Tilly’s IPO Moving Forward; Another S1 Amendment is Filed

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Not much is different in this filing, but we do get a few additional pieces of information. You can review what I wrote about their initial filing last July here. I updated that analysis in March of 2012 when they released their numbers for the year. My opinion hasn’t changed and I think the analysis is still valid.

What we learn from the newly amended S1 is that the share price of the offering is expected to be between $11.50 and $13.50. They expect to raise about $86.4 million (assuming a $12.50 a share price). Of that amount $84 million will go to the existing shareholders and only $2.4 million will be available to be utilized in the business. Here’s how the filing puts it:

“The principal purposes of this offering are to obtain capital to pay all undistributed cumulative earnings to date to the current shareholders of World of Jeans & Tops [the former corporate name of Tilly’s], obtain additional capital, create a public market for our common stock and facilitate our future access to the public equity markets….We expect to use $84.0 million of the net proceeds from this offering to pay in full the principal amount of the notes, as well as any accrued interest. Therefore, our stockholders immediately following this offering, who were also the shareholders of World of Jeans & Tops prior to termination of its “S” Corporation status, will receive most of the net proceeds from the sale of shares offered by us.”
 
When the offering is done, there will be Class A and Class B common stock. Purchasers of the offering will get the Class A, which has one vote per share. The Class B common stock has ten votes per share.
 
As a result, “The Shaked and Levine family entities [current owners of Tilly’s and the only ones who can own the Class B shares] will control approximately 96% of the total voting power of our outstanding common stock following the completion of this offering. As a result, the Shaked and Levine family entities will be able to control the outcome of all matters submitted to a vote of our stockholders…”
 
Tilly’s numbers for last year, as I discussed in my March article, were strong. It will be interesting to watch how the offering is received. 

 

 

Nike and Their Approach to Product Innovation. It’s Not All About Team Riders

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Nike recently came out with their 10Q for the quarter ended February 29th. I looked through it, read the conference call transcript, and sat down with the intention of doing my usual analysis.

Then I thought to myself, “Who am I kidding?” You want my analysis? They keep growing, make a lot of money, and their balance sheet is as imposing as the Death Star in Star Wars, but in a good way and with no exhaust vent for Luke to fire a proton torpedo into. There. Analysis done. You can see the 10Q here if you want to dig a little deeper.

What I want to focus on instead are President and CEO Mark Parker’s comments on how they constantly search for innovation and new products to “…create opportunities for everyday athletes to connect with NIKE, Inc. and each other around the world.”
 
He goes on to say:
 
“Collaboration is essential to how we innovate and grow. At NIKE, Inc., that always starts with insights from athletes, from the elite competitor to the everyday athlete. And it expands from there to include partners inside and outside our industry who inspire new ways of thinking; our retail partners, our manufacturing partners, universities, technology companies, NGOs, entrepreneurs and many more.”
“In our business, it’s collaboration and the ability to consistently innovate that create momentum and fuel long-term growth.”
 
Interestingly enough, last night I watched Sector 9 President and Co-Founder Steve Lake’s speech at the Transworld Snowboard Conference. Steve talked about constantly trying new things, reinventing his company every five years or so, and never standing still. Sector 9 probably isn’t quite $20 plus billion in revenue yet, but I bet he knows exactly what Mike Parker means. Go watch his speech here.
 
For Nike and Sector 9, doing something different is a core value. Standing still is dangerous and taking no risks is the biggest risk of all. I’ve said that a time or two myself and can’t resist pointing it out.
 
What struck me about CEO Parker’s comments is how their search for input and new ideas doesn’t stop (indeed, it barely begins) with elites athletes. We, on the other hand, too often won’t even consider something our team riders don’t like. Yet team riders aren’t our customers, get the product for free, don’t have that much in common with our average customer in terms of the comparative skill level and frequency of participation and, it occurs to me, might even have a vested interest in product not evolving.
 
We state proudly that our companies are “rider driven,” typically meaning, in my experience, that team riders have a disproportionate say in product decisions.  It looks to me like Nike CEO Parker would disagree with that approach.
 
Please don’t even try to use, “Well, we don’t have the resources of Nike” as an excuse. The issue is the ingrained way of thinking in action sports. It’s spending too much time talking to too many people who we’ve known for too long and who tend to share and validate what we already think. And I am as guilty as you are. I try and remind myself of that so maybe I won’t do it quite as much.
 
Here’s a link to an article about a company that looks for breakthrough ideas by seeking out and listening to “freaks and geeks.” They got together a group of Brazilian transsexuals to try and find out about hair removal products. To me that makes perfect sense. Nike, by the way, is one of their clients.
 
Nike CEO Parker goes on to say, “We consistently refer to 3 key components in our ongoing success: product innovation, brand strength and premium distribution. That’s what drives out growth.”
 
I think I’ve made my point about sources of product innovation. I’ve got nothing to say about Nike’s brand strength, as that’s self-evident. But isn’t it interesting that Nike, a brand available pretty much everywhere, talks about premium distribution?
 
That’s because distribution doesn’t stand alone. If you’ve got innovative product and a strong brand, you can have premium distribution in places other people can’t.
 
 Distribution, in a word, isn’t just about where your product is, but how it got there. And critical product innovations can’t just come from team riders, or at least that what Nike thinks.

 

 

PacSun’s Year and Quarter; Progress, but Work Left to Do

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I want to start by focusing on some comments PacSun’s management made that are indicative, I think, of why this is a harder environment for most industry companies and especially for one that is working through a turnaround.

Strategies

Improving their merchandise assortment planning is not a new theme for PacSun. It’s something that CEO Gary Schoenfeld has been focused on since he joined the company. They use to send pretty much all the same inventory to all their stores at the same time. They say in their 10K (you can see the whole thing here):
 
“We are now grouping our stores into a number of store clusters based on customer segmentations, brand performance, differences in weather and demographics, among other characteristics. In conjunction with this clustering, we have changed our allocation strategies to distribute what we believe to be the right products to the right stores for the right customers.”
 
That’s a good thing. It’s important, they need to do it, and there’s a lot of benefit to be realized. Some years ago, it might have conferred a strategic advantage. Now, though some retailers no doubt do it better than others, it’s just the price of entry. It’s something you need to do well just to compete.
 
As you know, PacSun has been, and continues, to close stores; 38 in fiscal 2008, 40 in 2009, 44 in 2010, and 119 in 2011. That got them down to 733 stores at January 28th, the end of their fiscal year. In fiscal 2012, they expect to close an additional 100 to 120 stores. They expect the store closings this fiscal year to cost them $13 million, but to save $9 million a year annually after that. Pretty good return on investment.
 
Referring to the stores closed and being closed, they note, “The affected stores generate on average annual sales revenue of approximately $0.6 million as compared to our remaining stores, which generate approximately $1.1 million in average annual net sales. “
 
You can be a specialty retailer or a chain, but the days of low volume stores being profitable are mostly over and, as I wrote years ago, has been for a while. With distribution as broad as it is, you just can’t earn the margin you need to earn to keep a low volume store profitable. By the way, I’d love to hear from stores that are the exception to the rule. Tell me how you do it. Working for free doesn’t count.
 
Moving on, here’s who PacSun identifies as some of their competitors; “…Abercrombie & Fitch, Aéropostale, American Eagle Outfitters, The Buckle, Forever 21, H&M, Hollister, J.C. Penney, Kohl’s, Macy’s, Nordstrom, Old Navy, Target, Tilly’s, Urban Outfitters and Zumiez, as well as a wide variety of regional and local specialty stores.”
 
It’s not that I think they are wrong. In fact you might want to see the article I posted just yesterday which deals with this. But if in fact Penney and Target are serious competitors for PacSun, then what market are they in and how do they differentiate themselves? It’s not just PacSun that has this problem, but I’d say they have it worse than most right now. It’s a problem they are trying to solve. How?
Here’s what they say their mission is:
 
“Our mission is to be the favorite place for teens and young adults to shop in the mall. Our objective is to provide our customers with a compelling merchandise assortment and great shopping experience that together highlight a great mix of heritage brands, proprietary brands and emerging brands that speak to the action sports, fashion and music influences of the California lifestyle. We offer an assortment of apparel, accessories and footwear for young men and women designed to meet the fashion needs of our customers.”
 
Referring again to the article I published yesterday, the assortment strategy seems the same as Buckle or Kohl’s. Or Zumiez for that matter. What is the different thing you have to do (for any retailer) “…to be the favorite place for teens and young adults to shop in the mall.”?
 
Your Volcom product can’t be any better than the next retailer’s Volcom product can it? Does your strategy have to focus on making your proprietary brands better than the next retailer’s proprietary brands? CEO Schoenfeld said in their conference call that “…the biggest shift we are seeing in our business is growth in our emerging and proprietary brands, offset by declines in some of our key heritage brands.
 
Think of the implications of that, especially if you’re a brand other than a proprietary brand. Perhaps we see a reason here why so many brands are becoming retailers. Although I can also imagine that some of what PacSun calls heritage brands (brands they don’t own) might be a bit cautious in their relationship with PacSun right now as stores are closed and until their financial position begins to improve.
 
Numbers
 
Revenues for the fourth quarter ended January 28, 2012 were $234.2 million, down from $237.6 million in the same quarter the previous year. The loss in the quarter this year was $38.1 million compared to $35.2 million in the same quarter last year. The loss from continuing operations (ignoring stores being closed) was about the same in both quarters at $30.5 million.
 
For the year, sales of $834 million translated into a loss of $106.4 million. The previous year sales of $837 million produced a loss of $96.6 million. The loss from continuing operations also grew from $84.3 million to $90.6 million. Internet sales were 6% of sales in 2011 compared to 5% the two previous years.
 
The discontinued operations (stores closed or being closed) by themselves for the year had sales of $62.7 million and a gross profit margin of 17.6%. They generated a loss of $15.8 million.
 
49% of revenue was men’s apparel, 37% women’s and 14% accessories and footwear. Before 2007, non-apparel represented 30% of their revenues. But now they’ve reintroduced footwear into 425 of their stores, and they expect it to continue to grow.
 
Comparable store sales fell 0.6% compared to declines of 7.9%, 19.1%, and 4.7% in the three previous years.
Gross margin fell from 22.3% to 21.7% due in part to a fall in their merchandise margin from 46.9% to 46.7% and also due to deleveraging of occupancy costs. When your comparable store sales fall, but your costs for achieving those sales don’t, your gross margin goes down.
 
PacSun reduced their selling, general and administrative expenses from 32.2% of sales to 31.3% of sales, and are working to reduce them further in light of store closings. Since CEO Schoenfeld joined the company, consistent with the reduction in stores, they’ve eliminated three zone vice presidents, gone from 9 to 6 regional directions, and from 90+ to below 60 district managers.
 
The balance sheet is not as strong as it was a year ago. The current ratio has fallen from 2.11 to 1.58 and debt to total equity has risen from 0.87 times to 2.14 times. Much of the debt increase is the result of the money they raised last year in the form of long term debt.
 
Inventory was down about 7%, which you’d expect with store closings. It was flat on a comparable store basis, which you’d also expect as sales haven’t changed much. They note that there’s no liability from closed stores sitting in their inventory today. Their inventory reserve sat at $12.7 million at the end of the year, up from $5.7 million at the end of the previous year.
 
I had commented at the time of that long term debt transaction that they’d bought themselves some more time to implement their strategy, and I think that’s still a valid assessment. They expect their current sources of cash will be adequate “…to meet our operating and capital expenditure needs for the next twelve months,” as long as they don’t experience declines in same store sales like they had in 2009 or 2010 or further gross margin decline.
 
Let’s conclude with a conference call quote from CEO Schoenfeld. “I think we all believe that if we can execute it right, there’s a real future for PacSun. A lot of the branded business is done across department stores, and we think that as a specialty retailer, we have the opportunity to offer something different than what a department store offers.”
 
As indicated when we talked about strategies in the first part of this article, operating well, while critical, may not generate any kind of advantage. There are a lot of smart people running a lot of good businesses out there trying to do the same things to generate their own advantage. I also think that “offering something different” is a great idea, but I don’t know exactly what it’s going to be.
 
It will be tough to see how PacSun is going to do until after the dust settles from all the store closings, and I guess that takes us through this year and maybe a bit beyond. The question, I suppose, and not just for PacSun, is whether doing everything well is enough in the market and economy we’re in.

 

 

Trying to Think About the Junction of Retail, Brands and the Internet.

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The more I think about it, the less I feel I know for sure. I know the internet and brick and mortar are changing each other, that brands are becoming retailers and retailers brands, that easy information and product availability is making most products commodities at some level, that brands are really pushing product extensions, and that consumers are making long term changes in their purchasing behavior. But stirring this soup of change just makes it cloudy. 

Yet we all have to be thinking about it, and I’ve had a few experiences in recent months that are at least helping with the thinking and, to my surprise, are turning out to be related. Why don’t I tell you about them and we’ll see if they turn out to be related for you too.
 
At the Mall
 
Bellevue Square is a large regional mall here in the Northwest. It’s anchored by a Nordstrom, Penney, and Macy.   I’m in it occasionally and usually take the time to walk through some of the retailers firmly in our industry to see if I can learn anything. For some reason, at my last visit I determined to make a list of those retailers and see just how long it was. Here’s the list I came up with:
 
7 For All Mankind
Abercrombie & Fitch
Aeropostale
American Eagle
Billabong
Buckle
Element
Forever 21
Helly Hansen
Hollister
Lidz
Lucky Brand
Lululemon
Oakley
PacSun
The North Face
True Religion
Vans
Zumiez
 
I didn’t include Nordstrom or Sketchers. Maybe I shouldn’t include Lululemon. There are a few other fashion retailers I might have added. I know the list is shorter if I include only committed action sports brands. Yet I think that would be deluding ourselves. Every store on this list tries to get at least some of the dollars from customers of the core action sports/youth culture market. And I’m sure they all sell on line.
 
That’s a lot of stores for one mall. Bluntly, I’m not sure there are enough market niches to go around especially given that there’s nobody on this list whose niche isn’t determined largely by advertising and promotion.
 
Buckle
 
Buckle, headquartered in Kearney, Nebraska (don’t ask me), has about 430 stores in 43 states and had revenue of $949 million in the fiscal year ended January 29, 2011. The first time I walked into a Buckle store, it had the action sports/youth culture vibe I was familiar with from various other industry stores. But there was something different, and I literally walked around for a minute or two trying to figure out what it was.
 
You know how most action sports retailers have fixtures, posters, and other promotional aids representing the brands they carry? Buckle, I realized, didn’t have as much of that as most retailers. If you look at the list of brands they carry at their web site, you’ll recognize many of the brands, but those brands don’t overwhelm the merchandising of the store. They kind of get equal billing with Buckle’s owned brands, which are not named Buckle.
 
PacSun carried and promoted the brands we’re all familiar with. Then they added their store brands as a way to generate some more margin dollars and to offer more price conscious customers a choice. The way they handled their private label felt tactical and financial- almost like an afterthought- rather than being part of a strategy. I think that choice, along with over expansion, poor merchandising, and a weak economy, was what got PacSun in trouble.
 
Now, PacSun is being more thoughtful in how they handle their mix of brands.  We learn in their recent filings that their mix is about 50/50 between private label and brands owned by others.
 
Buckle, on the other hand, has what I take to be a deliberate strategy of building its image based on all its brands combined- owned and bought from other brands. In their merchandising, there almost isn’t a distinction made between the two. Buckle is a retailer making itself into a brand (or maybe creating brands?) through this approach.
 
I have often thought of store label brands in terms of what percentage of revenues they could safely represent. Perhaps that was short sighted. Buckle’s premise seems to be that it’s the mix and merchandising of the brands that matters given the target customer; there’s no percentage that’s “too much” or “too little.”
 
I wonder if the day will ever come when we see a retailer that has created brands get enough traction with those owned brands to sell them to other retailers. Maybe internationally.
 
Kohl’s
 
I’d characterize Kohl’s as a discount department store with quite a broad array of merchandise (Here’s a link to their investor relations site, which is full of all kinds of good information). Among the brands they carry are Vans, Hawk, and Zoo York. I was struck by the good selection and attractive pricing. Interestingly, they’ve moved from 75% national brands and 25% “private and exclusive brands” in 2004 to 52% national brands and 48% “private and exclusive brands in 2010.” I guess Buckle isn’t the only store that has the idea of melding owned with national brands.
 
“Private” and “exclusive” brands are not the same thing, and it’s important to understand the difference. A private brand is just what you expect; created, owned and controlled by Kohl’s. An exclusive brand is not owned by Kohl’s, but is available exclusively in Kohl’s stores. The Hawk brand is such a brand for Kohl’s.
 
I noticed a poster in the store advertising the Hawk brand, but featuring a skater who was not Tony Hawk. Makes sense to me. That’s what you do when you’re trying to give a brand credibility and longevity beyond an individual.
 
Target has the same kind of deal with Shaun White. Say, I’m going to have to rush right out a nd get me some of those Shaun White window curtains at Target. There are 237 Shaun White items on Target’s web site. Well, good for him. I would have made the same deal even though at some level I hated to see it happen. But I wouldn’t have minded if they’d not done the curtains.
 
Kohl’s has revenues of almost $19 billion generated from over 1,100 stores plus their web site.
 
Reaching Everybody, Everywhere, All the Time with Everything
 
I noted after SIA that everybody who was selling hard goods was making apparel, and apparel makers were making hard goods. I recently commented on Quiksilver’s foray into board shorts for NBA teams and suggested that just because a market extension was possible didn’t mean it was a good idea. Referring to the trends in online shopping, I’ve suggested that consumers no longer feel compelled to have a product they want the same day, so one perceived barrier to internet shopping is falling. About 2008 I started to point out that it was going to be tough to get sales increases, and it was years before that I suggested that perhaps a focus on gross margin dollars was appropriate since that was what you paid your bills with. Even earlier than that, I noted that where to sell or not sell your product was something brand managers focused on every day.
 
It’s just interesting how all this is coming together, at least in my mind. In a weak (though slowly improving) economy with cautious consumers and an environment most companies describe as “highly promotional,” many companies are trying to reach new consumers through product extensions that may or may not widen distribution. And it’s funny, because I see this as the hardest kind of economy to do that in. Almost by definition, you’re moving into a space where other brands are stronger than you are.
 
This trend is driven partly by a need to find sales growth somewhere, especially for public companies. It’s facilitated by technology and the internet, improved logistics and information systems, and a sense, I think, that the distribution cat is already out of the bag so what the hell.
 
Just to be clear, product extensions and distribution expansion aren’t by definition bad. Nike can sell some product at Costco without crippling their brand. Think about what Sanuk did. I expect to see Nixon do some interesting stuff once Billabong’s deal to sell half of Nixon closes and I think they will succeed because of how Nixon is already positioned with their customers.
 
These Days, What is “Positioning?”
 
If you ask me what “we” should do about this, I’d say, “nothing.” It is, as usual, up to individual companies and brands. The first question in the everybody, everything, everywhere all the time chaos is, “Has positioning changed and is it still meaningful.”
 
I’ve thought about that a bunch, which is why this article was actually started before Christmas but is just being finished. I hope it’s being finished. I’ll know in a couple of paragraphs.
 
The tools you use to build your market position have changed in ways we all know. But the concept is still valid and maybe more valid than ever. You build and defend your market position by doing what you do well and communicating that to your customers.
 
When I wrote about companies in snowboarding pushing into apparel from hard goods and hard goods from apparel, I suggested that companies that didn’t do that might find themselves with an advantage. I want to expand on that a little.
 
Maybe effective market positioning is now at least partly a matter of doing less. That is, let other companies pursue dubious product extensions. To exaggerate a bit to make the point, let them try to sell everything to everybody everywhere all the time. I wasn’t even born the first time somebody said, “If you think everybody is your customer, nobody is your customer.”
 
That doesn’t mean never do a product extension. But, more than ever, come at it from a solid foundation of knowing who your customer is and why they buy from you. Never go after a new market because, “We need more sales!” And don’t over simplify the analysis by going, “Well, we’re in business X, and all our competitors in business X make product Y, so we should make product Y too.” That ain’t analysis.
 
If you take the time to really understand how customers perceive you and why they buy your products, you won’t ever be tempted by the wrong growth opportunity, and you’ll immediately recognize the good ones when they come along.
 
I guess that at the junction of retail, brands, and the internet what we find is a slightly different way to think about old, still valid concepts.

 

 

Skullcandy Releases Its 10K (Annual Report)

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I wrote about Skullcandy back on February 24th shortly after they’d released their numbers for the year and last quarter and held their conference call. You can see that article here. Now they’ve released the 10K and, as promised I’ve been through it. There’s not that much new, different or surprising that I want to highlight, but there’s a thing or two.

First, because it’s kind of fun and interesting, I want to point out that it was noted in a couple of places that the stock jumped on release of the annual report. The actual increase from the close the day the report was released (after the market was closed) to the close the next day was 3.25%.

The implication seemed to be that the numbers had made the stock rise. Maybe they did. Damned if I know. But back when the same numbers were released in press release form after the market’s close on February 22nd and the conference call was held, the stock dropped 7.4% the following day on the highest volume it’s had since it went public.
 
The learning here is that the stock market is a strange and mysterious place. The same numbers (though in different forms) released on two different days weeks apart seem to engender reactions of the stock in opposite directions. I’ve been through the 10K and I don’t see any difference that would account for the divergence.
 
Like I said when I wrote the above linked Skullcandy article referring to another issue, correlation does not necessarily equal causality. The apparently obvious factor isn’t necessarily the one having the impact. That’s a really good thing to remember on a lot of occasions.
 
Second, the only thing that really caught my attention in Skullcandy’s 10K was its description of its competitive strengths and its growth strategy. They are on pages two and three of the 10K which you can view it here if you want and see their discussion.
Here’s what they describe as their competitive strengths:
 
1)      Leading, Authentic Lifestyle Brand.
2)      Brand Authenticity Reinforced Through High Impact Sponsorships.
3)      Track Record of Innovative Product Design.
4)      Targeted Distribution Model.
5)      Proven management Team and Deep-Routed Company Culture.
 
It’s not that any of those are wrong or misdirected, but they are more or less the same five things most brands in our industry would list. That’s not a criticism of Skullcandy. The point is that as an industry we’ve gotten to the point that competitive strength tends to come from the ability to execute better than the other company rather than from a fundamental competitive difference.
 
The one thing I’d like hear them talk more about is the Targeted Distribution Model. It seems like they are targeted more or less everywhere. Maybe what they mean is that they are only selling to retailers, humongous or tiny, that buy into and support their brand distinctiveness.
 
Meanwhile, here are their growth strategies:
1)      Further Penetrate Domestic Retail Channel.
2)      Accelerate Our International Growth.
3)      Grow Our Premium Product Offering.
4)      Expand Complementary Product Categories.
5)      Increase Our Online Sales.
 
Again, I’d argue that none of these are distinctive to Skullcandy and are a matter of executing better than their competition. They don’t mention in this list increasing their average selling price, though it was something they focused on in their report. I guess it’s probably subsumed under selling more premium product.
 
Talking about product design and development, they made the following comment:
 
“We are able to bring new products from concept to market in approximately 10 to 24 months depending on the technology integration and complexity of the product. In situations where we are launching new products based on existing designs and do not require tooling, we can accelerate the concept-to-market process to approximately 6 to 12 months.”
 
Feels to me like keeping their competitive strengths and implementing their growth strategies would be easier if they could speed this up a bit. I imagine they are working on it.

 

 

Tilly’s Is Still Going Public

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In July of 2011, Tilly’s filed an S-1 with the Securities Exchange Commission as a first step towards going public. I read through the filing back then and wrote about it in some detail. On March 23rd, they filed a third amendment to their S-1, so I think we can conclude they are still trying to get Tilly’s public.

The amended S-1 is about 269 pages long, so you will have to excuse me if I don’t compare it page by page with the initial filing. I reviewed it briefly, then went back and reread my original article. If this interests you at all, I suggest you do the same.  As far as I can tell, the points I highlighted about Tilly’s offering in my original article really haven’t changed. However, we do some more current financial data and a bit of other information. I thought I might share that with you and get us all up to date.

We still don’t know what the total net proceeds from the offering are expected to be, but we do know that “$ 84.0 million of the net proceeds from this offering [will be used] to pay in full the principal amount of the undistributed earnings notes held by our existing shareholders in connection with World of Jeans & Tops’ final “S” Corporation distribution.” In other words only the proceeds in excess of $84 million will be available to the company to run and grow the business. And after the offering, the company will still be controlled by the founders as I noted last July.
 
I really suggest you use the link above to read my original article before you continue.
 
Back in July, we had numbers for the January 29, 2011 year end. Now, we’ve got the results for the January 28 2012 year, so let’s start by looking at those.
 
Sales rose 20.5% from $333 to $401 million. Their own proprietary brands account for about 30% of their revenue. Gross profit percentage was up from 30.9% to 32.2%. It had declined for a couple of years and it’s nice to see that reversed. Of the 1.3% increase in gross margin percent, they say that 0.7% was the result of leveraging their costs over more stores. The rest was due to smaller promotional markdown. That’s good to hear. As you know, other brands and retailers have been pointing to a highly promotional environment and markdowns as a problem.
 
Selling, general and administrative expenses rose, but were basically constant as a percent of sales. There’s a little interest expense, but no other strange or unusual expenses below the operating income line. That’s refreshing to see. New income was up 40.6% from $24.4 to $34.3 million.
 
Remember the net income numbers I’ve just given you are effectively without any tax provision because Tilly’s is a subchapter S corporation where all the earnings pass through to the owners. They are converting to a C corporation as part of going public. If they were a C corporation now, the earnings for those two years, after a normal tax provision, would have been $14.8 and $20.8 million respectively.
 
During the year, the number of stores grew from 125 to 140. They plan to open 21 stores in 2012 and expect to grow stores at the rate of 15% for the next several years. They think they can grow to 500 stores over the next ten years. They say they need to invest between $500,000 and $550,000 to open a new store, and that they expect a new store to have revenue of $2.2 million in its first 12 months and cash flow of $300,000. Comparable store sales rose 10.7% compared to 6.7% the prior year. Ecommerce sales increases 33% over the prior year and represent 11% of total net sales (almost $44 million).
 
The balance sheet is pretty solid, and cash provided by operating activities has grown from $35 million two years ago, to $42 million last year, and to $53 million in the year ended January 30, 2011. They have a $15 million line of credit, but no drawings under it at the end of the year. They do have a long term liability of $30 million for deferred rent, and a capital lease obligation to a related party of $4.0 million. The company leases a facility from a company owned by the cofounders of Tilly’s, and I suspect that’s what it refers to.
 
Tilly’s had a strong year, and I would expect their financial performance would make it easier to take the company public. Yet, the first filing was last July and it isn’t done yet. As far as I can tell, Tilly’s owners don’t have any immediate requirement to get the company public, so maybe they were just waiting for better market conditions or to negotiate better terms. But as I said last July a big chunk of the proceeds are going to the owners and it will remain very much a family controlled business.
 
I’ll keep watching for further updates.   

 

 

Spy (Formerly Orange 21): Their Results for the Year

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As I’ve noted pretty much every time I write about them, we’re lucky to have a smaller brand like Spy that’s public (though I don’t quite know why they are public) because we get to look over their shoulder as they manage their way through issues and opportunities. It’s much better than hoping VF gives us some clue as to how Reef is doing during their conference call.
 
It’s a tribute to the brand that it’s still around and growing after all its false starts, management changes, and financial issues. It’s also a tribute to the approximately 50% owner who’s been willing to put a whole lot of money into the company.
 
You’ve watched with me as the Italian factory (LEM) has come and gone, partnerships with entertainment industry figures have come and gone, management has come and gone (and come, and gone, and come, and gone), litigation with former CEO Mark Simo was settled, the economy whacked the brand, and it dealt with some big inventory issues.
 
The 10,000 Foot Level
 
Let’s start way up here so you see clearly what their challenge is. Here’s how they describe their debt on page 37 of their 10K. You can review that document here.
 
“As of December 31, 2011, we had a total of $16.2 million in debt under lines of credit, capital leases and notes payable. We recorded approximately $1.4 million in interest expense during the year ended December 31, 2011.”
 
That includes the note payable to stockholder of $13 million. The balance sheet shows a negative equity of $7.5 million, but you really need to look at that $13 million note as effectively equity. Interest on that note isn’t being paid in cash. The note principal balance is just being increased by the amount of the interest to conserve cash.
 
They indicate that at December 31, that had an additional $1.1 million in loan availability from their asset based lender, BFI. What they think is that with that availability and with normal cash flow they’ll be able to meet their operating requirements for the next 12 months “…if we are able to achieve some or a combination of the following factors: (i) achieve desired net sales growth, (ii) improve our management of working capital, (iii) decrease our current and anticipated inventory to lower levels, (iv) manage properly the increase in sales and marketing expenditures required to achieve the desired level of business growth, and (v) achieve and maintain the anticipated increases in the available portion of our BFI credit facilities.”
 
They don’t put any numbers to just how well they need to do in any of those areas, but I don’t think anybody would characterize doing those things as a slam dunk in any business at any time.
 
This capital structure and cash flow situation is for a company that had $33.4 million in revenues for the year ended December 31, 2011 and a loss of $10.9 million. Last year, sales were $35 million and they had a loss of $4.7 million.
 
To finish off the 10,000 foot level thing, you’ve basically got a company that needs to grow its sales pretty dramatically for some years before it can begin to support and reduce the level of debt it has. Right now, Spy is completely dependent on the balance sheet of its major shareholder.
 
They note that Spy expects “…that the amount of our indebtedness to Costa Brava (controlled by their major shareholder) that will become due in June 2013 will increase. It’s not clear if that’s just from capitalizing the interest on the existing loan as it becomes due, or from some additional borrowings. Guess it depends on how the year goes.
 
Notes on the Income Statement
 
I want to point out that there are some significant noncash items in the 2011 loss (like the interest being accrued but not paid) as well as expenses for the Italian factory and some costs for winding down the various deals with O’Neill, Mary J. Blige, and Margaritaville (Let’s call these three “the deals.”). Spy is also still struggling to get rid of some inventory they don’t need. It looks to me like those costs should mostly all go away this year, which will reduce expenses. If you eliminate the LEM business, sales for the year actually grew 10% from $30.3 to $33.4 million.
 
Gross margin percentage fell from 47.9% to 43% in the most recent year. They only talk about why the gross margin changed “on a proforma basis.” There was almost $400,000 for product they were required to take from LEM but didn’t take, so that’s a cost of goods against which you don’t sell any product. They also had some inventory reserves for the deals.
 
2011 revenues also included $3.0 million in Spy closeouts. There was $1.9 million the previous year. Spy had an “allowance for obsolescence” in their inventory of $1.3 million at the end of 2011. Their net inventory was $6.2 million. That’s quite an inventory reserve.
 
When you write down inventory, you take a noncash charge in the amount of the write down the year you take it. If you sell that inventory in the next year, you calculate your gross profit margin based on the cost at which you are carrying the inventory after the write down. This can move your gross margin percentage around a bit. It’s kind of confusing.
 
Wish they’d just tell us what the gross margin percentage was for in line Spy product so we could see how they were doing. If Spy did a conference call, I’d love it if somebody asked when this out of the ordinary closeout business would be done with.
 
Sales and marketing expense grew by 33% to $12.3 million during the year. Basically, this is a good thing. There’s a couple of hundred thousand of LEM expense in there, but most of this is for athletes, marketing, and building the management team. The strategy is to refocus exclusively on the Spy brand and, inevitably, that requires some money be spent.
 
There’s an “other operating expense” of $1.8 million, but it’s all for the deals. Hopefully, that expense disappears for 2012.
 
Strategy
 
Spy characterizes itself as “a creative, athlete-driven brand.” “We design, market and distribute premium products for hard core participants in action sports, motorsports, snow sports, cycling and multi-sports markets, which embrace their attendant lifestyle subcultures, crossing over into more mainstream fashion, music and entertainment markets.”
 
They identify their operating and growth strategies as brand development, driving product demand through quality and innovative design, brand authenticity, and actively manage retail relationships. You can read the detailed descriptions on pages three and four of the 10K if you’re interested.
 
They are committing resources to these strategies, but most of their revenue comes from sunglasses, a highly competitive market (show me one that isn’t) where there are a lot of really big players, as I pointed out many articles on Spy ago. I like what they’re doing and the renewed focus on the brand, but they need to be bigger to play in this space. I’ve said that before too.
 
My hope for them is that they get some growth this year, and that we’ve heard more or less the last of the deals, bad inventory, and LEM.  Wouldn’t it be nice to just focus on growing the brand. 

Quiksilver’s January 31 Quarter- Sales and Loss Both Grow

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Let’s start with the summary numbers. Sales rose 5.4% to $450 million. The gross profit margin fell from 52.4% to 50.7%. Quik reported an operating loss of $2.5 million compared to operating income of $13 million in the same quarter the previous year.

The net loss grew from $15 million to $21 million. Taxes were $4 million higher, but interest expense fell 48% from $29 million to $15 million.

Okay, so why did it work out this way? We’ll start by looking at results in the three operating segments; Americas, Europe, and Asia/Pacific. You can see Quik’s 10Q filing here.
 
Income Statement Analysis
 
Revenues were up in all three segments. The Americas rose 6% to $205 million. Europe was up 2.2% to $169 million (4% in constant currency), and Asia/Pacific grew 11.3% to $75 million (8% in constant currency).
 
As you already read, overall gross profit margin fell by 1.7%. The decline was from 46.4% to 42.8% in the Americas and from 54.7% to 51.1% in Asia/Pacific. It rose from 58.9% to 60.3% in Europe.
 
Based strictly on grow margin, sales outside of the Americas look most attractive, but let’s take a look at the selling, general and administrative expenses as a percent of sales. In the Americas, it was 43.6%, up from 42.8% in the same quarter last year. In Europe it rose from 48.7% to 51%. In Asia, it fell from 52% to 49.9%. So while the gross margins may be better outside of the Americas, at the moment the cost of doing business is higher. 
 
Quik reported an operating loss in the Americas of $1.6 million compared to an operating profit of $6.5 million in the same quarter last year. The European operating income fell slightly from $16.9 million to $15.7 million. The Asia/Pacific operating loss rose from $12.1 to $17.5 million.
 
Those are the income statement numbers. Let’s see if, as the analysts put it, we can add a little “color” to those numbers.
 
The 10Q reports that, “The increase [in revenues] in the Americas came primarily from Quiksilver and Roxy brand revenues, partially offset by a decrease in DC brand revenues.” It goes on to note that, “The decrease in DC brand revenues was primarily from the footwear product category and, to a lesser extent, the apparel and accessories product categories.” So DC was down across the board in the Americas, but Quik still expects DC to be its highest growing brand on a percentage basis worldwide for the fiscal year.
 
I also want to point out that the Americas include Canada and Central and South America. We don’t know how DC (or any other brand) is doing just in the U.S.
 
In the conference call, CFO Joe Scirocco said they expected growth in all brands for all regions in the fiscal year. The Quiksilver brand is expected to grow in the high single digits, he indicated. Roxy should be up in the mid-single digits and DC in the mid-teens.
 
On the gross margin side, one analyst reminded CFO Scirocco that the company’s prior gross profit margin projection was for a decline of between three quarters and one percent for this year and asked if that would change because of their inventory position (I’ll get to that). CFO Scirocco said, “…as a result of excess winter goods, let’s think about 50 to 100 basis points of additional contraction on gross margin for the year.” He also said they do expect profit growth, but didn’t say how much.     
 
The 4% constant currency growth in European revenues “…was primarily the result of strong growth in DC brand revenues, partially offset by modest declines in our Quiksilver and, to a lesser extent, Roxy brand revenues.” Remember that as reported on the financial statement the growth was 2%.
 
The 8% constant currency growth in Asia/Pacific (11% as reported), “…came primarily from strong growth in Quiksilver and DC brand revenues, partially offset by a slight decline in our Roxy brand revenues.”
 
Here’s how they talk about the change in the gross margin in the three regions:
 
“The decrease in the Americas segment gross profit margin was primarily the result of higher input costs and, to a lesser extent, higher levels of markdowns in our company-owned retail stores and price adjustments in the wholesale channel. Our European segment gross profit margin increased primarily as a result of a higher percentage of retail sales, including e-commerce, versus wholesale sales compared to the prior year. In our Asia/Pacific segment, the gross profit margin decrease was primarily due to additional clearance business in Australia.”
 
Higher costs, markdowns, and a promotional environment seem to be common themes for both brands and retailers.
 
Same store company owned retail grew by 11% in the Americas. It was 9% in Europe and 3% in Asia/Pacific. E-Commerce revenues were around $30 million in 2011, and they are projecting it to more than double in fiscal 2012. They closed “a lot” of underperforming stores and I guess that would tend to improve the comparable store performance. In the U.S. they closed 15 stores in 2011 and opened “a handful.” They expect to close eight to twelve in 2012. 
 
In the U.S. market, we’re told, retail is 17% of total sales. It’s 26% in Europe and 35% to 40% in Asia/Pacific. 
 
The Balance Sheet
 
Quiksilver provides balance sheets in their 10Q for January 31, 2012 and October 31, 2011- the end of the prior quarter. Some of you know that I think it’s more valuable to compare the current balance sheet with one from a year ago, and that’s what I’ll do here.
 
At first look there’s not much change. At 2.53 the current ratio is almost identical to a year ago and total liabilities to equity at 1.90 is up just very slightly from 1.82 a year ago. Cash and cash equivalents, however, is down from $177 million a year ago to $94 million. Inventory rose 33% to $412 million which seems a bit much given the sales increase.
 
Interestingly, in the conference call they talk about the change in inventory compared to a year ago even though the 10Q doesn’t include the balance sheet from a year ago. CFO Scirocco reasonably points to product cost increases as part of the reason the inventory is higher and mentions specifically increases of 10% to 15%. He goes on, “Also, as we said last quarter, we wanted to protect our supply and make sure that we were in stock to meet new orders.” He thinks it would have all worked out fine if winter had started on time.
He estimates they have what he calls excess inventory of $30 to $35 million and expects to sell it through “…normal clearance channels during the course of the fiscal year…”
 
There’s nothing exciting to report in the current liabilities. Long term debt is up about $32 million to $729 million from a year ago, and total liabilities rose 2.7% to $1.13 billion. Equity was down a bit from a year ago, but not enough to worry about. Overall the balance sheet hasn’t improved, but neither has it gotten worse in any meaningful way, though I’d like them to work through that extra inventory.
 
Two Interesting Things
 
Okay, I have no idea what to think about the fact that Quiksilver is marketing boardshorts “…that represent NFL and NBA teams with authentic team colors and logos.” CEO McKnight trumpets the fact that the NFL picked Quiksilver “Because we’re the best of breed.” I believe that.
 
What I’m not quite so sure of is whether these various brand extensions we’re seeing (and not just from Quiksilver to put it mildly) will ultimately be good for brands and their market position. I don’t know enough to be critical in this particular case, but let’s say I have a concern.
 
I noted in an earlier article after the SIA show that everybody who made hard goods was making apparel and everybody who made apparel was making hard goods and I wondered if the brands who resisted that trend might find themselves better positioned. Not every brand extension you are capable of doing is a good idea no matter what your hunger for sales growth is.
 
Then there’s the “adjusted EBITDA,” that Quik uses and you’ll notice I haven’t mentioned until now. Quik says (in footnote one on page 23), “We use Adjusted EBITDA … as a measure of profitability because Adjusted EBITDA helps us to compare our performance on a consistent basis by removing from our operating results the impact of our capital structure, the effect of operating in different tax jurisdictions, the impact of our asset base, which can differ depending on the book value of assets, the accounting methods used to compute depreciation and amortization, the existence or timing of asset impairments and the effect of noncash stock-based compensation expense.”
 
There’s some truth to that.
 
But later in the footnote they go on to say, “Adjusted EBITDA has limitations as a profitability measure in that it does not include the interest expense on our debts, our provisions for income taxes, the effect of our expenditures for capital assets and certain intangible assets, the effect of non-cash stock-based compensation expense and the effect of asset impairments.”
 
There’s some truth to that too. Which truth is true? Probably both, and yet there’s a seeming contradiction between them. Just saying.
 
I like most of Quik’s initiatives and I know that strategies take not months or quarters to evolve and succeed, but often years. I’m patient, but I’d sure like to see that bottom line turn positive. I imagine they would too.

 

 

A Minor Mind Dump

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I’ve had a few ideas lately and come across some information I wanted to share. None of them seemed worthy of its own article, so I thought I’d just spew them out as they sprang into my mind. I have no idea how this is going to turn out.

First, a housekeeping issue. I know that Quiksilver, Zumiez and PacSun have come out with earnings reports. I am greedily collecting their press releases and conference call transcripts, but won’t have anything to say until they release their 10Qs or 10Ks. I just don’t think it’s worth your time to read, or my time to write, an analysis that doesn’t include the unbiased and completer information of the SEC filings. Hope that makes sense to you.

Next, I want to talk about the evolution of consumer habits as they relate to the internet. It wasn’t that long ago that I wrote about how being able to buy something and take it home was an advantage that brick and mortar retailers had over the internet. Somehow, last week I realized that probably wasn’t true anymore. I’m now perfectly happy buying on line and waiting a few days or even longer for the item to arrive rather than go out and buy it. And having asked a few other people (hardly a scientific sample I admit), it appears that I’m not the only one.
 
Now, if the price is lower or there’s no sales tax well or shipping is free, even better. And I don’t mind that delivery services have gotten better. But I don’t think those are the deciding factor. I think I’ve somehow just gotten comfortable with the fact that most of the stuff I need (think I need?) I don’t need the same day I decide to buy it.
 
If I’m right, and most people are thinking that way, then it would help to explain why small retailers are struggling and internet sales for most brands are growing so quickly.
 
But it’s not that one day people wanted to buy at the store and get their stuff and next day they were content to wait. It’s an evolutionary process that’s happening over years. The question is why it was only last week that I went, “Oh shit, how could I not have noticed this before?”
 
Maybe you all already knew this. But I haven’t seen any discussion of it, and I’ve always been kind of fascinated by how trends evolve and finally get recognized in business as a competitive opportunity (or problem).
 
I like to spot what I think are meaningful competitive trends and wish I could do it more often. I try and improve my odds by doing things like turning off the internet when I’m writing/thinking. Like now. Truth is, our brains aren’t designed for multitasking and there’s no email that’s going to arrive that can’t wait until I’m through writing.
 
I pretty much flee the mainstream media because I consider it to be mostly human interest stories and noise rather than hard news and analysis.
 
I thought I would share with you this article about Spain on a web site called Stratfor.  If you do business in Spain, I think you’ll find it valuable and you’ll get more good information about conditions in Spain in the 15 or 20 minutes you spend reading it than you will get anywhere else. If nothing else, you’ll probably notice that the unemployment rate of Spaniards age 25 and under is 45%. We kind of sell a lot of stuff to that group.
 
I pay for Stratfor, but it’s free right now. It seems they got hacked by Anonymous and are still trying to recover. Very embarrassing to be a global intelligence/security firm and have to admit that your subscribers’ passwords weren’t encrypted.
 
Okay, I’m done. I’ve editorialized a bit but enjoyed it. As long as I’m doing this for free, I’m allowed to have some fun. Go check out Stratfor. It’s worth a few minutes of your time every day.    

 

 

Vail’s Quarterly Results. If You’re a Winter Resort, Be a Big One. With Rich Customers. And Great Facilities.

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In Vail Resort’s March 6 conference call, CEO Bob Katz described snow conditions during the quarter ended January 31st in the following terms:

“In Colorado, snowfall levels were the lowest in over 30 years and for the first time in as many years, we were not able to get Vail’s Back Bowl open until Mid-January.”

“In Tahoe, we experience weather patterns that have not been seen since the late 1800s including having zero inches snowfall in December.”
 
“…snowfall levels at our six resorts were down 60% through January as compared with the prior year.”
 
After those cheery pronouncements, you might have expected him to leap up, yell, “We’re doomed!” and throw himself out the window. Or, maybe more poetically, off the top of one of the resort’s not necessarily snow covered mountains.
 
But he didn’t and, in fact, he didn’t have any reason too. Vail’s total revenue did in fact drop during the quarter to $373 million from $395 million in the same quarter last year. But most of the decline came from the inevitably and notoriously bumpy real estate segment. Revenues in the mountain and lodging segments were down only $5.7 million. Net income fell from $54.4 million to $46.4 million.
 
Really not bad for a disaster of a snow year. How’d they do that?
 
Vail’s Four Key Drivers  
 
The first thing they point to is their season pass program. About 45% of the quarter’s total lift revenue recognized was from season passes. It was 39% in last year’s quarter. It’s good when people give you their money early. It motivates them to show up even if conditions aren’t great and spend money on restaurants, lodging, meals, lessons and other stuff. Those season pass holders, during the quarter, came to Vail’s resorts just half a day less than in the previous year’s quarter in spite of the conditions. With snow since the end of the quarter, that’s normalizing.
 
The second driver Vail points to is all the money it’s invested, and continues to invest, to give it the highest quality assets. They specifically point to the snow making capabilities that allowed them to have more terrain open than other area resorts.
 
Investments in those assets, they assert, let them increase prices. Their ability to do that is their third driver. Ignoring season passes, Vail’s effective ticket price was up 9.1% in the quarter.
 
And finally, notes CEO Katz, “…our resorts attract a high income demographic that allows us to benefit from the enhanced consumer spending, especially in the luxury segment, as we realized significant increases in guest spending per visit…”
 
The average daily rate of their lodging rose 13.8%. Ski school revenue per visit was up 17%. Dining revenue was up 9.5% and rental revenue was up 9.1% per visit.
 
I guess the moral of the story is to have rich customers and spare no expense in treating them well. At the end of the day, the 14.6% decline in visits during the quarter were mostly offset by strong season pass revenue, higher list ticket prices, and more spending per visit on other services. Ski school, dining and retail rental revenue ended up declining 0.1%, 6.4% and 0.6% respectively during the quarter.
 
Customers don’t seem to come to Vail’s resorts worrying about saving money. It no doubt has something to do with the fact that 55% of their visitors were destination visitors who came from somewhere besides the local area and stayed a while.
 
Financial Statement Metrics
 
Due to seasonality, winter resort balance sheets can be intriguing exercises in financial analysis as they jump around from quarter. That’s especially true when there’s real estate involved. But Vail’s January 31 balance sheet is pretty strong. It’s nearly unchanged from a year ago, but what change there has been is positive. I guess I’ll pay it the highest compliment I can pay a balance sheet by not spending much time on it.
 
The one thing I might point out (on a positive note) is that though they have about $725 million in long term debt (almost the same as last year’s $734 million) there are essentially no principal payments due on any of it until 2019.
 
I gave you an overview of their quarterly income statement at the start of this article. Vail divides their business into three segments. The first, Mountain, includes the resort properties of Vail, Breckenridge, Keystone, Beaver Creek, Heavenly and Northstar as well as all the services associated with those resorts. The Lodging segment is the hotel rooms and condos that Vail owns or manages. Obviously, that’s closely associated with the Mountain segment. Finally, there’s the Real Estate segment, which owns and develops real estate around the company’s resorts.
 
I suppose most of you already knew that.
 
Mountain revenue in the quarter rose from $191 million to $195 million. Lodging revenue fell from $50.8 million to $47.1 million, though it benefited from a favorable $2.9 million litigation settlement.  Real Estate revenue declined from $25.3 million to $12.6 million. Total revenue, then, was down 4.6% from $267 million to $255 million.
 
In the Real Estate segment, during the quarter, among other things, four condo units sold for $1.1 million each, and one condo unit at their Ritz-Carlton Residences for $2.4 million. As you can see, it doesn’t take many closings moving from one quarter to another to really move the revenue and expenses in the Real Estate segment around a whole bunch.
 
Vail reduced operating expenses during the quarter by 4.6% from $267 million to $255 million. Mountain segment expenses rose by $2.2 million because poor snow meant they spent that additional amount on snow making.
 
Operating income dropped from $97 million to $84 million. Pretax income was down from $89 million to $76 million. No expense between those two numbers changed much from the same quarter last year.
 
The net income drop from $54.6 million to $46.4 million benefited from an income tax provision that was $4.5 million lower this year than last.
 
Vail is also big on reporting its EBITDA numbers by segment (earnings before interest, taxes, depreciation, and amortization. Those of you have followed what I’ve written about winter resorts know that I recognize the validity of trying to isolate operating results to give better focus on how a business is running. But given the winter resort business model, I sometimes have a hard time filtering out interest expense, amortization and depreciation.
 
As Vail says, upgrading and improving their assets on a continuous basis is one of their key drivers and the amortization and depreciation is a direct result of that. I know it’s non-cash, but it’s an inevitable part of running a quality winter resort. They indicated that resort capital expenditures will be between $75 million and $85 million in calendar 2012.
 
Be that as it may be, EBITDA for the Mountain segment fell from $127.2 million to $120.6 million. Lodging’s EBITDA rose from $881,000 to $1,213 million. Real Estate’s EBITDA was a loss of $3.5 million compared to a loss of $197,000 in the same quarter last year.
 
Vail had a quarter where revenue and profit fell, but you might have expected much worse given the lack of snow. It’s a shame we don’t get more public results, and discussion of those results from more winter resorts. It would be interesting to see the extent to which other resorts, if any, benefit from the same factors as Vail.   There’s nothing like a good long term strategy consistently applied.