Billabong Purchase of West 49 and Implications for the Industry- Questions, Questions, Questions

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Billabong’s acquisition of West 49 was the biggest retail expansion by a brand so far. We’ll see more brands buying more retailers and opening more stores. This article is about why. What are the motivations and the industry impacts? And what are some of the conflicts and contradictions companies will face as they pursue this strategy? Some of this is a bit repetitive of stuff I’ve written before, but we’re really talking strategy and industry evolution at the highest level. I want to tie it all together.

A Little History

Years ago we all knew, and I and lots of others wrote, that we didn’t need any more retailers (not just in action sports). Especially as the internet came into its own, consumers had more choices of product and place to buy than could possibly be useful. That didn’t mean a new store by brand x couldn’t succeed- we were all giddy with rising income and asset values after all- but if it wasn’t opened, no consumer was likely to care.
 
Then came the recession. If things are improving, we’re hardly out of the woods yet. U.S. Unemployment is 9.6% (a lot higher if you count people who have given up looking). The creation of 150,000 jobs in October was hailed as a big success, but that’s not much more than the number we need to keep up with population growth. Foreclosures and housing prices are still a major burden. Banks are cautious about their lending (we want them to be, I think- isn’t not being cautious part of what got us into this mess in the first place?), and consumers are still paying down debt and saving (again, hard to say that’s a bad thing).
 
Wish we were doing as well in the U.S. as in Canada. Well, this is for a Canadian publication after all and there’s nothing like a little ass kissing directed at the editor to minimize requests for rewrites.
 
Anyway, retailers across the whole economy closed when the recession hit, and the process is still continuing. We are all intimately familiar with the impact on action sports core stores. I’m sure everybody reading this knows a favorite store that’s gone away or is struggling. West 49’s public financials made it very clear it had some issues before it was acquired, and I expect its problems were part of the motivation for the deal.
 
Point one, then, is that if the economy is improving, we’re still struggling, at least south of the border.
 
Point two is that the role and numbers of “core” retailers is changing. Use to be that we thought anybody who was an independent retailer and carried hard goods was a “core” shop. Turns out we were wrong. A real core shop caters to participants and serious lifestylers who are not so price sensitive, carries the newest and best product, and is owned and staffed by people who are part of the culture and are participants themselves.
 
What does a core shop have to do to be successful?   My list is below.
 
Attributes of a Successful Core Retailer
 
By the way, I first created this list (slightly modified here) so long ago that I can’t even find it on my web site.
 
·         Good management accounting systems that they actually maintain and use
·         A quality internet presence
·         Active participant in its community
·         Sales volume high enough to make their shop financially viable (duh!)
·         A career path that helps them keep good employees for at least a while
·         Willingness to carry and promote new brands
·         They excel at selling and servicing hard goods.
 
The Rationale for More Stores
 
Things are better in Canada, so maybe it’s easier to justify new retailers there than in the U.S. Still, looking at the overall economic picture, and what I’d characterize as the apparent lack of consistent, real, growth in skate/snow/surf participation, one has to wonder why more stores make sense.
 
Answer? They probably don’t overall. But of course each company does what it perceives to be in its own best interest at the time. Especially as a public company, you’ve got to find ways to grow and become more profitable. Your choices of how you might grow haven’t changed in a long, long time.
 
You can sell more to existing independent retailers. Well, the action sports market doesn’t quite offer the organic growth potential it used to. There are fewer of those retailers, and the growth you can expect from them becomes less and less significant as a company gets bigger and bigger.
 
You can expand your distribution. I think at this point we all understand that there are limits to that unless you’re fundamentally changing your brand’s positioning- not an easy thing to do.
 
You can make acquisitions, and we’ve seen a lot of that from Billabong and others. I expect we’ll see more.
 
You can try and expand your brand franchise into other product areas. Quiksilver’s women’s brand comes to mind. You can add product under an existing brand like Electric (owned by Volcom) is doing with apparel. You can start a new brand. All of these have costs and risks as well as potential that aren’t the subject of this article.
 
You can run your business better, trying to improve your inventory management and controlling expenses in hopes of improving the bottom line even with limited sales increases. Pretty much everybody who’s made it through the recession has done and is doing this.
 
And finally, you can go vertical and, as part of that, open or acquire retail stores. Why does that appear to be so attractive right now? That question brings us to the list below. The points on the list are not of my creation. They are taken from conference calls, publications, and conversations.
 
Why Retail Locations?
·         Capture the middleman’s margin dollars.
·         Better control of our brand and image. Improving the consumer experience with the brand.
·         As a response to fast fashion; we can get new product into retail faster and we don’t have to convince some buyer to order it.
·         Collection issues and uncertainty as to the future of small, independent retailers.
·         We don’t see better growth opportunities (okay, nobody exactly said it quite that directly).
·         Ability to merchandise their offerings better across the complete product line.
·         Leverage with landlords, infrastructure and vendors.
·         As a competitive response.
 
I am not saying these points are all valid for any brand that opens retail stores- only that they have the potential to be. Or that brands going into retail believe they are. One of the things I wrote when the Billabong/West 49 deal was announced was that I thought Billabong might find integrating a 130 or so chain with some apparent financial difficulties more challenging than integrating a brand (like their previous acquisitions) that was growing, profitable, and well managed. As far as I can tell, Billabong really has left their acquired brands more or less alone. I wonder if they can do that with West 49.
 
The Strategic Conundrum
 
I’ll get to the tactical issues for brands building its retail base below. Right now, I want to take a few paragraphs to talk about how this retail focus might fit into the industry’s general evolution. It’s possible I’ve got more questions than answers, but it’s clearly something anybody running a brand or a retailer needs to be thinking about.
 
And maybe the distinction between brand and retailer is a good place to start.  Action sports began as brands selling to core retailers. Those sales expanded into broader distribution. Now brands are also selling their own (and other) brands direct to consumer through both the internet and their own stores. I expect this to continue to grow.  Brands becoming retailers, retailers becoming brands. The impact?
 
If you’re a small independent retailer, go back and read the box with attributes of a successful core retailer. If you read between the lines, you have figured out that you have to be a brand too- but a local brand in your community, not a national one.
 
But maybe I’ve spoken too quickly. There’s the internet after all. Think of a shop like Evo in Seattle. It’s got a successful retail store, but just one. Where it seems to be growing is with its internet presence. And it’s not the only one. As a brick and mortar retailer, it’s a local brand. With its internet sales exceeding its store sales is it a national brand? Can it be? Will it start selling Evo branded product to other retailers?
 
Next, it seems clear that the brand retail explosion is pretty much ending any stigma there was to being in a mall. This is working particularly well for Zumiez which, with its hard goods and action sports lifestyle committed employees, looks and tries to act an awful lot like a core shop. It’s almost like brands open retail locations in malls are validating Zumiez’s business model, but can’t match Zumiez’s history and focus. Maybe Billabong thinks West 49 can have a similar positioning and advantages in Canada.   It will be interesting to watch Zumiez does in Canada now that West 49 is part of Billabong.
 
Now, let’s talk about the action sports business. What is that exactly? For one thing, it’s a term that’s been thrown around out of habit even as the industry has evolved almost beyond recognition. Try this: The action sports industry is that group of brands and retailers who develop and sell product to participants in the sports of snowboarding, skateboarding, surfing, and wakeboarding, (arguments can be made to add others) and to a close circle of non-participants actively involved in the sports and lifestyles.
 
If you accept my definition, it becomes pretty clear that retail building brands aren’t just after the action sports market. It’s just not a big enough market given their existing size and objectives. I came up with the “lifestyle sports fashion business,” as a description of the market they are focused on growing in, but I’m not sure that captures it either. Maybe that’s why we keep using terms like “action sports” and “core.” We have no idea what to replace them with. Maybe youth culture is the correct term.
 
It’s no secret that this growth and industry evolution means we’re more fashion and non-participant oriented in our sales. I don’t say that critically- it’s kind of inevitable. The retail blossoming we’re experiencing puts companies like Billabong into a whole new market. I’ll say it again- it’s where they have to go to grow, and they face a whole new set of competitors as they go there.
 
What Will Billabong Do?
 
There are a number of issues Billabong will have to address as they integrate West 49. But I hasten to mention that any company with multiple brands and a retail presence will face similar issues.
 
How much of their owned brands will they sell in West 49 stores? Billabong’s Paul Naude suggested it might get up to 60% eventually. West 49, of course, was already a customer of Billabong’s. But given the higher margins and the leverage they get, Billabong would like to increase it. Go back and review my “Why Retail Locations” list.   In a perfect world, where it wouldn’t cost them any sales, they’d probably love to make West 49 stores all Billabong and its owned brands. With brands including Nixon, Element, Sector 9, Dakine, Von Zipper. Xcel and others, they certainly have the product to increase the proportion sold in West 49.
 
Assuming for a minute that Billabong wants to keep essentially the same levels of total inventory in West 49 stores (subject to any changes in sales levels), do they bring in more Dakine backpacks and reduce or eliminate Hurley, just to pick a brand? There are also Element backpacks. And Billabong backpacks. And Vans. Etc.
 
Billabong’s strict financial and operational bias will be to replace Vans, Hurley and other backpacks with its own brands. They can’t, however, make that decision without reference to West 49s customers and its market position. Do customers come in asking for Hurley backpacks and will they care if they end up with an Element one instead?
 
Would Billabong be okay with selling a bit less at West 49 stores if they got higher margins because of their owner brands?
If Billabong sells more of its owned brands in these stores, it will have to carry and sell less of somebody’s brand. Who’s? How much less? Will the customers care?
 
Billabong believes it can better merchandise it product and position its brands through its own retail because it can present the whole line the way it wants. Doesn’t Hurley, to continue with the same example, feel the same way?
 
When Billabong, or another brand, begins to control how much of which product is carried in a retail store, what happens to the manager/owner’s ability to change product/brands in response to changing local conditions?
 
So, if you’re Hurley and Billabong is cutting back its purchases of backpacks for the West 49 stores, how far do they have to cut it back before you begin to feel like your product is an afterthought and that there’s not enough product and selection of product to represent the brand well?
 
Might not Hurley (owned by Nike) take a look at the situation not just in terms of backpacks, but strategically in terms of the overall impact of brand owned retailers on its brand? One conclusion they could reach is that the distinction between brands and retail is disappearing and that competitive conditions require them to control more of their own retail. Go look at the list of reasons a brand might want to be in retail again. Given the advantages listed there, how can a big brand not do some of its own retail?
 
How about the implications for retail chains? If you’re going to have to compete with vertical brands with the advantages I’ve outlined. You’d better have a hell of a market position. I wouldn’t be surprised to see some more chains up for sale as this all evolves. And I wouldn’t be surprised to see some competition for buying them. The economics are very compelling. They might be equally compelling when it comes to buying a brand that would fit into your retail.
 
What would I do if I were Billabong? I’ve be crunching my numbers, looking at margins and sell through for various brands in West 49. I’d be talking about Billabong owned brands and what are possible substitutes for other brands. I think I’d probably conclude that I don’t want to carry brands that I can’t merchandise correctly. My bias would be to eliminate some brands rather than to inefficiently cut back on a lot of them.
 
Conclusion
 
Billabong’s purchase of West 49 feels like it might be the formal announcement of a new industry consolidation based on vertical integration. The competitive dynamics associated with this out in the larger world of sports fashion lifestyle product are driving it. As I said, I don’t like that term. But I don’t have a better one and I have to draw a distinction between the action sports market as I defined it above and this much, much larger market that the big, public, multi-brand companies are focused on.
 
The break between the two seems so fundamental that I can almost see a big gap between them. Maybe that’s where the “youth culture market” fits in. If you are in what I’ve defined as the action sports market, forget about what vertical brands are doing. If you are one of those vertical brands, you aren’t going to ignore the “core” market, but you are going to get a declining piece of your revenue and profitability from it and you will focus accordingly.

 

 

Thoughts on a Longboard Trade Show

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Concrete Wave sent out a press release February 21 announcing the first longboard tradeshow in New York City on March 11. I didn’t think about it much at first, but as some time passed, a few questions occurred to me.

The first was, “Why does longboarding need its own trade show?” Maybe it doesn’t need it, but apparently the longboarding part of the skateboard industry wants it. Given the growth of longboarding, I can’t see any reason why they shouldn’t have it. I’ve heard estimates that longboarding represents up to 50% of the skateboard hard goods market (personally, I think that’s a little high).   It also seems logical to me that these longboarding companies, many of which are pretty small, can’t really afford, and maybe don’t need (yet?) a big, longer show like Surf Expo.

The second question was, “What, exactly, is a trade show?” This one will last only from noon to 8PM on March 11, will be streamed live over the internet (at www.pushculture.com), and is being held at the new and second location of The Longboard Loft, a retailer in New York City. The reason they are doing it there, I gather, is because the place isn’t quite completely open yet and there’s room. The show will be followed by the presentation of the Second Annual Concrete Wave/AXS Gear Reader’s Choice Awards.
 
Following the demise of ASR, there was a lot of ringing of hands, meetings and phone calls as organizations dependent on ASR scurried around to figure out how to replace their lost revenue. There was talk that those organizations might decide to combine forces and put on their own trade show. Honestly, I don’t expect it to happen if only because of the significant cash that would have to be committed and the fact that putting on an ASR type trade show is a complicated management undertaking- a fact that may not be appreciated until you start to think about doing it yourself. Done on a large scale it requires a long lead time and experienced trade show management.
 
This longboard show is called a trade show, but I think another term might be appropriate. How about “organic industry gathering?” All I know is that about 32 longboard brands decided to get together for day, show product, talk to their customers (consumers as well as retailers), exchange information, and probably have a good time.
 
Actually, there’s a waiting list of another 13 brands. They’ve been invited to come anyway, hang out with their product and, if necessary, display it at the bar next door. Brands that are attending include Sector 9, Globe, Earthwing, Triple 8, and Bustin.0   I’m guessing the people putting this on aren’t even certain how it will all work out.
 
If there was still an ASR, would this show even be happening? Yes. Longboard brands aren’t participating in this show instead of going to ASR. They needed something that met their needs, and they needed it on the East coast. Longboard is a distinct and growing industry segment. That’s not my opinion- it’s what the consumer has decided.   Action sports is no longer quite so distinctive and is not growing very quickly unless you include new sports in it, and then one wonders if it’s still action sports.
 
Organic industry gatherings work when there are common interests and rationales for participating. Part of ASR’s problem was that it lost that as the definition of action sports changed.
 
My third and last question was, “How come long and short skateboard companies aren’t in this together putting on a single skate industry show?” Different cultures and customers? Partly. Because they are competitors? That’s an interesting question I don’t know
the answer to. 

I expect to watch this show on the internet for at least a little while. Maybe what makes an organic industry gathering successful isn’t the location, the size, how long it lasts, how many people come or how much business is done there, but the common interests of the participants. Just a thought.        

 

A Couple of Things to Think About from VF Industries

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With a different company I’d probably do what I usually do; get down and dirty in the financial statements. Some of you like that. Some hit the delete key early in the article. A few tell me they fall asleep.

VF released its results for the quarter and year ended December 31, 2010 the week before last. I spent most of this week in Florida with my college roommates without wives playing bad golf and having an occasional beer. I don’t suppose you need any further explanation as to why this didn’t get posted sooner.

But I digress. I guess I could spend lots of time analyzing VF’s balance sheet, but basically what’s you’d take away from that analysis is that it’s big and strong with assets of $6.5 billion and equity of $3.86 billion. They had revenues of $7.7 billion for the year (up 6.7%) and $2.13 billion for the quarter (up 11%). Net income for the year rose 23.9% to $571.4 million. Cash flow was in excess of $1 billion. They have no debt due until 2017 and paid down $200 million of higher cost debt. Acquisitions remain at the top of their priority list.  Check out the press release yourself if you want more details.
 
So instead of my usual, and sometimes pedantic, financial analysis let’s look at how the actions sports components of their business did (to the extent they give us that information) and then review some of the things they discussed in their conference call. There are some lessons to be learned and some insights into how the industry is evolving there. 
 
Revenue for the quarter in VF’s Outdoor and Action Sports segment, which includes Vans, Reef and The North Face in addition to other brands, grew 20%. The Americas revenue was up 17% and international 32% on a constant currency basis. The North Face) and Vans businesses each grew in excess of 40% in the quarter internationally.” Not sure if that’s constant currency or not.
 
With revenues of $896 million for the quarter, Outdoor and Action Sports is the largest of their 6 segments. Direct to consumer (stores and internet) revenue rose 21% in the quarter in this segment, with Vans and the North Face experiencing double digit increases. Overall, VF ended the quarter with 786 stores after adding 85 during the year. “The strong top and bottom line growth [in the quarter] was fueled in part by a nearly 60% increase in brand-building investments and initiatives during the quarter, particularly in The North Face and Vansbrands.” Of additional selling, general and administrative expense spending of $100 million that occurred during the year, over the whole company $45 million was spent during the fourth quarter.
  
Revenue in that segment grew 14% for the year to $3.2 billion. The next largest segment grew 11% in the quarter and 5% for the year.
In 2011, VF expects their Outdoor and Action sports business to “…grow at a mid-teen percentage rate.” All their other segments are expected to in the “mid-single digits.” Outdoor and Action Sports is becoming increasingly important to VF. They expect a lot out of Vans and expect to grow North Face to $3 billion of revenue in five years. As they announced at a North Face conference last fall, they plan to “…reach new consumers by focusing on the unique needs of athletes and enthusiasts who participate in hiking, climbing, performance athletic, and action sports. We call this our Activity Based Model (ABM), which is designed to deliver technically superior and relevant products across four consumer segments: Outdoor, Performance, Action Sports and Youth.”
 
Pay attention to this. Action Sports is much less specific as a segment or industry than it used to be. This isn’t a new trend and it’s certainly not unique to VF. I’m sure you all saw Transworld Business’ recent announcement, as reported on Boardistan, that they would start covering wakeboarding, motocross and BMX.
 
Okay, that’s a very brief summary of their financial results and comments on the Outdoor and Action Sports segment. Let’s move on to other issues they discuss in the conference call.
 
I stopped dead in my tracks when the first question from an analyst was how much of the increased revenue for 2011 would be from price increases. I hadn’t heard that issue raised for a long time. The answer, by the way, was “a few percentage points” of the eight to nine percent projected revenue increase. Once you discuss price increases, of course, you also have to discuss the impact on demand of higher prices. Let’s spend a little time on the price of cotton, costs and cost management, and how VF is handling it. As VF notes, “We’re aware that we are entering a new environment here in terms of consumer reaction to broadly higher apparel prices and that some trade-off in unit volumes is likely.”
 
Management notes in its opening remarks that it’s already taken some price increases across its brand portfolio in recent months to offset product cost inflation, and that they will continue to implement further increases during 2011, more in the second half than the first. These increases will be focused on products, especially jeans, where the cost of cotton is most critical. VF’s overall product costs will rise a projected 7% in 2011 and “Price increases and other factors positive to our gross margin comparisons will not entirely offset the pressure from higher product costs.”
 
Jeans represent about 20% of VF’s revenue and “…for these jeans products, costs are expected to rise by mid-teen percentages for the full year…” “Now while price increases will partly offset higher costs, gross margins for these businesses in 2011 will come down from 2010 by over 350 basis points.”
 
That’s quite a decline. Jeans operating margins, however, are expected to decline by less than 100 basis points. How are they managing that?
 
Well, by expense management of course. And by “reengineering” their products. That can mean removing features, using different materials, or just be smarter in how you make things.
 
VF also has an advantage is dealing with rising cotton prices because they make 65% of their U.S. jean products in their own plants. That doesn’t help them with price increases in denim, but they believe they can keep their labor costs flat by bringing more volume into their own plants. Most of you who are reading this and sell jeans or other denim products don’t have that advantage.
Another thing they note is that VF purchases 50% more denim to carry into 2011 than they normally would. Obviously, that’s to stock up before price increases. It’s a great idea if you have the balance sheet to pull it off, and I’m sure VF isn’t the only large company doing it. But that increases demand and stocking up has some impact on prices all by itself. If you aren’t one of the companies that can do it, you’ll face even higher prices when you do your purchasing.
 
Here’s another way VF thinks about the impact of price increases: “On the domestic front where we are so heavily penetrated, particularly in our Jeanswear business in the mass and mid-tier, an increase in cost of denim has a much more severe inflationary impact on our pricing to consumers. In Europe and in Asia, where products are so much more expensive to begin with at a base level, the percentage increase from the inflation is relatively minor and relatively easy to pass through. This is a much lower percentage of higher priced products.”
 
So the percentage increases in Europe and Asia are smaller and, therefore, less noticeable to the consumer because the average retail price there is 50% to 75% higher there than in the U.S. But they note that the gross margin impact of higher costs not offset by higher prices will still be around 200 basis points.
 
VF management is, I think, very realistic about what’s going on in the U.S. “You raise a real issue that particularly American consumers face is cost inflation across their lives. And that comes home particularly strongly in the mid-tier and mass channels, where as consumers pay more for food and for gasoline, for their cars and for their apparel, it’s going to put pressure on what they spend their money on.”…“That’s what gets us to the mid-single digit unit declines in our Jeanswear business, which we just haven’t had. But that’s why we’re seeing that is we expect great cost pressure to really influence how much consumers can afford to spend on apparel.
 
I think VF is right, and if they are thinking about the impact of inflation on demand for their products, we all need to be thinking about it.
 
Overall, then, what does VF see that we might want to focus on as well? First, cost inflation that isn’t going to be easy to pass on and will impact consumer spending because food, gas, and other necessities come first. Second, that there’s more opportunity internationally than domestically. They plan to open 100 new stores in 2011. 60% will be opened outside of the U.S. due to the strength of the operating performance they are achieving internationally in their stores. Hardly a surprise since that’s where incomes are rising and more “middle class” consumers are popping up. Income has at best stagnated in this country over the last ten years.
 
Third, they see great opportunities in direct to consumer, and it seems that the distinction between brick and mortar and on line is blurring. I think they’re right and that’s probably worth a separate article. Fourth, making their own product in their own factories is an advantage in an inflationary environment. And the inflation they are talking about ain’t just in cotton prices.
 
Finally, the push they are making with The North Face tells us something about how they think about the action sports market. It’s outdoors and it’s youth culture and not nearly as exclusive as we use to think.
 
Your business is probably a bit smaller than $7.5 billion, but those are all issues that will impact it anyway.

 

 

Billabong’s Half Yearly Report; A Consistent Strategic Approach

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Billabong management told us at least six months ago that 2011 would be a “transition year” and it is. But the strategy they started to tell us about a few years ago remains intact and they continue to pursue it. As I’ve written before, I generally agree with that strategy and my experience is that companies that pursue a solid strategy over the long term succeed- unless the market environment changes and the strategy doesn’t.

Let’s set the stage a little. All the documents on which this analysis is based can be found here.

First, Billabong has always been protective of its brands. You’ll remember that when the recession hit, they resisted the urge to discount more than most other brands with the goal of maintaining their brand equity. Probably cost them some sales, but gave them better gross margins. My readers know that, in the current economic environment (which I expect we’ll be in for years) I believe in generating gross margin dollars even at the cost of some sales.
 
Second, they are probably done with acquisitions for now. They won’t say never or none, but they aren’t looking and think they have enough opportunities integrating what they’ve bought. Indeed, much of the reason Billabong describes 2011 as a transition year is because of the need to complete that integration and the positive impact they expect it to have.
 
Third, the nature and structure of Billabong has changed as their retail component and owned brands have increased. At December 31, 2010 they had 635 company owned stores. These stores represented about 40% of group revenue for the half year and all that new retail wasn’t owned for the whole six months. The core Billabong brand represents, for the first time, just under 50% of revenues. So Billabong is heavily focused on retail and is a portfolio of brands that needs to be managed. But due to the retail component, they can’t be managed completely in isolation of each other.
 
The final point I want to raise before getting to the analysis is not specific to Billabong and concerns the issues that are mostly of our control, though of course we try our best to manage them. I guess this relates to consistently pursuing your strategy unless the market changes.
 
Everybody who makes anything from cotton knows that cotton prices are at record highs. Billabong CEO Derek O’Neill points out in the conference call that cotton typically represents something like 40% of the FOB price of a garment and that some price increases are inevitable for all companies. It’s in the supply chain where he sees the biggest downside risk to their business. But inflation isn’t just in cotton, and it’s not just in China. With a soft economy, you wonder just how much of those increases you will be able to pass along. I’m pretty clear on what people with stagnant incomes, no jobs, or too much debt who have to choose from more expensive food, gas, or board shorts will tend to pick.
 
Which gets us to the subject of economic recovery, because a little inflation can be irrelevant if the world is growing, jobs are being created and customers are happy. Billabong, like most other companies I think, is assuming some improvement. Or at least they need that improvement to achieve their projected results. Here’s how they put it:
 
“…the Group expects NPAT to be flat in constant currency terms for the full financial year ending 30 June 2011 and, thereafter, assuming global trading conditions gradually improve, in particular in the Australian consumer environment, the Group expects to return to more historic EPS growth rates in excess of 10% per annum in constant currency terms.”
 
Finally, there’s the uncontrollable issue of exchange rates. This is a good time to remind you that the numbers in here are in Australian dollars (AUD) unless I say otherwise.  Between July 1 and December 31, 2010 the AUD strengthened from $US 0.85 to $US 1.02. That’s 20%. So revenues earned in US dollars were worth a lot fewer AUD at the end of the period than at the beginning. The Euro strengthened by about 11.6% over the same period against the AUD. I always felt that if you’re an investor, what you care about is your return in the currency you invested in and expect to get paid in.   But looking at constant currency provides a valuable perspective, and I’ll refer to it in this discussion.
 
Quick Look at the Balance Sheet
 
Let’s do the easy part first. Billabong has always been ahead of the curve in managing their balance sheet in anticipation of their cash flow, acquisition and expected growth requirements. In August, it increased its bank line from US$483.5 million to US$790 million and extended the two segments of the facility by one year to July 1, 2013 and July 1, 2014 respectively. This provided some flexibility, ability to fund acquisitions, lower costs, and general breathing room so opportunities and surprises could be managed.
 
Between December 31, 2009 and December 31, 2010, long term borrowings rose from $397 million to $571 million (remember those are Australian dollars). The number at June 30, 2010 was $405 million so most of the increase came in the six month period. 
The largest was West 49, acquired on September 1, 2010. There were four other acquisitions between July 2 and November 8. Note six to the financial statements reports that the “Outflow of cash to acquire subsidiary, net of cash acquired” was $203.6 million. $94 million was for West 49.
 
Inevitably, borrowing money has an impact on the balance sheet. Comparing last December 31 with the prior year, we find the current ratio has fallen from 3.81 to 2.27. Higher is usually better. Total liabilities to equity over the same period rose from 0.67 to 1.03. In this case, lower is generally better.
 
I feel obligated to report the change, but the balance sheet is still strong and it’s not like there’s an issue here. We know why it happened, that it was deliberate, and that they adjusted their lines of credit to give them the flexibility to manage it. Balance sheets can never be looked at in isolation from cash flow management. Well managed balance sheets give me a warm, fuzzy feeling.
 
Digging Into the Income Statement
 
Here are the summary numbers as reported. Half year revenues rose 15.7% to $837.1 million compared to the same period the prior year. The gross profit margin fell from 55.7% to 54.4%. Selling, general and administrative expenses rose 20% from $239 million to $287 million. Other expenses were up $33 million to $87 million. Interest expense rose from $12.2 million to $19.9 million.
Profit before tax dropped from $98.4 million to $62.3 million, or 36.7%. After tax income fell 17.9% from $69.7 million to $57.2 million. The income tax provision was down from $28.7 million to $5.1 million. The lower tax rate was largely the result of several one-time events. Without those, the tax rate would have been 24%. 
 
EBITDA (earnings before interest, taxes, depreciation and amortization) fell by 23.4% as reported. Billabong says five factors were responsible for the decline:
 
1)      The very weak retail environment in Australia.
2)      The strength of the AUD against the US$ and the Euro.
3)      The impact of the recent acquisition of retailers (see discussion below).
4)      M & A and restructuring costs of $10.3 million.
5)      An increase in global overhead costs.
 
In constant currency, revenue was up 24.4%, EBITDA fell by 17.3% and after tax profit fell 9.8%.   Revenues would have been $49 million higher. Net income would have been up $6 million. Big currency impact.
 
Billabong reports its business in three segments; Americas, European, and Australasian. Sales in the Americas were up 28.6% as reported and 38.2% in constant currency. In Europe, they fell 4.1% as reported and rose 14.3 in constant currency. In Australasia, it was 12.4% and 13%.
 
As reported, EBITDA in the Americas fell from 13.7% during the period from $33.7 million to $29.1 million. The EBITDA margin was down from 10.6% to 7.1%. In constant currency it fell 5.8% from $30.9 million to $29.1 million and, as a percent, from 10.4% to 7.1%. It was noted that conditions in the wholesale accounts were showing some improvement, but that retailers were still cautious about holding inventory. Good for them. During the conference call it was noted there were “significant declines” in sales to Pac Sun during the six months, with orders for the Billabong and Element brands down 50%.   
 
Reported European EBITDA fell 17.4% from $29.1 million to $24.1 million. The margin dropped from 17.8% to 15.3%. In constant currency, it rose 3.9% from $23.2 million to $24.1 million but the EBITDA margin declined from 16.8% to 15.3%. Growth in this segment was led by the Element, Nixon and DaKine brands.
 
For the Australasian segment, it was reported to decline 32.5% from $59.7 million to $40.3 million. The EBITDA margin fell from 24.9% to 15%. In constant currency, the numbers in this segment were almost the same as reported.           
 
The Impact and Management Challenge of Acquisitions
 
The other expenses line in the income statement includes $7.4 million in acquisition related expenses. West 49 contributed $82 million in revenue and $1.7 in after tax profit to the group for the six months ended December 31, 2010. The other acquisitions (which aren’t broken out separately because, I assume, of their smaller size) contributed revenue of $66.5 million and after tax profit of $6.2 million during the same period. If you take that $148.5 in acquisition related revenue out of the total for the period, total revenue from existing brands was $688.6 million, down 4.5% from the same period the prior year. CEO O’Neill says in the conference call that “…once we strip out the acquisitions, there was revenue growth in the underlying business…”  Strangely enough, I’m guessing both statements may be correct. The difference, which is discussed in some detail during the conference call and below, may come from how you categorize between wholesale and retail during the transition period following acquisitions. 
 
Now, let’s talk about the impact on sales and margins when a brand acquires a retailer that was a customer before it was acquired. First, revenues no longer get recognized when the brand ships its product to the retailer. The retailer has to sell that new inventory before it’s recognized as revenue by the consolidated entity. On the other hand, Billabong immediately starts recognizing sales of inventory held by the retailer as of the closing date. But if Billabong has previously sold some Billabong branded product to, say, West 49 and the product’s still in the West 49 store after the closing date, what happens? Billabong has already recognized the sale of that merchandise and taken it out of their inventory. It comes back into their inventory at the acquisition date, but at what cost? You can’t go back and adjust your financial statements based on an acquisition that occurs the next period. I guess you bring it in at the acquired company’s cost. Okay, I’ll stop. I don’t want to go all debit and credit on you. But you can see that there’s some delay in recognizing sales and the increasing gross margin.
 
And these retail acquisitions start out with lower margins than Billabong is use to earning. Before they can really influence that, according to CEO O’Neill, “…we have to sell the inventory on the floor, the inventory in the warehouse and also the inventory on order by the previous owners before we get the opportunity to affect the mix of product on the floor and generate additional wholesale margin through the sale of company owned product to the stores. So that means we have to get through one or two inventory turns of existing product from third party suppliers before we can start to realize the benefits of owning retail.”
 
Changing the product mix on the floor and getting better margins sounds so simple, but it’s pretty complex as I’ve pointed out previously. Billabong has to decide how much of which of its owned brands it can carry in the stores. Obviously, they make more money on those brands. Are they going to reduce the footprint of the brands their retail carries that they don’t own? By how much? How will those other brands react to that? CEO O’Neill says, “As far as the third-party brands go, I think we are still having a lot of discussions in terms of who’s coming with us over the medium term.” I’ll bet they are.
 
You can see why these acquisitions have a lot to do with why management calls 2011 a transition year.
 
Critical Factors
 
As you think about the things that will influence Billabong’s success, where should you focus? First, on the economy. Billabong appears to be counting on some improvement there to meet its goals. Well, why should they be different from the rest of us? I hope we get that improvement, but I’m not certain it will come quickly.
 
Second, as I discussed above, they’ve got some non-trivial work to do to realize the benefits of their retail acquisitions. It’s easy to buy a company. It’s hard work to achieve the benefits you projected when you bought it. We’ll get a better sense of how it’s going in six months or so. I was glad to see the discussion in the conference call about the progress they are making in consolidating four computer systems, warehouses, and back office functions into one. I don’t know the details, but there’s typically some money to be saved and efficiencies to be gained there.
 
Some of those efficiencies come in getting product to market a little faster and having to hold less in inventory, and I suspect that requires those integrated systems. That was also a subject of the call, but this isn’t the first time Billabong management has focused on it.
 
Accomplishing that requires that things go smoothly in the supply chain. Billabong has some concerns not just about the price of cotton, but about labor shortages and shipment delays.  Once again, this is a concern we all share.
 
Finally, with no acquisitions expected in the near future and the economy improving slowly at best, you have to ask where growth will come from. Every company that protects its brands through control of distribution eventually runs up against this. Where can you sell without diluting your brand equity?
 

My sense is that Billabong, while they wouldn’t trumpet it from the roof tops, knows sales increases are harder to come by than they’d like. But they believe that can accept slower top line growth in exchange for vertical margin, system efficiency, and certain savings you can sometimes achieve when your brands are well positioned and cautiously distributed. If they do think that, well, I agree with them

 

Thoughts on the SIA Show in Denver- It Doesn’t Get Any Better Than This

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Before my friends at SIA get too cocky over the title, they should know I’m referring to our industry’s current business environment as well as the show. Granted, I was a bit of a slow convert to the move from Vegas to Denver, and I still miss playing blackjack with friends, but overall I’m glad they made the move.

There were the usual opportunities to see friends I don’t see often enough, get some new perspective,  and see some great new product (and be mildly amused at some other new products that I’m guessing won’t be back next year). If the snowboard section continued to lead the way in sheer noise and excitement, the ski section wasn’t as far behind as it has been in the past. That ski/snowboard distinction ought to start (is starting, I think) going away.

I want to remind you all that no matter how good a job SIA does, it wouldn’t have been nearly as successful a show if, as an industry, we weren’t firing on all four cylinders. I’m saying four because there are four things that went right for us this season that I want to review.
 
The first, of course, is snow. Pretty much great in North America (with the exception being here in the Northwest where, unfortunately, I live). Europe got good early snow I’m told, though it tailed off after that. We all know that when it snows, we’re great managers.
The second thing was a consumer who, if still cautious, isn’t quite as scared to death as they have been the last year or two. The purse strings were a bit more open.
 
With apologies to some of the marketing types who want to believe they can influence consumer behavior more than I think they can, I would point out that those two factors are pretty much out of our control.
 
The next factor, which we can control to some extent as long as we invent something, is new technology. This season has seen the ascendance of all sorts of new rocker and camber technology, which aside from giving us something new to sell, makes it easier and more enjoyable to slide on snow. I don’t think we’ve had this kind of breakthrough in a while. It gives our customers a reason to buy, and may encourage them to replace existing equipment.
 
But I suppose we can’t expect, and perhaps wouldn’t even want, a big breakthrough every year. We need a couple of years to take advantage of those breakthroughs when they come along. So let’s characterize this cylinder as sort of controllable, but not reliably present every season.
 
And that leaves us with inventory levels, which are absolutely, positively, completely, and irrevocably under our control. Not so much as an industry. Let’s be realistic- a company’s management will control its inventory and distribution because they believe it’s the best thing for the company; not due to some altruistic concern for “the industry.”
 
A company can control its inventory. And apparently most of them did last year to the benefit of all of us. I wrote about the benefit of inventory control as it relates to conversion and participation at the show after SIA’s breakfast on that subject.
 
In the recent past, we haven’t always done quite so well at inventory control. Greed, misplaced competitive zeal, entrepreneurial ego, a misreading of market conditions and prospects or some combination of all of these has caused some companies to produce too much and try to sell it in the wrong places. This has had a negative impact, in some cases, on the whole industry.
 
Now, having been beat up by the recession, we all seem to have come to the conclusion that it’s really, really bad to have left over inventory in a one season business. Maybe we’ve even figured out that losing a few sales and creating a little product scarcity is way better than having to dump a bunch of stuff at the end of the season or carry it over to the next. The best companies have even crunched the numbers around some lost sales, leaner inventories and better, higher margin sell through and have figured out that, depending on company specifics, they are better off on the bottom line and on their balance sheet in spite of leaving some sales on the table.
 
But fear fades and greed is eternal. I don’t expect anybody to “take one for the industry,” in planning their growth and managing their inventory. But I do think it will be in all of our interests if, as individual companies, we recognize there are both short and long term benefits to constraining growth and product supply just a bit in the interest of the bottom line.
 
That way, the next time we aren’t firing on all four cylinders, we’ll just have to change the spark plug wires, not rebuild the engine.   

 

 

Skullcandy Going Public; What We Can Learn From Their SEC Filing

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It’s always interesting when a company in the industry decides to go public. They’ve got to drop their drawers and provide you, in their S1 filing, with information you could only speculate about previously. If you want to see it, the whole thing is here.

As of last week, Skullcandy’s drawers are well and truly dropped. Since I returned from the excellent SIA show in Denver, I’ve been through the complete filing. I’ll review the numbers with you, but what’s more interesting to me is their market positioning and strategy.

They’ve grown quickly by recognizing and exploiting the “…increasing pervasiveness, portability and personalization of music.” They stylized what had been a commodity product and connected action sports, youth culture and music in a way it hadn’t been done before. Rick Alden and his team get all the credit in the world for recognizing and capitalizing on an opportunity that was staring us all in the face.

The question for me is whether Skullcandy can retain its “first mover” advantage against companies like Sony and Nike as they inevitably expand their distribution to grow, which they will have to do as a public company. That’s the intriguing part of the discussion, but let’s go over the numbers first.
 
Historical Financial Results
In 2005, Skullcandy (hereafter known as SC) had revenue of $1.33 million. Over the next four years, its revenues were $9.1, $35.3, $80.4, and $118.3 million for the years ended December 31. Its 9 month revenues for 2009 were $70.7 million compared to $95.9 million in the first 9 months of 2010. Domestic sales represented 72.5% and 81.1% of revenue for 2009 and the first 9 months of 2010 respectively. During both these periods, Target and Best Buy each represented more than 10% of their net sales. SC products are also sold in Radio Shack, Fred Meyer, Dicks, and The Sports Authority in additional to independent retailers and specialty chains.
 
Their gross profit percentage has been north of 48.5% for 2007-2009. It was 48.2% for the first 9 months of 2009 and 51.4% for the same period in 2010. That increase in 2010 was largely the result of domestic sales, with higher margins, growing compared to a temporary decline in lower margin international sales. They had a now resolved dispute with their European distributor that cost them a few million in revenues.
 
Selling, general and administrative expenses, as a percentage of sales, have risen every period. They were 20.8% in 2007. They rose to 22.4% in 2008 and 22.9% in 2009. In the first 9 months of 2009 they were 26.4%. The number was 31.5% in the first 9 months of 2010.
 
Typically, you might see that percentage decline with growth after a certain point. I’m thinking (and I can’t ask SC because they are in what’s called the “quiet period” that follows this kind of SEC filing) that they recognize that first mover advantage doesn’t last forever and they are trying to maximize their market penetration before players with a lot more resources than they have start to catch on and catch up. They state that of the $11.5 million increase for the first 9 months of 2010, $4.1 million was for advertising and marketing. Advertising costs by themselves for the years ended December 31 2007 through 2009 were $922,000, $3.55 million, and $3.1 million respectively. Interesting to see that decline in 2009. 
 
When they talk about their athlete and musician sponsorships, they list snow, ski, skate, surf, moto, wakeboarding, BMX and Bike teams totaling 83 athletes. There is also a five member NBA crew, a 21 plus music family, and 24 members of the DJ family. But they go on to note that, “The majority of the individuals and groups listed above do not have contractual relationships with us but support our brand by wearing our products and participating in Skullcandy events and marketing activities.” I guess that means that the majority are people they flow product to and hope that product shows up being used by the personality.
 
Income from operations has risen each year. There was an operating loss of $274,000 in 2005. There were operating profits of $954,000, $9.8 million, $21.2 million and $30.4 million from 2006 through 2009. But as a percentage of revenues operating income has declined. It was 27.8% in 2007, 26.4% in 2008 and 25.7% in 2009. For the first 9 months of 2009 and 2010, it fell from 21.7% to 19.9%. With the rise in selling, general and administrative expenses and the sales to more price sensitive customers, I suppose that’s not a surprise. Given their distribution and apparent growth plans, I’d expect some further decline in that percentage. 
 
Interest expense was fairly low the first three years of SC’s life. It rose to $586,000 in 2008 and to $8.9 million in 2009. During the first 9 months of 2010 it was $6.6 million compared to $6.5 million in the same period of 2009. Well, growth takes capital and SC raised some pretty expensive money. Notes payable to related parties totaled $27.5 million at the end of 2008 and $52 million at the end of 2009. Stockholders’ equity was $20.7 million at the end of 2008 and fell to negative $18.6 million at the end of 2009. Cash was $19.4 million at the end of 2008 but only $1.7 million at the end of 2009.
 
You can see the rationale for going public. It will clean up the balance sheet, get rid of most of the interest expense, and give them growth capital. It was probably either that or sell the company.
 
Net income was $13 million in 2008, up from $6.3 million the prior year. In 2009, net income was $13.5 million, only slightly above the prior year in spite of increasing revenue from $80.4 to $118.3 million. You can see the impact of the rise in interest expense there.
 
Market Positioning and Strategy
Here it is in a nutshell: “We believe the increasing use of portable media devices and smartphones, and the growing popularity of action sports, support our anticipated long-term sales growth.”
 
Now let’s look at what they see as their competitive strengths as they describe them and, as possible, talk about each. These competitive strength statements are quotes from SC’s filing.
 
Leading, Authentic Lifestyle Brand. Skullcandy fuses music, fashion and action sports, all of which permeate youth culture. We believe the power of our brand has driven our strong market share.
 
Fair enough. Their success to date would suggest they’re right about that. But of course somewhere between lots to all successful brands in our industry would make more or less the same statement. And all those companies, at some point in their growth, have run into difficulties (not necessarily insurmountable) associated with distribution and the size and resources of their competitors as they’ve stepped away from action sports and into fashion. Why might SC be different?
 
They would probably make two arguments. First, that with each of Best Buy and Target accounting for over 10% of their sales, they’ve leaped over the distribution issue without damaging their brand and have placed SC in those channels before their hugely larger and stronger competitors could get there with comparable offerings. Second, they’d point (they do point!) to the continuing growth in portability they are taking advantage of.
 
My perception is that all products in our industry that have pushed their distribution have ended up with some competitive pressure on their prices and the extent of that pressure has been dependent on the speed and extent of their distribution.   At some point, growth requires that you end up selling to customers who are more utilitarian and price conscious and less concerned with “cool.”
 
The bigger the market, and the more attractive the opportunity, the sooner you attract competitors and the stronger they are. Nike stumbled around in action sports for a while before they got it right, but they did get it right. Skate brands will tell you what happened when the Chinese decided they could make skateboards and the market was big enough to warrant the effort. 
 
Are headphones somehow different because they’re an electronic product even though SC has positioned itself as an action sports company? At the end of the day, there’s no easy answer and it’s a question of SC’s ability to implement its strategy. It always is. How do they stay an “authentic lifestyle brand” as they grow?
 
Brand Authenticity Reinforced Through High Impact Sponsorships. We believe we were the first headphone brand to sponsor leading athletes, DJs, musicians, artists and events within action sports and the indie and hip-hop music genres. We believe this has increased our brand awareness and reinforced our credibility with our target consumers.
 
It’s an element of faith in our industry that sponsorships matter and SC seems to have done a hell of a job here. But there’s nothing stopping Sony or Nike from doing the same thing in SC’s market. Nike in particular does know a few things about sponsorship.
 
Track Record of Innovative Product Design. Our company was founded on innovation, and we employ innovative materials, technologies and processes in the design and development of our products.
 
One of the things that particularly impressed me was their focus on getting product to market quickly. I think that’s key. The company has gone from one SKU in 2003 to over 1,200 as of September 30, 2010. Note that 1,200 SKUs translate into basically 20 models with various colors and graphics. Headphone represented 87% of gross sales for the 9 months ended September 30, 2010. It was 90% in 2009.   SC talks about having utility patents on certain features and technologies and about having filed for others. They aren’t specific and I suppose they shouldn’t be. But I’d love to know if any of these offers a proprietary advantage in the market.
 
Talking about their product, they note that, “…Two of our manufacturers together accounted for 72% of our cost of goods sold in 2009 and 73% of our cost of goods sold for the nine months ended September 30, 2010. Each of these manufacturers is the sole source supplier for the products that it produces.” They have 19 independent manufacturers in total. They are working on developing some more sourcing flexibility and have opened an office in Southern China. Good idea.
 
Targeted Distribution Model. We control the distribution and mix of our products to protect our brand and enhance its authenticity.
 
Now wait a minute. I know what works and doesn’t work in distributing a product has changed, and I know the company’s been around since 2004, but as they describe it, it sounds like SC’s distribution is being targeted with a blunderbuss. They could explain it in a much more positive way.
 
Essentially, I think SC management believes, due to the nature of the product and the market, that they can be “cool” in Best Buy and that some of the distribution constraints that would apply to other action sports products don’t apply to head phones. They may be on to something. Not to get the lawyers in an uproar, but I suggest you say that in the S1 if it isn’t too late. The assumption, or the hope at least, may be that SC can eventually be almost anywhere headphone are sold without damaging the brand. This isn’t really targeted distribution as we think about it in our industry. But that doesn’t mean it isn’t carefully thought out.
 
Growth is not just anticipated to be through domestic retail. They expect to increase their international penetration, which was slowed by a dispute with a distributor in Europe (now resolved) and sell more on line. Current on line sales are 4% of revenues. They have started to add premium products selling well above the $10 to $70 retail prices of existing product. Finally, they expect to branch out in to complementary products such as cases and speaker dock models. The first of these will be out this summer.
 
Proven Management Team and Deep-Rooted Company Culture.
 
From what I’ve read and know, I’d have a hard time saying anything but, “Yes, they do.”
 
When the public offering is complete, they hope to have raised up to $125 million.  SC will use about $45 million of the proceeds to pay down debt. The balance will be “for working capital and other general corporate purposes,” which is what these things always say.
As I said when I started, Rick Alden and the Skullcandy team have done a great job identifying and taking advantage of a market opportunity that, in hindsight, looks obvious. Hell, they all look obvious in hindsight. I think the key to being able to continue their growth while keeping their profitability up is as simple, and as difficult, as keeping SC cool in Best Buy and other places as their distribution grows.
 
They are going to run into some heavy duty competition and I’m not aware that they can make a technically superior product. Or at least they don’t talk about it in the S1. But you know what? If you’re successful in business you run into competition, and that’s just the way it is. Skullcandy has done about the best job I’ve ever seen of using their first mover advantage and I look forward to watching this play out.

 

 

Inventory Management and Customer Conversion/Retention in the Snow Sliding Business

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SIA was kind enough to feed me a nice breakfast this (Friday) morning before the show opened. While I ate and drank coffee, people from the various industry organizations that are and have been involved in the industry’s programs to convert first time snow sliders talked to us about what they’ve accomplished and what more needs to happen.

I guess the headline number was that conversion of first timers has increased 2% over ten years to 18%. There was a sense of “that’s not so good and we can do better” in how it was presented. I am sure we can do better, but I’m not quite sure that’s such a bad result. When you talk about trying to change people’s fundamental behavior, ten years isn’t very long and I’m not quite sure that 2% is so bad. We’ve learned a lot over the last ten years (both about what to do and what not to do) and I expect more progress over the next ten.

One thing that didn’t come up was how our inventory management can contribute to conversion. One of the stories in the Snow Show Daily for Friday is called Sold Out and Stoked. It’s about how hard goods inventories have reached equilibrium.
 
If there’s one thing every retailer, resort, and brand has learned over the last couple of years it’s that having leftover snowsliding inventory at the end of the season sucks. When you’ve got to carry over or close out a bunch of inventory, it can easily mean you make no money on your snow business for the year. Not to mention the impact on your cash flow and balance sheet.
 
I’ve been arguing for years that you might be better off focusing on your inventory management and gross margin dollar generation than on getting every last sale you could. Now, in the midst of our little ongoing economic inconvenience, I feel even more strongly about that and I want to discuss how it ties into the conversion issue.
 
Every brand I talked to yesterday told me they were managing their inventories tightly and had next to nothing left. I’ve heard a couple of stories about retailers exchanging product with each other to meet customer requests because they couldn’t get any product from suppliers. This morning at breakfast one long time industry participant I chatted with bemoaned not being able to get a pair of boots he needed for himself.
 
I’m in favor of tight inventory management, but I sure hope it doesn’t come to us all having to pay retail for product.
 
So what does this have to do with conversion and retention? Suddenly, the harder to find product looks special to the consumer and finding whatever they need at a discount isn’t something they can take for granted. Under conditions of uncertain supply, price can’t always be the driving factor in a purchase. Retailers are making a good margin, which means they are better positioned to service their customers. Price increases are more likely to stick. The money the retailer would like to have to pay his suppliers isn’t tied up in inventory. There won’t be excess inventory that will keep him from ordering for next season and he won’t go out of business.
 
Brands will have happy, solvent retailers. I’d even suggest they might be in a position to spend a bit less on advertising and promotion because there’s no better marketing than customers and retailers who want more of a product and can’t always get it.
 
Want more people to go snowsliding? Or to do almost anything for that matter? Make the product just a bit hard to find and require that the consumer make a conscious, active decision to seek it out because if they don’t, it won’t be there. I think that’s an important step in creating commitment.
 
And now what’s happened? We go and have all this great snow (unless you’re from the Northwest like me where we have floods instead of powder) and I know that somewhere out there some management team at some brand is planning for next year. And they’re going, “Wow! We had a great year! We’re great managers [We always are when it snows]. We could have sold more if we’d had it!”
 
And some retailer is thinking, “Damn! I have got to make sure I don’t run out of product next year! I’m boosting the hell out of my preseason orders.”
 
Well, you can see where this is going. Not for a minute am I suggesting that “the industry” should control inventory levels. It won’t happen and isn’t legal. Every business will and should do what they perceive to be in their own best interest.
 
I know.   If you’re a retailer that it just felt awful when you didn’t have the product your customer wanted, though hopefully you sold them something else. But forget that bad feeling. Think of the good feeling when you had great margins and less discounting and closing out to manage. And look at your bottom line and balance sheet. What I’m suggesting is that it’s not in your best interest to boost those orders too much. Clean inventory and high margins may well give you a better bottom line result than a boost in sales. I talked about that a while ago in an article you can see here.
 
As a brand, when that wild eyed retailer comes to you with a greedy look in their eye and wants to books their order for next season 58%, try and calm them down. And you calm down too. Talk about how much it sucked when they couldn’t pay their bill, and you had to either take product back or they had to sell it for cost or through some ugly distribution channels you’d rather have stayed away from.
 
Both of you try to remember how nice it feels when inventory is clean, margins are high, and customers are clamoring for product they see as special. You just don’t want to return to the days of overbuilding and overstocking for hoped for incremental sales.
 
 If we can maintain the mentality that has led to just a bit of product scarcity we just might contribute to getting more people snowsliding. And we could make some more money besides.

 

 

Another New Retail Concept. Just What We Need.

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Back in early December, I bookmarked an article I wanted to write about then promptly forgot about it with the holidays and other intriguing stuff going on. It was a short article in Stores News about Sports Authority starting to open stores called S. A. Elite.

Like the story said (read it here), Sports Authority has 450 stores of the 40,000 to 50,000 square foot size. S. A. Elite stores are supposed to be “high performance lifestyle shops.” They will be from 12,000 to 15,000 square feet in size. There are only two of them now (both in Colorado), but they expect to open another dozen in 2011. They will tend to be in city centers and high end malls.

The S. A. Elite web site says the following:
 
“S.A. Elite by Sports Authority carries top-of-the-line assortments and premium collections from elite global vendors. Our stores house performance and fashion-focused athletic apparel, footwear and accessories. If you are the athlete who requires specialized apparel and accessories to reach your goals, we’ve got you covered. If you are an individual who rocks an athletic aesthetic, we’ll outfit you in style.”
 
Sports Authority EVP Jeff Schumacher said in the article, “We’re not looking to create fashion statements. We’re looking to create performance statements…[with] products that consumers can’t find elsewhere.”
 
When you go to the web site and see featured brands that include Nike, Burton, Ray-Ban, Columbia and Adidas (there are only 15 brands listed in total) you kind of wonder what “can’t find elsewhere” means.
 
Still, I’d have a hard time disputing that the concept might be valid. Regular readers will have seen me suggest that a true “core” store is one that caters to participants in the sports and the first level of nonparticipants that closely associate themselves with the sports. That appears to be the group S. A. Elite is targeting.
 
There are, however, some differences. From the pictures on the web site, I’m guessing the stores will be a bit more boutique like and fashion focused than what we think of as core shops. I also expect that the target demographic is a bit older. Finally, it sounds like there will be a focus on performance and improving it; not just on participation like in a core store.
 
As our market gets sliced and diced by more and more people in the endless and inevitable hunt for a meaningful competitive advantage among products that mostly don’t offer one based on performance (because it’s all good stuff), the space left in the market for the traditional core shop gets smaller and smaller. I guess that’s why there are fewer of them.
 
On the other hand, that space seems to get more and more clearly defined all the time. Those who are left who feature new and lesser known brands, are part of their community, manage their inventory cautiously and have a solid balance sheet, have a quality internet presence (whether they sell or not), manage to keep at least a handful of committed employees, and are of size both in terms of revenue and square feet that make them viable, can still succeed.
 
I have to try and see this store when I’m in Denver for SIA.

 

 

Quiksilver Files Its 10-K for the Year

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Last week, Quik filed its’ annual 10-K report with the SEC covering the quarter and year ended October 31, 2010. They announced their earnings by press release and held a conference call back in December. I’m not going to reanalyze their financials. I did that last month and you can read it here. But the north of 100 pages annual 10-K has a few additional details I thought might interest you. They aren’t presented in any particular order, except sort of from front to back in the 10-K.

Here’s a paragraph where Quik describes its average retail prices:

"We believe that retail prices for our U.S. apparel products range from approximately $20 for a t-shirt and $43 for a typical short to $190 for a typical snowboard jacket. For our European products, in euros, retail prices range from approximately €22 for a t-shirt and about €50 for a typical short to €162 for a basic snowboard jacket. In Australian dollars, our Asia/Pacific t-shirts sell for approximately $39, while our shorts sell for approximately $60 and a basic snowboard jacket sells for approximately $250. Retail prices for our typical skate shoe are approximately $60 in the U.S. and approximately €67 in Europe."
 
I don’t know that there’s anything of great import to deduce from that, but I thought some of you might like to see how it compares to what you know about retail prices. On to the next random piece of information.
 
Quiksilver branded products are sold in the Americas through about 11,500 store fronts. The Americas includes Canada, and South and Central America. Roxy is in 11,300 store fronts. The number for DC is 12,000. All three brands together are in a total of 10,800 locations in Europe and 3,360 in Asia/Pacific.
 
About 40% of revenue worldwide comes from what Quik calls “core market shops.” Interestingly, that number is lowest in the Americas at 28%. It’s 41% for Europe and 77% for Asia/Pacific. I’d love to know what their definition of “core market shop” is.
 
18% of consolidated revenues from continuing operations were from their ten largest customers. The largest single customer accounted for less than 3%.
 
Quiksilver has pretty much gotten away from seasonality, which is a good thing (take it from somebody who has had to manage cash in a snowboard company). Their biggest quarter last year was 27% of revenues and their smallest 24%.
 
At the end of the year, Quik had 540 stores worldwide. 116 are company owned outlet stores and 6 are licensed outlet stores. Quik had a total of 224 of what they call licensed stores. In these stores they “…do not receive royalty income from these licensed stores. Rather, we provide the independent retailer with our retail expertise and store design concepts in exchange for the independent retailer agreeing to maintain our brands at a minimum of 80% of the store’s inventory. Certain minimum purchase obligations are also required.”
 
I wonder what happens if those Quik brands aren’t the ones selling well, what flexibility they have with regards to that 80%, and what the purchase terms for that merchandise are.
 
Future season orders: $478 million as of November 2010 compared to $535 million at the same time the previous year. That’s a decline of 10.65%.
 
Number of employees: 6,200 full time equivalent; 2,600 in the Americas, 2,200 in Europe and 1,400 in Asia/Pacific.
 
Advertising and promotion budget: $106.9 million in 2010. It was $101.8 million in 2009 and $122.1 in 2008.
 
Allowance for doubtful accounts: It has risen from $31.3 million at the end of fiscal 2008, to $47.2 million at the end of fiscal 2009 to $48 million at the end of fiscal 2010.
 
I’ve got no great analysis to lay on you. I did that, to the best of my ability, when they announced their earnings. But I am very aware that a number of you heave a sigh of relief when I go through these somewhat arcane documents so you don’t have to. Anyway, I hope this was useful.   

 

 

Accidental Encounters with Two Magazines and Market Evolution

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The other day I was reading Vanity Fair. That’s a little weird. But my wife gets it, and one of the highlighted cover stories was “Surfing the World’s Giant Waves.” I enjoyed it and learned a little more about surfing history. Still, I was a bit surprised to find the story there. The mag was full of high end fashion ads. Those ads weren’t a surprise.

Then, on another other day, I picked up Complex magazine while getting my oil changed. Actually, it was my car’s oil. Mine should be okay through trade show season.

There were five pages of Vans ads and Volcom had a two page spread. They were right there with the Smirnoff’s ad, the Puma ad, the video game ad, and the various car ads.   DC had an ad for the Rob Dyrdek collection.
None of the ads I notice in either of these magazines (I might have missed one) mentioned skateboarding, snowboarding, surfing, or any of the other sports that might be considered to be “action sports.” Not even the Vans, Volcom or DC ads.
Vanity Fair obviously believes that big wave surfing is of interest to its readers. That’s good news for surf companies. I’m guessing that most of Vanity Fair’s readers don’t surf. But all but the smallest surf companies sell a chunk to most of their product to non-surfers, and they are certainly pleased to see upper income non-surfers be exposed to surfing.
Complex represents a culture, attitude, lifestyle that I’d characterize as young, urban, sarcastic, and a bit in your face. It suggests a certain level of indifference to convention and norms and implies that if you adopt its standards you’ll somehow be self-confident and respected. Cool, if you will.
It is what and how the cores of skate, snow and surf began. Except that you actually had to skate, snowboard or surf to achieve this differentiation back then, and that was a simple distinction.
If our industry was all about, and only about, supporting people who surf, skate or snowboard, I doubt there would be any successful public companies. The participant market and its growth prospects are not large enough to interest Wall Street.
Vans, Volcom, and DC, public or owned by public companies, know this. So we find them running what I think I can fairly characterize as fashion ads (hell, maybe all ads in our industry are fashion ads) making no mention of their roots and the sports they are/were closely associated with. You and I, of course, know what those associations are and our perception of those three brands are influenced by that knowledge. And the people who read Complex? Some of them know, but I imagine a lot don’t. And apparently that’s fine or these brands would feature that association in their ads.
No ads in Vanity Fair yet, and maybe we’ll never see that day. The Vanity Fair sensibility (high style?) is a lot different from Complex (urban/trendy?). Still, though I don’t expect to see it, wouldn’t it be interesting if some brand decided to take a flier just for fun? I can see the Mervin Manufacturing ad now. “Some fool in the marketing department put an ad in Vanity Fair.  They’ve been fired but you can buy our snowboards anyway if you want to. They work good and besides, the ad’s already paid for.”
Yes, it’s easy for me to be cavalier with somebody else’s money.
But you can see a divide happening in the industry, whatever industry we’re in. On the one side are companies that service participants. On the other side are the ones who are more and more fashion based and have to decide how to position themselves with respect to their roots. Is it about trendy, stylish, comfortable product or about making the trick? Can it be both? Depends on your market and how you segment it.
It isn’t that black and white, and the discussion would be different for every brand. But if you make the fashion decision, then you are choosing to compete in a market that dwarfs the traditional action sports industry in resources and sophistication. And you probably need help. This is, and will continue to be, the rationale (a valid rationale) for consolidation and the acquisition of brands that want to “take it to the next level.” In fact, I think it will be the unusual company that gets to that next level without being acquired.