Billabong’s Half Yearly Report. Now What?

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I listened to Billabong’s conference call yesterday and have spent part of last evening and this morning going over the detailed financial reports. I lead an exciting life. There’s a lot going on at Billabong, and I want to start with an overview before we get to the financial nuts and bolts. All numbers are in Australian Dollars. 

An Overview
 
The first thing everybody no doubt wants to know is whether or not there’s any news on the company being sold. There is not. All we’re told is that due diligence with both parties is in “an advanced stage” and should be completed in March. Whether there will be a firm bid when the due diligence is complete, what price the bid will be at, or whether Billabong’s board would accept a bid is not known.
 
You’ll recall that both potential buyers preliminarily offered $1.10 per share. Given the half year results, deteriorating business conditions, and Billabong’s lowering of its guidance for the full year from an EBITDA (before significant items- we’ll get to those) of $85 to $92 million down to $74 to $85 million, I’ll be interested to see if they still feel that the $1.10 offer is appropriate. 
 
Meanwhile new CEO Launa Inman is pursuing the transformation strategy she described some months ago. You may recall that there were a lot of things I liked about that strategy. It seemed like there were a bunch of costs that could be reduced. Some of those savings have been realized, but others will take some time and there’s significant expense required to realize them.
 
119 retail stores had been closed as of February. Forty more will be closed by June. Starting in March, the number of suppliers will be reduced from north of 270 to 50. That has to be worth a lot of money but of course you don’t see the benefit until you’ve actually been through the product cycle with just 50 suppliers. Their process of reducing SKUs is also ongoing, but we didn’t get any specifics on that.
 
The organization is moving from a regional to a global reporting structure and there’s a global information technology strategy is place and being rolled out in the middle of this year. In the conference call we’re told that IT used to report through to each region. Billabong has now hired an IT director who reports to CEO Inman and is tasked with pulling it together. The comment that most caught me by surprise was her statement that Billabong does not have a true general ledger across the whole business.
 
I suppose that’s a hangover from the days of “Buy good brands with good management and let them run their operations.” Perhaps an appropriate strategy for a different economic reality and, in any event, lacking a companywide general ledger, you had no choice.
 
It sounds like there are a lot of changes in reporting relationships and responsibilities going on.  Wonder how it will all impact the people running the various brands. No doubt they are wondering the same thing. The described changes are necessary in my opinion, but also disruptive. Peter Meyers, the CFO, has been there only four weeks speaking of drinking through a fire hose.
 
Remember when Gary Schoenfeld became PacSun’s CEO and turned over the entire senior management team? We talked then about how there had to be a settling in period measured in months. I don’t know how extensive the changes will be at Billabong, but it’s the same concept. Some patience is required.
 
So there are a plethora of ultimately good and necessary changes and a certain level of organizational musical chairs going on. Accomplishing all this costs some money. Meanwhile, cash flow is impacted by weak business conditions and the bank is nervous enough to make Billabong move to an asset based line of credit. And then there are two potential bidders for the company. What happens to which brand if one of them is successful? The stock closed at $0.86 a share yesterday, down from $0.92 before the announcement, so it looks like the market is not quite sure, after yesterday’s results, that a deal will happen at $1.10.
 
CFO Meyers noted that of course the company had to watch its cash flow, but he said he was comfortable that they have the cash flow to continue the transformation strategy. I wonder if that’s true if business conditions worsen more.
 
The best thing that could happen to Billabong is to resolve the issues of whether the company is going to be sold. The disruption, uncertainty, and general organizational angst surrounding just the transformation strategy is adequate without the addition of due diligence and the possibility of a new owner. If there is a firm offer to purchase Billabong, I suspect it will be accepted (or not) based on how Billabong’s board perceives the company’s financial ability to implement the transformation strategy.
 
Numbers
 
Let me start by giving you the actual income statement numbers. Then I’ll go through various explanations, adjustments, and qualifications you’ll want to know about.
 
Revenues from continuing operations were $702.3 million, down from $764.3 million in the PCP for a decline is 8.1%. As you would expect, cost of goods fell from $360 to $335 million and gross margin was down from 53.4% to 52.1%. Selling, general and administrative expenses fell from $297 million to $268 million.
 
Okay, now here’s the biggie. Other expenses rose from $96 million in the PCP to $624 million this year. I guess I’d better stop and explain that.
 
As we’ve discussed before, companies are required to evaluate their intangible asset values and adjust them if those values have changed. Impairment charges they are called. I consider the process to be valid. If you don’t expect to earn as much with an asset as you did before, it’s certainly worth less. But doing the calculations is arcane as hell and it’s tough to say if the numbers you arrive at really reflect market value. Impairment charges for brands and goodwill are noncash charges.
 
Billabong ended up having to take big write downs on the goodwill and brand values they had on their balance sheet. By far the biggest chunk was for the Billabong brand, whose carrying value was reduced from $252 million to $30 million. Billabong took total brand and goodwill charges of $427.8 million. The charge for Nixon was an additional $107 million and it took its carrying value down to $29 million.
 
Including those charges, Billabong called out “significant charges” that totaled $567 million pretax. You can see the list on page 12 of the Half Yearly Report Presentation. Click on it on this page to open.
 
The charges include $1.9 million for inventory clearance below cost, $3.1 million for specific doubtful debts, $5.8 million for takeover bid defense, $6.3 million for the transformation strategy, $11.7 million for Surf Stitch, and $3.5 million for a supply agreement they had to pay as part of the Nixon deal. They then proceed to show their results as though these costs hadn’t been incurred, arguing that these are unusual, one-time costs. You can decide for yourself which of these you think should or should not be excluded. $1.9 million was included in cost of goods sold, and $16.2 million in selling, general and administrative expenses.       
 
The bottom line, including all these charges, was a net loss of $537 million compared to a profit of $16 million in the PCP.
 
Nixon
 
 Let’s take a short detour to examine the impact of the Nixon deal on the income statement. Total revenue in the PCP was actually $850 million. But remember they sold 51.5% of Nixon in April, 2012. Accounting treatment required that their share of Nixon’s revenues no longer shows up as revenue on the income statement. We just see their share of Nixon’s after tax profit for this year. For the PCP it’s carried as discontinued operations and the $86 million in revenue is excluded from the top line. Nixon’s $18.4 profit after tax is shown as a separate line item called profit from discontinued operations. For the six months ended December 31, 2012, there is a loss shown of $2.44 million. This is a one-time cost they had to pay to get out a contract when the deal was done and doesn’t have anything to do with how Nixon is doing.    
 
However, Billabong’s share of Nixon’s profits in the most recent six month period was $1.142 million, “materially down” from what it was expected to be at the time of the transaction and 30% to 40% down compared to last year. During the question session, there was some concerned expressed about the debt on Nixon’s balance sheet ($175 million) but we were assured there was no recourse to Billabong for that debt.
 
Looks like the timing of the Nixon sale was pretty good. Probably wishing they’d sold the whole thing. Boy, I didn’t see that one coming.
 
Segment Results
 
Billabong reports its results for three main segments; Australasia, Americas, and Europe. The headline is that revenue and EBITDAI as reported were down in all three segments. These numbers include the Nixon revenue of $86 million in the PCP. I’ll give you the numbers without Nixon after this.
 
In Australasia, revenue fell from $296 million to $276 million or by 6.8%. In the Americas, the decline was 20.2% from $401 to $320 million. Europe was particularly bad (not a surprise) falling 30.7% from $150 to $104 million.
 
Here are the EBITDAI numbers. Australasia fell 48% from $27 to $14 million. The Americas was down $30 to $13 million, or 56.7%. Europe went from $16 million to a loss of $799,000. When you include third party royalties, Nixon, and that bad contract they had to pay, we’re left with total EBITDAI falling 66% from $74 million to $25 million.
 
Now here are the numbers, but without Nixon. It’s kind of overkill, but I think it’s important. Without Nixon, revenues in Australasia fell 2.5% from $283 to $276 million. In the Americas, they were down 7% from $344 to $320 million.  Europe fell from $135 to $104 million, or by 23%.
 
EBITDAI without Nixon fell from $21 to $14 million or 33% in Australasia. The Americas went up slightly from $12.2 million to $12.5 million. Europe’s EBITDAI fell from $10 million to a loss of $799,000. Total EBITDAI excluding Nixon fell from $45 to $28 million.
 
As you can, the comparisons look better without Nixon and, in fact, the EBITDA is $3 million higher.      
 
In the CEO’s presentation, we learn that the sales decline in the Americas was led by retail which fell US$ 19.1 million. This was “driven by negative comparative store sales growth in Canada and store closures.” Wholesale revenue fell US$ 4.2 million. $US 3.9 million of that was in Canada. Future orders are up in the U.S., but down in Canada. West 49 was down 8% for the six months. Retail sales in the Americas were down 6%. 
 
There was also a comment that they did substantial closeout business in the Americas including to TJ Max. They are hardly alone.
 
In Europe, action sports distribution continues to shrink, there’s pressure on margins, and heavy promotional activity. CEO Inman noted they lost 25% of all their accounts in Europe last year either because they went out of business or due to credit hold. There were also some accounts that reduced orders due to stock left from last year.
 
In Australasia, the sales decline was driven by store closures, but the online business is growing. Wholesale forward orders are “not where we’d like.” 
 
The numbers are a bit different in constant currency, but not enough to justify me laying them out here.
 
So these results are not specifically too good. How might Billabong management give us a little different perspective? 
 
Here’s what Billabong says on page four of their Half-Year Financial Report. You can see the report here. Just click on the link and open it as a PDF.
 
“Given the impact of the Group’s transformation strategy announced to the market on 27 August 2012 and the impact the difficult global macro trading conditions have had on results this half-year, the Group’s results have been presented on an adjusted basis to exclude the significant items to enable a more representative comparison to the prior year as detailed below.”
 
Calling the transformation strategy costs one time I can see, though I don’t expect they are done with those costs. But certain costs that result from the “impact of difficult global macro trading conditions” can be adjusted for? How can those possibly not be normal operating costs? Maybe I just don’t speak Australian English. A company doesn’t get a “do over” because the economy sucks. That’s what you’re supposed to manage through.
 
Anyway, if you eliminate all those costs they have labeled as significant, the adjusted EBITDAI is shown to fall from $83 million in the PCP to $57 million. Net profit is down from $38 to $19 million, which is a bit better than a loss of $537 million.
 
The balance sheet has gotten smaller but, thanks to the sale of half of Nixon and the raising of capital, not gotten much weaker. Cash generated by operations has fallen from $87 million to $29 million.
 
As much as I like Billabong’s transformation strategy, I’m left wondering if they’ve got the time and financial capacity to implement it, especially if the world economy should stay soft or even get worse.      

 

 

Trade Show Evolution: The Boardroom with the Vans U.S. Open. I Like It, I’m There.

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Over the years I’ve had a lot (some would say way too much) to say about Trade Shows. I’ve suggested there were too many, that they were too expensive, that the internet made them less necessary, that they’d lost focus, weren’t efficient, and that the way product was sold into broader distribution made them less important. 

The poster child for most of these issues was ASR which, as you all recall, went away a couple of years ago. I don’t think my concerns are all resolved, but there’s been progress.
 
And the smartest thing anybody did in the wake of ASR’s closing was, well, nothing. Absolutely nothing. This brilliant doing of nothing was conceived and implemented by Surf Expo.
 
You remember all the noise and wringing of hands that accompanied the closing of ASR. Everybody wanted to know what was going to “replace” ASR. There were various proposals and discussions among all the usual suspect organizations about doing a new trade show. Happily, in my judgment, nothing happened.
 
I say happily because the last thing we wanted to do was replace ASR which, I think it is generally agreed, had become a flawed model. But when ASR went down, people lost streams of income. Having carefully studied this for many years, I have determined that nobody likes it when they lose a source of income, and they will flail about madly trying to replace it.
 
Flailing there was, but no new event emerged. A little time needed to pass, things had to settle out, and we had to get a better idea of just what it was we needed, because it sure wasn’t to “replace ASR.”
 
In the fullness of time, the Agenda show evolved to be part of the solution for the street and skate part of ASR. I never saw Agenda as a surf trade show and, frankly, how well did having skate and surf under the same roof at ASR work out anyway?
 
Then enough time passed. Nike walked away from the U.S. Open, Vans (owned by VF) became the title sponsor for the event owned and operated by IMG and GLM Fashion Group that runs Surf Expo and LAUNCH LA bought The Boardroom. The stars became aligned (and a bunch of people worked really hard).
 
The result is that we get the event announced today and described in this press release. I’m saying event because trade show doesn’t do it justice and I don’t yet have a better word to describe it. Here’s what the press release says in part.
 
“A celebration of surfing, surfboards and the shapers who make them, The Boardroom will be held within the Vans US Open of Surfing in a 50,000 square foot freestanding pavilion that will be floored, carpeted, and fully climate controlled. It will feature shaping competitions, seminars, entertainment, autograph signings and hundreds of booths filled with surfboards, legendary and contemporary shapers, surf apparel and accessory companies. The Boardroom will be a hybrid trade/consumer event with two days exclusively dedicated to retail buyers and media as well as two days also open to the general public.”
 
Here’s an event, then, that involves the surf industry, its customers, the media and the world’s best surfers.   It will be all about surfing and, I hope and assume, we won’t have an Invisilign tent on the beach this year. I don’t know- I just had a hard time seeing their connection to surf.
 
The industry needs this kind of focus and excitement.   Whatever this thing is, I’m enthusiastic about going to it like I’ve haven’t been about a trade show in years. I’m expecting to have fun, which is kind of why I got into this industry in the first place. 

 

 

PPR’s Annual Report: How’s Volcom Doing?

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When a smaller company in our industry is acquired by a conglomerate, it often becomes difficult to follow how the acquired company is doing because the conglomerate isn’t required to release any details on that company’s performance. Think Reef after it was acquired by VF (though I imagine we might have heard more if Reef had been doing better). 

PPR, however, is telling us a bit about what’s going on with Volcom and its plans for the Sports & Lifestyle segment of which Volcom is a part. 
 
PPR is a French company with revenues of 9.7 billion Euros in the year ended December 31, 2012. The current exchange rate is about $1.3 to the Euro. So 9.7 billion Euros is around US$ 12.6 billion. It acquired Volcom in July of 2011.
 
PPR has two divisions; its Luxury Division and Sport & Lifestyle. PPR’s luxury brands, including Gucci, Bottega Veneta, and Yves Saint Laurent, contributed 64% of its revenue for the year, or 6.2 billion Euros. The remainder (3.532 billion Euros) came from its Sports & Lifestyle segment that includes Volcom and Electric as well as Puma, Cobra (golf) and Tretorn (outdoor footwear). 
 
The last complete fiscal year results for Volcom we saw before it was acquired was for the year ended December 31, 2010. In the complete year, in US dollars, Volcom reported revenue of $323 million. Operating income was $30 million net income $22 million. Keep those numbers in mind as we move forward.
 
Of the total Sport & Lifestyle segment, Puma revenue represented 3.271 billion Euros, or 92.6% of the segment’s total. That means that Volcom, Electric, Cobra and Tretorn collectively generated revenue of 261 million Euro. You can see that result on page 27 of this PPR document. Go ahead and look just so you know I’m not making it up.
 
At 1.3 Dollars to the Euro, that’s about US$ 339 million. That’s only 2.7% of PPR’s revenue for the year, so it’s not really significant financially.
 
There is a bit of confusion here. Page 40 of the full financial result (which you can down load here  (It’s the first item on the list after you click “documents” at the top) talks about “Other Brands” in the sport and lifestyle segment. That is, all brands in that segment except Puma. It specifically lists Volcom and Electric (but not the other brands) and says they had revenue of 261 million Euros and recurring operating income of 15 million Euros. But it seems to exclude Cobra and Tretorn.
 
I can’t tell, then, if the 261 million Euros in 2012 revenue is just Volcom and Electric or includes these other two brands. I suspect that it does.      
 
Compare those numbers for Sport & Lifestyle segment excluding Puma with Volcom’s numbers in its last year as a public company. Note that operating income is US$ 19.5 million and is a third less than Volcom’s stand-alone operating income in its last full independent year.   At best, Volcom has grown only a bit. If that 261 million Euros in revenue includes Cobra and Tretorn, Volcom’s year over year revenues could have fallen. In the fourth quarter, according to the financial report, Sport & Lifestyle revenues rose 7.6% on a comparable basis. But excluding Puma, comparable segment revenues were down 4.8% and totaled 64 million Euros. As far as I can tell Volcom (including Electric) is most of what’s left in the segment after you remove Puma. 
 
I would like, at this time, to renew my congratulations and admiration, expressed at the time of the deal, to the Volcom management team for the timing of their sale to PPR and the price they got.
 
In the conference call, we learn that Volcom held its gross margin, but that marketing initiatives had a negative impact on operating margin. PPR management also referred to a “…worsening economic context…” and a “…major reorganization of certain retailers, notably in the United States…” in the second half of the year. 
 
Puma’s recurring operating income for the year was down 13% while that of the other sport and lifestyle brands rose 9.6%. EBITDA fell 10.5% for Puma but rose 28.1% for the Sport & Lifestyle segment. Remember most of the improvement in the other Sport & Lifestyle brands results from owning Volcom for a whole year. Impossible to tell what they would have been without that.
 
In spite of the rising sales Puma’s net income fell from 230 million Euros in 2011 to 70 million Euro in 2012. PPR is implementing a Transformation and Cost Reduction program for Puma. This will involve clarifying brand positioning, improving product momentum, improving efficiencies in the value chain and revamping the organization. Apparently, the organization didn’t evolve as the brand grew and that caused some problems. I’d note that as this program of transformation and cost reduction proceeds, average head count at Puma has risen from 10,043 in 2011 to 10,935 in 2012.
 
It’s also interesting to see that for the year wholesale revenues, which accounted for 81.6% of Sport & Lifestyle revenue, grew by only 0.6%. We’re told, “The unsettled economic environment in Western Europe, coupled with the reorganization of Volcom’s distributor store networks in North America, weighed on the performance of this distribution channel during the year.”   Retail sales in directly operated stores (don’t know if that includes online) rose 17.6%.   
 
In the conference call, we were told that more Sport & Lifestyle acquisitions were expected after Puma had been turned around and that there would be a focus on outdoor. Puma is to remain the core of the Sport & Lifestyle segment.
 
Here’s what PPR wants to do with its Sport & Lifestyle brands:
 
“For its Sport & Lifestyle brands, PPR’s strategy is based on expanding into new markets while bolstering
growth in the most mature ones, developing distribution, launching new products that are consistent with each brand’s DNA, and continuing to identify and foster synergies between the brands, particularly in sourcing, logistics and knowledge sharing in the areas of product development, distribution and marketing. The objective is to regroup sports brands that have an extension into Lifestyle.”
 
There’s nothing wrong with that but it’s kind of generic and pretty much lists what all brands want to do. But as I’ve noted before, that’s all you can expect in a public document. No company wants to lay out its strategy in detail for its competitors. 
 
While Puma struggles and it’s not clear that Volcom is doing all that well, PPR management is looking at revenues from their Luxury Brands that grew 26.3% year over year, while Sport & Lifestyle was up only 11.9%. Recurring operating income from Luxury was up 27.6% but fell 12.1% in Sport & Lifestyle. EBITDA rose 26.6% in Luxury, but fell 9% in Sport & Lifestyle.
 
It’s enough to make a management team schizophrenic. The Luxury Brands that represent two thirds of your revenue are doing great. Sport & Lifestyle, where you obviously see potential and opportunity (or you wouldn’t have bought Volcom) aren’t doing so well. But you expect to make further acquisition in this segment and have an outdoor focus.
 
We’re only a year and a half from the acquisition of Volcom, and that isn’t long to integrate a company and bring the strengths of PPR to bear. Puma has obviously helped Volcom introduce its new shoe line. But Puma and Volcom seem to me to be very differently focused companies. And as I think about outdoor, I’m not sure that’s how I think of either of them.
 
When PPR bought Volcom, I suggested, kind of half seriously, that maybe PPR would turn Volcom into an upscale, boutique kind of brand and develop some appropriate products. I’m now up to maybe two-thirds serious about that.
 
PPR no doubt has noticed that everybody is interested in the youth culture and outdoor markets and think they should be too. Can’t blame them. But I come away from their documents and conference call with the sense that they maybe they aren’t quite clear on what the sport/lifestyle/outdoor market represents.
 
During the conference call, between the presentation and the question and answer session, there was a short video featuring flashes of most of their brands. There was a lot of action sports material in it. But occasionally when the skate or snowboard trick was bracketed with the golf shot, it felt like there a certain discontinuity in the whole thing. Maybe I’m reading too much into that, and it was perfectly appropriate for the audience. But I think PPR knows that they need to think about how the brands in their Sport & Lifestyle segment are positioned and, ultimately, why they are in the business if they can’t get growth and returns consistent with their luxury brands.

 

 

A Comment About a Billabong Deal and a Chance to Place Your Bet

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I was a bit surprised when VF’s preliminary bid for Billabong came as late as it did, and I was also intrigued by the partnership with Altamont. Why, I wondered, didn’t VF just buy Billabong itself? 

A couple of possible answers occurred to me. The first was that somehow they couldn’t afford it. But a review of their most recent balance sheet made me think that wasn’t the case. However, I did recall that they borrowed a bunch of money to pay for Timberland and had committed in their conference calls to reduce debt. Even though they could borrow the money to purchase Billabong, it might not have been a comfortable place to go for either VF or the analyst community that follows them.
 
Second of course is the fact that VF is primarily interested in the Billabong brand, and it’s a lot easier to just acquire that brand rather than acquire the whole thing and sell off the other brands. Here’s how they put it in the press release:
 
“VF’s primary interest in the transaction is in the Billabong® brand. This interest is consistent with VF’s stated intent to pursue acquisitions, particularly in the Action Sports category, to continue to build shareholder value. Altamont’s interest lies in acquiring Billabong’s other brands and related assets, and is predicated on the firm’s mandate to invest in situations where it can provide strategic and operational support to build business success stories.”
 
When it says Altamont’s interest is in “other brands and related assets,” I wonder what that means. Do the Billabong stores go with the Billabong brand? I guess Altamont would get West 49, though of course I don’t know that.
 
If a deal should be struck, Billabong shareholders would just get money, and they’d be done with it. But VF and Altamont would be the ones who would put up that money, and you have to wonder how they’d decide who put up how much.
 
They would have to agree on a value to the brands or assets being acquired by each of them. That certainly can’t be done before due diligence. How do you decide how much RVCA, for example, is worth before you know how much they are selling and have seen an income statement?
 
But even after due diligence it could be a bit of a hard thing to do. Valuation almost always has an element of subjectivity to it, and one might suspect that both VF and Altamont would want the assets their partner is taking to be valued higher so their partner’s piece of the purchase price was higher. Value also has to do with the future prospects of a brand and reasonable people can disagree on that.
 
Altamont is more what we call a financial buyer. That is, their valuation of an asset is based on what financial return they can expect. VF is more of a strategic buyer in the case of Billabong. By that I mean they look at the Billabong brand and look at how they can improve its operations and results by bringing their own strengths in, for example, sourcing to bear on it. They look for and expect synergies in other words. Read VF’s description of how they are managing their newest acquisition Timberland to improve its performance.
 
So VF might tend to come to a higher value for the Billabong brand than Altamont would, but it would be in their interest to convince Altamont that the value was lower. 
 
Not only, then, do VF and Billabong have a bias in favor of valuing the assets their partner is buying higher (so their own cost is lower), but it may not be easy to agree on those values because of differing perspectives. I imagine there would be ongoing discussions about this as due diligence proceeds. They really wouldn’t want to make a deal to acquire Billabong then find out that they couldn’t agree among themselves on who would pay how much.
 
I am sure you all realize I am speculating here, but I thought it might be valuable to think about the process that has to occur. But if you’re really interested in speculating, you can go to this Australian betting site and place your wager on whether Paul Naude and his group or VF and Altamont will snag Billabong. All bets are off if neither one buys it.

 

 

Aunt Jenny’s Egg Beater, Hoodies, and Water Heaters; The Evolution of Manufacturing, the Future of Fast Fashion and the Impact of the Internet

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My Aunt Jenny died maybe 12 years ago at the age of like 97. I helped clean out her house and one of the things I saved was her egg beater. It was made by the Dazey Manufacturing Company in St. Louis. I don’t know if it’s 60 or 90 years old. The company is out of business. 

I didn’t keep it for sentimental reasons (I mean, it’s an egg beater). I kept it because it’s the best damned egg beater I’ve ever seen and I wouldn’t know what to replace it with. It’s made of heavy duty stainless steel. Except for some paint chips on the handle, it looks and works like the day it was made. It spins so effortlessly and smoothly that it keeps going for north of half a dozen turns after you release the handle and is well balanced and almost vibration free.   No planned obsolescence here.
 
I really miss products like this. I believe that paying more for a product that lasts a long time (if you can find them) is a better financial decision than paying less and having to replace it often.
 
So I was intrigued to find this article on a hoodie made by American Giant. I’ve ordered the full front zip one for $79.00 (shipping included). It’s made in the U.S., only available online, and is supposed to last a long, long time. The product is backordered due, I assume, to all the favorable publicity they’ve had.
 
They started by redesigning the hoodie from scratch, as you’ll read in the article. CEO Bayard Winthrop “…argues that by making clothes in America, he can keep a much closer eye on the quality of his garments, and he can make changes to his line with much more flexibility. An Asian manufacturer wouldn’t have been able to do all of the custom, intricate work that American Giant’s clothes required.”
 
Okay, hold that thought. Let’s move on to the water heater.
 
The December issue of The Atlantic has an article called “The Insourcing Boom” by Charles Fishman which you can read here. Anyway, General Electric owns something called Appliance Park in Louisville, Kentucky. It includes six factories, each as big a suburban shopping center, and it’s where GE use to make all its appliances. It employed 23,000 at its 1973 peak, but only 1,863 by 2011. They tried to sell it in 2008 but there were no takers.
 
But in February, 2012, they started a new line to make their high end GeoSpring water heaters there. On March 20, they started making high end French door refrigerators there. By now, they’ve probably started making a stainless steel dishwasher and they are working on an assembly line to make front loading washers and dryers, the article says.
 
Bringing certain products back to the U.S. to make has to do with higher Chinese labor costs and, for better or worse, lower U.S. ones.   But that’s not the whole story. When they took a close look at the GeoSpring water heater, they found it was a manufacturing nightmare that could only be justified when labor was $0.25 an hour. In their redesign, they cut out 20% of parts and reduced the cost of materials by 25%. They cut required labor hours from 10 in China to 2 in Kentucky. Quality and energy efficiency improved.
 
Okay are you ready for this? The Chinese made product retailed for $1,599. They were able to cut the retail price of the U.S. made one by 19% to $1,299. I assume they are holding their margins or they wouldn’t have done it.
 
Here’s what I said in a recent article talking about U.S. manufacturing.
 
“Once the labor cost differential isn’t so dramatic, then other costs become more important. Travel, freight, time to market (which impacts the amount of inventory you have to hold), communications issues, surprise delays, custom duties, control of intellectual property and quality control are among the costs that may be higher with foreign production. But most general ledgers aren’t set up to isolate those costs.”  I missed, by the way, energy costs which are also making the U. S. more attractive.
 
“It’s an accounting hassle, and no fun. But if you take the time to figure out those costs, you may find there’s a certain logic to making some formerly foreign produced products in the U.S.”
 
I’m guessing the CEOs of both General Electric and American Giant would agree with me.
 
The American Giant business model works because the product is only sold through their web site. They have no brick and mortar retailers. I may be willing to pay for quality, but if you had to add a retailer’s margin in there, it would be out of my price range.
 
Pretty clearly, the internet can facilitate the sale of higher quality products by avoiding a level of distribution and cost. I’m not quite sure if that’s completely good or bad, but it’s a fact. I’ve written before that I thought we were early in the process of figuring out the model for internet and retail coexisting. Here’s an impact I hadn’t thought of until now; it might facilitate U.S. production and higher quality. The benefits of having design, production, marketing and fulfillment in one place are, I suspect, significant. 
 
Let’s distinguish between fast fashion and supply chain and inventory management. Fast fashion (which I define as rapid turnover of artificially supply constrained product) is a marketing idea. Good supply chain and inventory management is necessary to fast fashion, but it would be a good idea even if nobody ever came up with the fast fashion moniker. It can never be bad to be able to react quicker to the market and hold less product in inventory.
 
Every company I write about these days is talking about managing their supply chain better, reducing their time to market and “micromanaging” their inventory. They don’t all use the term fast fashion, but to some extent that’s what they are reacting to or trying to emulate. It’s so universal it seems like a bubble.
 
I’m wondering if fast fashion isn’t a trend that will run its course. I understand the excitement it can generate, but once the novelty wears off, I am uncertain shopping more often for product that isn’t really that well made just because it’s “new” will support a long term business model. 
 
In the days of our ongoing economic malaise, it can be hard to find a lot to be positive about. But as I use Aunt Jenny’s eggbeater to make an omelet, wait with anticipation for a hoodie I expect will last a long, long time and wonder if I should be replacing my water heater, I’m feeling kind of hopeful about what might be an important long term trend back towards higher quality products and domestic manufacturing.

 

 

I Went to the Know Show. I’m Back

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I haven’t been before, and I didn’t stay long, but that’s a really good thing because it’s an indication that the show is accomplishing just what it’s supposed to be accomplishing.

The show was full of focused retailers paying close attention to presentations by reps and, as far as I could tell and from what I was told, writing orders.  Sometimes there would be ten or twelve people sitting in a booth as the rep went through the line.  They were quiet and attentive.

The aisles weren’t jammed, there was no carpet on the floor and the booths were mostly not big and fancy.  There were no competing sources of loud music and not much in the way of in-booth parties and craziness.  Relax, it’s not like you couldn’t find a beer here and there.

If it wasn’t as upbeat at other shows I attend, that’s because it’s not supposed to be.  It’s not a marketing extravaganza.  It’s a place to attend to the nuts and bolts of business and people seemed to be doing just that.

So you can see why I didn’t stay long.  I wasn’t going to meet consulting clients there, senior executives were generally not attending, and the reps in the booth were busy talking to people who wanted to buy product from them, so why waste their time with me?

The Know Show was a preview of the snowboard product I’ll see at the end of the month at SIA’s show in Denver.  I saw Volcom’s shoes for the first time.  I knew they’d be making them, but I walked by wondering if there was anybody who wasn’t making shoes at this point.  Which made it about perfect when I walked by a booth for a company called Generic Surplus that also makes shoes.

There are so many nice shoes out there, and mine are so uncool (as I got told at my last trade show- you know who you are).  I am just going to have to break down and buy some new ones.  Boy, that will be a market top.

DC was exhibiting their snowboard hard goods under the slogan, “Snowboarding: Defined by DC.”  I don’t even know where to go with that.

I saw Canadians doing business with Canadians in a solid environment for doing business.  I liked it.

 

Quiksilver’s Year, Quarter, and Strategy; EBITDA Declines

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Three days ago, Quik filed its annual 10K with the Security and Exchange Commission for the year ended October 31, so I’ve had the happy task of wading through it and rereading the earnings conference call from a few weeks ago. You can see the 10K here if you want.  

I’ll look at the results for the quarter and the year, but I want to talk about the company’s strategy first and its similarity to other industry companies.
 
Strategy
 
This is right from page one of the 10K. “Quiksilver,” it says “is one of the world’s leading outdoor sports lifestyle companies. We design, develop and distribute a diversified mix of branded apparel, footwear, accessories and related products. Our brands, inspired by the passion for outdoor action sports, represent a casual lifestyle for young-minded people who connect with our boardriding culture and heritage.”
 
They continue, “Our mission is to be the most sought-after outdoor sports lifestyle company in the world by inspiring individuality, creativity, and freedom of expression through our authentic products along with the lifestyle and culture of our brands.”
 
Last year they said “We are a globally diversified company that designs, develops and distributes branded apparel, footwear, accessories and related products, catering to the casual, youth lifestyle associated with the sports of surfing, skateboarding and snowboarding. We market products across our three core brands, Quiksilver, Roxy and DC, which each target a distinct segment of the action sports market, as well as several smaller brands.”
 
What I’d like you to notice is that there is an evolution in how they define their target market and competitive environment. They acknowledge, of course, their heritage in action sports, but the focus seems to be moving away from it towards the broader outdoor market. Their potential market just got a lot bigger, but so did the number and size of their competitors.
 
A couple of years ago, I started asking where Quiksilver would get its growth from. Here’s their answer to me; they are now an outdoor lifestyle company.
 
Also from page one, Quik has three long term strategies. They are “1) strengthening our brands; 2) increasing our sales globally; and 3) increasing our operational efficiency.”
 
Can’t disagree with any of those, though I find them a little general to be useful. To be fair, nobody in these public documents wants to give their competitors more information than they have to, so there’s a limit on what we can expect to learn. Still, those three strategies, if that’s what we’re calling them, are pretty much the same thing everybody in this industry is trying to do. Or in any other industry I guess.
 
Some years ago when Burton took the “Snowboards” out of their name, it was because they wanted to address the broader apparel and fashion market. That’s a difficult road to travel not just because Burton is so closely identified with snowboarding but because once you get out into the fashion world, the competitors get bigger and more sophisticated and fashion is a different market than action sports.
 
That’s not a perfect analogy because Quiksilver has never been a hard goods company like Burton and, at $2 billion in revenue, is larger than Burton (I don’t have any actual numbers on Burton- that’s my best guess).
 
Companies like Quiksilver may, in reality, not have any choice but to go after the outdoor market. The outdoor market is certainly coming after them and as somebody once said, “The biggest risk in business is to not take any risks at all.”
 
Okay, on to some numbers.
 
The Quarter
 
Revenues in the quarter ended October 31 were $559 million, up 3% from $545 million in the same quarter last year. The growth mostly came from the Americas, which was up 12% to $279 million. Asia Pacific was up 6% to $87 million. Europe fell 9% to $192 million.
 
“Q4 results also point to 2 areas of concern. First is that we need to be careful managing inventory in light of uncertain economic situations in some of our key markets. The second and related area of concern is the level of clearance sales and discounting we saw in Q4. We ended Q3 with past seasons’ product, representing 16% of our total inventory. We focused on liquidating this inventory in Q4. We had significantly higher volume and lower recovery margin on these liquidations than in Q4 last year. The volume and recovery of liquidating the past season’s inventory had a meaningful impact on our Q4 gross margins.”
 
“Gross margin fell from 52% to 46% and was down in all three regions. “The gross margin erosion was driven by several factors, including increased sales of prior season goods in our wholesale channels, along with lower margins on those sales; increased discounting in our retail stores; increased sales to larger multi-door accounts who typically earn volume discounts that erode our margin; currency exchange rates; and the impact of decreasing sales in Europe, which has traditionally generated the highest margins of our 3 regions.”
 
Sorry for the long quotes, but sometimes I can’t say it any better and don’t want to put words in people’s mouths. Europe’s a bit of a mess (no surprise there) and Quik’s inventory got bigger than it should have is how we might summarize. At the end of the third quarter, 16% of Quik’s inventory was from past seasons. By the end of the 4th quarter, they’d sold $40 million of the old stuff, and the total past season’s inventory remaining was down to 7% of the total. They note in the conference call that “…the store of Q4 is really that we overbought during fiscal 2012 and we had higher liquidations through the wholesale channel because of that.”
 
SG&A expenses were down $12 million to $236 million. They reduced marketing and other expenses but increased e-commerce spending. There were charges of $4.7 million for severance and $3.1 million for lease termination costs. 
 
Net income was $4.4 million during the quarter compared to a loss of $22.1 million in last year’s quarter. I don’t have all the numbers I’d usually have for quarterly results, so I can’t take a hard look at what caused that change. Let’s move on to the whole year.
 
Annual Results
 
Revenues for the year rose from $1.953 billion to $2.013 billion. Quik lost $11 million in the year ended October 31, 2012 compared to a loss of $21.3 million in the previous year. Reported operating income improved from $41.5 million to $57 million. But last year, above the operating income line, it had asset impairment charges of $86.4 million. This year those charges were $7.2 million.
 
If we just remove those charges from the income statement, last year’s operating income would have been $127.9 million and this year’s $64.2 million. That would represent a decline of $63.7 million or 50%.
 
Quiksilver shows adjusted EBITDA which is net income or loss before interest, income taxes, depreciation, amortization, non-cash stock-based compensation and asset impairment. As they calculate it, their adjusted EBITDA fell from $194.3 million to $140.6 million.
 
The Quiksilver brand represented 39% of revenues during the year, down from 41% the prior year. The numbers for DC are 30% and 28% respectively, and 26% and 27% for Roxy. Pretty good balance. Other brands, including Mervin Manufacturing, are up from 4% to 5%.
 
Wholesale business as a percentage of revenues fell from 76% to 73%. Retail was up from 22% to 23%. E-commerce doubled from 2% to 4%. Apparel’s percentage of total revenue rose from 61% to 63%. Footwear was up 1% to 24% while accessories and related products fell from 16% to 13%.
 
I was interested to see that Quik ended the year with 605 retail locations, up from 547 at the end of the previous year. 291 were what they characterized as full price. 194 were shop-in shops (within larger department stores) and 120 were outlet shops. Of the total, 110 were in the Americas, 271 in EMEA (which is primarily Europe), and 224 in APAC (Australia and the Pacific).
 
Talking about their sales strategy, Quik notes, “We believe that the integrity and success of our brands is dependent, in part, upon our careful selection of appropriate retailers to support our brands in the wholesale sales channel. A foundation of our business is the distribution of our products through surf shops, skateboard shops, snowboard shops and our own proprietary retail concept stores, where the environment communicates our brand and culture. Our distribution channels serve as a base of legitimacy and long-term loyalty to our brands. Most of our wholesale accounts stand alone or are part of small chains. Our products are also distributed through active lifestyle specialty chains.”
 
Gross margin for the year fell from 52.4% to 48.5%. “We experienced gross margin decreases
across all three of our regional segments during fiscal 2012, primarily due to increased clearance sales at lower margins within our wholesale channel compared to last year (240 basis points), increased discounting within our retail channel (80 basis points), and the impact of changes in the geographical composition of our net revenues.”
 
Selling, general and administrative expense (SG&A) rose 2%, or $20 million, to $916 million. As a percentage of revenue, it fell from 45.9% to 45.5%. The increase was mostly due to spending more on their online business and to non-cash stock compensation expense.
 
Overall, the balance sheet hasn’t changed that much in a year, but there are a couple of things I’d point out. Cash is down from $110 million to $42 million. Inventory is actually down a few million, from $348 million to $345 million. Receivables were up from $398 million to $434 million, pretty much consistent with sales growth. Average days sales outstanding (DSO) rose from 78 to 85. “The increase in DSO was driven by the timing of customer payments at year end and longer credit terms granted to certain wholesale customers.”
 
Inventory days on hand fell from 119 to 103 “…primarily due to the increased clearance sales that occurred during the fourth quarter of fiscal 2012.”    Long term debt was more or less constant. Equity fell by more or less the amount of the loss.
 
Quiksilver’s sales for the year rose slightly, but it sounds like if hadn’t overbought and then been forced into liquidating, revenues would not have been up. We saw the big impact on their gross margin. It’s hard to be a public company and not plan for revenue growth I guess, but I’d argue they would have been better off if that’s exactly what they’d done. Wonder what the bottom line would have looked like if they’d left revenues even but held their gross profit margin by not overbuying.
 
Actually, I guess there’s no reason I can’t figure that out at the gross profit line.
 
If revenues had been the same as in 2011 at $1.953 billion but the gross profit margin had held at 52.4%, then gross profit would have been $1.023 billion. That’s about $40 million higher than reported in 2012. I don’t know what the tax impact might have been, but I’m pretty sure they would have earned a profit.
 
How many years is it now I’ve been suggesting it was time to focus on gross profit dollars rather than revenue growth?

 

 

What’s Going on With Rip Curl?

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I don’t generally have a way to get good information on Rip Curl, but somebody sent me the interview below with Rip Curl co-founder and owner Brian Singer. Why don’t you read it, then I’ve got a comment for you. 

Rip Curl co-founder and owner Brian Singer speaks exclusively to the Surf Coast Times about Rip Curl sale.
 
Rip Curl will only be sold to a company that looks after brands and the communities in which they reside and to which they are connected, according to one of its owners.
 
Following the announcement last week that the board of Rip Curl has appointed financial advisors Merrill Lynch to assist the business in exploring opportunities for whole or partial sale, company co-founder and part-owner Brian Singer spoke exclusively to the Surf Coast Times to reassure the community that Rip Curl would only be sold to a company that has the business’ and community’s best interests at heart.
 
“Merrill Lynch has got a clear objective in this,” he said.
 
“We’ve told them we’re interested only in a company with a track history of looking after brands and the people involved with them.
 
“We’ve had a couple of approaches from a couple of companies that have that track record, which led us to appointing Merrill Lynch to explore the opportunities on our behalf.”
 
Mr. Singer said should the business be sold, he could see no reason as to why the purchaser would change much about how the business is run – including maintaining Rip Curl’s global headquarters in Torquay.
 
“We see no reason to believe anything would change. If somebody or (a) company purchases it, why would they upset the apple cart? The company was born there (Torquay). Why mess with a formula that’s worked?
 
“The company’s had a long association with Torquay and the (Easter Rip Curl Pro surfing) competition at Bells Beach. We expect that the building would remain there and the people will remain there.”
 
Last week, Rip Curl issued a statement saying the company had grown its revenue compared to the year prior – in contrast to general surf industry performance – and the board had appointed Merrill Lynch to assist them in exploring opportunities available as well as assessing the merits of introducing a third-party investor to the group.
 
“The board recognizes that if any such investment were to occur it would need to be consistent with our objectives of ensuring our company values and brand values are respected – supporting our staff and being in the interests of our shareholders,” the statement read.
 
The company is valued between $480 million and $500 million and employs 260 staff in Torquay, making it one of the biggest employers on the Surf Coast.
 
Surf Coast mayor Brian McKiterick said he had spoken to Mr. Singer who had reassured him that the company would continue in Torquay if it were sold.
 
“He confirmed that they’ve been looking at some companies who made approaches,” Cr McKiterick said.
“He was adamant that it would be business as usual; the Rip Curl Pro would continue at Bells Beach and the business would remain operational in Torquay.
 
“He said they were very conscious that if it was sold it would have to be to a company who didn’t have a history of breaking up brands. “It’s very welcome news for the town, the surf industry and the shire as a whole.”
 
What I find intriguing about this is that it’s hard to imagine a buyer or investor paying full price for Rip Curl, or any other company, and agreeing in the contract not to move it or break it up and that it would be “…looking after brands and the people involved…” regardless of what assurances they might give outside of the contract. One has to believe that Merrill Lynch has told Rip Curl’s principals exactly that, as typically investment banks only get paid if the deal closes.   
 
I personally admire what Mr. Singer is saying and hope he can pull it off. Maybe Rip Curl doesn’t really need a deal or is so attractive that Mr. Singer can be very selective as to who he makes a deal with. If that’s not the case, he’d better lose the rose colored glasses. 

 

 

More on Winter Resorts Targeting Baby Boomers: I’m Not the Only One Who’s Worried

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You may recall (or not) that about a month ago I wrote an article expressing some concern that winter resorts were targeting baby boomers. My point was that dependence on high income baby boomers couldn’t be an exclusive, long term strategy because, inconveniently, those people are going to get older sooner and stop snow sliding. When that happens, it would be nice if we had some other customers. 

Now, a gentlemen I’ve never met named Roger Marolt, a columnist at the Snowmass Sun in, unsurprisingly, Snowmass, Colorado has written a really good rant (I mean that in very positive way) on the same subject. He makes some points I didn’t make and it’s a pretty fun read.
 
So here it is. Go and read it.     

 

 

Trade Show Season or, “Hi Ho, Hi Ho, It’s Off to Sell We Go!”

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My list this year includes Agenda, The KNOWSHOW in Vancouver, and SIA in Denver. Part of me would like to go to others, especially Surf Expo, part of me wouldn’t and, like all of you, I figure it out based on schedule, resources, expected results and, frankly, my tolerance for travel. 

I liked Agenda as usual. Also as usual, people think it’s a bit early but on the other hand it doesn’t conflict with another show and I expect they get a hell of a good price on the space given those dates which I hope they pass on to the exhibitors.
 
Here are a couple of things I noticed at the show:
 
Thinking About U.S. Manufacturing
 
I talked to four brands that are considering starting or increasing their manufacturing in the U.S. I’ll have more to say about this in an upcoming article, but I wanted to highlight it now as something maybe you should be thinking about too. Partly, it’s because Chinese wages have risen something like 17% a year for five years and are continuing to rise. And some of their factories have started to automate. But it’s also because U.S. wages, for better or worse, have fallen.
 
Once the labor cost differential isn’t so dramatic, then other costs become more important. Travel, freight, time to market (which impacts the amount of inventory you have to hold), communications issues, surprise delays, custom duties, control of intellectual property and quality control are among the costs that may be higher with foreign production. But most general ledgers aren’t set up to isolate those costs. 
 
It’s an accounting hassle, and no fun. But if you take the time to figure out those costs, you may find there’s a certain logic to making some formerly foreign produced products in the U.S.
 
The Great Skate Divide
 
When I go to Denver for SIA, I’m pretty sure I won’t find the snowboard companies that make pipe boards in one part of the show, and the ones that make all mountain boards in another. But at Agenda, I find the street skating companies in The Berrics, and the longboards mostly in one aisle far away.
 
Perhaps it’s just because of how the Berrics was organized and set up with Agenda. You know- institutional inertia. But I wouldn’t be surprised if there was still some left over and nonproductive stuff (I’m struggling here for a good word. You know me, I always want to be careful what I say) going on. A bit of a hangover from longboarding growing so much and street skating continually hoping it would go away?
 
I would like to remind us all (including myself) that we will never be the arbiters of how a twelve year old decides to roll down the street and have fun. The “stuff” we’ve got going on doesn’t matter to them. Can anybody say “plastic skateboards” or “scooters?”
 
I know longboarding is different from street skating like snowboarding in the back country or on groomed runs is different from being in the half pipe. But the snowboard companies all think they are in the same industry. I’m not sure I know how to get there, but the skate industry needs to think the same. Most of our retailers already do.
 
IASC
 
And speaking of progress, it isn’t a new development but it was great to see Steve Lake from Sector 9 and Monica Campana from Transworld sitting up there with the IASC board of directors at the open board meeting at the show. The meeting was well attended, but then they had a keg so what would you expect. They introduced a great new insurance product for skaters from Aflac at the meeting which is probably worth the cost of membership all by itself. You can find a link to it at the bottom of this page.
 
Hoodiebuddie
 
Hoodiebuddie is a couple of years old, but I chatted with them at the show and discovered some interesting business things (Full disclosure- they gave me a hoodie which I passed on to my kid, so he thought I was cool for almost 20 minutes).
 
As you probably know, they make the hoodie with the ear buds built in and you can put it through the laundry without removing them. The technology that allows them to make buds that can withstand the wash and dry cycle is patented.
 
That’s cool, but what really caught my attention was their business strategy. First, they do all the design, product development and marketing themselves. But they have a business partner that handles production, accounting and most of the back office. And the partner is big enough to defend their technology around the world as people try to rip it off. I like that arrangement.
 
More importantly, the company isn’t really just about a hoodie with washable ear buds. That’s their entry product that establishes their market position and gets them recognized as a brand. But longer term, they are building a product line that expands out from the basic hoodie, but is based on it. Essentially, they are trying to make hoodies into a category with a fashion component to it. This isn’t all that different from Clive in back packs and Nixon with watches.
 
It might be that they could have a nice little company just selling hoodies with ear buds, but I doubt that would be of much interest to their partner. The lesson for all of us is that the focus needs to be on the market position the product gives you, not just the product.
 
Okay, that’s it. See you at the next show.