Paul Naude Explores Billabong Leveraged Buyout

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I suppose you have all heard that Billabong Director and President of the Americas Paul Naude has stepped aside from his duties for six weeks to try and pull together a leveraged buyout of Billabong. You can see the Billabong announcement and the conditions under which he is working here at Billabong’s investor web site. It’s the first link under Recent News called Company Update. 

To be clear, I have no information that’s not public. However, I thought it might be useful to review just what a leveraged buyout is and how it works. And, I’ve got a couple of questions.
 
In a leveraged buyout, the buyer (or buyers) purchases the target company by using some of their own money (the equity portion) and borrowing the rest. The loan amount is secured by the assets of the target company.
 
You might reasonably ask, “How much of the purchase price is equity and how much is debt?” It used to be that you could borrow most of the purchase price, but that was back in the good old days. I’m not close to the leveraged buyout market, but I’m guessing you have to put up more equity now. That’s both because lenders are a bit more cautious then they use to be and because it’s harder in this economy (in general- I can’t speak to the specifics of Billabong) to put together a plausible business model that shows fast revenue growth to be used in paying off the debt.
 
On the other hand, interest rates have come down to historically low levels even, or maybe I should say especially, for lower rated debt. People seem to be forgetting again that there is an inevitable relationship between risk and return. You may recall that’s what got us into our current economic/financial mess in the first place.
 
Anyway, the point is that lower interest rates make it easier to make a deal pencil out. Once a leveraged buyout is complete, the new owners have to pay down the debt. They typically try to do that by some combination of asset sales, expense reductions, improved efficiencies and revenue growth.
 
You remember that Billabong had to sell half of Nixon and then a few months later raise additional equity to address concerns about their balance sheet. By definition, in a leveraged buyout, their balance sheet would deteriorate again as they added the debt used to purchase the company to it. The former owners and banks won’t care, because they will get their cash and be gone. The new owners will understand that they are taking higher risk but hey, that’s the business they are in and their plan will have convinced them that the risk is justified by the potential return.
 
We also remember, of course, that a couple of potential buyers evaluated Billabong to see if they might be interested in buying it and choose not to. Why? Well, we don’t know specifically but I think it’s fair to say that they didn’t see the risk as justifying the potential return.
 
Below is a chart of Billabong’s stock price from an article in The Australian that will remind you of the series of events.
 

       
 
One would assume that Paul Naude knows why Bain and TPG pulled out, but on the other hand maybe they had no obligation to explain it to the Billabong Board of Directors.
 
That doesn’t really matter anyway. When I evaluate a company, as you know, I do my own analysis and don’t pay attention to anybody else’s conclusions. Perhaps after I did that with Billabong I’d:
 
–          See the risks and returns a bit differently than Bain and TPG.
–          Think I could get it for a lower price because of the performance of the stock since the October 12th withdrawal of TPG.
–          Believe that the transformational strategy had the potential to drop a lot of Australian dollars to the bottom line pretty quickly.
–          Be prepared to be more aggressive in selling assets to pay down debt.
–          Think that the Australian dollar was going to depreciate a bunch over the next year.
 
Paul didn’t take this step without thinking it through. His experience with the company, reputation in the industry and, I assume, willingness to be CEO and put up some of his own money, is at least going to get him listened to. His agreement with Billabong keeps him from disclosing any confidential information, so I wonder if he won’t go back to TPG and/or Bain and show them a different vision of reality. They’ve already got the confidential information.

 

 

VF’s Quarter. Thank God for 10Qs (What an odd thing to say)

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VF had a quarter in which total revenues rose 14.3% from $2.73 billion to $3.12 billion. Net income was up 26.8% to $381 million. I don’t find it as clear cut as that sounds, and the way to approach analyzing it is to go right to Note G- Business Segment Information in VF’s 10Q and reproduce part of it for our discussion. So here it is.

 

VF refers to its business segments as coalitions. In the chart above you see the revenue and operating profit each coalition produced during the quarter. Total company revenue rose by $398 million. The Outdoor & Action Sports coalition, which includes Vans, The North Face, Timberland and Reef, grew by $415 million, or 104% of total revenue growth.
 
Without the growth in Outdoor & Action Sports, VF’s total revenue declined very slightly.
 
Total coalition profit (profit before interest, taxes and corporate overhead which I call operating profit) grew by $111 million. Outdoor & Action Sports operating profit grew by $92 million to $413 million, representing 83% of operating profit growth and 67% of total operating profit. Outdoor and action sports revenue was $1.85 billion, up 29% from $1.44 billion in the same quarter last year. It represented 59% of total revenues for the quarter.
 
I guess we better dig into the Outdoor & Action Sports results as they appear to be kind of important to VF’s overall results and because they are what we’re most interested in.
 
First, let’s remember that Timberland, which is part of that segment, was acquired by VF on September 13, 2011. So its results were included in VF’s numbers for only a few weeks in last year’s quarter, but in the whole quarter this year. 
 
In last year’s quarter, “Timberland contributed $163.6 million of revenues and $11.0 million of pretax income…” In this year’s September 30 quarter, it contributed $499.1 million of revenues and $55.8 million of pretax income.
 
Let’s adjust the Outdoor and Action Sports segment for those revenue numbers. Without Timberland last year’s quarterly revenues would have been $1.27 billion. This year they would have been $1.35 million. That is growth of 6.3% in revenue for Outdoor & Action Sports.
 
I’m not going to try and do that adjustment for operating income, because the operating income number I have for Outdoor & Action Sports is before interest, taxes and corporate overhead, but the number they give for Timberland’s quarterly impact is just pretax and I’m afraid I’d be comparing apples and oranges.
 
The North Face and Vans grew 5% and 21% during the quarter respectively. Those brand’s direct to consumer businesses grew 10% and 18% respectively. Outdoor & Action Sports U.S. revenues increased 26% with 16% of that increase coming from Timberland. International revenues for the coalition rose 32%, but 30% came from Timberland. European revenues rose 24%, but fell 6% excluding Timberland.
 
We get some further interesting comments on those brands in the conference call. The North Face’s revenue growth in the Americas was in the high single digits. It experienced mid single digit declines in revenue in Europe for the quarter, though they say the brand continues to take market share there. If their revenues can decline, but they can still take market share, things must be pretty hard in Europe.
 
They also note that The North Face’s constant currency revenue were up 60% in Asia. No idea what size numbers we’re talking about.
 
Vans grew at a mid-teens rate in the U.S. Constant currency revenues were up more than 45% in Europe and more than 40% in Asia. Both Vans and North Face are increasing their marketing investments.
 
Total Timberland revenues actually “…declined slightly in the third quarter.” The growth in Timberland we talked about before was for the period when VF owned them. Timberland was obviously generating revenues before the acquisition. I gather it was down more (“moderately”) in the Americas due to the hangover in inventory from last year’s warm winter. It was flat in constant dollars in Europe. There’s further discussion about how they are still integrating Timberland into their business model with expected improvements in performance.
 
The company’s overall revenue growth of 14.3% came mostly from Timberland. Only 2% of that growth was organic. Direct to consumer revenue grew 28%, with 19% coming from Timberland. Direct to consumer was 18% of total revenue.
 
Gross margin grew nicely, from 45.3% to 46.7%. “Gross margin increased in the third quarter in nearly every coalition due to a greater percentage of revenues from higher gross margin businesses and the impact of lower product costs. The increase in the first nine months of 2012 also reflects the continued shift in the revenue mix towards higher margin businesses, including the Outdoor & Action Sports, international and direct-to-consumer businesses.”
 
Strategy
 
The first thing I’d note is CEO Eric Wiseman’s conference call comment that “We’re seeing some slowing in the U.S. economy, increasingly challenging conditions in Europe and slowing growth in China.” Those issues aren’t unique to VF.
 
Let’s go on and quote him again. “As you know, we’re constantly looking at the shape of our portfolio because we believe that the diversity of our portfolio is our strength.” What that means is that they will sell businesses that don’t meet their expectations and look to buy ones that do. And while, “We’re pretty focused on the integration of Timberland this year for all the appropriate reasons…acquisitions are our priority, and we’re beginning to look into 2013 about what we might do.”
 
Right now, Vans appears to be the best performing sizeable brand VF owns, and you know that performance has their attention. They are trying to create some of Van’s attributes at The North Face and I expect they will do the same thing with Timberland once it’s fully integrated.
 
Given the results they are getting from Vans and expect from The North Face and Timberland, I wonder if the sale of some of their brands that aren’t performing as well isn’t in the cards.
 
It used to be hard to be a big company and be “cool” in this industry. That doesn’t seem to be the case anymore. Either the formula has changed or they’ve figured it out. Or maybe it doesn’t matter like it used to. I just think the lines between action sports, youth culture, and fashion have blurred to such an extent that it’s harder to keep a specific identity that really differentiates you.            

 

 

Some Lessons From Zara; How Fast Fashion Fits Today’s Economy

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Zara has 5,900 stores in 85 countries. Only 45 are in the United States. I’ll get back to why that is. I’ve been aware of Zara for a while of course, but when my ever vigilant research department sent me this article, I decided there were some lessons we could all learn.

Because I don’t want to rehash the whole article, this will be pretty short. Zara, headquartered in Spain, has factories and a distribution center right across from its corporate offices. Their template is “…trendy and decently made but inexpensive products sold in beautiful, high-end-looking stores. “ Sales people are trained to gather information from customers. That information goes to headquarters daily, where trends are identified, clothing designed, and manufacturing orders placed.
 
The production time is two to three weeks. There’s never an over production issue. The company does not advertise. I may have said a time or two that selling through at full margin and telling your customer, “Sorry, it’s all gone!” is the best advertising.
 
Typically, stock turns over in like 11 days. The result is that “…every purchase is an impulse buy” because you know it won’t be there when you come back.
 
Think about the quality and efficiency of operations, including inventory management, required to operate like this. I’ve been writing for a while now that operating well was no longer a competitive- just a requirement of being in the market. Maybe in fast fashion it is an advantage.
 
Here’s another quote you should pay attention to. “A business model that is closely attuned to the customer does not share the cycle of a financial crisis.” You know, we all knew that. But it’s so obvious I, at least, have never thought about it quite in that way. I guess the closest I’ve gotten is to say focus on the gross margin dollars you generate rather than sales growth.
 
Zara’s business model encouraged its customers to visit their stores often, to spend less on each item, but to buy more items because they know they won’t have each of those items long. It’s not a perfect comparison, but the moment I read about spending less on items you know you won’t have long, I thought about how the popsicle skateboard market has evolved.
 
I wonder if, at some point, an unexpected reaction to fast fashion might be for consumers to get tired of constant shopping and turnover. Maybe the next retail chain will be “Timeless Concepts” offering apparel that tends to not go out of style, at least not so quickly. Or maybe I have no clue how men and, especially, women think about fashion.
 
And why does Zara have only 45 stores in the U.S.? Partly because they are aware that foreign brands have a long history of failing here. But it’s also because the Americans “…don’t fit in the clothes. So why do it?  Having to make larger sizes makes production so much more complex.”
 
Well, that’s embarrassing. Maybe having an extra-large burrito and a milk shake for lunch will make me feel better.           

 

 

Skullcandy’s September 30 Quarter; This is Going to Get Interesting

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Since Skullcandy went public, I’ve characterized the bet they are placing as “whether or not you can be cool in Fred Meyer.” I’ve also asked if coolness is enough of a market differentiator in a product which, especially at the lower end, is increasingly something of a commodity. And finally, I’ve wondered if Skull can have any lasting technological advantage given the resources of some of their competitors. 

Let’s see what their 10Q and conference call tells us about these issues.
 
The Income Statement
 
Sales for the quarter ended Sept. 30 rose 17.1% from $60.6 million in the same quarter last year to $71 million. Gross profit rose from $28.8 million to $34.1 million as the gross profit margin rose from 47.5% to 48%. Operating income was up from $8.2 million to $10.6 million, and income before taxes grew like mad from $3.39 million to $10.2 million. That seems pretty good, but there are complications.
 
The first thing you should know is that interest and other expenses were $4.84 million last year. This year during the quarter they totaled $403,000. That’s a pretax improvement of $4.4 million that has nothing to do with selling headphones and related products. Most of that expense in last year’s quarter was related to the initial public offering and was a one-time expense. Without that, the income before taxes improvement wouldn’t be nearly as great.  Skull points this out in their public information.   
 
Next, keep in mind a transaction from last year. On August 26, 2011, Skull acquired Kungsbacka 57 AB. That was the company’s European distributor. Once they acquired it, in the middle of last year’s quarter, their numbers changed. Before the deal, they sold to Kungsbacka at a lower margin, but didn’t have any of the operating expenses of running a European business. Once the deal was complete and they were going direct, their sales and gross profit rose, but so did their operating expenses.
 
I think getting control of your distribution as you grow is a good idea, and it’s common in our industry. But Skull notes in the 10Q that, “As a result, the three month ended September 30, 2012 are not comparable to the three months ended September 30, 2011…” That’s neither bad nor good. It’s just inevitable and you need to keep it in mind.
 
If we can’t just compare quarters, let’s dig into some details and try and figure out what we think.
 
North American sales as reported rose only a little from $56.3 million to $57.4 million. International sales accounted for almost all of the net sales growth, rising from $4.4 million to $13.6 million. But remember the impact of the Kungsbacka deal. Last year, until the deal date, Skull only operated in one business segment. With the acquisition, they are now in two; North America and International.
 
The 10Q says, “Included in the North America segment for the three months ended September 30, 2012 and 2011…are international net sales of $6,015,000 and $10,713,000… that represent products that were sold from North America to retailers and distributors in other countries.”
 
In last year’s quarter, before the acquisition closed on August 26, sales to Kungsbacka were just sales. After the closing date, they were part of the international segment. And, with a whole quarter under their belt in this year’s quarter, international sales in North America fell, as you’d expect because they got moved to the international category.
 
Let’s take all those international sales out of both quarters and see how things are going just in North America. Skull tells us that North American sales included $10.7 million of international sales not all of which, I guess, were to Kungsbacka. If we subtract, we find that North American sales were $45.54 million. That includes Canada and Mexico.
 
This year, North American sales were reported as $57.41 million, including $6.02 million of international. Subtracting, we come up with $51.39 million of sales in North America. So sales in North America, excluding any product sold internationally from North America, rose from $45.5 million to $51.4 million, or by 13%. Total international sales were up 29.7% from $15.1 million to $19.6 million.
 
You can expect, they tell us, that more sales will transition from the North American to the International segment.
 
On an as reported basis, the 2.1% North American sales increase was “…primarily driven by increased Astro Gaming sales of $4.7 million.” We also learned that online sales, as a percentage of net sales, fell 3.8% to $6 million compared to last year’s quarter. Skull notes that, “An increase in Astro Gaming online net sales was offset by declines in our direct audio consumer business.” Online sales fell from 9.1% to 8.3% of revenues in the nine month period ending September 30 of each year.   “Online sales,” we’re told, “continue to be negatively impacted by price competition in the ease of online price shopping.”   
 
Total gross profit in the North American segment declined by $54,000 to $27.18 million in the quarter compared to last year’s quarter. The gross margin fell to 47.3% from 48.4%. They attribute the decline to “…a shift in sales mix to higher price point products with lower gross margin structures” as well as how some of the Astro Gaming inventory had to be accounted for at acquisition. I would have expected that the Kungsbacka acquisition would have had a positive impact on North American gross margins (because North America would no longer be selling to Kungsbacka at distributor pricing, or at all for that matter) and I was surprised they didn’t mention that.
 
The mention of lower gross margins on the higher price point merchandise was a concern to some analysts. As you know, I’ve been a champion of focusing on gross margin dollars as well as gross margin percentage so I’m maybe not so concerned.
 
The Strategy
 
CEO Jeremy Andrus reminds us in his conference call comments that Skullcandy is “…focused on 4 key strategic areas to drive continued long-term growth. Raising our average selling price, expanding the gaming category, growing international and developing other brands and categories.”
 
Here are some numbers from the conference call for the quarter that tell us something about their sales breakdown worldwide.
 
Product that retails for $30 or less represented 38% of dollar volume and 67% of units. Over the ear products were 26.5% in dollars, but only 7.4% in units. Products in the $30 to $75 range were 28.1% in dollars and 15.4% in units. And products retailing for $100 and over were 5.3% in dollars and 1% in units. The numbers don’t exactly to add to 100% and I can imagine that “over the ear” includes product in more than one price category, but you get the picture. At the moment, the less expensive products are their biggest sellers by units and dollars.
 
Management notes in a couple of places that there is increased competition in the low end buds and that they have lost some market share to competitors in that segment. While I’m obviously not the target market, I paid $2.99 for a recent pair of buds I bought because I knew they were going to get broken at the gym, lost, or left in a pocket and put through the wash.
 
That low end buds would become a bit of a commodity (try to name a consumer electronics product that hasn’t eventually become one- especially at the lower end) can’t be a surprise to anybody. Skull management pretty much acknowledged this when they introduced their 2XL brand “…developed to sell into drug, convenience and grocery channels.”
 
The Skullcandy brand is already in certain retailers (like Fred Meyer) that I’d say is equivalent to where the 2XL brand is be sold. I wonder if 2XL will replace the Skullcandy brand at certain price points and retail outlets, or if they will both be sold in the same place. 2XL, they say without giving any numbers, is small but growing quickly.
 
The Astro gaming headphone brand was about $10 million in international sales at the time Skull acquired it. Skull is pursuing the gaming market with both Astro and Skull branded products. Astro will be the premium product in Skull’s gaming offerings. They’ve just launched the Skull gaming product so it’s not a lot of business yet.
 
In international, Skullcandy is “…still in the early stages of building our direct business in Europe and expanding distribution in other foreign countries.”
 
They are also working to move up their average price points. They think they have a lot of potential in the $50 to $100 price range and “…have invested heavily on product development and are reengineering the development process through an in-house team of designers, developers and acoustic engineers. Everything from the form, function and sound quality are now being controlled in-house.” During the quarter sales in this price range rose 60%, but “…this segment is still relatively small.”
 
What’s It All Mean?
 
They’ve got the 2XL brand, but it’s still small. They see a lot of potential in Europe, but that’s at early stages. They are focusing on higher price point products in both the Astro and Skullcandy brands, but are just rolling them out. Meanwhile, they’ve got some competitive pressure in the $30 dollar and under price point which was their largest by units and dollars during the quarter. Online sales, except for Astro, declined.
 
How’s the overall business environment? “We are confident in our ability to continue to drive long-term sales and earnings growth. That said, the overall retail environment is definitely a bit uneven right now in the U.S. and overseas, particularly in Europe. Over the past few months, we have seen retailers become more cautious in their outlooks for the holiday season and at this point, it is impossible to gauge the impact of Hurricane Sandy.” Those problems aren’t unique to Skullcandy.
 
What’s the short term impact of this? “As a result, the company is lowering its operating margin and profit projections in the fourth quarter and revising its fully diluted earnings per share outlook for 2012 to a range of $1 to $1.04 from the previous range of $1.10 to $1.20.” Management expects “…the fourth quarter to roughly mirror what the third quarter has been in terms of revenue.”   They would not provide a lot of guidance for 2013 because they are in the middle of their budget process, but CEO Andrus did say“…my general sense is that operating margins will be flat next year.”
 
Here we are at the crossroads that every successful, fast growing company eventually arrives at. It’s no surprise that Skull’s lower priced products (that produced 38% of revenue and 67% of unit sales during the quarter) are to some extent becoming commodities and are under competitive pressure. I’d expect that to continue. If there’s continued price and margin pressure there, one wonders what kind of volume they need to do to be competitive in this segment. Their new 2XL brand is to be part of the solution to that.
 
Skullcandy management sees growth opportunities in Europe and in moving to higher price points with both the Skullcandy and Astro brands, but those are at early stages of development. How quickly can they be expected to compensate for the lower priced, more competitive business in North America? And if, in these small but growing niches, competitive positioning is based on the cache of the Skullcandy name- it’s “coolness” if you will- how big is that market?
 
Like I said, this is going to get interesting.

 

 

Let’s Review; Lessons for Being in the Winter Sports Business

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Well, here we are in the middle of a new snow season. Among the things people are probably thinking about are:

“It can’t be any worse than it was last season.” That seems statistically likely to be correct.
 
“What am I going to do with last year’s product?” Probably something brands and retailers are both still thinking about that.
 
“I am never, never, ever going to order (or produce) more than I’m absolutely certain I can sell.” I do hope you stick to it.
 
“Wow! Am I glad I wasn’t over inventoried when last season started.”
 
And, if you’re a smaller, single season company, there’s the ever popular, “I hate having to finance this business and I’m really, really tired of personal guarantees.”
 
With those in mind, I thought it might be useful to review the things you have to do to be successful in a one season business. Most of these ideas I’ve written about before, but I don’t think I’ve ever pulled them all together in one place.
 
Be Cognizant of What Is and Is Not Controllable
 
Business is good when it snows and bad when it doesn’t- and there’s nothing we can do about that. That means you’ve got to assume and prepare for an average season at best (though you might need to think about what you mean by “average” in a lousy economy with global warming).
 
You Have to Make Money 
 
I know this sounds kind of obvious, but if you can’t make money, don’t be in the business. We’re all aware of retailers who have pulled out of snowboarding after doing that analysis. Though I don’t like to see that, I say good for them for facing the reality. I guess the good news is that it helps those who remain in the business by reducing distribution a bit.
 
Unfortunately, the analysis is not as cut and dried as I just made it sound. You mean make money every year? How do you allocate your overhead to winter sports if that isn’t all you do? Is it cash flow positive even if it isn’t bottom line profitable (I doubt it)? Will it cost me customers who buy other stuff? Can I make it profitable by carrying different brands or inventory mix? Etcetera. 
 
Don’t Be a One Season Business
                               
I suppose the only snow only retailers left are shops associated with resorts, and they close in the summer. Except that winter resorts have figured out that not being a one season business is a good thing. Water slides, zip lines, mountain biking trails, golf, and other activities are allowing them to generate at least a bit of cash flow in the summer. What significant snowboard brand hasn’t, or isn’t trying to create year around revenue or isn’t owned by a larger company that has that year around cash flow?
You’d be stunned at what getting just 10% of your total revenue in the off season does for the ability of your finance person’s ability to sleep at night by improving the cash flow.
 
Basically, there’s no good way to finance a one season business except to make it less seasonal. You can do it with equity, but you really don’t need to tie up all that money all year and your return on equity will probably suck. You can do it with debt and pay it down in the off season but lenders, especially now, want to see a strong balance sheet (implying lots of equity) before they will lend you the money. It’s a bit of a conundrum.
 
I’ve been responsible for the financial management of a couple of snowboard companies and the only solution I see is increasing off season revenue.
 
Inventory Management
 
I would always prefer to bemoan a sale I didn’t make than inventory I had to liquidate. It was years ago I suggested that a focus on the gross margin dollars you generated rather than the gross margin percentage was a good idea, and it’s only gotten more important as the economy has become and remained soft. Sales growth is harder to come by, but maybe you can improve your bottom line anyway by growing your gross profit.
 
In a more formal sense, this method of looking at your inventory is referred to as gross margin return on inventory investment. To over simplify, it makes you confront the fact that you’d rather sell an item with a 35% gross margin that sells for $175.00 than three items with a 50% gross margin that sell for $12.00. 
 
That’s worth thinking about in any business, but especially in the seasonal snow business. To put it as directly as I can, if you’re stuck with much inventory at the end of the snow season, the chances of your making an overall profit in snow that season are slim to none.
 
And there are other advantages to managing inventory a bit more tightly and in a more sophisticated manner, as if making more money shouldn’t be enough to convince you. You tie up less working capital. You create a perception of value through scarcity. I think “Sorry it’s all sold!” does more to create value in the eyes of the consumer than all the advertising in the world. What exactly is wrong with selling a bit less, but paying the bank less interest, generating more gross margin dollars, and perhaps being able to spend a few less bucks on advertising and promotion?

I thought this was going to be a way longer article.  I know, I know.  Conceptually simple sounding, but not all that easy to do.  But much of what I’m describing just represents good business practices that these days you can’t ignore.

 

 

Nike’s Quarter- It’s (Still) Good to Have a Big Balance Sheet

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Nike’s 10Q was released three days ago, so it’s time to take a look at their results. Sometimes I wonder why we even talk about Nike.   I guess it’s because after arrogantly stumbling around in the dark in the action sports world for a few years, they developed some patience, mixed it with a bit of humility, hired some people who understood this market and used their undeniable skills in product development, distribution and marketing, along with their financial strength, to take a chunk of it. 

But that’s only part of it. We’ve got to look in the mirror and recognize that when we (of course these were all individual company decisions) decided to grow and look for business outside the core action sports market of participants and the first level of lifestyle enthusiasts, we made things a lot easier for Nike and other mainstream companies like them. Remember when we weren’t mainstream?
 
It was inevitable and even appropriate for some companies, and I’ve got no criticism for the companies who pushed into the mainstream. But the competitive equation changed as that happened. When and as the market becomes more about fashion, it gets harder to compete with a mainstream company whose revenues for the quarter is probably larger than the whole core action sports market for the year.
 
Nike had $6.7 billion in revenues in the quarter ended August 31. That’s up 10% from $6.1 billion in the same quarter last year. But its gross margin fell from 44.3% to 43.5%. They note that factors including higher product input costs, more North American sales (up 23%), where margins are lower, and other factors actually decreased their gross margin by 4%. But all but 0.8% of this was offset by product price increases, fewer closeouts, more direct to consumer business, and projects to reduce product costs. Ain’t pricing power grand?
 
Now, no doubt the lower gross margin made them a little more cautious financially.
 
Nah. Their “demand creation expense” (advertising and promotion) rose 29% from $692 million to $891 million. Operating expenses were up 12% from $1.13 billion to $1.26 billion. Those two increases, along with a tax rate that rose from 24.3% to 27.5%, meant that net income actually fell 12% from $645 million to a mere $567 million.
 
Now, you can imagine the conference call if this was anybody besides Nike. There’d be moaning, wailing, gnashing of teeth, expressions of incredulity, and probably groveling as analysts and management alike tried to get their heads around how a company can possible increase their spending so much while net income declined.
 
Obviously, Nike could have not spent all that money and kept their net income from falling in the quarter. But they didn’t take that approach and nobody expected them to. The conference call was very positive, with discussion of all the great marketing opportunities they took advantage of, how well the brand is positioned, and their focus on “…innovative product, strong brand connections with consumers, and transformative distribution…” The implication, with which I agree, is that if you do those things well, the bottom line will work out.
 
Wait a minute. I’m not sure, but I think, yes, it appears to be!  It’s a public company not just managing for quarterly results, but consistently pursuing its long term strategy even at the expense of the short term bottom line!
May have over oozed sarcasm there. I know Nike isn’t the only company that does it. But it’s appropriate to remember the importance of a good strategy consistently applied over time, especially when coupled with a rock solid balance sheet.
 
Nike’s Other Businesses unit, which includes Converse, Hurley and Nike golf, had revenue of $635 million, up from $585 million in last year’s quarter. Other Businesses used to include Umbro and Cole Haan, but they are being sold so are segregated as “Businesses to be Divested.” Converse experienced “low double digit growth” during the quarter. Hurley’s growth was “mid single digit.” That’s all we’re told.
 
Nike brand revenues were up 11% in footwear, 10% in apparel, and 13% in equipment. In constant currency those numbers, respectively, are 16%, 15%, and 17%. Footwear was $3.69 billion, or 55.3% of total revenue. Apparel, at $1.76 billion, was 26.4%. Equipment, at $386 million, is only 5.8%. The remainder is the other businesses and the units being divested.
 
Direct to consumer sales rose 21% from $909 million to $1.1 billion.
 
Without the 23% revenue increase in North America, Nike’s revenues for the quarter would have been up just 1.3%. Western Europe was down 5% to $1.17 billion (Up 6% in constant currency). Greater China revenues grew 8% (7% in constant currency) to $572 million, and Japan was down 6% to $183 million (down 7% in constant currency). Emerging markets grew 8% to $867 million.
 
Of its total earnings before interest and taxes of $779 million, $630 million, or 81%, came from North America. That $779 million includes a loss at the corporate level of $265 million which results from “…unallocated general and administrative expenses…” It also includes a $375 million loss in the Global Brand Divisions which “…primarily represents NIKE brand licensing businesses that are not part of a geographic operating segment and general and administrative expenses that are centrally managed for the NIKE brand.”
 
That’s about it. For all its size, a discussion of Nike’s results never requires writing a treatise. Lessons? Well, the one about a good strategy consistently applied and the value of a strong balance sheet. That’s not new. And I suppose the one where we opened the door for Nike and similar companies as we inevitably took our little, quirky, underground industry mainstream. That’s not new either.
 
Maybe that’s why I don’t write about Nike every quarter.

 

 

Globe’s Results for the Year

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I’m kind of late getting this done. The June 30 fiscal year results were released at the end of August. But we only see Australian company results twice a year, so it still seems worthwhile. Happily for me, there’s not that much information in the report so it shouldn’t take long. The “Review of Operations” for the whole year is four short paragraphs- less than half a page. I guess not much happened.  You can see Globe’s whole report here.  It’s the fourth item down on the page. 

To summarize, Globe’s revenues fell 6.1% from $88.5 million to $83.1 million in the pcp (prior calendar period- the previous full year in this case. And all numbers are in Australian dollars). Earnings before interest, tax, depreciation and amortization (EBITDA) were down 41.3% from $2.93 million to $1.72 million. Net income fell 94% from $1.089 million to $62,000. However, those numbers include $1.0 million from settlement of a lawsuit. Without that, Globe’s EBITDA would have been $72,000 and it would have had a bottom line loss.
 
Australasia revenues were $25 million, up 4.3% from $24 million in the pcp. In North America, revenues of $41.8 million declined 15.2% from $49.3 million in the pcp. The press release refers to North American revenues being down “…in single digit percentage terms…” but I keep coming up with 15.2%. Maybe that’s a constant currency number, though it’s not clear.
 
Revenue from Europe rose 7.7% from $15 million to $16.2 million. In Australia (as opposed to the Australasia segment) we see revenues up 6.4% from $21.2 million to $22.5 million. With revenues up $1.0 million for the whole segment, we can see that all the growth in that segment came in Australia itself.
 
Revenues in the United States fell 17.1% from $31.6 million to $26.2 million. In other foreign countries (which I assume means everywhere but the U.S. and Australia) revenues were down 3.5% from $35.5 million to $34.3 million.
 
The sales decline was blamed mostly on the strength of the Australian dollars. We’re told they were basically flat in constant currency.
 
Globe doesn’t provide the gross profit number we’re use to see in the U.S. But there is a cost of sales figure, which I imagine is a reasonable proxy. If we use it to calculate a gross merchandise margin, we see it’s basically unchanged, falling just 0.1% over the year from 45.4% to 45.3%. But the press release says, “Reduced gross margins, which are largely responsible for this decline in profitability, resulted from a combination of sales mix, competitive market pressures and an increase in cost of goods.”
 
They don’t tell us exactly what the gross margin decline was, but it’s pretty clear that what we in the U.S. call ‘cost of goods sold” isn’t the same as “cost of sales” in Australia. Wish I spoke better Australian accounting. Yet you would think an “increase in the cost of goods” would show up in the “cost of sales” as a percentage of merchandise sales. I’ve got some Australian readers. Can one of you tell me the definition of “cost of sales” in Australia?
 
There’s no long term debt on the balance sheet, and the usual ratios are fine. Cash is at $10.2 million down from $12.3 million in the pcp. I would note a 2.2% increase in total receivables to $12.5 million. However, trade receivables rose 11.1% from $8.4 million to $9.4 million. Receivables were down in the Australasia segment even with the revenue increase. But in North America, where revenues fell 15.2%, receivables rose 37% from $2.8 million to $3.85 million. Yikes. That seems to imply something not specifically too good.
 
There was a 14.8% increase in inventory to $14.5 million. They note that there some footwear shipments that arrived in the first quarter of the current year that had been expected to arrive before June 30. Don’t know how big those shipments were, but obviously they would have pushed the year end up inventory up even further.
 
In general, you’d prefer to see receivables and inventory decline when sales decline. It would be interesting to see how much of the inventory growth was in units as opposed to being caused by the higher cost of goods they refer to.
 
The last balance sheet thing I’d mention, under “Other Financial Assets” is an amount of $1.35 million called “Investments in other entities (available for sale).” No big deal, but I wonder what it is because that’s what I do.
 
Well, there was a bit more information in the report than I thought on first read. But we don’t get any sense at all about what they might be planning to do to reverse some of the trends they highlight in the press release. And the sales decline in North America coupled with the increase in receivables is troubling. I guess, unfortunately, it will be six months before we find out how things have evolved. Make that four and a half months, as I’ll try to be more diligent in writing about it. 

 

 

Miscellaneous Stuff; Not Your Typical Market Watch

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I read a lot of stuff. From time to time I come upon something I want to share with you. Often I hold on to it until it fits into something I’m writing. But at this point, I’ve got a few articles I’ve been saving that it’s just time to spring on you in the hope you might find them interesting or even useful. 

The first, and the most eclectic of the three, comes from the investor George Soros. It’s entitled “The Tragedy of the European Union and How to Resolve It.” Soros has been a hell of a successful investor over many years and at this point is worth bazillions. Part of the reason for his success, I think, is his sense of history and culture and his ability to look beyond the next month or year or more. As an investor, that has allowed him to see more clearly than most and to have some patience.
 
This is written at a high level, but the quality of the writing makes it a pretty easy read, and there are no graphs or mathematics. Obviously, it’s not about action sports or youth culture or fashion. But many of you do business in Europe, are already impacted by what’s going on there, and know there’s a great deal of uncertainty about a how it all work itself out.
 
Soros has an opinion about what the choices are, or at least should be. Whether those seem reasonable to you or not, his historical analysis of how Europe found its way to its current mess is about the best I’ve seen in the space he uses. I recommend turning off your cell, disconnecting from the internet, locking your door and reading this thoughtfully.
 
The second article is called “A Seasonal Business Aims to Survive the Off-Season.” I imagine this might strike a little closer to home for those of you in the snow business. The business in question is a restaurant and specialty food store, and its lean months are October through April. Still, I think you’ll find some of the issues they face and actions they consider to improve their off season and manage their cash flow recognizable. From time to time, I’ve said that we spend, as an industry, way too much time talking to each other and confirming what we already think and want to believe. Here’s a chance to see how a small business not in our industry deals with a similar issue.
 
“Building a Brand When You Can’t Afford an Ad Agency” will strike a chord with everybody in our industry who has built a business from scratch. Interestingly, it’s not about social marketing and the internet.   I like it of course because what this guy did is pretty much consistent with what I’ve told people who’ve called me to ask how to build their new brand.  If I can find some Tito’s Handmade Vodka, I might have to change from Grey Goose (straight up with a twist).                   
 

 

 

Buckle’s Quarter and a Note on Auction Rate Securities

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I should start out by telling you that the Buckle July 28, 2012 balance sheet is strong. But long term investments include $15.1 million in Auction Rate Securities (ARS). An ARS is a long term security with an interest rate that resets via a “Dutch auction” every 7 to 49 days depending on the terms of the security. Until about February of 2008, the ARS market was very active and very liquid and was a great way for corporations to park excess cash and earn a little extra return. Now it’s not liquid. I guess I mean it’s still not liquid. 

How do you know what an investment that isn’t trading regularly and isn’t liquid is worth? Well, you use “Unobservable inputs that are not corroborated by market data and are projections, estimates, or interpretations that are supported by little or no market activity and are significant to the fair value of the assets.”
 
Every time I read that somebody (not only Buckle) is using “unobservable inputs” as the basis for evaluating an investment, I chuckle. And Buckle notes that “…the Company has reason to believe that certain of the underlying issuers of its ARS are currently at risk…” But they also point out that even if the investment ends up being worth nothing, they’ll be fine, and I agree.
 
I first wrote about ARSs a few years ago and wanted to remind you that the issue is still around. The reason you might care (aside from “unobservable inputs” making you chuckle too- god I love that) is that our current economic mess was caused by a certain level of paralysis in the financial system. You can see, in the case of the ARS market at least, that there’s still some paralysis out there.
 
Buckle’s performance in the quarter ended July 28, 2012 was pretty much exactly the same as in the pcp (prior calendar period- same quarter the previous year). Sales rose 1.5% from $212.4 million to $215.5 million, but comparable store sales were down 0.8% or $1.6 million. “The decrease in comparable store sales was primarily due to a 4.2% decrease in the number of transactions at comparable stores during the period and a 0.9% decrease in the average number of units sold per transaction, partially offset by a 4.6% increase in the average retail price per piece of merchandise sold.” The sales increase came from opening new stores. They had 439 stores in 43 states at the end of the quarter.
 
The average retail price of a piece of merchandise sold was up $1.94 or 4.6% in the quarter compared to the pcp. I think it’s interesting that the average accessory price point was up 13.7% ($0.54). Accessories were 10.1% of revenues up from 8.9% in the pcp. Denim was 36.2% of revenue. Tops represented 33.9%.
 
Online sales rose 12.1% to $16 million. Those aren’t included in the comparable store sales number.   
 
Gross profit fell a bit from $87.1 million to $86.5 million. The gross profit margin was down from 41% to 40.1%.
 
Selling, general and administrative expenses were almost constant, falling from $50.4 million to $50.1 million. Net income declined just barely from $23.6 million to $23.2 million.
 
In the conference call, they noted that private label business was around 30% of sales compared to 28% in the pcp. In response to an analyst question about their target for private label, CEO Dennis Nelson responded, “…we don’t set a specific number of what we want private label to be. We evaluate the product with the brands, and we have our plans. But depending how strong the brands look and are performing, cuts into the percent of how — what our private label is. So private label will continue to grow, it’s just a matter of how much the brands will grow.”
 
The point, which I’ve noted before for Buckle, is that private label isn’t just a way to make some extra margin. It’s part of their strategy for branding Buckle and merchandising their store. I think that’s the right way for a retailer to approach private label.
 
That analyst also asked, “…And then out of the remaining third-party offerings you have, how much of that product is exclusive to Buckle?” Here was the response.
 
“I would say the majority of our product from the brands is exclusive. I don’t know if that would be 80-plus percent. It might vary by season. And sometimes, in season, we’ll pick up some of their product that is out of their line if something is performing and we don’t have time to either tweak the fit, or the color or styling details.”
 
I was a bit surprised by that answer. What I think he’s saying is that of the 70% of product that’s not proprietary, 80% of that is merchandise only Buckle has. I need to walk back through a Buckle store and look at their merchandising with that in mind. Are they saying that 80% of the non-owned brands that Buckle carries are created exclusively for Buckle? While that’s consistent with what’s going on in the relationship between brands and retailers in general, it surprises me that the number would be that high.
 
Buckle’s quarter, then, was not too good and not too bad. The most intriguing thing to me is the comment about so much of their merchandise being exclusive to Buckle. I haven’t followed Buckle all that closely, but I think I’ll start.

 

 

The Possible Rip Curl Deal

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A couple of readers were thoughtful enough to send me articles on the possible sale of Rip Curl. You can read them here and here. What’s intriguing from my perspective is that the offers came along at the same time as the conditional TPG offer for Billabong. As you know, that’s in due diligence right now, though there’s no certainty a deal will be made. 

Rip Curl is a private company, but according to one of the articles it earned AUD 7.9 million in the year ended June 30, 2011 after making AUD 15.5 million for the year ended June 30, 2010. No numbers are given for the latest fiscal year results, but we do learn that, “During the 2012 financial year Rip Curl acquired 24 Rip Curl branded and multi-branded stores in Australia and South Africa.”
 
For all I know, Rip Curl had a spectacular fiscal 2012 and just thought it would be a good time to sell the company, but that seems unlikely given what we know about conditions in Australia. And if I were going to sell, I don’t think I’d look to do it at the same time a direct competitor was up for sale.
 
Anyway, just thought you might want to see these articles.