Naude/Sycamore Bid $0.60 for Billabong, but Deal Not Done Yet

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Paul Naude and Sycamore Partners (“NS”) have made a non-binding bid of AUD $0.60 for each share of Billabong yesterday, down from their preliminary bid of $1.10. Billabong has given them an exclusive period of ten business days to complete their investigation and finalize the bid. You can read Billabong’s press release here. It’s the “proposal update” under “Recent News.” 

And before we get into the details, you might also want to read this article, which was published over the weekend in Australia. Ms. Knight does an excellent job of encapsulating Billabong’s history and the forces and decisions that lead the company to its current situation. I wish I’d written this. Thanks, you who sent it to me!
 
Here’s what we know from the press release:
 
Sycamore is going to form a new company which would legally be the entity buying Billabong. A seller of Billabong shares can either take $0.60 a share or shares (they call it scrip) in the new company. I don’t know if scrip is something different from stock under Australian law.
 
It’s a condition of the proposal that at least 15% of shares accept scrip and that insiders Gordon Merchant and Collette Paull and their families take the scrip unless they get a better offer. Together, they own about 16% of the Billabong shares, and they’ve indicated they’ll take the scrip. What this means is that NS has to come up with less cash then they otherwise would. The fact that they got this provision accepted is to me an indication of Billabong’s need for a deal.
 
I don’t know what will happen, but if I’d paid, say, $5.00 or more (or maybe less) for my Billabong shares and was about to get $0.60 a share, I might just take the scrip and hope Paul and his team can do good things.
 
NS is also going to “…engage an internationally recognized accounting firm to complete a confirmatory quality of earnings analysis typical of an acquisition debt financing.” Not a surprise given the number of times Billabong has reduced its earnings expectations in recent months.
 
Also, the “…conditions of the bidder’s debt funding” have to be satisfied. We don’t know how the debt is being funded or what those conditions are. Could be Sycamore’s money, could be a third party, maybe Paul’s putting in some cash or maybe some combination of all three. In any event, as the press release makes clear, the deal isn’t done and right now neither party has an obligation to go through with it. I suspect the quality of earnings analysis will have a lot to do with satisfying the lenders, whoever they are.
 
We don’t learn whatever happened to the VF/Altamont offer. Maybe they didn’t make an offer or maybe they offered less. As I wrote when their interest was first made public, I thought they might have a hard time agreeing who got which piece of Billabong at what price.
 
As you are probably aware, Billabong’s assets are pledged to their bankers and, basically, that gives those bankers a lot of influence. As bankers, they aren’t so much concerned at this point about Billabong growing and prospering as they are about getting their money back. So it’s reasonable to assume they are in favor of any deal that gets their loans paid off or at least improves their security.
 
Billabong, for its part, can only not make this deal (or some other deal not in evidence) if, with the support of those banks or from another source, they have the working capital to cash flow their business while current CEO Launa Inman’s strategy is implemented. Remember she said at their half yearly presentation that while they were working on it and had already seen some results, the real benefit wouldn’t show up until next year.
 
Unless the quality of earnings analysis turns up something pretty bad, I think the odds are that this deal will happen, though I have no opinion as to what the final price per share will be.           

 

 

The Confluence of Internet with Brick and Mortar, and Notes from Nike’s 10Q

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Nike filed its 10Q for the quarter ended February 28th on April 4th. You can see it here. An actual analysis of their financial statements seems like a waste of time. I’ll mention a few comments I pulled out, but then I want to get on to what they are saying about e-commerce as it seems to be consistent with what other companies are saying. 

The first thing about Nike’s 10Q and conference call is what’s conspicuous by its absence. I can’t claim to have read every word, but nowhere did I see “skate,” “skateboard,” or “skate shoe.” I assume those sales are just part of footwear. Hardly a surprise. As I’ve discussed, skate shoe sales were never going to move Nike’s earnings per share. Their goal was to become credible with a piece of the market that didn’t see Nike as quite legitimate. Mission accomplished I’d say. And it doesn’t hurt Nike that the skate shoe market has evolved towards casual footwear, because they are pretty good at that.
 
Next, here’s the little bit we find out about Hurley. Nike’s “other businesses” are Converse, Hurley and Nike golf. Revenues for the quarter of those businesses totaled $615 million, around 10% of total quarterly revenues of $6.187 billion.
 
“Excluding the impact of currency changes, total revenues for these businesses increased by 9% and 8% in the third quarter and year to date periods, respectively, reflecting growth in Converse and NIKE Golf.”
 
I read that to say little if any revenue growth in Hurley.
 
“On a reported basis, EBIT for our Other Businesses increased 23% for the third quarter and 18% year to date, driven by improved profits at Converse and Hurley.”
 
So even if Hurley’s revenues didn’t increase, it’s being managed a little more rigorously to improve operating profitability. You know I like that approach.
 
Meanwhile, here’s what President and CEO Mike Parker says about their online business:
 
“In Q3 our online business grew 33% – outpacing the growth in our total DTC business and for total NIKE, Inc. We’ve delivered strong double-digit results in our e-commerce business every quarter for the last 5 years.”
 
He continues:
 
“That said, I’m not satisfied. Right now e-commerce is a relatively small portion of our total revenue. There’s a pretty big gap between where ecommerce is today and where we can take it. So we’re driving more innovation into the shopping experience, elevating the level of service and expanding customization online. At the same time we’re simplifying the user experience making it easier to find and buy our products. I can assure you given the size of the opportunity; everyone on the leadership team shares my sense of urgency around e-commerce.”
 
We’ve all watched a lot of companies get big percentage increases from their e-commerce business though sometimes those big increases were coming from small bases. We’ve wondered (or at least I’ve wondered) just what the mix of online and brick and mortar was going to be and how the two would influence each other. I think I’m getting an inkling.
 
The two channels are supporting mutual growth, but I suspect that online is going to mean fewer brick and mortar stores. That doesn’t mean there won’t be total brick and mortar revenue growth, but the number and purpose of actual stores will change. 
 
Zumiez alluded to this in their last conference call where they talked about the need for new metrics to measure comparable store sales and discussed how growth in the number of stores no longer translates in the same way into revenue.
 
It’s not that stores still won’t be opened (and closed). But the decisions may be more strategic. That is, there will be more to that decision than what sales that store can generate. The question is becoming, “How can opening a store here contribute to our reaching our customers through all available channels?
 
I don’t know how to measure that, but lots of companies are no doubt working on it. As they figure it out, I expect it to have implications for store size, location and inventory. There isn’t any doubt that e-commerce sales cannibalize brick and mortar sales to some extent, but that doesn’t mean there can’t be growth in the combined channels as well as some potential cost savings in the brick and mortar channel. I assume everybody who’s doing both (which is basically everybody) believes that.
 
We’ve also noted that brands are becoming retailers and retailers are becoming brands. We noted it, however, without really explaining why. Now we’ve got a clue. The internet and the need to be at all consumer touch points (Omni channel to use Zumiez’s phrase) requires it.
 
Uh, am I saying here that branding is becoming more important at a time when product is everywhere, it’s hard to create meaningful differences among a lot of products in a category, and the consumer knows everything and is picky? That implies high marketing costs but not always great margins and would seem to favor larger players.
 
Yeah, I guess I am saying that. I’ll be back to you after I’ve thought about it some more.

 

 

SPY’s Sales Up, Loss Reduced; But There’s Still That Pesky Balance Sheet

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It’s been years since we’ve had an annual or quarterly report from SPY so focused on growing the brand and with so little mention of managing past problems. Remember, though, that all I know and write about is what I hear in the conference call or read in the public documents. Speaking of which, here’s the link to the 10K. 

Strategy and Market Positioning
 
SPY’s presentation is about new, innovative product, expense management and reduction, their “specialized athlete consultants,” (which I guess some people might call team riders), the brand’s irreverent attitude as a positioning statement, a stabilized and focused organization, a rationalized structure in Europe (going direct never made sense with just $6 million in revenue there), and the focus on and growth of the SPY brand.
 
SPY characterizes itself as a “…creative, performance-driven brand,” and divides its eyewear products into three groups:
 
“(i) sunglasses, which includes fashion, Happy Lens™, performance sport and women specific sunglasses; (ii) goggles, which includes snow sport and motocross goggles created for our core demographics, and a new goggle line extension for the SPY ® brand that targets new distribution opportunities and customers; and (iii) optical, which includes optical-quality frames and sunglasses for persons in a slightly older, but still youthful, demographic.”
 
“We design, market and distribute premium products for people who are happy to be outside, especially youthful people who love action sports, motorsports, snow sports, cycling and multi-sports markets. Our products embrace their attendant lifestyle subcultures, crossing over into more mainstream fashion, music and entertainment markets. We believe a primary strength is our ability to create distinctive products for young minded, active people with a very different and irreverent point of view.”
 
They talk a lot more about their business strategy and products in the first couple of pages of the 10K and it’s worth a quick read. Here are their product categories and retail price ranges for each.
 
Fashion Sunglasses                                                         $75 to $180
Happy Lens Sunglasses                                                 $140 to $200
Women-Specific Sunglasses                                       $$85 to $135
Performance Sport Sunglasses                                  $85 to $160
Prescription Frames                                                       $180 to $210
Snow Sport Goggles                                                       $40 to $160
Motocross Goggles                                                         $30 to $75
 
The management challenge is pretty clear. SPY’s a smaller company whose product categories range from core to broad fashion. Its description of its market and customers would seem to position it as a niche brand but, as noted above, it crosses over into much larger markets with much bigger competitors. It would be a really interesting exercise (I’m sure SPY’s team has done it) to look at competitor price points for each of SPY’s categories and see who they define as competitors. SPY looks like it’s created some innovative products to differentiate itself, but many to most of its competitors have a lot more money to throw at product development (SPY spend $600,000 in 2012). How do you succeed as a small company in both the core and larger fashion market?
 
Hardly a new question, is it? I’ve recently noted that Skullcandy has some of the same issues, and wondered how Quiksilver can be focused on performance products but sell them in very broad distribution (JC Penney for example) to people who may not really understand or care so much about performance. Bluntly, I think every action sports/youth culture brand has to address the issue. How?
 
You do it by building a solid brand identity with patience over a period of time that I think is measured in years. You develop a consumer base that identifies with your brand and supports it. You watch your distribution. You don’t push into the broader market; you wait until you are pulled into it. 
 
SPY, in spite of all its past issues, has done that if only by virtue of the brand having survived this long. The brand has some strength in spite of those past issues. But the balance sheet limits options, as we’ll discuss after reviewing the numbers. 
 
The Results
 
Starting with the GAP numbers, sales for the year ending December 31, 2012 grew 6.8% to $35.6 million from $33.4 million the previous year. Sunglasses represented 77% of sales. Goggles were 22%. The gross profit margin rose from 43% to 46.1%. This was due to sourcing more product from China (the impact of the Italian factory is declining), and selling less closeout product of both the SPY and the licensed brands (discussed below).   
 
Operating expenses fell 9.8% from $23.8 to $21.5 million. Most of that decline was in general and administrative expenses. The sales and marketing spend rose, which you’d expect given their strategy. Advertising rose from $721,000 to $819,000.
 
The loss from operations fell for the year from $9.4 million to $5 million. Total other expense (mostly interest) rose from $1.5 to $2.2 million. The net loss was $7.2 million compared to a loss of $10.9 million the previous year.
 
Now for some important clarifications. Remembered all those licensed brands they tried to market and gave up on? They sold $2.2 million of that during 2011 but only $500,000 of it during 2012. Further good news is that they expect to sell $50,000 of that stuff during the current quarter, but then they will be done. It’s all gone!
 
Anyway, their sales were up 6.8% in 2012 even though they sold $1.7 million less of those licensed brands. Sale of the SPY brand product actually increased in 2012 by 13% to $35.1 million from $31.1 million the prior year. Sales of SPY brand closeout product fell to $2.6 million from $3 million in the prior year.
 
Past reports from SPY have spent way too much time describing money they had to spend for one thing or another that hadn’t worked out. If we aren’t completely over those, we’re certainly getting damned close. Not only don’t they have to spend money on those various inconveniences anymore, but they don’t have to waste time on them when it could be better spent building the SPY brand.
 
Sales during the last quarter of the year fell by 4.3% from $8.5 to $8.1 million. But the gross profit margin rose from 33.1% to 44%. The net loss in the quarter dropped from $3.4 million to $1.2 million.
 
SPY expects one-third of its 2013 sales to come from its new products. They are targeting operating expenses of under $18 million and believe if they could get revenues to the $37 to $38 million level, they can break even at the operating profit level. To put things in perspective, an increase to $37 million would be a 3.9% revenue increase over 2012.
 
Be aware, however, that their definition of operating profit excludes the noncash interest that is being added to the principal of their debt rather than paid in cash. It was $700,000 in 2012 and I expect it to be higher in 2013. And that brings us back to-
 
The Balance Sheet and Strategy
 
As you recall, SPY’s major shareholder has put a whole bunch of money into the company. If he hadn’t, the company would have gone belly up or been sold for not much. As of the end of 2012, notes payable to stockholder on the balance sheet was $19 million. Total indebtedness, including those notes, lines of credit and capital leases was $23.9 million.
 
Where the balance sheet and strategy come together (or maybe where they conflict, actually) is in creating a company and brand with a value that would permit the shareholder to get his $19 million back as well as pay off the other debt. That requires not only that the company make money at an income before interest line, but that it demonstrate some solid growth potential.
 
When you look at their product categories (above) you see they are placing bets in quite a number of markets (though there’s some obvious overlap among them). I hope SPY, as a $36 million dollar company, has the resources to pursue them all. In a perfect world, you’d sell the company to a larger player with the resources to insure they could, but the circumstances of the balance sheet make that difficult.       
 
I like the operating and marketing actions SPY is taking. I just hope there isn’t urgency around growth that leads to them trying to push the brand too fast in too many categories.

 

 

Zumiez Annual Results and its Evolution as a Brand

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I’ve talked before about brands becoming retailers and retailers becoming brands. There’s a lot of uncertainty as to what that would mean and how it would cause the market  to evolve. I’ve also said that the best retailers make the brands they carry credible- not the other way around. That’s true, but I don’t think I completely understood the implications. 

I’m sure I still don’t- completely.  But Zumiez, with its annual report and conference call, may have advanced my thinking a bit. I want to talk with you about how Zumiez management sees their company developing. I’ll get to all the numbers, but this isn’t about comparable store sales, or the growth of ecommerce, or the number of stores they open, but what it means for Zumiez to be a brand and how they expect to reach their customers.
 
The Integrated Experience
 
Interestingly, and maybe intentionally, you don’t really find the discussion in the 10K (which you can read here). They say, under Marketing and Advertising, “We seek to reach our target customer audience through a multi-faceted marketing approach that is designed to integrate our brand image with the action sports lifestyle,” but that’s as far as they go.
 
Multi-faceted marketing approach requires some more explanation. Integrating the brand with the lifestyle goes a long ways towards Zumiez giving credibility to the brands it carries.
 
Let’s start by noting that Zumiez includes ecommerce sales when calculating comparable store sales. To me, that’s an acknowledgement that ecommerce and brick and mortar sales impact each other and neither can be looked at in isolation. It is also an acknowledgement that the relationship between them is dynamic and a bit uncertain. We’re all still learning. CEO Richard Brooks notes in the conference call that they are going to have to “…reinvent the way we think about these metrics…” and they say in the 10K that, “There is significant interaction between our in-store sales and our ecommerce sales channels and we believe that they are utilized in tandem to serve our customers.”
 
Take a look at his’ comments in the conference call on what Zumiez is trying to accomplish and why.
 
“…what I really want to get everyone focused on this idea of what we’re really trying to do, which is build an omni-channel model, which is an integrated, multichannel selling platform, where you can unleash the power of what we’re doing with inventory and the brand experience for consumers, as well as our salespeople in every touch point of the business.”
 
He sees a lot of opportunity in their pure ecommerce play, “But the primary opportunity is going to be continuing to look and build — continuing to look at how we build this integrated multichannel selling platform across the organization and that’s really where our growth has been coming from, will continue to come from, as I see it over the next year or so.”
 
If you’re unclear about what he means by touch points and why they are important, take a look at this book, which I’ve recommended before.
 
CEO Brooks believes “…we’re in a period of market consolidation, where the best operators will win share.” Acknowledging the power that the consumers now have, he continues, “…when you talk about the power of the consumer, the integration of their ability to shop in any time of the day, any place, any time through these new smart devices I think it simply means that more volume moves towards the direct channel, in whatever form that may take… And I think what it highlights is that there is simply too much physical retail space. When we talk about share consolidation,…that’s the underlying reasons, as we see it, for the consolidation that’s taking place…our perception is that we’re in the early stages of this idea of omni-channel retail, of integrated multichannel selling…So this has a ways to go. It’s going to take a number of years yet for this fully to play out. And that’s why in our comments, you hear us talk about, again, striving to make the right investments, continuing to invest in our people throughout the organization, as key things that are going to drive our ability to perform well in this kind of environment.”
 
Like me, and probably most of you, Richard Brooks doesn’t know exactly how this is all going to work out but he’s sure it’s going to continue. I wonder which retailer will be the first to have one of those solid object, 3D printers.
 
In the past, Zumiez has indicated they thought they might ultimately have 600 to 700 stores in North America. But Brooks says Zumiez is “…regularly reevaluating what that range is…” and that they are managing their store portfolio “aggressively.” That’s because they are not as focused on their store number as on how those stores fit in with their omni-channel world.
 
“…it doesn’t really matter where we end up in that 600 to 700 range, we’re modeling the same amount of revenue. It’s how we’re capturing the revenue, Paul, that is the key thing and in which channel we’re capturing it, whether it be purely e-commerce, whether it be in-stores or whether it be an integrated omni-channel world.”
 
We could go back to the 10K (it wouldn’t hurt you to skim pages four and five) and learn what Zumiez thinks are their competitive strengths and growth strategies. But I’ve listed and discussed them before. I think those strengths and strategies are basically tactics. Their strategy is to develop an integrated omni-channel retailing model where each channel supports the other and, by doing that strengthen the Zumiez brand, makes it something of an arbiter of the brands it carries, and create a competitive advantage. They’ve been working on it for years, and it feels like market evolution is playing right into their hands.
 
There is a danger for brands here and I’ve written about it before. To the extent Zumiez can actually succeed in becoming an arbiter of which brands are cool, and to the extent a brand becomes dependent on a large order from Zumiez, a brand might lose some control over its own destiny. What that probably means is that brands need to pursue some of the same “touchpoint” strategies as Zumiez.
 
Financial Results
 
As of February 2, 2013, Zumiez had 500 stores; 472 in the U.S., 20 in Canada (ten opened during the year), and 8 in Europe (remember they acquired Blue Tomato in July of 2012). In the year ended February 3, 2012, they opened 53 stores, closed five, and acquired eight. Typically, each store gets merchandise five times a week. Private label was 16.9% of net sale, consistent with the last couple of years. No single brand accounted for more than 9% of their revenues. That’s up from 6.3% the prior year.
 
Sales for the year ended February 2 grew 20.4% from $556 in the prior year to $669 million. This includes $28.3 million in net sales from Blue Tomato, which are not yet included in comparable store sales. Comparable store sales rose 5.0%. That 5% includes a 2.9% increase in brick and mortar sales, and a 32% increase in ecommerce sales which, as I noted above, are included in comparable store sales. Note that the most recent year included an extra week compared to the previous year. That’s just the way the calendar worked out.
 
Men’s apparel represented 34% of net sales. Footwear was 23%, accessories 19%, and hard goods and junior apparel each 11%. It’s been assumed that carrying hard goods has been an important differentiator of Zumiez in the mall. I’ve assumed that as well, but I think if I were Zumiez management, I’d be taking a close look at the roll of hard goods. I’m guessing they aren’t highly profitable, but they take up some room. Wonder how few they can carry and still get the market differentiation they think it provides?
 
Of the total sales of $669 million, $619 million were in the U.S. and $50 million were foreign. Foreign includes Canada and Blue Tomato. 
 
Gross margin fell from 36.3% to 36%. Selling, general and administrative expenses (SG&A) rose from $141 to $173 million and as a percent of revenue were up from 25.4% to 25.8%. Advertising expenses, which exclude sponsorships and vendor reimbursements (love to know more about that), were $6 million, up from $2.5 million the previous year and $1.3 million the year before that. I interpret that as more spending to support the Zumiez brand, consistent with what I’ve described above.
 
Zumiez also committed $700,000 to the Zumiez Foundation, a charitable nonprofit organization focused on the helping the under-privileged. Cool.   
 
Operating profit grew about $8 million to $68.5 million, and net income was up 12.9% from $37.4 to $42.2 million. The latest year’s results included $7.3 million in costs associated with the Blue Tomato acquisition and $2.1 million in charges for relocating their home office and ecommerce fulfillment center.
 
For the last quarter of the year, net sales rose 21.7% from $184 to $224 million compared to the same quarter the previous year. The gross profit margin fell from 38.9% to 38.2%. Comparative store sales (including ecommerce remember) fell 1%. Net income grew from $18.7 to $22.9 million. There’s no discussion of the quarter’s results in the 10K.
 
The balance sheet is fine. There’s a big decline in cash, but that’s due to paying for Blue Tomato, their share repurchase program and the cost of opening new stores.
 
The Plan for 2013.
 
Zumiez expects to open 60 stores globally during the current year. 15 will be in Europe and Canada. Due to economic conditions in Europe, they have reduced their projections for Blue Tomato, though they don’t say by exactly how much.
 
They don’t provide a projection for the full year because, according to CFO Chris Work, “…consumer sentiment is tough to gauge and there is still uncertainty about the sustainability of an economic recovery.” For the first quarter they expect “…same-store sales [including ecommerce remember] to decrease in the mid-single-digit range.”
 
But they “…are planning our comparable store sales to increase in fiscal 2013, although we are cautious in outlook and believe this could be lower than comparable store sales in 2012.” Chris continues, “…we expect our consolidated product margins, excluding the impact of the inventory step up, to be down slightly. We plan to continue making strategic investments that we believe will reap long-term benefits, focused on enhancing the customer experience across multiple channels, growing our international footprint and investing in our people and infrastructure to support our domestic and international growth in 2013 and beyond. We expect these investments to slightly deleverage our overall gross margin, as well as SG&A for 2013. However, we expect operating profit to increase.”
 
Like all of us, Zumiez is hostage to economic conditions. But they are pursuing their strategy (as discussed above) even at some short term cost and have the balance sheet to do it.

 

 

Skull Candy’s Results and Management Change; Rick Alden Rides Again!

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I have been writing recently about organizational dynamics, changing CEOs, and the situational authority you have when you walk into a turnaround. My own experience is that when things suck and you walk in as the new guy, it’s really liberating because you can try anything. 

About five weeks ago, Skull’s founder Rick Alden returned as interim CEO in the wake of Jeremy Andrus’s departure. You may recall that Rick was replaced by Jeremy during the middle of Skull’s initial public offering process. The circumstances surrounding that transition were kind of unusual. That leaves me wondering if he won’t go from interim to permanent. Based on what he’s doing so far, I’d like that.
 
What’s good for a company in the longer run often doesn’t always support the regular, predictable improvement in sales and profits wall street likes to see. To Rick’s credit, he doesn’t seem too worried about that. Let’s see what he’s up to. If you’re interested, you can see the 10K here.
 
Changes
 
As I write this, the Skull’s stock is trading at $5.28 a share and has basically trended down since the public offering. It closed at $6.78 on March 7, the day of the earnings announcement and conference call, so has lost 22% since then.  Announcing that first quarter 2013 revenue would be 30% lower than the first quarter last year and there would be loss of $0.25 to $0.35 a share for the quarter didn’t help. We also hear from CFO Wescoat that "…the way I think you should be thinking about this is that sales are expected to decline over the rest of the year at an improving rate in each of the quarters beyond Q1".     
 
There are two things I want you to think about. First, there was no way Jeremy Andrus could, as CEO, have announced the changes Rick Alden announced (discussed below) without trashing his own credibility. Second, I suspect (though don’t know) that the first quarter loss will be bigger than it had to be because CEO Alden has chosen to go fast and hard at these changes. Like Andy Mooney at Quik and Launa Inman at Billabong, we’ve got a CEO at Skullcandy who, because they are new and because of the situation of the company, can do anything that needs to be done. And Rick Alden comes in with the added credibility of being the founder who built the business.
 
It’s not that I don’t think Skull still has some strategic issues. I’ve been writing about them since before the company was public and I’ll discuss them below. First, here’s what Rick’s up to.
 
He says, “An immediate personal focus will be the low-quality sales that comprise roughly 10% of our total 2012 revenue, much of which was driven through the off-price channel. Not only do we need to cut this back significantly, which is already being implemented for 2013, but we also need to make sure that we do not rely on this channel in the future. Our first quarter guidance reflects this effort.”
 
Those of you who have read what I’ve written about distribution know I love this. In the short run, it costs them some sales and profits. In the longer run, it supports the brand, improves the gross margin and, I think, improves competitive positioning.
 
They are going to redo their packaging which was, well, redone in 2011 and introduced in the first quarter of 2012. Alden tells us it didn’t “…support acceptable sell through metrics throughout the year.” He also thinks it set them on a course for more reliance on off price sales. He’s going back to an earlier approach to packaging which was “…incredibly unique, creative, colorful; told a great brand, product and feature story.” The new packing will flow into retail as the other stuff is sold. It won’t be a change out from one for the other.
 
Talking about Skull’s brand ambassadors, he says there will be “…better utilization of our brand ambassadors in telling product stories, especially at point of sale, and offering transparency around product differentiation and improving the activation of our marketing assets.” He doesn’t think they’ve been well used, though he isn’t specific.
 
He also notes that among the brand ambassadors, his personal favorite is “…our supermodel crew, including two-time Sports Illustrated cover girl Kate Upton.” That’s probably one of those things you’re not supposed to say in conference calls, but I think I’d feel the same way. He notes a couple of times that he’d said something he probably shouldn’t say. But you know what? Good for him. I actually managed to read this transcript without resorting to chewing coffee beans and thought I got some unusual insight into how the organization will function under Rick.
 
Then he talked about product, and I really liked this. He notes that they’ve been bringing out product in some cases just to meet a price point. He indicates that’s over and that new products will come out because they offer a new feature or meet a customer need. In fact, he says he’s“…stuck a fork…” in some products because they didn’t do that. He refers to the new product pipeline as “thin,” an acknowledgement probably not likely to help the stock price but I love it. Hell, you can’t solve your problems until you acknowledge they exist. 
 
Some of you remember when the snowboard companies all expanded their board lines beyond all reason in response to what other companies were doing. I remember hearing the justification that “Competitor X has a board like this one at that price point, so we need one too.” That was lazy and irrelevant competitive analysis. It’s harder to figure out what your customers want, but way more valuable, and that is the direction CEO Alden is taking Skullcandy.
 
In this vein, he notes that Skullcandy has not “…kept up with changing trends, nor have we led with our own innovations. This is unacceptable, and we need to get back to creating the leading edge rather than waiting to see what our competitors are doing.”  
 
He continues this approach, addressing the criticism the company has faced for not entering the premium price market aggressively. He says we know, we are, and we will be there, but that “…we will not enter the premier price points merely for the sake of raising prices…when we are motivated by the right product and inspired to tell our story at a specific price point, we will not hesitate.”
 
He also alludes to a big retailer customer who had expressed disappointment that Skull hadn’t yet extended its brand “…into adjacent categories such as speakers and mobility products. Brand extension is a long-term opportunity and absolutely a major shape for the future of Skullcandy.”
 
My guess is that such extensions will be absolutely necessary if Skull is to grow as quickly as the markets will require.
 
The Numbers
 
Sales for the year grew 28% from $232 to $298 million. That requires some explanation. On August 26, 2011, they finished buying their European distributor. After that, they operated and reported in two segments (North America and International) instead of one. 
 
“As a result, the twelve months ended December 31, 2012 are not comparable to the twelve months ended December 31, 2011 as the prior year does not include a full year of activity for our international segment…”
 
“Also, included in the North America segment for 2012 and 2011 are net sales of $26.1 million and $33.8 million, respectively, which represent products that were sold from North America to retailers and distributors in other countries…Adjusting for these sales from North America… North America net sales increased 21.4% to $224.2 million from $184.6 million in 2011 and international net sales increased 53.7% to $73.5 million in 2012 from $47.8 million in 2011. Included in the increase in international net sales, was an increase in net sales in Europe of $13.6 million, or 45.2%, to $43.6 million in 2012 from $30.0 million in 2011. Net sales made prior to August 26, 2011 in Europe were to 57 North.”
 
Of the adjusted increase in North American sales, $22.4 million, or 57%, came from sales of Astro Gaming product. Excluding that, North American sales of Skullcandy branded product rose 9.3%.
 
Gross profit rose from $115 to $140 million, but gross profit margin fell from 49.7% to 47.3%. In North America it fell 3.4% from 50.2% to 46.8%.  This was “…mostly due to a shift in sales mix to higher price point products with lower gross margin structures, lower margin sales to the closeout channel and an increase in the level of discounting provided to our customers.” The international gross margin was up 8% to 50% due to the acquisition of the European distributor. I’ll spare you the accounting specifics.
 
Talking about the overall gross margin decline, CFO Kyle Wescoat says, “…the shift in sales towards higher-priced, low-margin products accounted for 200 basis points of the decline; two, higher levels of promotional sales and retailer discounting accounted for 180 basis points of the decline; and finally, product liquidations through the off-price channel, which contributed 140 basis points to this decline.
 
I’ve always been a gross margin dollars rather than a gross profit margin kind of guy, so I’m just fine with lower margins on higher priced products as long as the sales increase justifies it. As noted above, CEO Alden has the company headed that way as the product and consumer demand permits it. He seems to be all over the issue of discounting and product liquidations.   
 
Selling, general and administrative expenses rose from $73 to $99 million. As a percent of revenue, they rose from 31.6% to 33.4%. That includes $1.5 million for the bankruptcy filing of a big UK retail customer. 
 
Operating income fell from $42.2 to $41.5 million. It fell from $39 to $32 million in North America and rose from $3.2 to $9.6 million in International. Net income rose from $18.6 to $25.8 million, but that was exclusively because interest expense fell by $6.8 million and Other Expense was down $1.3 million.
 
The balance sheet is stronger than a year ago. Inventories are down a bit even with the sales increase, falling from $44 to $41.6 million. Part of the decline was from “…selling off older and end-of-life…” inventory. Interestingly, Wescoat notes that “…we’re coming into the first quarter with a much higher level of inventory in the channel than we had at this time last year, and that is one of the things that we’re concerned about.” As a result, it’s hard to know how to think about the inventory decline.
 
Receivables rose from $51 to $76 million due to later sales in the fourth quarter and a $13.7 million increase for the launching of the Astro product at retail.
 
Strategy
 
The 10K says that the following are Skullcandy’s competitive strengths:
 
-Leading, authentic lifestyle brand
-Brand Authenticity reinforced through high impact sponsorships
-Track record of innovative product design
-Targeted distribution model
-Proven management team and deep-rooted company culture
 
There’s been some management turnover. And we’ve just heard from that new CEO that the brand ambassadors aren’t being correctly utilized, that the new product pipeline is “thin” and that he’s unsatisfied with how and why products are being developed.
 
With regards to targeted distribution, CEO Alden notes, “We really have had a target as calling out product differentiation to the different channels to make sure that we had unique and specialized product for those specialty retailers. And I will tell you straight up, we’ve done a really poor job of doing that. We tell the story real well. We just don’t deliver the product highly differentiated from one channel to the other.”
 
So the strengths aren’t being utilized as they need to be, and Alden is in the process of changing that. The competitive environment is getting tougher, and Skull acknowledges that in their expanded section in the 10K (page 11) on the competition.
 
I find myself compelled to repeat what I seem to have said every time I write about Skull, starting with their IPO prospectus. “Can you be cool at Fred Meyers?” Or Walgreens, or Best Buy, etc. Maybe, if you execute on those competitive strengths listed above and if the product doesn’t become a commodity.
 
You may recall that Skullcandy’s balance sheet and debt structure really required it to go public. But it feels to me like we’ve got yet another industry company with some problems that could be solved a lot easier if it wasn’t public. I applaud the steps Rick Alden is taking even as I recognize that some of them, as they strengthen the brand and its competitive position, will make it harder to meet investor expectations in the short to medium term. As a private company, Skull might rule the niche it created, growing sales slowly while controlling distribution and improving its bottom line. Public company pressure puts it in a tougher competitive environment.

 

 

Quiksilver’s Quarter and the Impact of New Management

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Using Quik’s recent changes as an excuse, I wrote a week or so ago about the dynamics of organizational change in companies experiencing new business environments. You can see that article here. Now, Quik has come out with their 10Q for the quarter ended January 31, 2013 and held a conference call. A lot of what they said in the call resonates with the article I wrote and is worth exploring. First, though, let’s look at the numbers for the quarter. 

The Results
 
Revenues for the quarter were down 4% compared to the same quarter the previous year from $450 to $431 million. The Quiksilver and Roxy brands were each down 8% globally. DC was unchanged. Wholesale revenue was down 9% from $295 to $268 million. Retail fell 1% from $131 to $129 million. E-commerce rose 40% from $24 to $33 million.   
 
Revenue fell 9.3% in the Americas segment from $205 to $186 million. It was down for all three brands and in both wholesale and retail. The decline was due to:
 
“…a) lower sales to wholesale clearance customers, largely driven by the timing of shipments between the first and second quarters of fiscal 2013; b) lower net revenues in our Company-owned retail stores due to 17 store closures since the end of the first quarter of fiscal 2012; and c) increased markdown
allowances and sales discounts to wholesale customers to assist the sell-through of inventory in this channel.”
 
The comment about lower clearance sales being partly responsible for declining revenues is kind of intriguing. It’s a big enough number that they have to call it out?
 
EMEA (Europe, Middle East, Africa) rose 1.2% from $169 to $171 million “…with high-single digit percentage growth in DC net revenues and low single digit percentage growth in Roxy net revenues largely offset by a high-single digit percentage decline in Quiksilver net revenues. Growth in the e-commerce and retail channels within EMEA were largely offset by a decline in the wholesale channel.”   
 
APAC (Asia, Australia, New Zealand) fell 2.3% from $75 to $73 million “…with a high-single digit percentage decline in Roxy net revenues and a low-single digit percentage decline in Quiksilver net revenues largely offset by a low-teens percentage increase in DC net revenues. Wholesale channel net revenues decreased in the high-single digits on a percentage basis, while retail net revenues were flat and e-commerce net revenues grew substantially…”
 
The gross profit margin was up slightly from 50.7% to 51%. It was up from 42.8% to 43.4% in the Americas, down from 60.3% to 57.8% in EMEA, and up from 51.1% to 53.9% in APAC.
 
Selling, general and administrative expenses (sg&a) fell about $5 million from $230 to $225 million. There was one of those asset impairment charges for $3.2 million (none in the quarter last year). As a percentage of sales it grew from 51.2% to 52.3%.
 
The operating loss rose from $2.5 to $8.7 million (including that non cash asset impairment charge). In the Americas it worsened, growing from a loss of $1.6 million to one of $8.8 million. AMEA reported an operating profit of $1.41 million, down from $15.7 million. APAC’s operating result improved, rising from $901,000 to $2.1 million. 
 
Interest expense was more or less unchanged at $15 million. There was an exchange rate gain of $3.2 million compared to a loss last year of $1.85 million. That’s a $5 million positive turnaround.
 
The net loss grew by 46.4%, rising from $20.9 million to $30.6 million. Quik ended the quarter with 840 owned or licensed retail stores worldwide. Over 60% of revenue was generated outside of the U.S.
 
Overall, the balance sheet is not much changed from a year ago. You would like to see further improvement and debt reduction, but that’s not likely given the losses. I would note that trade receivables have risen 5.5% from $322 to $340 million while sales have declined and the time it takes them to collect their receivables has risen 13%. “The increase in DSO [days sales outstanding] was driven by the timing of customer payments, longer credit terms granted to certain wholesale customers, and the net revenue decrease during the first quarter of fiscal 2013.” None of that sounds exactly good.
 
Inventories were up $7 million to $419 million. Inventory days on hand rose 7%. “These increases were primarily due to the net revenue decline in the wholesale channel during the first quarter of fiscal 2013, resulting in higher ending inventories than planned. Inventory from prior seasons was 14% of total inventory at January 31, 2013 compared to 19% at January 31, 2012.”
 
Generally, you’d like to see inventory decline if sales are down all things being equal. Of course, they never are equal. Timing (inventory received the last day of the quarter instead of the first day of the next quarter) and inventory cost (which can make the value in inventory rise even when units aren’t up that much) can make significant differences. But they didn’t really offer an explanation, so it’s worth mentioning.
 
Comments from the Conference Call
 
When Quiksilver got through the Rossignol mess I said, “Good! Now they can finally focus on making and selling great product.” But I also wondered, and wrote, that given the distribution they already had in place, where was sales growth was going to come from? A lot of companies thought they’d see significant growth in Europe. But with at least Greece and Spain in depression, and weakness in most other countries, that doesn’t seem to be happening.
 
We also heard in various conference calls about marketing initiatives, Quiksilver Women’s, selling board shorts in vending machines at resorts, and other things. I liked some of these ideas, but I didn’t see them generating the revenue growth a public company needed.
 
Now new CEO Andrew Mooney has come along and, with regards to most of these initiatives said, “FAGETABOUTEM!” His key theme is focus; on “…strengthening our brands, expanding sales and driving operational efficiency…”
 
“We will increase our focus, energies and resources on our 3 flagship brands of Quiksilver, Roxy and DC. Within these brands, we will further focus on critical product categories. To that end, we have clarified the brand positioning and gender focus of each brand, with Quiksilver being a male brand for surf and snow; Roxy, our flagship brand for women; and DC, refocus on skateboarding and snowboarding.”
 
None of this can happen overnight. SG&A reductions have already started, but there’s more to come and “…some of them will be actioned on this year, and others will be actioned on over the next 12, 18 and 24 months.” Apparently there are some contracts that will keep some from happening sooner. In terms of product lines, they “…can’t be significantly affected until fall of ’14.” CFO Richard Shields, talking about operational efficiencies, said, “…we’ll see some initial rewards from the work for the spring 2014 line come over. [What] I would just say is that the lion share of the opportunity, when I think about style rationalization, when I think demand aggregation, when I think about vendor consolidation, still remained to be done.” He expects this will not just decrease costs, but improve the gross margin.
 
CEO Mooney’s discussion of some of the already announced product line decisions is interesting.
 
“Within the 3 brands that we have, say, for example, in Roxy and in Quicksilver, we were doing skate products that were generating marginal revenue. And after all costs were attributed to those categories in terms of athlete endorsements, et cetera, et cetera, we were losing money on. Similarity in DC, we were in the surf category. So exiting surf in DC and skate in Roxy and Quicksilver was relatively a very, very easy decision to take, both strategically and financially.”
 
“When you go into categories like swimwear, it was impossible to tell the difference between a Quicksilver girls swimsuit and Roxy girls swimsuit because so we believe even within the wholesale channel, much of those sales were cannibalistic, plus again once you start loading the costs up to the subset of the business that was truly viewed as incremental, the profit was just not there. So it was a difficult decision to make emotionally because we had a lot of — we have 30-some people had given up to us doubling but the bottom line wasn’t there we really need to focus with a Quicksilver brand and the Roxy brand.”
 
He has more to say, but you get the picture. Isn’t it interesting how two different managements can have such different perspective and can reach such different decisions? I’d refer you again to my article I referenced in the first paragraph above and to Andy Mooney’s comment about the decision being difficult to make emotionally.  I would assume there were reasonably business differences on the potential of the initiatives and the investment required, but there were also issues of organizational momentum and personal relationships.
 
Okay, let’s move on to some related issues of distribution and product discussed in the conference call. Here’s CEO Mooney again:
 
“I think increasingly, the larger accounts, whether it’s JCPenney or Kohl’s, Famous Footwear, et cetera, I think increasingly, we’re going to have to move to fully segmented lines. We’re essentially unique to each account, custom-made for each account, which I think is becoming more the norm for the industry because in that way, we can make the best use of our resources to meet the expectations of both the consumer and the retail in that particular store, and the volume warrants that type of dedicated attention.”
 
Now, I need a lot more information, but it sounds like he’s saying they’ll do special makeup lines for each big account. Not unique, I’m sure and there’ll be overlap, but still. Damn, I’m usually not at a loss for words, but I don’t quite know what to say.
 
Here’s CEO Mooney talking about Quiksilver product:
 
“We believe really that our products are performance-oriented products. And I think that future lines will present themselves as much more bold and performance-oriented than the current line is, because that is — that’s really the origins of DC as a footwear company. And it’s an area where we can feel we can really excel in.”
 
One more quote from CEO Mooney, then I’ll have some comments.
 
“Today we launched the Diane von Furstenberg collection within Roxy, and it’s- we were very optimistic about the success of that collection and it’s exceeded—wildly exceeded our expectations so far, which kind of reiterates my earlier point about this very much being a product, this is a product driven business.”
 
Do they really believe that real, actual, performance oriented products are important to the customers at Kohl’s and JC Penney (excuse me, JCP)? Would those customers know a performance oriented product if they saw one? I don’t know exactly what a Diane von Furstenberg collection within Roxy means, but does the Roxy name require that? I thought we were refocusing on the three core brands here.
 
Much of what Andy Mooney is doing seems right to me. He’s getting rid of money losers, going to tighten up the supply chain, continuing to close losing retail stores, make the business global rather than regional, put in the systems he needs to do that (a process under way before he got there) and focus on the three core brands. In a lot of ways, it’s what Launa Inman is doing over at Billabong.
 
His bet is that the three brands can grow and remain credible, and in fact take market share in this economy, while remaining distinctive in very broad distribution. 
 
The problem I see is that he’s trying to do it as a public company. He’s going to be required to make some decisions for growth that I wonder if he’d make if Quiksilver were private. Unless he’s very, very careful, the requirements of brand building and growing revenues may not mesh up very well.

 

 

Interesting Comments From Deckers; What Will They Do With Sanuk?

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Deckers, the owner of UGG and Teva as well as Sanuk, filed their 10K annual report with the SEC and I’ve been through it. As you may remember, Deckers bought Sanuk on July 1, 2011 so the year ended December 31, 2012 is the first complete year with Sanuk included. 

For the year, revenue rose 2.8% to $1.41 billion, but net income fell 36% from $202 million to $129 million. The biggest reason for the decline was a gross profit margin that fell from 49.3% to 44.7%. The big problem was the cost of sheepskin, which was 40% higher than in 2011. By itself, that hit the gross margin by 4.5%. Deckers tried to push a chunk of this cost increase through to consumers and found they had pushed too hard. Consumers became reluctant to buy the product. With sheepskin prices declining some, Deckers expect things will start to get better in 2013.
 
UGG wholesale revenues were down 10.5% to $819 million. Teva at wholesale fell 8.5% to $109 million. Sanuk at wholesale was up from $26 to $90 million, but remember that last year Deckers only owned Sanuk for half a year, and Sanuk’s strongest quarters are the first two of the year. 
 
Decker’s other brands at wholesale were down about $1.5 million to $20 million at wholesale.
 
Ecommerce sales, on the other hand, grew 22.6% during the year from $106.5 to $130.6 million. Sales at retail stores rose 30% from $189 to $246 million.
 
Looking at brand sales across all channels, UGG was down 1.5% from $1.20 to $1.18 billion. Teva fell 7.2% from $125 to $116 million. Sanuk was up from $26.6 million to $94 million. They are selling almost no Sanuk ($20,000) in their retail stores, but ecommerce sales were up from $539,000 to $4.17 million. Other brands fell from $24.1 to $21.3 million. 
 
Without Sanuk, then, total revenues would have fallen from $1.35 to $1.32 billion.
 
I’ll get back to Sanuk. Decker’s presentation got me thinking strategically about the intersection of wholesale, ecommerce, and retail. The question is simply this; to what extent does growth in one of those three channels support or diminish sales in one or more of the others?
 
Thoughts on Ecommerce and Brick and Mortar
 
Deckers certainly believes that their net profit is higher because they are in brick and mortar and ecommerce than it would be if they weren’t. But I doubt they, or any other brand, would try and convince me that there isn’t some cannibalization among channels. And they’d also assert that the channels are supportive of the brand and, hopefully, ultimately, revenue growth.
 
Where’s the balance? What are the “things to consider” as we think about the intersection of wholesale, retail, and ecommerce. 
 
First, being on the internet and participating in ecommerce is somewhat defensive. I really don’t think you have a choice but to be there.
 
Second, a brand opening stores is a choice, not a requirement. A few stores are probably a good idea if only because of what you will learn about your brand, what sells, and why. A lot of stores is a whole different management challenge and should not be undertaken solely for financial reasons. Those few extra margin points can turn out to be illusionary if you aren’t very, very careful.
 
Third, opening stores and ecommerce should not be what you do because you can’t figure out how to grow your business any other way. This, I think, has particularly been a public company problem.
 
Fourth, stores and a good ecommerce presence may help your brand beyond countering what your competitors are doing, but if you’re brand isn’t already strong and well defined with your customers, it’s not a solution. Being everywhere can still be being nowhere. There’s a certain almost circular, unsatisfying, and ambiguous logic here. As we watch the evolution of brands, ecommerce and brick and mortar, I guess the winners will be the ones who are best at quantifying without deluding themselves the impact of each channel on the other.
 
Fifth, this ecommerce and brick and mortar stuff costs a whole lot of money. See point four again. You better know why you’re doing it and how it will impact your overall business. “To grow” isn’t a good answer.
 
Finally, once companies start opening stores, they seem to keep opening them. We can all think of some instances where that hasn’t worked out too well. Deckers had 77 stores worldwide at the end of the year. In 2012, they opened seven stores in the U.S. (giving them a total of 26) and 23 internationally. At end of the year, they had 56 UGG Australia concept stores and 21 UGG outlet stores worldwide. They expect to open more in 2013 and beyond. Same store sales were down 3.4% during the year.
 
Plans for Sanuk
 
Deckers paid around $200 million for Sanuk. That’s $123 million in cash plus additional contingency considerations that they are presently estimating to be $70 million for a company that was doing around $40 million at the time it was acquired. So I’m thinking they’d like to see it do well.
 
In 2012, Sanuk’s wholesale operating profit was 17.3% of revenue. That was well below UGG’s at 32.7% but better than Teva’s 9.3%.
 
“We believe,” they say, “that the Sanuk brand provides substantial growth opportunities within the action sports market, as well as other domestic and global markets and channels.”
 
They go on to say in, “Sanuk brand complements the Company’s existing brand portfolio with its unique market position…The Sanuk brand also brings additional  distribution channels to the Company, as it sells to hundreds of independent specialty surf and skate shops throughout the US that were not significantly in the Company’s existing customer portfolio.”
 
In the conference call, we’re told, “The acceptance of the Sanuk brand expanded collection of cold-weather shoes- colder weather shoes rather, and boots was very positive…” They want to “…evolve the Teva and Sanuk brands into year-round businesses.”
 
I’m looking the Sanuk web site right now, and I can’t find any boots or colder weather shoes so I’m not quite sure what it was that was well accepted. I guess I can understand why Deckers management might try to steer Sanuk towards boots and colder weather. UGG is by far the dominant brand in the company, and you can imagine that Deckers is confident in that market. And they’ve got to justify that $200 million purchase price.
 
Let’s just say I’m a little nervous about Deckers trying to expand the Sanuk franchise that way too fast. I have just three words for Decker’s management: Reef skate shoes. If you don’t know what I mean, then I’m right to be worried.
 
For 2013, Deckers is expecting a 15% increase in Sanuk, but only 4% for UGG and 6% for Teva. When you first see that comparison, you think, “Gee, Sanuk is doing well.” But when you think about it, it feels like Sanuk’s growth has slowed rather precipitously. I know big percentage increases are harder to come by as you grow, but that feels like too much slowing too quickly. What’s going on?
 
Other Deckers Stuff
 
Revenues in Decker’s fourth quarter rose 2.2% to $617 million. But the gross profit margin fell from 51% to 46.3%. As a result, net income was down from $124.5 million to $98 million.
 
Most of their production is done in China, but since 2009, they have started to source in other parts of the world. In 2011, they opened manufacturing locations in the U.S. and Latin America.
 
Their December 31, 2012 backlog was $323 million, down 16.5% from a year ago. They acknowledge an ongoing change in the inventory cycle, and think it’s “…likely that an even higher percentage of classic and cold-weather product sales are going to be concentrated in the fourth quarter. We are adjusting our supply chain resources accordingly, while also introducing new fall products for the transitional period between summer and the holiday selling season.” Anybody who sells winter product is going to have to think about that.
 
They are also looking at distribution, especially domestically. CEO Angel Martinez put it this way in the conference call.
 
“As the brand has evolved…it requires a commitment of inventory, it requires a commitment on the brand by a retailer. And where we get those commitments and we see that kind of support for the brand, we have partners for life, if you will. However, there are some environments where we don’t — we’re not happy with the brand presentation, we’re not happy with the support for the year-round elements of the business and the support for the men’s product, so we have to reevaluate whether or not those are long-term participants in the brand success going forward. Consumers today expect a full brand experience when they have a brand they love like UGG. They don’t want to see a piecemeal representation and a brand that gets cherry picked and put out there at retail.”
 
Well, obviously, you can’t blame him for feeling that way. But if every brand were to expect all its retailers to offer a “full brand experience” and carry the inventory that required, the smallest specialty shop would be 30,000 square feet. Either that or it would just be a brand retail shop. Opps.
 
Deckers highlights, and is addressing, some of the issues we’re all facing. More interesting to me is how they are going to manage Sanuk. The brand is highly credible in its market. If they try and push it into other markets too quickly, bad things could happen.

 

 

Globe’s Six Month Results; Sales Rise, Profit Falls

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Globe filed its financial results for the six months ended December 31, 2012 on February 28th.  There’s not a lot of information, but I thought it was worth a brief look.

The headline is that sales rose 3.8% from $42.3 million to $43.9 million. Those numbers are in Australian Dollars as are all the numbers in this report. Net profit, however, fell from $761,000 to $148,000.
 
Revenues in the Australasia segment rose from $13.6 to $16.3 million, or by 19.9%. In North America, revenue was down from $21.4 to $19.6 million (8.4%). In Europe, there was an 8.5% growth in revenue from $7.6 to $8.3 million. Revenue growth everywhere but North America then, but North America is 44% of revenues.
 
EBITDA (earnings before interest, taxes, depreciation and amortization) rose handily in Australasia from $1.53 to $2.34 million, or 53%. North America EBITDA took it on the chin, falling from a positive $1.32 million to a loss of $284,000. In Europe, it fell 45% from $448,000 to $247,000. Total EBITDA fell from $1.5 million to $892,000 or by 41%. However, there’s a clarification you need to hear.
 
The report states, “The Segment Result (EBITDA) in the half year ended 31 December 2011 includes other income of $1.1m, of which $1.0m relates to the net proceeds from the settlement of a legal case during that half year.” They note that if you ignore that (though I’ve always had a hard time ignoring a million bucks) EBITDA really rose from $0.5 to $0.9 million “…driven by net sales growth and stabilizing growth margins.” I note they didn’t say improving gross margins.
 
They go on to say, “This increase in net sales is driven by the continued growth in Globe branded net sales across the world, as well as growth from new initiatives in Australia, including the streetwear division (4Front) and a new workwear brand that was launched during the half year, F.X.D.”
 
In the press release, CEO Matt Hill says, ““It is pleasing to deliver branded sales growth despite continued macro-economic uncertainty and the well-publicised challenges in our global retail account base. We anticipated these trends would persist, and strategically invested in the diversification of our brand and category mix to minimise the effect of those trends on the group. However, while these investments are starting to pay-off, we are not immune to the impact on our traditional, core business and continue to develop strategies to ensure our business as a whole remains relevant and buoyant.”
 
It sounds like the two new initiatives are generating sales in Australia only, and we don’t know how much. The comment about “continued growth in Globe branded net sales across the world seems to fly in the face of what I assume is a decline in North America, but it’s hard to tell. Their web site shows 12 brands, so maybe they are just referring to the Globe brand and not to Globe the company. Again, I can’t tell.
 
Here’s the link where you can see their report, the press release and some other documents as well.
 
Technically, I suppose you can argue that the balance sheet is a bit weaker, but not really enough to matter. Current ratio is down from 2.95 to 2.67 but is still very solid. Total debt to equity is up slightly from 0.37 to 0.45, but that’s not much of a change. The thing I tend to focus on is the negative $89.7 million number shown as retained profits/(losses) over the life of the corporation.
 
Cash generated by operating activities went from a negative $1.24 million in last year’s six months to a positive $173,000 for the six months ended December 31, 2012. That’s good to see. Basically, last year they got less from customers then they paid to suppliers and this year they turned that around.
 
Globe’s board has just three directors; Paul Isherwood, Peter Hill and Stephen Hill. Paul is the single outside director and, as of February 25th, owned 900,000 share of the company or 2.17%. Peter and Stephen Hill each own about 12.4 million shares, or 30% each. CEO Matt Hill, who is not on the board, owns 3.5 million shares, or 8.5%. The Hills are the founders of the company.
 
Globe had an unsolicited take-over offer from a company called Mariner. It also had to hold a special meeting as required by Australian law after at least 25% of shareholders voted down the company’s report on executive pay for two years running. That meeting was held February 13th.
 
As you can imagine, with people named Hill controlling almost 69% of the voting stock, the take-over offer was rejected, and the board of directors was not replaced. It appears there is some dissatisfaction with the company, and given the composition of the board of directors and its results, that’s hardly a surprise. If I were a shareholder, I’d certainly want a couple of additional outside directors on the board.
 
There are a lot of questions I’d love to ask about which brands are doing how well where. We don’t get that information but, to be fair, we don’t always get it from other companies either. I can imagine I see some improvement here if only because sales grew, but I am given pause by the lack of specificity in the comments and the small profit.

 

 

VF’s Strategy; Why it is Consistent with the Competitive Environment

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VF filed its 10K annual report with the SEC three days ago, so I’ve been able to get a more complete picture of their performance for the year and quarter. You can see that report here. As you probably know, VF is a large consumer conglomerate that owns 30 brands including Vans, The North Face, Reef and Timberland which are part of its Outdoor and Action Sports segment. Its other segments include Jeanswear, Imagewear, Sportswear and Contemporary Brands. We’ll talk about the general strategy and focus on Outdoor and Action Sports. 

Pieces of the Strategy
 
Revenue for the year rose 15% as reported from $9.46 to $10.88 billion. Not following my usual process, I want to jump right to the balance sheet and report that inventory fell 6.8% over the year from $1.45 to $1.35 billion. Partly what’s going on here is that they are getting their Timberland acquisition (purchased in September of 2011) under control. But typically, you’d expect inventory to rise some with sales and when it’s doesn’t, it’s a good thing.
 
Now let’s jump to page 1 of the 10K to see what their broad strategy is:
 
“VF’s strategy is to continue transforming our mix of business to include more lifestyle brands. Lifestyle brands connect closely with consumers because they are aspirational and inspirational; they reflect consumers’ specific activities and interests. Lifestyle brands generally extend across multiple product categories and have higher than average gross margins.”
 
Connection with consumer and higher margins. No wonder they like outdoor and action sports.
 
Meanwhile, over in the conference call, VF Chairman, Chief Executive Officer, President, Member of the Finance Committee and for all I know Czar of all the Russians Eric Wiseman talks about their other focuses.
 
“…an obsessive focus on continuously improving our operational capabilities to drive growth and strong consistent returns to our shareholders; and finally, a highly efficient supply chain that includes owned and sourced manufacturing, which gives us unparalleled structural advantages, including product innovation, speed to market, low cost and outstanding quality. Individually, any one of these strengths would be an enviable asset for any company to have. Yet together, in concert, they’re at the center VF’s DNA and what allows us to be so successful.”
 
Keeping the supply chain efficient is no simple task. From the 10K:
 
“On an annual basis, VF sources or produces approximately 450 million units spread across 36 brands. VF operates 29 manufacturing facilities and utilizes approximately 1,900 contractor manufacturing facilities in 60 countries. We operate 29 distribution centers and 1,129 retail stores. Managing this complexity is made possible by the use of a network of information systems for product development, forecasting, order management and warehouse management, attached to our core enterprise resource management platforms.”
 
I don’t want to put VF on a pedestal here. There’s a never a section in the press release, conference call or SEC filings called “Places where we really, really screwed up.” It does not always go smoothly. 
 
Nor is it ever finished. I wouldn’t be surprised if a big piece of CEO Wiseman’s job was to make sure the whole organization is thinking about incremental ways to make things better. Everybody should be empowered to ask, “If we combine production for these two brands, can we save $0.03 a garment?” “If we make it at a factory we own, will the faster turnaround time mean lower total inventory that offsets the higher cost per piece?”
 
Sales increases are swell, but it’s nice to have ways to improve your profitability by increasing gross margin dollars or controlling expenses if they aren’t easy to come by. And it’s good to have a balance sheet that lets you invests in efficiencies- especially if your competition can’t.
 
VF is trying to do what I’ve been arguing in favor of for years. No wonder I like them.
 
The Outdoor and Action Sports Segment
 
This segment generated $5.87 billion, or 54%, of VF’s revenues for the year. It had an operating profit of $1.02 billion, representing 58% of total operating profit for VF, and an operating margin of 17.4% (higher than other segments with Jeanswear being second at 16.7%). That margin is down from 19.9% in 2010 and18.2% in 2011. The decline is largely due to Timberland.
 
Segment revenues grew 28.6% from $4.56 billion the previous year. Jeanswear is second at $2.79 billion representing 26% of total revenue. It was up only 2.1%. Growth of 6.3% by Sportswear was the second fastest segment growth.
 
But there’s a caveat. Of that 29% growth, 19% was the result of the Timberland acquisition and only 10% was organic (from the existing brands). But 10% organic growth is way better than any of the other segments did, except for “other” which grew 12.5% but was only $125.5 million in revenue for the year. 
 
The North Face is the largest brand in the segment, with Timberland second and Vans third by revenue. There are 100 VF operated North Face stores worldwide. Timberland has 200 stores and Vans 350.
 
Domestically, the whole segment was up 21% but 12% of that came from Timberland. International revenue was up 37% with Timberland representing 26%.
 
The North Face and Vans grew globally 9% and 23% respectively in 2012. Their direct to consumer business, including new store openings, comparable store sales and online, increased 13% and 18% respectively. In 2013, Van’s revenues are expected to be up 20% and The North Face up in the “high single-digit” range. Timberland’s revenues are projected to be up in the “mid-single-digits.”
 
Outside of the Americas, Vans revenue growth was in excess of 30% in constant dollars. It was up 60% in constant dollars in Europe and 20% in Asia. Direct to consumer was “a big part” of this growth.
 
We also learn that Reef’s revenues were up 17%, though we aren’t told anything about what its total revenues are. This is significant only because they haven’t said anything about Reef in the past probably because there was no good news to report. 
 
VF’s total capital expenditures in 2012 were $252 million. Of that total, $156 million or 62% were in Outdoor and Action Sports.
 
Some Overall Numbers
 
VF’s $10.9 billion of 2012 revenue generated $1.09 billion in net income. They spent $585 million on advertising. International revenue was 23% of total. 5% was organic and 18% due to Timberland. Direct to consumer revenue rose 25%, but 15% of that was Timberland. It accounted for 21% of total revenues. They opened 141 retail stores in 2012 and expect to open 160 in 2013. Gross margin improved from 45.8% to 46.5% “…primarily due to the continued shift in the revenue mix towards higher margin businesses, including Outdoor & Action Sports, international and direct-to-consumer.” Hmmm. Sort of seems to leave out North American wholesale business. 
 
For the last quarter of the year, VF’s revenues were $3.03 billion and it earned a net profit of $334 million. No details provided.
 
Okay, don’t stop reading here just because I’m going to talk about pension accounting. This is important. VF made a $100 million voluntary contribution to its pension plan during the year. What’s going on in the world of pensions? Not just at VF. 
 
How much you need to contribute to a pension plan obviously depends on a whole bunch of assumptions involving how many people will get pensions for how long and how much you’ll earn on the money invested in the plan. In 2012, VF assumption was that the rate of return on its pension assets would be 7.5%. They’ve reduced that to 7% in 2013. At the same time, they’ve “…altered the investment mix to improve investment performance.” I won’t go into the details, but from their description, I’d conclude they’ve increased the level of risk in their portfolio to try and earn that lower targeted return.
 
There’s a lot of this going on. Company and government pension plans have found themselves underfunded at least partly because they’ve been stubbornly unrealistic for years about what they could expect to earn on their pension assets. I think they’re still unrealistic. If they reduce the expected rate of return, the required contributions to the plans go up.
 
This is going to be messy. Not for VF necessarily, because they earn a lot of money and can afford to contribute to their pension plan, though obviously it will have some impact on the earnings per share. You’ve already seen some governments have problems in this area. Just be aware is all I’m saying.
 
The Evolution of VF
The Outdoor & Action Sports segment is presently the driver of VF’s success. They’ve acknowledged that in the description of their strategy quoted above that describes the kinds of brands they want to own. If they can improve Timberland’s performance, this will be even truer. As a company, they’ve changed their focus through buying and selling of brands. I don’t expect that to change. They say it won’t. They sold one brand last year. If Outdoor & Action Sports continues to offer the growth and returns it’s getting now, and brands in other segments can’t offer similar ones, I would expect to see further buying and selling of brands by VF.
 

 

The Changes at Quiksilver; A Broader Industry Organizational Perspective

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On Monday, The Editors at Boardistan, posted a still evolving story about cuts to Quiksilver’s team rider programs. Here’s a link to the post. As Boardistan points out, at that time there had been no official announcement from Quik, so we didn’t know the extent of the changes. 

They then make the insightful comment that “…Hollister doesn’t spend a dime on “core teams” and they don’t seem to be having any problem in the “So Cal inspired clothing for Dudes and Bettys” space.” Good point.
 
Since the Boardistan posting, Transworld Business and Shop-Eat-Surf have reported related stories, and we’ve also learned that Quik is also cutting certain brands and staff.
 
With the management changes that have happened and are happening at Quik, it’s hardly surprising that we’d see some things done differently. Tactically, it would make sense to me to cut team programs some. I can’t find the article (I have too many articles) but it was some years ago I suggested that your very best team riders have value and the guys you flow product to and maybe pay for wins or photo credits have value, but that it was time to take a look at the value of the members in the middle of a larger team. A lot of brands have done that.
 
Strategically, if it makes sense to cut your team budgets now, then it probably made sense a few months ago or even longer. Why didn’t it happen sooner at Quik? Or, for that matter, at other companies.
 
In recent years, we’ve watched management and organizational transitions at Spy, PacSun, Billabong, Burton, and Quiksilver. In at least some cases we’re still watching and I’m sure there are some other companies that should be included in the list.
 
Remember when Burton cut The Program? In the press release, or in an interview, Jake said something like, “I didn’t want to do this, these people are my friends, I fought it and tried to figure out another solution, but the annoying and persistent finance people on my board wouldn’t leave me alone.” From time to time, I am one of those annoying and persistent finance people, so I know exactly what he meant.
 
Organizations have momentum. People don’t like to change. Successful entrepreneurs have a high level of self-confidence and capability or they wouldn’t be successful entrepreneurs.   
 
A founding entrepreneur or long time CEO is successful partly because of the values she has imbued the organization with and the consensus around what the company is about. There is a sense of “how we do things” that gives comfort not just to the stakeholders (of which the employees are one part) but to the CEO as well. People have an understanding of their place in the company and their responsibilities that goes beyond their box on the org chart. At its best, this can be liberating and create efficiencies.
 
But it only works as long as the competitive business environment it was created to function in doesn’t change too quickly or dramatically.
 
In 2008, we experienced that quick and dramatic change. We are still experiencing it. And we experienced it suddenly after the best economy for the longest period anybody has seen for, well, forever.
 
Those of you who might have followed the travails of JC Penney (Excuse me, I mean JCP) know that attempts to fundamentally change a company’s market positioning and way of doing business aren’t unique to the action sports/youth culture market, nor are they easy.
 
You’ve probably also noticed that it’s typical for the pressure to build and then for the change to begin with a defining event.  The period immediately following that event often seems a bit chaotic.
 
If you’ve reflected on my descriptions of organizations above, maybe that’s not such a surprise to you. My experience in turnarounds is that really fundamental change is resisted as long as it can be (hence the need for the turnaround. Typically, it is some outside stakeholder that forces the change. It can be the banker, the accountant, investors, or a tax authority (hint: it’s a really, really, bad idea to use payroll taxes as a short term source of working capital).
 
Prior to the defining event that leads to the organizational change there’s almost always, as I’ve described it before, “more of the same” going on. “If we do the same thing, but work harder, we can solve this problem,” is the way the thinking goes. I have also called it “denial and perseverance in a period of change,” and I think that’s a damned good phrase. That will often extend to claiming that required changes are being made, but they are tactical rather than strategic and don’t truly address the new business environment.
 
But what would you expect when you’ve got an organization created to function under a set of assumptions and positive business conditions that have lasted for decades that suddenly, in a few months, change so dramatically that in some sense those business conditions cease to exist? The existing organization, the existing management, the existing relationships, may simply not be capable of coping with the new environment and making the required changes. That’s not what they were optimized for.
 
When you’re dealing with a difficult business situation, it starts to wear on you after a while. Where it used to be fun to get up and go to work (most days- there is no perfect job), now it’s a struggle. If it’s tough enough, you spend most of your time talking with suppliers, bankers, and investors and worrying about cash flow. It takes an incredible amount of time and energy, but doesn’t do anything to help you address the new business environment. The management team, and the entire organization, starts to get a little beat up. Attitudes can turn negative.
 
Interestingly, that’s the moment when you can get the most accomplished in the shortest amount of time. The CEO’s I respect the most are the ones who figure out what has to happen but decide they don’t want to be the ones to make those changes and aren’t the right ones to do it.
 
So you end up with a new CEO. That CEO has incredible situational authority, at least for a while, exactly because the change has been resisted long enough that things are tough. He doesn’t have the personal relationships or vested interest in the organization that the previous CEO had. Look, when you walk into a company and they say, “Welcome Jeff. We can’t make payroll next week. What should we do?” it’s incredible liberating because there’s nothing you can’t try.
 
Inevitably, the changes are a bit chaotic because they’ve been put off too long, change fundamental things about the company, and usually happen fast. Insecurity among employees can also be coupled with a sense of relief, because they all knew something had to happen.
 
When we hear about these dramatic and maybe unexpected changes from Quik or any other company going through this process, let’s by all means feel bad that people are losing their jobs. Let’s also remember that the goal here is to keep Quiksilver a successful, profitable company that supports the surf industry and provide jobs and careers to the people still working there.
 
For the reasons I’ve described above, the change process in companies facing a dramatically new business environment can often by chaotic and look pretty awful at first. Typically, however, it’s happening for a good reason and needs to happen. To that extent, I look at it as positive.