) companies explain how they are going to do it with particular attention to who their customer is.

 

 

Abercrombie & Fitch Quarter: Trends Impacting Us All

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Consistent with other retailers, A&F’s numbers for their August 3 quarter were not so good. Let’s look at those numbers and then talk about the general trends I think are impacting most retailers in our space.

The Numbers
 
Net sales fell about 1% from $951 to $946 million. U.S. sales were down 8% compared to last year’s quarter, while international rose 15%. The impact of foreign currency rates benefited this quarter’s sales by about $3.4 million.
 
Direct from the 10Q, here’s how the sales number break down:
 
 
You might take a look at sales by brand in dollars and then at the comparable store sales change below that. You’ll note that overall comparable store sales fell 10% even though total sales were down just 1%. Including direct to consumer, they were down 11% in the U.S. and 7% internationally. Hollister comparable store sales fell 13%.
 
The comparable store sales decline was “…partially off-set by new international stores and the impact of the calendar shift, that resulted from the 53-week fiscal year in Fiscal 2012.”
 
Let’s talk about this calendar shift stuff. The retail calendar is divided into 52 weeks of seven days each. Simple enough. But that’s only 364 days and leaves an extra day each year to be accounted for. So every five to six years a week is added to the fiscal calendar.
 
In the words of VP of Finance Brian Logan, “…due to the calendar shift from the 53rd week in fiscal 2012, the prior year comparable 13-week period ended August 4, 2012, had approximately $44 million of additional sales versus the reported 13-week period ended July 28, 2012, which provided a benefit to second quarter year-over-year sales and earnings.” The point is that this quarter looks, comparatively speaking, better than it would have if the extra week hadn’t dragged sales from one quarter to another last year.
 
As you may have noticed, all the retailers are talking about it this year. Thank god we won’t have to deal with it again for another six years now.
 
Okay, still on sales, let’s look at how A&F did by region. Here’s another chart from the 10Q.
 
 
You can see the U.S. took a big hit. I’ve included the 26 week results as well just so you can see  the 5% sales decline over that period.
 
Saving their bacon for the quarter was an increase in gross margin from 62.3% to 63.9%. They tell us the improvement was “…primarily driven by lower product costs.” What they don’t tell us is whether the lower product was the result of epic, creative, insightful management efforts or pure dumb luck. If they’d done some good management things to make that happen, you’d expect they’d tell us. On the other hand, they are in the middle of a profit improvement plan that’s supposed to generate in excess of $100 million annually. But much of that isn’t supposed to be realized until 2014. Okay, let’s say it’s the profit improvement plan. May well be.
 
Store and distribution expense rose from $592 to $604 million. As percentage of sales, it increased from 48.1% to 49.9% quarter over quarter. We aren’t really told why. Marketing, general and administrative expenses rose from $458 to $471 million and from 11.7% of sales to 12.4%. The increase was “…primarily driven by increases in consulting and other services.” It includes “…$2.6 million related to the implementation of the ongoing profit improvement initiative.”
 
During the quarter, and reflective of some of this expense, A&F opened four international Hollister chain stores and two A&F outlet stores- one in the U.S. and one in the U.K. So far this fiscal year, they’ve closed seven stores in the U.S. and one in Canada. They expect that by the end of the year they will have closed a total of 40 to 50 U.S. stores. The remainder of the closures will all happen at the end of the year as leases expire.
 
Net income for the quarter was $11.4 million, down from $17.1 million in last year’s quarter. For the fiscal year to date, they’ve got a profit of $4.2 million compared to a loss of $4.3 million in last year’s first half.
 
Net cash used for operating activities for the year to date is $209 million, compared to $24.3 million in the prior year. About $98 million of that increase is for shares repurchased. Inventory was down by 9% compared to last year’s quarter. They’d expected it to be down by more.
 
Trends and Strategies
 
A&F didn’t give any guidance as to future results beyond the current quarter “Due to the lack of visibility given the recent traffic trends…” CEO Mike Jeffries talked about the market this way:
 
“The reasons for the weak traffic we’ve seen in the U.S. are not entirely clear. Our best theory is that while consumers in general are feeling better about the overall economic environment, it is less the case for the young consumer. In addition, we believe youth spending has likely diverted to other categories. We assume that these effects will abate at some point, but until we have seen clear evidence of that, we are planning sales, inventory and expense levels on a conservative basis.”
 
He goes on to discuss their profit improvement plan (mentioned above) and ongoing long term strategic review. He notes, “…the plan emerging from this review will map out clear strategies covering our assortment, our real estate plans, direct-to-consumer, omni channel, technology, marketing and CRM and sourcing. We are confident that these plans will give us a clear roadmap for sustainable growth in sales, profitability and return on invested capital.”
 
To me, the most amazing part of his presentation is where he says, “We assume these effects will abate at some point” to which I respond, “Why?” If he really believed that- if he didn’t think things were changing dramatically- why is the long term strategic review necessary?
 
At one point an analyst asks, “I’m just wondering if you could maybe comment on the potential for maybe non-traditional competition within the teen space potentially driving some of the weakness that you’re seeing across the entire industry from you and some of your competitors. Is there perhaps a structural change that’s occurred? And is that what we’re seeing within the teen category?”
 
Mr. Jeffries answer is, “…I think you’re right on in terms of the potential for non-traditional competition. It’s happening and we’re — we want to be in the forefront of that. I think what we own is very powerful brands. And owning those brands, we think we’re going to be able to be in the forefront of the non-traditional brick-and-mortar part of the business.”
 
CFO Jonathan Ramsden, responding to a question about what won’t change in the business model, says “…the core aesthetic and what the brands stand for.”
 
There’s an understandable limit as to what I expect management to disclose in a conference call. And it’s certainly not a problem that’s unique to A&F. But assuming things will go back to the way they were when “…youth spending has likely diverted to other categories” and stating that the ”core aesthetics and what the brands stand for” won’t change seem like they could be incompatible statements.
 
In his excellent book The Black Swan, Nassim Taleb talks about the life cycle of the turkey. From the day it’s born, everybody takes really good care of him. They feed him, give him medicine, keep him warm and don’t ask him to do anything. If you asked the turkey what tomorrow is going to be like he’ll say, “Why just as good as today.” The turkey doesn’t know tomorrow is Thanksgiving.
 
We’re in a market where where you need to be particularly careful in examining your assumptions.

   

A Tale of Two Retailers

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A recent trip to the East coast found me in a mid-sized, somewhat economically depressed city that’s undergoing quite a revival in its downtown core. I had the chance to walk the downtown with one of the people intimately involved in that development as he explained the vision and showed me the construction. 

Part of what he does is talk with local retailers to explain to them what’s happening and how it impacts them. One of those retailers has what I’ll characterize as an urban clothing store, and I got a chance to meet and talk with him. He’s doing a major upgrade in expectation of the impact of the development.
 
The shoes were all Nike and Vans (maybe there were a couple of pairs of Adidas). The clothing brands were mostly ones I hadn’t heard of. The prices and, I’d say, the quality tended to be towards the lower side. He had hats and belts, but really nothing else I’d call accessories. No watches, sunglasses, wallets, etc. He seemed trend sensitive, made full use of his point of sale register in managing his inventory, and knew who his customers were. Here’s how he described them. He hit me with this out of the blue, and I didn’t have a way to write it down, so I’m paraphrasing.
 
“I’ve got the best customers in the world,” he said. “Every dollar they have is available to be spent. Nobody has a mortgage, and nobody is saving for college.”
 
“I make most of my money the first five days of the month when the government checks come in. When the income tax refunds are received, it’s like Christmas. Nobody pays me with checks or credit cards.”
 
I can be a little slow sometimes, but when somebody hits me in the head with a two by four I usually notice it. What forms my retail perception? The stores in the mall and the specialty shops I visit that have an internet presence? I am afraid, in this economy, those places may not be completely in touch with reality and the result is that I am not either. Perhaps you have the same problem.
 
With something like 14% of households getting food stamps, the average wage having gone nowhere to down for at least a decade, and with participation in the labor force at a three decade low (making the reported unemployment rate decline even when things aren’t really improving much) is it any wonder that many of our prominent brands have had to close stores?
 
This guy has good customers. But they don’t take snowboard trips, buy $200 sunglasses or spend $300 on a pair of jeans.
 
Are you in touch with this very large customer group with income that is all disposable? Lord knows I’m not, but I’m going to change that. And I expect that I’m going to discover new trends and new brands as a result. There’s a whole new kind of store to be opened here but it’s often not going to fit your image of your brand and customer. Not quite as cool as you once were? This might actually be a chance to change that. I hope you’ve already figured that out even as I’ve remained comfortably clueless in my bubble.
 
The second retailer was a core skate shop, and I hope those of you with core skate shops have paid attention to what I described above because I think you might do well carrying some of the brands that guy carried.
 
This shop had recently been opened by a guy (let’s call him Ralph) because it’s what he had always wanted to do. I stumbled into it because we had some time on the way back to the airport and had pulled into a small town with some interesting stores. My wife said, “I’m going to shop.” Those of you who have been married a while understand the sub text there and know that Diane had dismissed me, which was fine.
 
He was all branded skate product; hard goods (longboards, popsicles, plastic decks, trucks, wheels, bearings) plus shoes and a few t-shirts and stuff. Small shop. He wants to carry Nike and Vans shoes, but isn’t yet. He’s also not doing a shop deck, but expects to. In talking to him, I found there was not another skate shop in the town, which was good.
 
I just kind of hung out and watched Ralph work with customers. Kids were coming and going and one came back in to introduce Ralph to his friends. A good sign I thought. He spent a while putting grip tape on a deck for a kid who, I think, had just bought the setup.
 
But then a father who was a skater came in with his young son (9 years old maybe?) to buy him his first deck. That was just great to watch. What was no so great was when the father got concerned about price. Ultimately, Ralph went down to the basement and got a couple of completes he doesn’t display that retailed for $60 to show the guy. The good news is that the kid chose, and his father bought him, a more expensive setup ($80 I think). I probably watched Ralph spend 20 minutes with them after which he sold an $80 product on which he made how much margin?
 
It felt like Ralph was doing it right in terms of location, product selection, and building community connection. But if he’s got to work that hard to make $80 in revenue, there may not be enough hours in the day.
 
He needs to take the cred that skate has in the urban market and carry some of the products the first retailer has, but he’ll need a few more square feet to do it in. 

 

 

The Buckle’s Quarter

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This, I’m happy to say, is going to be pretty short. But I’ve gone to the trouble of reviewing their information so I might as well write something. 

As I’ve noted before, what intrigues me about The Buckle is the way they’ve integrated their private label brands with the other brands they carry in their merchandising. They call it “…a collaboration on the styling details throughout brands and private label.” They are not an action sports retailer, describing the business as “…a retailer of medium to better priced casual apparel, footwear, and accessories for fashion conscious young men and women.”   Nor, given their pricing are they focused on fast fashion, though no retailer can ignore the issue of fresh product and time to market these days.
 
At the end of their quarter on August 3, they had 452 stores in 43 states, up from 439 a year ago. Their 10Q and conference call are notable for their brevity (a good thing from my point of view as the one who has to read it) but also their lack of useful information (a bad thing, though I suppose one leads to another).
 
Sales for the quarter rose 7.9% to $232.5 million compared to the same quarter last year. Comparable store sales rose 3.2%. This was “…primarily due to a 3.5% increase in the average number of units sold per transaction and a 1.2% increase in the average retail price per piece of merchandise sold, partially offset by a 1.6% decline in the number of transactions at comparable stores during the period.” However, they also had more stores, a one week shift in the fiscal period, and online sales growth. Online sales were up 5.3% to $16.8 million. The Buckle does not include online sales when calculating comparable store sales.
 
The chart below from their 10Q shows their sales by category. 
 
 
It makes you think what the impact on various retailers in addition to The Buckle would be if denim became unpopular. I know, that’s hard to imagine.
Their gross profit margin (which, remember, for a retailer includes buying, distribution and occupancy costs- not just product cost) from 40.1% to 40.6%. That’s a pretty attractive margin. It increased because of the extra week and due to leveraging certain costs over more stores.
 
There’s nothing particularly notable about their selling and general and administrative expenses. They were up in line with sales growth.
 
Net income rose from $23.2 to $25.1 million. In both periods, that was 10.8% of revenue.
 
The balance looks fine, but there’s literally no discussion of it or any footnotes. Too bad. There are some items I was curious about.
 
Why, as one analyst asked,  are you bucking the trend we’ve seen in some retailers recently? CEO Dennis Nelson says, “We take a true specialty store approach, where not only the selection of the product of continuing to flow new product in to create the excitement, but we really have a high quality sales management team throughout the company that supports our managers who are promoted from within. And they do a very nice job of developing teams that can help the guest and really benefit them in finding the right fits and the outfits. And that’s a real key part of our business as our team in the stores and our sales management team that helps develop them and keeps them looking for the next level.”
 
That is just an excellent job of not saying all that much, though I have no doubt, whatever it means, that it’s true.
 
And that is the end of what I think is the shortest article on a 10Q I’ve ever written. 

You Own Action Sports in the Mall. Now What? Zumiez’s Quarter

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 The headline I guess is that for its quarter ended August 3rd, Zumiez increased its sales and profits smartly. We have to talk about the impact of the Blue Tomato acquisition (July 4, 2012) and some restructuring costs, but basically things look good on a quarter over quarter basis. 

The more interesting issue, however, is the one I started to highlight when I talked about PacSun’s results. Zumiez is now the only pure retailer with an action sports focus in the mall. They describe themselves as “…a leading multi-channel specialty retailer of action sports related apparel, footwear, accessories and hard goods, focusing on skateboarding, snowboarding, surfing, motocross and bicycle motocross (“BMX”) for young men and women.”
 
I know Vans, Quik, and Billabong have mall stores, but they aren’t pure retailers and their focus is on their own brands. Their retail will live or die with the strength of their brands. Let’s not look for Billabong, just as an example, to replace Element with another skate brand if it’s not selling well. PacSun, as I discussed recently, has changed their focus away from action sports towards California based fashion trends.
 
If it’s too much to say that Zumiez owns the mall action sports niche, we can at least say they are the leader in the U.S., with 495 stores. They also have 27 in Canada and seven in Europe under the Blue Tomato name.
 
As CEO Richard Brooks describes it, their goal  “…is to reach all of our global markets with the right number of highly productive stores and a strong omni-channel presence that seamlessly extends our culture and our unique perspective on the action sports market wherever and whenever our customer interacts with us.”
 
So they are all about action sports. It’s great to be a leader in a niche as long as that niche supports your growth. I’d go so far as to say that through their consistent pursuit of a solid strategy over many years, their willingness to try and support new brands, the culture they’ve nurtured and their attention to system and operations that strive to get the right product to the right place at the right time, Zumiez has done most things right.
 
As you know, I’ve discussed how the action sports industry is actually smaller than we all thought it was during the good old days. I haven’t had anybody tell me I’m wrong about that. And we’ve all noted that fashion, youth culture, urban, or some other descriptor we haven’t come up with yet is a more accurate description of the market as it’s evolving.
 
If I were Rich Brooks, what would keep me up at night is wondering whether the market the company has worked so hard to stake its claim in isn’t changing so much that the competitive strengths the company has worked so hard to develop might not support the growth I need as a public company.  And if I step outside of the action sports market seeking that growth, how does that affect my ability to compete?
 
And Now, the Numbers
 
Sales for the quarter were $157.9 million, up 16.9% over the $135 million in last year’s quarter. North American sales grew 13.7%. European sales were around $6 million. Remember Zumiez only owned Blue Tomato for 1 of 3 months in last year’s quarter. Ecommerce sales increased 19.1% and represented 8.8% of revenue for the quarter, or %13.9 million. Comparative store sales were up 0.9%, but that includes the ecommerce results. Brick and mortar comparable store sales fell by 0.4%. If you add August in, comp sales are up by 0.8% for the year. By the way, I think including ecommerce sales in the calculation is the way to go. You just can’t isolate brick and mortar from ecommerce results any more.
 
The top line included 52 more stores than they had in last year’s quarter and benefitted from a calendar shift that meant the first week of back to school was in this second quarter instead of the third.
 
The gross profit margin rose from 34.4% to 34.9%. Most of the improvement was the result of not having half a million dollars in relocation costs they had last year, and not having another half a million in inventory step up costs they had due to the Blue Tomato acquisition. The product margin was “down slightly.” They expect it to be flat to slightly down for the rest of the fiscal year. 
 
Selling, general and administrative expenses rose from $42.6 to $47.3 million, but as a percentage of sales fell from 31.6% to 29.9%. Last year’s SG&A expenses included $800,000 in corporate office relocation costs. There were also $2.4 million of Blue Tomato related acquisition costs. In this year’s quarter there are $1.7 million of such costs. If we remove those costs from both quarters, SG&A expenses rose from $39.4 to $45.6 million.
 
Net income rose from $2.1 to $4.7 million.
 
There were comments about how promotional back to school continued to be and, consistent with other companies, how tough things were in Europe. There was this comment from CEO Brooks: “I think there is a trend back towards young women wanting to see more brands, perhaps better quality, in some of the clothing that they wish to purchase.” If he’s suggesting that fast fashion- cheap clothing bought often- might wear out its welcome, I agree with him.
 
I’ll be interested to watch Zumiez’s comparative store sales in coming quarters. I’ll also be interested to see if market evolution requires them to change the way they describe their market position in their filings. To me, Zumiez’s key strategic issue is whether the action sports market by itself will support the business they are building.

 

 

Billabong’s Deal. I Didn’t See This One Coming.

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I thought the Altamont deal would happen. I figured Billabong just had to get a deal done. That’s what they were doing until Centerbridge Partners and Oaktree Capital Management (we’ll call them the Consortium as Billabong does) asked the Australian Government’s Takeover Panel to take a look at the deal. 

Basically, the Consortium claimed that the deal with Altamont kept anybody else from bidding, and the Takeover Panel agreed. Billabong and Altamont changed the deal terms to satisfy the panel, and that opened the door for the Consortium to come in with what looks to me, and everybody else, like a better deal.
 
I imagine you’ve read the terms of the agreement in various places, so I’m not going to spend a lot of time on that. In Australian Dollars, Billabong is getting a six year $386 million term loan with a lower 11.9% interest rate compared to 13.5% from Altamont. They will use this to pay off the $315 million loan they previously received from Altamont.
 
They will sell $135 in equity to the Consortium and give existing shareholders the chance to buy another $50 million of shares at $0.28 per share. It will be interesting to see who goes for that. Depending on the success of that offering and Billabong’s cash flow requirements, some of that new equity will be used to pay down part of the term loan.
 
The Consortium will get 29.6 Billabong options exercisable at $0.50 a share. The $150 million asset based credit facility from GE Capital is still part of the deal.
 
Billabong will have to pay Altamont a $6 million breakup fee, and Altamont will continue to hold 42.3 million Billabong options that expire July 16, 2020. And Dakine is still sold.      
 
Okay, that’s enough. If you’re a shareholder, you care a whole lot about the specific terms of the deal. Hell, if you’re a shareholder you probably wish you’d never heard of Billabong. In any event, if you want more details here’s the link to the announcement on Billabong’s web site.   It’s currently the first item under “Recent News.”
 
Here are a few questions/comments I’m left with:
 
1)      We know West 49 is for sale. I wonder when that deal will happen and what the price will be.
2)      Will any other brands be sold? I expect new CEO Neil Fiske might undertake a strategic evaluation similar to what happened at Quiksilver and Skullcandy when a new CEO came in and the decisions will flow from that.
3)      Both Altamont and the Consortium will have seats on the Board of Directors for some time. That should be fun.
4)      For all the sound and fury and distraction of the deal cycle, the key question is what kind of market strength the Billabong brands will have going forward.
5)      What happens to the plan former CEO Inman started to implement? Will that, in whole or part, be out the window?
6)      What will be the specifics of the asset based credit line? That will have a lot to do with how much of the $150 million line is actually available to borrow at a given time.
 
I’m just glad the deal is finally done. I agree with Billabong’s Board of Directors, who put it like this in the release:
 
“The Board of Billabong decided that it was in the best interests of shareholders and all of the
Company’s stakeholders to conclude a long term financing as soon as possible. The Board of
Billabong had regard to the protracted period of uncertainty, distraction and disruption that had
been faced by the business and have entered into the long term refinancing so that the
Company can now focus on rebuilding the business and execute on its ambitions to improve
earnings.”
 
For those of us who don’t own shares, I suspect we’re mostly glad for our friends who have jobs there, and hope Billabong can just focus on building its brands and supporting the industry.

 

 

Joining the Party; Quiksilver’s July 31 Quarter

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It’s almost unanimous. Companies in our industry, (whatever industry we’re in) or for that matter most other industries, are cutting expenses, rationalizing supply chains, targeting marketing efforts, cutting SKUs, creating omni channels, growing ecommerce business, being more discriminating in distribution and generally doing all the things they have to do if they assume that sales growth will continue to be hard to come by. 

In their 10Q for the July 31 quarter, they list the action items for their Profit Improvement Plan:
 
“Important elements of the PIP include:
• clarifying the positioning of our three flagship brands (Quiksilver, Roxy and DC);
• consider divesting certain non-core brands;
• globalizing product design and merchandising;
• consider 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;
• supply chain optimization;
• reduction of SKUs; [Note from Jeff: CEO Andy Mooney says they want to reduce SKUs by 40%]
• 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 and implementing greater pricing discipline.”
 
They plan to be finished with plan implementation by the end of fiscal 2016 and expect it could “…improve adjusted EBITDA by approximately $150 million.” And they are only expecting “…modest new revenue growth compared with fiscal 2012 results.”
 
According to CEO Mooney in the conference call, Quik continues to focus on its “…3 key strategies of strengthening our brands, growing revenues and driving operating efficiencies.” However, “…revenue growth in the short-term will be difficult to achieve.” They don’t expect to see improved revenue results until the fall of 2014, “And we’re really looking at spring 2015 for the teams to hit full stride.” 
 
This all feels like good stuff. But to the extent it’s kind of ubiquitous, where does the competitive advantage come from? Let’s keep that in mind as we go through the numbers.
 
Income Statement
 
Sales were down 3.3% from $512 to $496 million. Last year’s quarter included $2.5 million of Quiksilver Women’s sales, a line the company has now exited. CFO Richard Shields tell us that, “…The decline was primarily in the Americas wholesale channel, where revenues decreased $16 million…”   As reported, the Americas fell 6.3% to $268 million, EMEA (Europe, Middle East and Africa) grew 6.3% to $164 million, and APAC (Asia Pacific) was down 11.5% to $63 million. In constant currency the Americas was down 6%, EMEA grow 3% and APAC was down 1%. More than 60% of Quik’s revenue came from outside the U.S.
 
 
The Quiksilver brand’s revenue was down 10% as reported to from $191 to $172 million. Most of the decline was “…due to a high-teens percentage decline in wholesale channel net revenues…” worldwide. It’s noted in the conference call that sales of Quiksilver product to clearance channels was down $5 million. I hope that’s an intentional trend.
 
Roxy revenues fell 1% to $130 million “…due to a high-twenties percentage decrease in the APAC wholesale channel and a high-teens percentage decrease in the retail channel within both the Americas and APAC segments…These decreases were largely offset by a low double-digit percentage increase in the Americas wholesale channel and growth across all channels within the EMEA segment.”
 
DC was also down 1% to $166 million “…with a low-double digit percentage decline in the Americas wholesale channel largely offset by growth across all other channels and regional segments. This growth was largely driven by increased discounting and clearance sales as we continue to reduce slow-selling DC inventories. Based on current channel inventories, we anticipate that DC brand net revenues in the fourth quarter of fiscal 2013 will decrease by approximately 15% from the $166 million recognized in the third quarter of fiscal 2013.”
 
You know, I seem to remember somebody writing that they hoped Quik wouldn’t push the DC brand too hard in their search for revenues because they might hurt it. Oh wait, that was me! I know- I shouldn’t do that, but once in a while I just can’t resist.
 
Revenues in Quik’s wholesale channel fell 7% from $369 to $345 million. Retail was constant at $120 million, and ecommerce grew 33% to $31 million. From the 10Q:
 
“Wholesale net revenues declined across all three regional segments, particularly in the Americas and APAC segments. Wholesale net revenue declines were focused within the Quiksilver brand across all three regional segments and the DC brand in the Americas segment.”
 
“Retail net revenues increased in the EMEA segment but were offset by decreases in the Americas and APAC segments….Retail net revenues in the DC brand increased significantly across all three regional segments but were offset by single-digit percentage decreases in the Quiksilver and Roxy brands. Retail same-store sales increased 2% during the third quarter of fiscal 2013.”
 
They are continuing to close underperforming stores and had 15 fewer than at the end of last year’s quarter. This accounts for most of the decline in retail sales. Quik ended the quarter with 562 stores. I didn’t get a sense for how many additional stores they are planning to close.
 
Gross margin was essentially unchanged, going from 49.5% to 49.4%, but total gross profit fell from $253 to $245 million with the sales decline. Quiksilver and Roxy gross margins improved, but DC’s was down. We are told they “…expect continued discounting on DC footwear product in the back-to-school and holiday seasons.”
 
Selling, general and administrative expenses fell 4.1% from $226 to $216 million. As a percentage of sales, it was down from 44.1% to 43.7%. Quik accomplished that decline in spite of $9 million of SG&A expense for employee severance and restructuring costs.
 
Those pesky, but noncash, asset impairment charges were $2.2 million compared to $141,000 in last year’s quarter, resulting in an operating income that fell 5.5% from $27.6 to $26 million.
 
Interest expense rose from $14.8 to $20.2 million, but was offset by a foreign currency result that went from a loss of $2.2 million to a gain of $4 million. Net income fell from $12.5 million to $1.8 million. The result for the quarter includes a total of $14.8 million in restructuring charges. For the nine months ended July 31, Quik had a net loss of $61 million compared to a loss of $15 million in the nine months the previous year.
 
Balance Sheet and Cash Flow
 
Quiksilver continued to use (rather than produce) cash in its operating activities. They used $12.5 million, down from $16.9 million in last year’s quarter. Trade receivables rose a bit from $399 to $418 million. The number of days it takes them to collect their receivables increased by 6%, “…driven by the timing of customer payments, longer credit terms granted to certain wholesale customers and the net revenue decrease…”     Inventory was also up from $391 million to $399 million, or 2%. Mostly, that’s because of the sales decline. However, inventory from prior years represented 9% of the total compared to 16% a year ago. Wonder how much of the old inventory is DC?
 
The current ratio dropped from 2.3 times to 1.7 times a year ago. Leverage increased with total liabilities to equity rising from 2.06 to 2.97. However, their debt includes $409 million that they paid off now from the $409 million in restricted cash that is part of their current assets, so be careful what conclusions you draw.  Basically, they’re refinancing their senior notes to push out the maturity and improve liquidity.
 
The Secret Sauce
 
I don’t have much doubt as to Quik’s ability to generate the cost savings it expects. It feels like there’s just too much low hanging fruit and we’re already seeing the results. And things will also improve on the cost side once they are mostly done with closing stores and with incurring restructuring expenses.
 
The question is around sales growth. I’ve been saying that those might be hard to find and I still feel that way. Quik is taking the approach of building their plan around low increases but expecting, as they note in their conference call, that they can do better.  But even if larger increases don’t happen, I think their approach will give them the ability to improve profitability. Let me quote from CEO Mooney in the conference call to explain this.
 
“We’re not really using discounting to drive the top line growth in our retail or e-comm channels.”
 
“But I think the other aspect that really caused the kind of slowdown of sell-through in North America is that the men’s product line wasn’t particularly well-segmented across the various distribution channels. And that’s one of the things that we’re very much focused on right now.”
 
“…we have just made significant progress on over the last few months is a reallocation of the marketing mix to a downshift in athlete endorsements, a downshift in events, a downshift in headcounts. So we freed up within the current percentages significantly more demand creation dollars that we believe will have some potential to drive demand at a higher rate. But even within the model that we’ve developed, the $150 million profit improvement model, we have factored in taking up demand creation from 5% as a percentage of revenue to 8%, basically stair-stepping up a percent point per year.”
 
“…the issue on the gross margin side for our company has never been one of the delta between pricing and cost. The issue has been one of — entirely of inventory management, so buying too much and then having to flush it through the clearance channel.”
 
Do you see the relationships here? Better inventory control and fewer SKU’s means lower closeout sales and makes it a lot easier not to use discounting to drive revenue growth. More thought as to distribution and better focusing marketing dollars to support that distribution strengthens the brands. Does this mean unexpectedly good sales growth? Not necessarily. In fact I’ll not be upset if it means lower sales for a couple of quarters, and it looks like that what we can expect. But the profitability of the business should improve, and I’d hope they can reduce their working capital investment and maybe, over time, debt and interest expense, further enhancing profitability.
 
We’re still left with the conundrum of being a public company that comes out of the action sports world. How and where do you grow while maintaining your brand’s strength and positioning? At some level, the two can be contradictory.