Volcom Quarter & Nine Months Ended 9/30/09

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Volcom’s Quarter and Nine Months Ended September 30

Back on October 29th Volcom released a press release with its third quarter results and hosted a conference call on those results. Everybody read, and listened, and analyzed, and wrote stuff.
On November 9th, with no press release, they filed their 10Q for the same time period. Nobody seems to have noticed, and maybe nobody cares. But I do.
I don’t think there should be a conference call until the 10Q (or annual 10K) is out and people have had a chance to review it. The numbers in the press release and conference call are of course the same as in the 10Q. But there’s more detailed information in the 10Q, but some of those numbers only come out orally in the conference call and you have to write really, really fast to get it down. Either that, or listen to the replay fourteen times which isn’t any fun.
Then there’s the part where the analysts ask questions and request some additional “color” on an issue. You do sometimes get some good information this way and “color” can mean more detail. But it can also mean interpretation, estimate, evaluation, etc.
I read the press release and listened to the conference call. But here’s what I got out of the actual, uncolored numbers and management discussion from the 10Q.
The balance sheet is very strong, with about $90 million in liquid assets and no long term debt. It’s strong enough that we don’t even have to discuss it.
At the conference call, Volcom management said that the third quarter results had exceeded their expectations “primarily driven by revenue that was above plan in all three of our business segments. “ It was $9 million higher than the high end guidance provided at the last conference call.
That I suppose is a good thing, though another interpretation might be that they did a lousy estimating at the last conference call. I guess the worse you estimate one quarter, the better you can look next quarter. Oh well- a lot of that going around in this economy. Companies are justifiably cautious.
The conference call message is that they did a lot better than their last estimate but the 10Q tells us that revenue for the quarter fell 15.9% to $93.9 million, and net income was down 18.5% to $13.3 million. For nine months, revenues are down 18.2% to $216.5 million and net income fell 39.8% to $18.3 million. Net income as a percentage of sales fell from 14.6% to 14.1% for the quarter and from 11.5% to 8.5% for nine months.
Volcom reports their results for three segments; United States (which includes most of the world except Europe), Europe, and Electric. For the quarter and for nine months, revenue and gross profit were down in all three segments. Operating income for nine months was also down for each of the three segments. For the quarter, it fell in the United States and Europe, but rose in Electric.
They also report revenue for eight product categories; means, girls, snow, boys, footwear, girls swim, Electric, and other. For nine months, all the categories but snow were down. It rose from $23.3 to $23.9 million. For the quarter, everything but snow and girls swim was down. Snow rose from $22.9 to $23.1 million and girls swim from $110,000 to $156,000.
You can see the detailed breakdowns for the segments and product categories on pages 14 and 15 of the 10Q here. http://www.sec.gov/Archives/edgar/data/1324570/000119312509229368/d10q.htm.
Volcom believes that “…our overall decline in revenues was driven primarily by the deteriorating global macroeconomic environment and the decline in discretionary consumer spending worldwide.” I agree with that and it’s true for most, if not all, industry companies. The trouble is that nobody can do anything about it except protect your brand, control expenses, and take advantage of competitors’ weakness.
The discussion of Volcom’s relationship with PacSun was interesting, and I’m going to quote here what they said.
“Sales to Pacific Sunwear decreased 42.4%, or $17.6 million, for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008. We currently expect a significant decrease in 2009 revenue from Pacific Sunwear compared to 2008. It is unclear where our sales to Pacific Sunwear will trend in the longer term. Pacific Sunwear remains an important customer for us and we are working both internally and with Pacific Sunwear to maximize our business with them. We believe our brand continues to be an important part of the Pacific Sunwear business. We also recognize that any customer concentration creates risks and we are, therefore, assessing strategies to lessen our concentration with Pacific Sunwear.”
It’s almost schizophrenic, isn’t it? ‘Well, the business is going to be down. But it’s important to us! We aren’t quite sure what this business will be in the future, but we want to maximize the business with them. But you got to be careful about customer concentration!’
This is indicative of the same old problem that companies in this industry face every day- especially when they are public. You have to find growth, but you can’t do it in such a way that it damages your distribution and, potentially, your brand equity.
Volcom is also in 105 Macy stores, they pointed out in the conference call.
Volcom managed to increase their gross margin from 49.4% to 51.6% for the quarter and from 49.9% to 50.5% for nine months. This is a good result that they attribute to limited discounting, better inventory management and an increased margin from Japan after they acquired their Japanese distributor in November, 2008. Total gross profit, of course, was down consistent with the decline in revenues. 
Acquiring your distributor increases your gross margin, but also increases your selling, general and administrative expenses. For the quarter, these grew from 27.1% to 30.7% of revenues and for nine months, from 32.5% to 38.3%. This percentage increase was also the result of having to spread costs over a lower revenue base, increased bad debt write-offs, and incremental expenses for retail stores. In dollar terms, these expenses fell in the quarter from $30.3 to $28.9 million. For nine months, they were down from $86 to $82.7 million
The decrease during the quarter was due to reduced commissions because of lower revenues, decreased amortization, bad debt declining by $400,000 and a $1.5 million decrease in other categories including tradeshow, warehouse and legal. A lower exchange rate also helped. These declines were offset by a $1.5 million increase associated with the Japanese distributor.
Volcom is of a good size and in a good market position to take advantage of other brand’s problems and rebounding consumer spending, whenever that happens. In the meantime, they are controlling expenses, trying to source better, managing inventory and doing everything else they can do to maximize those gross profit dollars. Every company should be doing all those things all the time- not just when the economy is lousy.
But there’s a limit to how much good operational management can improve your bottom line. You can’t cut expenses and reduce inventory forever.   Ultimately, I expect Volcom to be one of the strong brands that benefit from the impact of the recession. But where will growth come from, and when will it begin?  

Opportunities for new Labels and Small Brands. What, Exactly, Should You Do?

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I’ve been chanting for the last few months, and maybe longer, that our current economic environment represents a great opportunity for new and smaller brands. At an ASR seminar in September, somebody actually, finally, asked me, “What do you mean by that exactly?”

My answer was that if you were a specialty retailer, and were still standing, you weren’t likely to succeed by relying on big, national brands as much as you use to. I think I cited four reasons this was true.
 
First, a lot of that product has become available in different channels cheaper than you can afford to sell it. Second, a specialty retailer can’t differentiate itself (which it has to do) by carrying the same product everybody else carries. Third, the percentage of revenue large brands get from specialty retailers is declining and even though those brands may be supportive, specialty retailers are simply financially less important to them then they use to be. Fourth, the size of some of the offerings from the large brands makes it tough as a smaller square footage store to carry and effectively merchandise a selection from that brand that meets customer expectations. And of course, we’re not talking about just one brand.
 
I think I’ll add a fifth. If those big national brands are the focus of your store, then you risk being defined by the brands you carry, and I like to think it should be the other way around. The specialty retailer should give credibility to the brands they carry.
 
What Specialty Retailers Want
 If you’re a new label or small brand, and you agree with my above points, what should you do? First, consider this from the specialty retailer’s perspective. I think the ones I’ve talked with would mostly agree with what I’ve said. But that doesn’t mean they are ready to throw out the big national brands they have long term relationships with and make money on. The ones they don’t make money on are another issue, but that’s for a different article.
 
What do they get from, or at least expect to get from, the established, larger, brands?
·         An advertising and promotion campaign that, hopefully, creates demand.
·         Discounts and extended payment terms.
·         Maybe some POP and other kinds of in store support.
·         Reliable, though certainly not always perfect, delivery.
·         Some level of customer service.
·         Margins and a merchandise selection you can make money on. Hopefully.
 
And they also get a comfortable, long term relationship that has a certain momentum to it. I’m not quite sure if that’s a good thing or not.
As a new label or small brand, you might look at that list and think, “Well, I’m screwed. No way can I match that.” You are, I suppose, partly right. But if we cut to the chase, what does a retailer really require?
 
You have to be able to reliably deliver a quality product that offers the retailer some exclusivity and differentiation and that turns well at a good margin. That’s it. And if the retailer is sophisticated, or maybe has read an earlier column of mine, they might also be interested on the possible gross margin return on inventory investment.   If you can do that, I guarantee all the other stuff will fall into place.
On the other hand, if you can’t do that, forget it. You’re not in business.
 
A Checklist
Life’s a whole easier once you’re brand with a track record, so I’ll address my comments to people with new labels that they want to turn into brands. However, most of these items are appropriate to small brands as well.
 
First, we’re assuming you can make and reliably supply a quality product and have identified some trend or point of differentiation that makes the product relevant to the specialty retailer. You’re on your own as far as doing that goes. You also have to have access to some working capital. One of your advantages- maybe your biggest- is that unlike a large brand, you don’t have much to lose by trying something really innovative, creative, and maybe even a little controversial.
 
Second, you’ve got to prepare a business plan. This document will be important not just in clarifying your own thinking, but in building credibility with stakeholders. More on that later.
 
Third, you have to solidify your relationship with a supplier. A known, reliable one would be good. This is not a matter of a few emails and a phone call. It requires visits and takes some time. Show potential suppliers your plan. Explain to them the market opportunity you see. Make sure they understand how they will get paid, and what the longer term potential can be. A supplier can be a crucial source of support.
 
Fourth, figure out your initial target market. Are there three skate parks where you first want to show your product around? What local influential people do you know that can help you build a little credibility?
 
Gotcha founder Michael Tomson, in an interview in the last issue of Transworld Biz, pointed out that when you start, you don’t have a brand- just a label. “You become a brand once you develop equity in that name and label,” he said. That takes time. Maybe five years he suggested.
 
He’s right, and it’s a great distinction. But of course you’re not a label one day and suddenly a brand five years later. There are baby steps along the continuum of brand building. As a new label, you have to pick the place or places where you want to become a brand first. On a mountain, in a skate park, at a couple of local retailers in a club, or some combination of these and others. You aren’t a brand because you call yourself one. You’re a brand when people recognize the name and attribute certain characteristics to it and the product it’s on.
 
Now, it’s time to make some product, and because of all the work you’ve done educating and building your supplier relationship, that hopefully goes well. Or as well as production ever goes. I don’t mean you’re going to make three samples. That’s already happened. It’s time to make enough product to make a quality presentation to potential retailers (assuming you’ve decided you’re not strictly internet) and to begin to build some support and awareness in the local community you’ve chosen as your first target. If somebody says, “Okay, we’ll take it,” you need to be ready to supply and service your new account. “Great! I’ll have product for you in three months,” is probably not the answer you want to give.
 
The steps I’ve listed above don’t happen as independently and sequentially as I’ve listed them. But they all have to happen. Now comes the big moment.
 
Meeting With the Potential Customer
This cannot be a casual meeting where you talk in off the street.  And it cannot be with the second string, substitute, relief buyer. Because of all the work you’ve done, the owner/decision making buyer may have heard of you and your label. Maybe they’ve even had a few kids ask for it. You schedule half an hour or 45 minutes or maybe more and when they say, “I don’t have that kind of time for a brand I’ve never heard of,” you say, “Mr. Owner, we both know it’s a great time to look at new labels, but I have no idea how you’d decide to take a risk on one without spending that kind of time on it.”
 
And no matter what they say, you do not just “drop off a few samples” or let yourself be pushed down to somebody who isn’t in charge.
Now comes the hard work. You have to get ready for this meeting. Find all you can about the shop. Prepare a meeting agenda and send it to them in advance. Put together a folder or a power point for the meeting that might include, but is not limited to:
 
·         The executive summary of your business plan.
·         An explanation of your points of differentiation and the niche the product is going to fill. Why are you going to be competitive?
·         How you are financed and why that financing is adequate.
·         Information on your suppliers. Who they are, how long they’ve been around, who else they produce for. Perhaps a personal letter   to the owner of the shop explaining how you’ve been working with them and that they are prepared to provide product.
·         Personal and business references.
·         An explanation of your distribution strategy. Who else in the area will have the product and when?
·         A copy of your insurance certificate, business license, etc.
·         Brief biographies of the principals and investors.
·         A suggested order, terms sheet, and explanation of how you’ll support the shop in merchandising the product. If you’ve done your homework, you should be able to suggest where in the shop the product should go, and how much space it will take.
·         Your marketing and promotional program- what you’ve done, and what you plan to do.
 
This list isn’t all inclusive, and not everybody will be able to make equally strong presentations of all the items. But if you do this, and you’re making the presentation (which you have practiced for hours and hours) to a business person, I can pretty much guarantee you will blow their socks off. Because for some unfathomable reason, in this industry, they will generally not have seen this level of professionalism from a new label.
 
This whole discussion started with the premise that it’s a great time to be a new label or small brand. Here’s a link to an article in the New Yorker that talks specifically about why opportunities exist right now. http://www.newyorker.com/talk/financial/2009/04/20/090420ta_talk_surowiecki.

 

 

Inventory Risk and Inventory Management; Our Own Version of Musical Chairs?

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Janet Freeman, owner of the small but well established women’s snowboard apparel brand Betty Rides, has a problem. On October 17th, she told me, “It’s weird but Betty Rides has ALREADY been getting lots of re-orders for snowboard jackets and pants. We cut to order, and are sold out on most things.”

Naturally, I was sympathetic to her terrible problem and said, “Which means that you are holding margins, selling through at good margins at retail, creating demand without running a big promotional campaign, being important to your retailers, and minimizing your (and the retailer’s) inventory risk?  I predicted some products shortages a while ago and I think, for the industry overall, it’s a great thing.  I think you are also seeing that small retailers are dependent more than ever on small brands that have not blown up their distribution and on which they can make good money.”

Better ringing your hands over sales you missed then inventory you can’t sell. Of course, I recommended this strategy for smaller brands especially years ago but, for some reason, it’s suddenly gotten popular. You can track the article down on my web site if you want.
 
What’s Inventory Risk?
I imagine most of you don’t need that question answered, but there are a few points I want to make and that seems like as good a subheading as any. Mathematically, I suppose your total inventory risk is the cost of everything you purchase or make for resale. If you want to eliminate that risk, you don’t make or buy anything. But that seems a little extreme. Instead, let’s define inventory risk as the potential decline in the value of your inventory from what you expect it to be; from the anticipated selling price, that is. Once you sell it, it’s no longer inventory risk. It’s credit risk if you weren’t paid before you ship it. Retailers, of course, are typically paid before “shipping.”
 
Inventory risk gets managed in two ways.  First, by buying well. Hopefully, that helps you with the second part of inventory risk management- selling well. My last article for Canadian Snowboard Business actually talked about that. Maybe they’ve put it up on their web site and could put the link HERE?  I’ve also written about using a concept called Gross Margin Return on Inventory Investment (GMROII) as a tool to increase your gross profit dollars and, incidentally, reduce your inventory risk and you can see that on my web site here. 
 
You can never get rid of inventory risk, but if you’re buying well and using GMROII, you’ve probably done everything you can reasonably do to minimize it.
 
Who’s Inventory Risk?
It’s impossible to completely eliminate inventory risk and be in business. In a perfect world, a retailer would love it if the brand could give them only the stock they need to merchandise their store and then have replenishments show up over night. Oh- and they’d prefer it if everything they got was on consignment. The brand, sitting on the other side of the equation, wants the store to buy everything all at once and pay cash in advance. Obviously neither is going to get their way.
 
The original premise behind this article was that inventory risk was a zero sum game. That is, it existed and somebody- the retailer, the brand, or the manufacturer- had to shoulder it. Zero sum means that you can pass it around, but not reduce or eliminate it. The only question is who takes the risk.
 
I’m not so sure that’s completely true. After some thought, and some conversations with some smart people, I’m beginning to look at inventory risk as an indivisible part of systemic business risk. You can manage it, but it’s just not independent of overall business conditions and your relationship with your customer or buyer. It’s not zero sum because you can work together to reduce it.
 
Some Real Life Examples
 
“One you find the demand line and are honest about it, and start producing under it, you really start building your brand,” Jeff says.
And of course both the retailer and the brand reduce their inventory risk because they aren’t kidding themselves about demand. You can see where I’m going with this. Good demand planning at all levels of the supply chain can reduce the inventory risk for everybody- not just transfer it from one player to the other.
 
Sanction is a snowboard and skate retailer with shops in North Toronto and the Kitchener/Waterloo area. Co-owner Charles Javier says he dropped a lot of the larger snow related brands or lowered the quantity he bought this year. He’s been bringing in smaller brands, and does better with them than with some of the larger ones. In fact, they upped their total buy this year. “How we manage inventory risk isn’t about how we put risk off on the brand, but about how we buy,” he told me.
 
And he’s not particularly concerned that his smaller preseason orders with some brands will keep him from having enough product later in the season. “There’s always going to be inventory available,” he said.
 
A consistent theme in my conversations has been brands warning that they aren’t making product much beyond orders, and that retailers who want it better have gotten their orders in, and retailers not quite believing them, or not quite caring, or thinking they could substitute another brand. I guess by the time you read this, we’ll know how it worked out. I hope to hell there are some product shortages that make some of this stuff a bit scarce and special again.
 
Darren Hawrish is the president and owner of No Limits Distribution. Located in Vancouver, it handles Sessions, Reef, Osiris, Capita, Union and other brands in Canada. He and Charles at Sanction would probably get along just fine, as Darren, like Charles think you manage your inventory risk by how you buy. He’s been more diligent on inventory this year, looking at it weekly instead of monthly.
“Inventory is the make or break part of your business,” he told me. “You can’t increase sales [which they expect to do, though not as much as in previous years] without it.” But posted on their walls is a sign that says, “Inventory Is Death” so it seems they have a healthy balance in how they handle it. “The discount doesn’t matter if you can’t sell it,” he reminded me.
 
He’s seeing tightness all along the supply chain. He thinks it’s a lot tougher to make in season buys than it was 18 months ago or so. His goal is to sell what he gets in. On the face of it, that sounds kind of obvious. But in his mind inventory and buying are closely tied to having clearly defined growth and margin goals, so there is a strategic component to inventory that a lot of people may not be thinking about. And that is another way that Darren works to reduce inventory risk.
 
I’m not quite sure the musical chairs analogy I used in the title holds up. Inventory risk can’t be isolated from general business risk, and it’s not a known quantity that just gets passed around. A brand that sells its product and gets paid for it still hasn’t eliminated its inventory risk. What happens when all that inventory doesn’t sell and the retailer has to dump it? What’s the impact if they go out of business and aren’t around to buy anything next year? What if the value of the retailer’s inventory goes to hell because of the distribution actions of the brand? What’s the brand suppose to do when a retailer grey markets stuff outside of normal distribution channels?     Seems to me that inventory risk exists all across the supply channel and we’re all in it together.
 
It gets minimized when the sales plan is realistic and consistent with the brand or retailer’s market position and strategic goals. Not to mention market conditions. It is further minimized when you buy based on your best estimate of demand regardless of terms, discounts and or other incentives.
 
Current economic conditions are requiring us to reduce our inventory risk and to pay closer attention to all the management accounting and operations management things that, frankly, aren’t much fun. But we’ll be a much better run industry as a result and might even bring back to at least some of our product the sense of exclusivity it has lost over time.

 

 

Zumiez’s Fireside Chat

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Rick Brooks, Zumiez’s CEO and CFO Trevor Lang held a half hour question and answer session today at the Thomas Weisel Partners Consumer Conference in New York. Previously, Zumiez had announced on September 2nd that “…total net sales for the four-week period ended August 29, 2009 decreased 2.9% to $51.7 million, compared to $53.2 million for the four-week period ended August 30, 2008. The company’s comparable store sales decreased 12.1% for the four-week period, versus a comparable store sales increase of 0.2% in the year ago period.” Their comps for September were positive.

They started by defining themselves as an action sports lifestyle retailer (duh) and went on to explain what you had to do to be one. To Zumiez, that means you have to carry hard goods and all the brands (not only in hard goods) that you find in independent shops. They characterized their customer as “very smart” and as knowing what’s authentic and what’s not. Those customers are 12 to 24 years old and more male than female.

They focus on making their employees people who are living the lifestyle and they try to build a distinct culture that empowers these young people to localize product for their stores and create a vibe around it.
 
Their description of their business makes perfect sense. It also leads me to two questions. The first is what does it mean to be an action sports company? That’s a strategic question for every brand and retailer in this industry and one, I have to admit, for which I don’t have a good answer. That label, which has been around a long, long, time, might be seen to suggest that we are the same industry now that we were 15 years ago. But we’re not. If only because of the breadth of distribution and the number of non participants who buy our products we’re a lot different. I guess I’m not against the term as long as you don’t fall into the trap of thinking it means the same now as it did then.
 
The second question is more focused on Zumiez, but not only for them to think about. As they create this focused culture of cool kids who are committed to and invested in the lifestyle, are they defining themselves in a way that might restrict their growth or their attractiveness to certain consumers?
 
The answer, of course, is yes, they are. But every company decides who they want their customers to be and what they want to mean to them. Or at least they should. And any company that tries to be meaningful to everybody probably ends up meaningful to nobody. Unless, I guess, they are an electrical utility, for example. Interestingly, I wonder if Zumiez hasn’t helped themselves manage this issue by being mall based.   They can work to make their stores what they consider core while at the same time exposing themselves to a much broader spectrum of potential customers in an environment that is not intimidating to those customers.
Zumiez noted that their smaller brands are continuing to gain share and specifically that brands need to be careful with distribution and how quickly they grow. They indicated they hadn’t seen any bankruptcies from any of these brands and hadn’t had to do anything special for any of them because of financial difficulties.
 
I have been arguing for a while now that current economic conditions represent an opportunity for new and small brands. It appears Zumiez agrees with me.
 
One of the questioners noted that Zumiez use to talk about an operating margin target in the low to mid teens and asked if that was still a reasonable objective. Zumiez indicated it was, though not in the current environment. They said they were growing selling, general and administrative expenses at half the rate they had been before and spending $85,000 less on each store. Because of these adjustments, they think they can get to those margins with less sales per square foot, but not until sales turn around.
To me, that sounded like an acknowledgement that they have no expectation of sales returning to previous growth rates in the foreseeable future, an assumption I agree with.
 
Zumiez’s growth plans are somewhat restricted right now, and management pointed to the failure of landlords to be more realistic about the rents they could expect as a major reason for this. My belief is that the commercial real estate market is going to get worse before it gets better, and I expect Zumiez will eventually get the cooperative landlords it needs to open more stores. They seem to think so too, as they acknowledged the “capacity rationalization” (what a benign sounding term for something that can be so difficult) that was going on not just in action sports but in all retail sectors. In other words, we’ve got too many retailers and too much retail space
.
The last thing I’ll mention that really caught my attention was their description of how they were working with individual brands on strategies that were appropriate for them. They might, for example, ask a brand to explore a new product or category where Zumiez saw an opportunity. I don’t know how much of that they’re doing, but that guidance could be really useful for a smaller brand and might explain why Zumiez is having success with such brands.

 

 

Nike’s 8/31/09 Quarter, Their Impact on the Industry and Quips on Conference Calls

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Nike put out a press release on its quarterly earnings two days ago and held a conference call on their results yesterday. This has all happened before the actual 10Q with all the detailed information and footnotes is available. So on the one hand, I’d like to be timely and have this done before everybody loses interest, but on the other hand I’d like to have the best information I can have before expressing an opinion. There’s a concept!
 
The prepared comments that started off the conference call had a sort of “Aren’t we wonderful? Didn’t we do just what we said?” feel to them. From a business point of view I suppose they are and I guess they did. Still, I’d like to do my own analysis and not be lead by the hand to my conclusions. That’s why I’d like the 10Q to come out before the press release and the conference call.
 
Then come the questions from the analysts that work for the investment banks.  The questions are usually preceded with some form of “Hey, how are you guys today?” Great Ralph/Sally/Fred! Good to talk with you again!” There’s a collegial sense to the conversations that seems to preclude tough questions.
 
To be fair, I’m not sure there are a lot of tough ones you could ask about Nike, but it still feels a bit like an attorney questioning his own witness at a trial. This isn’t an issue just with Nike. At the last Quiksilver conference call, nobody asked, “Where are you going to get revenue growth from?”   As I’ve written, I think that’s the key issue they have to address.
 
There was one question from a guy named Brian on the Nike call whose last name I couldn’t quite hear from a company called Research something and I couldn’t hear the end of that either. I’m thinking he might not be an investment banker. Nike had announced that they were changing their primary profitability measure from pre-tax income to earnings before interest and taxes, “…which is the primary measure used by our management team and board to make decisions about resource allocation and to evaluate the performance of individual operating segments.”
 
Now, I see Nike’s point from a management perspective. But if I were an analyst concerned with the stock price, I’d know that net income is the primary determinant of stock performance over anything but the short term, and that’s what I care about when I look at a stock. Not pre-tax income, not earnings before interest and taxes, not proforma income, not earnings before extraordinary items, not even EBITDA- earnings before interest, taxes, depreciation and amortization. Call me old fashioned, I guess.
 
So my hero Brian steps up and asks, “Will the change to EBIT change the company’s focus on how you deploy capital?”  I don’t think I have his questions exactly as he asked it, but the implication was that it wasn’t clear if the change was conducive to focusing on bottom line earnings. Nike, you’ll be stunned to learn, said that of course they would continue to be focused on bottom line earnings. They went on to explain that this didn’t change the way top management was measured and incentivized and that among the things they were measured on was stock price and earnings. Good answer I thought. Also the only one they could reasonably give.
So Brian, if you’re out there, thanks for asking a great question and keep up the good work.
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Anyway, in the quarter ended August 31, Nike’s revenues fell 12% to $4.8 billion. Gross profit fell 14% to $2.215 billion. Gross profit percentage fell from 47.2% to 46.2% as a result of currency fluctuations and mark downs. Selling and administrative expense was down 17% to $1.546 billion. It actually fell as a percentage of sales from 34.2% to 32.2%, which is a good job with sales also down.
Because their income tax rate fell from 28.5% to 24.7%, they were actually able to increase net income by $3 million to $513 million.
The balance sheet is strong, to say the least. I guess their biggest issue is what they are going to do with $3.6 billion of cash and short term investments. That can’t be earning much given current interest rates, and I’m sure they’d like to see it deployed.
 
Revenues in all their categories (footwear, apparel, and equipment) declined in North America, Western Europe, Central and Eastern Europe, and greater China. Japan managed four and five percent increases in footwear and equipment respectively. The “Other Businesses” group includes Converse and Hurley. We learned in the conference call that “Converse grew revenue by 10% and delivered its most profitable first quarter ever, up 13% over last year.”
 
“Hurley delivered its 2nd biggest revenue quarter ever.” Nike reported that it “…gained share in the Action Sports Industry,” and “…continued to grow at a double-digit rate with market share gains while the rest of the industry declined.”
Overall, Nike’s action sports business grew 25% in the first quarter. Without giving any numbers, they noted that the direct-to-consumer business saw record revenue in the quarter. Online business was up 19%.
 
The interesting thing about Nike, of course, is that we’re even talking about them. I’m guessing it was only six or so years ago that nobody in action sports even cared about Nike. We’d go to their parties, drink their beer and laugh at their failed attempts to break in. They now seem to have figured it out. Partly that’s because they learned from their mistakes- always a good thing to do. But it’s also because being big in this industry is no longer a sin that automatically costs you credibility.
 
Too much analysis of their numbers is, frankly, kind of a waste of time. Their numbers are big and good. Complaining, as some have, that it’s somehow wrong for them to use their size and financial strength to push their action sports business at a time when other companies are weaker is a waste of time. I’d do the same thing in their position. So would you.
 

The question isn’t how Nike is going to run their business. I imagine they are going to do just fine, thank you very much. The question is how you are going to run yours, big or small, given what their success represents to the evolution of the industry.

 

Trade Shows. There Can Be Only One?

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 So let me see if I understand this. At a time when economic conditions are leading us to fewer brands and fewer shops and consumers spending fewer bucks, and those brands and retailers that are left want to spend less money and send fewer people to trade shows, we have more trade shows.   Will somebody please explain to me the economic model that says you increase supply when demand is falling?

I’m sure the people who bring us all Agenda/ASR/Crossroads/Surf Expo would all agree that one show is a great idea- as long as it’s theirs. The snowboard/ski industry can be more efficient in their approach. They have one national (and they might argue international) show followed by smaller regional shows. They can do that because a) SIA owns the show and b) they are a one season business. Never thought I’d hear myself giving a reason why the snowboard industry’s seasonality was a good thing.
 
Over on the skate/surf side of things we’ve got two sports, shoes, and a lot of apparel sold to non participants, and shorter product cycles, so if somebody wants to suggest that those differences might justify other shows, I can imagine they can make a reasonable argument.   Still, it seems like a good time to talk about the role of trade shows and how it has changed. And how it hasn’t changed.
 
It’s Still About the Retailer- Isn’t it?
There wouldn’t be any trade shows if retailers didn’t show up. I know there are other reasons to go to trade shows, but without the chance to see and sell to customers, brands aren’t going to want to shoulder the cost and effort of a show. That, at least, should be pretty non controversial. Let’s talk, then, about how retailers are best served.
 
At the risk of oversimplifying, they are best served by having to go to the fewest possible shows for the fewest days it takes to get their work done and seeing the most brands in the industries they are in. As I said, that doesn’t necessarily mean one show- issues of seasonality and geography may make it logical to have others, but having shows in related industries that run essentially at the same time and in the same place seems counterproductive. If you’re a local retailer, maybe this isn’t too much of a hassle. I once heard a retailer tell an industry person, “Hey, if you put on that show, we’ll come.” He wasn’t saying, “That’s a great idea! We need another show.” He was saying, “Oh what the hell, we’re located here anyway, it’s not much of an inconvenience, it won’t cost much, and I need to see those brands, and these guys seem determined to do it whether I want them to or not.”
 
Retailers also want to see new brands and get the “vibe.” I wouldn’t want to have to define that, but we all know what I mean. I think they can do that better in larger shows with more brands and retailers. And while I acknowledge that the vibe is different in skate than in surf, I’d remind everybody that the skate shoe business has become the casual shoe business, we’re increasingly in the fashion/apparel business, and most of our sales as an industry are to people who are not participants in the sports- especially in surf. That’s the reality of the selling environment most of our retailers deal with. If shows are going to help retailers make good buying decisions, and thereby stay relevant, doesn’t it seem logical that they should reflect the selling environment the retailer has to operate in? All trade shows might start from that perspective as they consider changes/improvements in their shows.
 
Trade shows have also become less important to big brands and retailers, and more important to small ones. I guess I should say that’s my perception and not state it as a fact. Less buying for large brands and retailers happens at shows because large brands are servicing large retailers much better outside of trade shows than they use to. The internet and cheap to free communications has played a role in this. It’s also true that the percentage of sales to small retailers has declined for big brands.
 
The trouble is that the big brands, with their huge footprint and big trade show budgets allowed the trade show producers to spread their overhead and effectively subsidize the smaller brands. But the recession, and the evolution I describe in the paragraph above, changed that.
 
How Did We Get Here?
IN THE BEGINNING there was ASR (I don’t know what the first show was- just go with me here). And the snowboarders, skateboarders, and surfers looked and saw that it was good. Also, it was their only choice. And they said, “Let us go forth to the temple [convention center] and use our many shekels to build altars up to the sky [trade show booths] that we may convert the consumer, gain market share, impress our competitors, and act 10 times bigger than we really are. And they smoked burnt offerings and saw that it was fun.
 
Then the prophet Ingemie came down from the snowy mountains and spake to the snowboarders saying, “Nothing shall ye sell in September, and only one show can you afford anyway.” And they saw that he was righteous, and made a great pilgrimage unto the desert, and lay down with the ski companies and made offerings to the gods at the many altars there, for the acolytes gave them free sacramental wine.
 
Then the God of Commerce sent the twin plagues of oversupply and lack of product differentiation, and they were laid low. Most of them had just been hoping to get laid.
 
But the skaters were unafraid. “For the third time, we have risen from the dead, but we have been perfumed and no longer stinketh, and are beloved of parents and park and recreation departments everywhere.” They chose as their symbol The Hawk, and it was much worshipped in the land. Their followers multiplied beyond reason, for the skaters were cool.
 
In their sanctuary in the land of Cabo, the surfers gathered and were troubled. “Who are these skaters who are said to be cooler than we and who try to take from the people the offerings that were surely meant for us?”
 
They didn’t have to be troubled for long.
 
For the high priests of the skaters had sent forth a decree so that all would know and love the skateboard. “Of Canadian maple shall thy deck be made with from 7 to 9 plies. Neither six plies nor ten plies shall it have.   Of no other wood shall it be constructed and whoa be to he who uses other materials or technologies.” And the high priests sent out unto the land the lesser priests (team riders) to carry the message to the faithful. There was a plague of advertising and promotion and the high priests grew content.
But the God of Commerce saw their hubris and said, “The high priests of skate have turned their faces from me. For I have sent unto them a great market, and they have prospered, but have forgotten the humble consumers, who are the true gods of commerce and always get what they want.”
 
Then the God of Commerce did send forth a disciple to the Land of Buddha. And he gathered followers and lifted up their faces saying to them, “Behold! I bring you great tidings of a new market. Surely you whose labor costs are lower than the belly of the serpent crawling upon the firmament can help the humble consumer?”
 
Then the people of the Land of Buddha saw clearly. And so they spake: “If we can manufacture integrated circuits, we sure as hell can make a skateboard.”
 
And they made many. And the prices were low. The high priests of skate were visited by a plague of blanks and shop decks. And they saw that they were fucked. There was much wailing and gnashing of teeth. But many consumers rejoiced. For they could spend fewer shekels to do what they loved.
 
Then the surfers rejoiced. “See!” they said. “The skaters are struck down but we are still mighty and definitely cooler than they are for people still flock to join our church though they live in Oklahoma.”
 
The God of Commerce heard this and sent surf boards from the Land of Buddha as a warning, but it was not heeded. And when skate, surf, and snowboard product had covered the world, even unto the land of Costco, the God of Commerce said, “Oh the hell with it,” and he sent The Great Recession.
 
Reboot
I’m sorry about that. I wrote “in the beginning” actually meaning to talk about trade shows but it just got out of control. Can’t wait to see what the editors do about this. How can I recover?
 
Trade show companies want to make money.   So do brands and retailers. So do I. Nothing wrong with that. How do you make money as a trade show? One way to do it is to charge more (and provide more services) when times are good and everybody is focused on revenue growth and market share and not quite so focused on expense management. You can be more efficient because you’ve got more exhibitors taking more space and you’re spreading your overhead. We all spend a lot of time figuring out pricing and try to charge a little more from time to time if we think conditions permit it. Why wouldn’t a company putting on a trade show do the same thing?
 
Suddenly times get a little tougher. Either for skate, or for surf, or for snow, or for everybody. Some brands decide to reduce their booth space. Retailers don’t bring as many people. Maybe one segment of exhibitors feels that the show isn’t quite supporting their needs or is favoring the other segment. Not that that would ever happen in our industry.
 
The trade show, with its revenues squeezed, may initially raise its prices. This, of course, just makes the problem worse. This is an especially big problem for small and new brands that had previously, to some extent, been subsidized by the larger brands. Ultimately, the show has to cut services. Brands who already thought the show was too expensive or that it wasn’t meeting their needs see this as proof that they are right. They may pull out or reduce their presence further.
 
You can see we’ve got a huge negative feedback loop going here.
 
Meanwhile, to meet what they see as a demand, somebody rents a hotel or puts up some tents and has a trade show. The brands say, “Hey, we can afford this!” and some of them who are unhappy with the big show or don’t think they can afford it, flock to these shows. This, of course, makes it even tougher for the big show, reinforcing the negative feedback loop and, by the way, making it tougher on the retailer.
 
Maybe at some point the big show starts to lose money. They don’t like that. They cut everything they can, invest as much as they can afford, but the negative feedback loops keeps working. Finally they say, “That’s it, we’re done.”
 
When that show goes away, you have probably lost most of your retailers who came from out of the country or even from out of the local area. And I am certain there would immediately be pressure on some small show to expand to meet demand. Guess what will happen?
 
The growth process will be painful, and when it’s done the little show will have to be in a convention center somewhere and guess what their cost structure will look like? It will be just the same as the old big show and the whole thing can start over again.
 
And the retailer, who’s suppose to be the most important reason for having these shows, will have been jerked around and inconvenienced. Don’t we want to make it easier for them to see and buy product- not harder?
 
I don’t care how it happens or who does it, but there needs to be one main trade show. If you believe that shows are for the benefit of retailers, I don’t see how you can disagree with that.

 

 

Quiksilver’s Quarter and Nine Months Ended July 31, 2009

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I’ve read the press release and listened to the conference call, and here’s what I found out.

Quik’s total revenue for the quarter fell 11.2% to $501.4 million from $569.9 million for the same quarter the previous year. Their gross profit margin fell from 50.4% to 46.7%. Selling, general and administrative expense was down 9.1% to $211.8 million. Interest expense rose 30% to $15.3 million. Instead of a foreign currency gain of $1.2 million, they had a loss of $3.5 million.

After taxes, they had income from continuing operations of $3.4 million compared to $33.1 million in the same quarter the previous year. Those numbers exclude Rossignol.
 
The loss from discontinued operations (Rossignol) was $2.1 million this quarter compared with $30.2 million last year. Net income this quarter was $1.35 million compared to $2.85 million last year. That’s $0.01 per share compared to $0.02 last year. Income per share from continuing operations was $0.03 compared to $0.26 in the same quarter last year.
 
The numbers for the nine months ended July 31 show a decline in revenue of 13.2% to $1.44 billion compared to the nine months the previous year. Gross profit margin fell from 50.0% to 46.9%. There was a net loss from continuing operations of $57.5 million compared to a profit of $79.4 million for nine months the previous year. Net income, including the impact of Rossignol, was a loss of $190.3 million this year and $225.3 million last year for nine months.
 
We learned in the conference call that footwear sales have finally softened, and that weakness in the junior’s market is having some impact on Roxy. They are in the process of implementing structural changes and expense reductions that should improve profitability by $40 to $60 million over a full year once implemented. About half of this amount will come from margin improvement, and the restructuring has been extended to include DC Shoes once it was clear that the brand was not going to be sold.
 
They are using what Chairman and CEO Bob McKnight characterized as “More measured and creative approaches to marketing and advertising.” He cited as an example a reduction of 75% in trade show expense achieved by utilizing buses outfitted as booths that are driven into the show and then surrounded by pop up tents. I like it and look forward to seeing it.
      
Over on the balance sheet, total assets fell from $2.34 billion at July 31, 2008 to $1.88 billion at July 31, 2009. That includes a $67 million reduction in trade receivables and a $25 million decline in inventory, both of which you’d expect as part of managing through a recession. Most of the reduction came from current assets held for sale falling from $358 million to $2 million with the sale of Rossignol. There was also a decline of $96 million in goodwill.
 
Total liabilities fell $204 million to $1.435 billion. This was almost exclusively due to the reduction in current liabilities. Long term debt fell only $10 million to $734 million. That’s not a surprise as the debt restructuring Quik has been working on (the last piece will close this month) was meant to spread out maturities, not reduce debt. 
 
The current ratio, at 1.65 has declined only marginally from 1.71 last year. Total liabilities to equity has grown from 2.34 times to 3.26 times, largely as a result of stockholders’ equity falling from $700 million to $441 million. To me, this highlights the fact that Quik still has some work to do in improving its balance sheet, but with Rossignol and the restructuring behind them, they can do it by running their business well. 
 
Quik expects its fourth quarter revenues to be down in the mid teens on a percentage basis compared to the same quarter a year ago. It anticipates a loss per share, on a fully diluted basis, in the mid-single digit range. Earnings will be impacted by the higher interest expense they will incur as a result of the restructuring. They reduced their projection of that expense by $10 million to $100 million and pointed out that $30 million is non cash. Interest expense in their last complete fiscal year was $45 million. They expect interest expense of $21 million in the fourth quarter, and further gross margin contraction of 150 basis points (1.5%) 
     
Quik’s profitability improvement plan should just about make up for their increased interest expense. After all this good work in restructuring and managing expenses, the question is where do sales increases come from? In that regard they have the same issue as every other brand; “The company indicated that longer term visibility into revenues and earnings remains limited due to global economic conditions.” 

 

 

The Post Recession Role of Company Stores

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When a brand said, “We’re just going to open a few flag ship stores to build the brand image and collect some good consumer information,” I was okay with that. Made sense.
When it said, “We’re just going to open a few outlet stores to keep stuff that didn’t sell well out of the wrong channels,” I was okay with that too. In both these instances, I even bought into the idea that it wouldn’t hurt, and might even support, their specialty retail customers.
But when opening stores started to evolve into a vertical integration growth strategy, I got worried. It suggested saturation of the market and a lack of other growth opportunities. It was like the canary in the coal mine for the distribution issue. It might turn out to be good for consumers (if price, rather than any kind of “specialness” was the main purchase driver for them) but it certainly wasn’t good for the industry. Not for a moment did I think that somehow it was good for specialty retailers. I don’t think anybody actually did.
That’s not to say I think opening retail stores was a bad decisions for some brands. No more than I think it’s a bad decision for a retailer to decide to stop carrying a popular brand when they realize they can’t make any money on it because of how it’s distributed. One of my business mantras is that every company does what it perceives to be in its own best interest. That’s the way it should be. The interests of “the industry” come in second.
Well, wherever you go, there you’ll be. And here we are.
The market has changed. Some brands have closed stores, and certainly they are all thinking long and hard about how quickly and how many to open. Sales increases are going to be harder to come by. Gross margin dollars and expense control are going to be where businesses look to increase their profits. What does this suggest for the role of company stores?
By the way, I consider a brand’s internet sales another type of company store, and I think what I’m discussing here applies to the internet as well.     
Why Brands Open Stores
As a brand, the traditional ways to grow are by taking market share, by getting your piece of a growing market, by acquisition, by adding products, and by extending your brand franchise, under which I guess opening retail stores might fit.
When times were good and the cash was flowing, brands could look at all of those. Though of course, only larger brands generally had the capability to make acquisitions and open stores. From a strict financial perspective, having your own retail stores looks like a no brainer. If Gertrude’s Skate Shop can make money selling $1 million of product, they have to buy it from us (and other brands), and they carry lower margin hard goods, can’t we make even more? We can probably control certain expenses better, we can merchandise our stuff the way we want and, with luck, we won’t have any trouble collecting receivables from ourselves.
Now, I trust the actual analysis was a bit more sophisticated than that, but you can see that the initial financial analysis would be compelling—especially if you needed some more growth and didn’t know where else to get it. And if you figured times were so good and sales growth and cash flow so robust that the “fat and happy” syndrome, from which we all suffered and would no doubt like to suffer from again, meant that any business blowback, including dissatisfaction from your specialty retail customers, would be minimal.
Like managers at winter resorts who believe themselves to be great managers when the snowfall is good, we were all a bit deluded by many years of good times.
It’s Not Quite That Easy Any More
In the same way that no battle plan long survives contact with the enemy, no business plan gets far into implementation unscathed.
In the first place, you have to find people to manage and work in your new stores. I don’t care how well you know the product and the industry—running a retail store takes a different skill set than running a brand. How hard is it to get and keep good people? Look at the effort Zumiez puts into finding, training, and keeping good people for their stores. It’s one of their top priorities and never something they take for granted.
The best retail managers, of course, are already working at retail stores; stores that probably buy product from your brand. Call me mean spirited, but I’m just not seeing specialty retailers being happy about a brand they have worked to build hiring their people to work in the brand’s new store. Though perhaps there are now some good people available from retailers that have closed.
Next, you’ve got to stock your new store. VF Corporation has enough brands to comfortably diversify its store offerings, if you believe that enough of their brands belong in the same retail environment. Other companies may not, depending on what you believe about consumers’ retail preferences. Do they want to shop regularly in a store with only one or a few brands even if the assortment is very broad? Should you carry brands you don’t own in your stores?
What’s the impact on your overall sales? Will you increase sales, or will you just cannibalize sales from other places now that sales increases are harder to come by? Perhaps you’ll be happy if you just hold your sales levels, as this would improve your profitability based on the much higher margins you earn at your stores.
Assuming we’re not talking about an outlet store, how do you handle pricing? As an image store, you want to hold full retail. In fact, you’ve probably assured your other retail customers that you will. That’s all fine until those specialty retailers start discounting your product. Now what? Do you truly not care if nobody buys the stuff in your company owned stores because it’s cheaper in other specialty retailers? Tempting, in this environment, to cut those prices but still make a great margin, isn’t it? Maybe those stores you own become part of your strategy for reducing the excess inventory you got caught with last fall.
Before our economic circumstances changed, company stores posed some issues, but they somehow seemed manageable. Now, they require some harder decisions.
Like, for example, what is a brand’s relationship with specialty retailers? There are, of course, fewer specialty retailers, and fewer retailers in general. Though this was starting to be true long before the economy went south, big brands with wide distribution are and will find themselves getting a smaller percentage of sales and profits from specialty retailers.
The surviving specialty retailers aren’t going to be that excited about selling brands they really can’t compete and differentiate themselves with due to that brand’s broad distribution. I had an email from a specialty retailer a couple of weeks ago telling me about a certain brand he could buy at a big multi store retailer at their discounted retail price cheaper than he could order it directly from the brand. If that’s true, it’s hard to imagine him carrying that brand for long.
Specialty retailers will have no choice but to focus on smaller brands, or limited distribution offerings from large brands that give them enough margin and differentiation to survive. You just don’t stay in business by selling stuff you lose money on, no matter how cool it may be.
Specialty retailers and company stores are going to have less competition because of the decline in retailer numbers. Whether this makes up for the decline, or at least slower growth, in overall sales we’ll have to wait and see. If you’re a large brand looking to maximize your gross margins dollars in a period of slower sales growth, company stores can make a lot of sense-—if you can manage the (admittedly incomplete) list of issues I outlined above.
A large brand may tend to look at specialty retailers as a place where you want to be well represented, but not as the source of a lot of growth and profitability. Years ago, I suggested that brands should have a list of the 50 or 100 specialty stores they thought they just had to be in for brand integrity and credibility and make sure they were in them. I still think they should be doing that.
The corollary is that larger brands may have a preference for their own stores over smaller retailers that the brands perceive can be hard to work with and offer limited opportunities for growth. After this recession ends (whenever that is), and the associated retrenchment, I expect to see more company stores selling the more widely distributed brands.
The numbers almost demand it.

A Tale of Two Surf Shops. Kind Of.

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I grew up spending all my summers on Long Beach Island, New Jersey. That’s where I learned to surf. And just before anybody makes the comment yes, the surf is generally lousy and for anything really good we have to pray for hurricanes and a change in the prevailing south winds.

We still have a family beach house there, and I was back last week on vacation. We left, naturally, on Friday, the day before Hurricane Bill hit. So instead of getting surf, I got stuck with a five hour weather delay in the airport. Life is not fair.

Enough bitching and moaning and explaining. Naturally, since I was on vacation, I took the best part of a day and visited surf shops and I wanted to contrast two of them.
 
The first is Farias, which has been on the island for 35 years and has three locations. I was in the largest location in Ship Bottom. It’s open all year. It was attractive, well merchandised and well lit. The large selection of boards was upstairs.
 
It’s a big store and they carry, well, all the soft goods brands you would expect them to carry. Go look at the list on their web site here. http://www.fariassurf.com/products/surf-gear/ Even though Farias was large and carried all the requisite stuff you have to carry when you’re on the main street of a summer vacation town, it did a good job feeling surf focused- because it is.
 
The second shop was the Brighton Beach Surf Shop. According to Michael Lisiewski (who’s business card says, “Owner/ Surf Instructor,” the shop was opened in 1962, giving them 47 years under their belt. I’m assuming it was his father who started it- either that or Michael is the best preserved guy I’ve ever seen. They also started Matador Surf Boards around the same time.
 
Here’s the link to their web site. http://brightonbeachsurfshop.com/   Check out the list of soft good brands they carry- oh wait, they don’t have one. That’s because they don’t carry any of the usual soft goods brands. Not one of the 22 industry standards that Farias carries are sold at Brighton Beach. Of course they have some soft goods- sweat and hats and t-shirts. Many of them say Long Beach Island on them. There are probably some store t-shirts as well, but I don’t specifically remember them. Hey, I was supposed to be on vacation.
Why don’t they carry them? First, because merchandising just one of these brands the way Farias can do it might come close to filling the whole Brighton Beach store. If I’m exaggerating, it’s not by much. The place is a bit small.
 
Second, that’s not what their focus is. As I stood there, the kids came in and went out asking about surf boards and surfing. According to Mike, these are his key customers.
 
At Brighton you can get “Everything you need for a day at the beach.” You can get that at Farias too. Like Farias Ship Bottom store, Brighton Beach Surf Shop is open all year around. Unless Mike is out surfing or isn’t there for some other excellent reason. 
So we’ve got two surf shops, both focused on surfing, but very different in terms of how they do business and where they make money. Is one better than the other one? Nope. At 35 and 47 years, it’s pretty clear that they both have strong business models.
But what fell on me like a sack of hammers after my tour was that you can’t be Brighton Beach Surf Shop if you try and carry even one or two of the brands that Farias carries. And you can’t be Farias if you carry only one or two of those brands either.
 
Maybe I just don’t get out often enough, but it suddenly occurred to me that there might no longer be room for shops caught in the middle. You either carry a large assortment of brands (or you’ve got to figure out which ones to carry and that’s a crap shoot) or you carry few to none of the broadly distributed brands (because you can’t merchandise them well or compete on price).
Perhaps that’s already been obvious to everybody but me. Who says you don’t learn anything on vacation?

 

 

Billabong’s Annual Report for Year Ended June 30, 2008

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I’m supposed to crunch a bunch of numbers when I do these things, but first I’d like to highlight Billabong’s Operating Principles from its Corporate Governance Statement. There are eight of them and they are:

1.       Lay solid foundations for management and oversight.

2.       Structure the board to add value.

3.       Promote ethical and responsible decision making.
4.       Safeguard integrity in financial reporting.
5.       Make timely and balance disclosure.
6.       Shareholder communication.
7.       Recognize and manage risk.
8.       Remunerate fairly and responsibly.
 
They discuss in some detail how they try to accomplish each of these. You can see the discussion on pages 30-36 of their financial report here. http://www.billabongbiz.com/documents/20090821_Appendix4EFullFinancial_ReportWebsite.pdf
I’m sure it’s not easy, and I imagine you’re always working to get it right, but you can’t go too far wrong in running your business if you follow those eight principles.
 
Net profit fell from $176.4 million to $152.8 million Australian Dollars. That includes a noncash after tax impairment charge of $7.4 million on retail assets (all numbers in this article are in Australian Dollars unless otherwise noted. At June 30, 2009, it took 1.243 Australian Dollars to buy one U.S. Dollar). The profit decline came on a 23.6% increase in total revenue from $1.354 billion to $1.674 billion.
 
Sales grew by 9.1% in constant currency terms (that is, assuming the exchange rate was the same all year). Without the Dakine acquisition, constant currency sales grew only 2.8%. The date of the Sector 9 acquisition was July 1, 2008 so it was included in the results for the whole year. Billabong is projecting net profit after taxes to be flat in the fiscal year ending June 30, 2010. What happened? The recession, particularly in the United States, happened.
 
“Excluding the acquisitions of DaKine and Sector 9, as well as the Quiet Flight retail business which was acquired in June 2008, sales in North America were down approximately 13% in USD terms.” This was the result of generally poor economic conditions and retailers changing their traditional buying patterns to minimize inventory risk, as well as the company’s decision to hold prices.
“…sales to chain retailer Pacific Sunwear continued to decline and accounted for less than 10% of the Group’s sales in the Americas. This followed the Group’s reluctance to endorse Pacific Sunwear’s shift into a value price driven retail offer.”
 
Gross profit margins were 53.2% compared to 54.9% the previous year. Their ability to hold the margin decline to 1.7% reflects the company’s strategic decision to minimize discounting with the goal of maintaining brand equity. What discounting they did was mostly in the U.S. The margin decline also reflects Dakine’s and Sector 9’s use of third party distributors.
 
The sales increase means that gross margin dollars earned rose from $746 million to $894 million, but increasing expenses below this line meant that pretax profit fell 16% from $246 to $206 million. Selling, general and administrative expenses rose $126 million, or 31.6%, from $399 to $525 million. $75 million of that increase was employee benefit expense. The Sector 9 and Dakine acquisitions were going to increase those expenses. As percentage of total revenues, it rose from 29.5% to 31.4%.
 
Company owned retail was responsible for approximately 21% of revenue during the year. EBITDA (earnings before interest, taxes, depreciation and amortization) for the retail sector fell from 10% to 10.2% “…due to a marked decline in comparative store sales from October 2008 to the end of the financial year.” At year end, Billabong had 335 company owned stores.
 
The most important thing that happened over on the balance sheet was the raising of $290.8 million in new equity (before transaction costs) last May. As a result, net debt decreased by 36.6% to $225 million. Interest coverage is 7.1 times, down from 11.1 the previous year.
 
The new capital improved Billabong’s current ratio from 3.07 to 3.30, and its total liabilities to equity improved from 1.04 times to 0.89. It’s an especially good time to strengthen your balance sheet.
 
Intangible assets rose from $800 million to $1 billion, representing 45% of their total assets. That includes a $117 million increase in goodwill mostly, I expect, as a result of the Sector 9 and Dakine acquisitions.
 
During the conference call on the annual report, management noted that they were dealing with 10% less accounts than in the previous year because the account was no longer in business or due to credit risk. Receivables over six months past due have risen from $11 to $21 million. They noted that they were working hard on collections, and had slowed their payments to suppliers to compensate for their customers not paying them.
 
They indicated that they expected to see some product shortages during the holiday season due to retailer caution in placing orders. They have been meeting with retailers to discuss the product cycle and make it clear that while Billabong will do everything it can to respond to retailer and customer requirements, production times (especially for technical, seasonal products) can only be reduced so much.
 
Billabong has done a lot of things right. They have bought good brands (the only kind to own these days) at fair prices. They have managed their inventory and expenses in response to economic conditions. They have resisted discounting to maintain brand image and retailer support. They are reducing sales to customers who can’t support that brand image and the pricing it implies. They have raised capital to build their balance sheet. The decline in income (they still had a 15% return on equity) is in line to better than what other brands are experiencing and they are certainly well positioned for a recovery, though of course it depends on what form that recovery takes.
 
But you know what? The most important thing I’ve talked about in this article is probably those eight principals. If you do that, the rest will probably fall into place.