Good News And Bad News; Ride Reports Third Quarter and Preseason Orders.

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            It must suck to be the only public, pure snowboard company left standing. All the other snowboard brands are suffering from some of the same industry issues as Ride, but they can equivocate about it with impunity.

 
            But Ride’s management wouldn’t want to do that anyway. Like the title says, there’s good news and bad news. The good news is the improvement in the income statement and the preseason orders (up 26 percent). The bad news is a weak balance sheet and a capital structure that needs, well, restructuring.
 
            The income-statement result and preseason-order growth is all the more impressive given the balance sheet Ride has had to work with and the constraints placed on what the company can do. A weak balance sheet means the CEO spends all his time managing cash, assuaging banks, and trying to raise capital. Who knows what Ride—or any other snowboard brand for that matter—could accomplish if the management team could actually focus on running the business?
 
The Income Statement
 
            Sales for the nine months ending March 31, 1999 are up 14.2 percent to 38.1-million dollars over the same period last year. Ride’s loss for those nine months was 1.389-million dollars compared to 14.645-million dollars last year. The improvement isn’t as spectacular as it seems at first glance. Last year, the company took an 8.6-million-dollar write-down for impairment of goodwill. In other words, given market conditions at the time of the write down, it had some assets that were worth a lot less than what Ride paid for them.
 
            Nine-month selling, general, and administrative expenses have been more than cut in half, but that includes the 8.6-million-dollar write-down. If you take that out of the equation, the expense reduction is still 19.7 percent—which is pretty impressive. According to Ride, and excluding the impact of the 8.6-million-dollar write-down, the expense reduction “ … was primarily due to staff reductions and lower executive salaries.”
 
            Gross margin over nine months was up to 27.4 percent, an increase of 1.3 percent. May not sound like much, but 1.3 percent of Ride’s nine-month sales is half-a-million bucks, which would buy a lot of beer at Vegas. Perhaps you recall, many years ago, when having your own factory was the Holy Grail of the snowboard industry because “it would let you have a really great gross margin.” Numbers like 45 percent were once thrown around. Too bad everybody had the same idea.
 
The Balance Sheet
 
            Ride’s receivables at March 31 were 6.5-million dollars net of a bad-debt allowance of 750,000 dollars. That would be bad if those receivables represented uncollected accounts from last season. But according to Ride President Robert Marcovitch, those receivables represent early 1999 sales of last season’s product that will be collected this fall.
 
            The 10Q confirms this, stating, “The company made the decision to move our closeout inventory at prices lower than would normally be the case in order to gain quick sales and hence borrowing availability.” Translation, we needed the cash!
 
            If it isn’t getting paid until fall, how does that get the company any cash? The bank line from CIT allows Ride to borrow a percentage of eligible inventory and receivables. Ignoring the issue of what’s “eligible” and what’s not, the percentages for Ride are 55 and 85 percent respectively. Let’s say you’ve got a million bucks in inventory. You can borrow 55 percent of that, or 550,000 dollars assuming it’s all eligible. If you’ve got a million in receivables, you can borrow 85 percent or 850,000 dollars. Because I went to business school, I know that 850,000 dollars is better than 550,000 dollars, so Ride sold at lower prices to create receivables. 
 
            Inventory of 7.3-million dollars on March 31 gives you pause for a moment. But the footnotes in the 10Q tell us that 2.5-million dollars of that is raw materials and work in progress. That will turn into next season’s product. The remainder is finished-goods inventory. According to Marcovitch, almost all of the finished goods are product for the coming season. Not only do we know from this that the inventory is good, but it suggests that however tight cash is, Ride is finding enough dollars to run its factory efficiently. That is, it’s getting materials from suppliers and not having to start and stop the plant because of material or cash shortages. The major liquid assets then—inventory and receivables—are more or less worth what the balance sheet says they are. And, in the normal course of business, when Ride ships that inventory to customers it will turn into receivables (and, hopefully, someday cash), that will be worth substantially more than the current inventory value.
 
            Meanwhile, down on the liability side of the balance sheet, we find current liabilities of 15.1-million dollars broken down as follows:
 
            Accounts Payable: 4,247,000 dollars.
            Accrued Expenses: 2,383,000 dollars.
            Short-term Borrowings: 8,484,000 dollars.
 
            The short-term borrowings include three million dollars owed to U.S. bank and a note for 1,725,000 dollars payable to Advantage Fund II, Ltd. The remainder is owed to CIT Group/Credit Finance, Inc. under Rides’ revolving line of credit. Accounts payable and accrued expenses are moneys owed to the phone company, materials suppliers, insurance agents, employees, and everybody else Ride needs to get goods and services from to operate its business. Ride’s current ratio (its current assets divided by current liabilities) is 0.98. The current ratio is a standard financial measure of a company’s ability to meet its ongoing operating expenses. The lower
the number gets, the tougher things are. You can’t continue to operate with a current ratio under 1.0 for too long.
 
            Let’s put that in a little perspective. In a highly seasonal business, in the part of the season where the cash is drying up (like the end of March for example) no snowboard company has a great-looking balance sheet and is rushing to pay all its bills. Nevertheless, Ride’s current ratio is symptomatic of the need for a balance sheet restructuring and additional working capital.
 
Preseason Orders
 
            Up 26 percent to 43-million dollars. Wow. Any other snowboard company that had a bigger increase, step up and claim it. I won’t be holding my breath. The only category that’s down is “OEM, wakeboards, and other.” That’s only down, according to the press release, because it chooses not to accept certain OEM orders, which is probably a correct strategic move.
 
            What I like even better are the categories the increases came in. Boards are up nineteen percent. However, boots, bindings, and apparel and accessories (excluding SMP) are up 38, 33, and 58 percent respectively. That is, higher margin products represent an increasing percentage of total sales, which should bring the whole margin up.
 
            Some of these sales may get shipped before June 30. But just for fun, let’s say Ride sells that 43-million dollars, and nothing more, in the nine months of their next fiscal year. Let’s assume the company’s gross margin stays the same. Its gross profit will be 11.78-million dollars.
With the preferred stock dividend eliminated, that increase in gross profit by itself will bring Ride to break-even. A restructuring should reduce the company’s interest expense from 798,000 dollars, if only because Ride is paying punitive interest rates right now. Margins should go up a point or two just based on the change in the product mix. Obviously, the quarter ending June 30 isn’t a strong one, but for the twelve months ending June 30, 2000 Ride ought to earn a few bucks just from what’s in place right now. That is, if Ride management can get the restructuring done.
 
Restructuring
            The U.S. Bank facility is a term loan for three million dollars that is due and payable August 31, 1999. That loan, according to the 10Q, “ … is secured by promissory notes from Global Sports, Inc. in the original aggregate amount of 1.8-million dollars. Additionally, the facility is secured by the personal guarantee of one of the Company’s outside directors, including certain real-estate property owned by the director.”
 
The note for 1.725-million dollars, also according to the 10Q, “ … has a term due date of June 30, 1999 which date is automatically extended to September 30, 1999 in the event the company has executed a letter of intent for a transaction which would raise capital sufficient to fully redeem the note.”  The note’s interest rate is ten percent, but it has a default rate of
eighteen percent. The CIT line of credit expires August 30, 1999.
 
            So, there are a lot of critical deadlines coming up, and the 10Q is replete with the usual statements companies in these circumstances make about dire consequences if Ride can’t meet some of these deadlines.
 
            My guess is that there will be a successful restructuring. The improvement in operating performance and increase in preseason orders makes me believe that. Its likely shareholders will be hit by additional dilution as a result of the restructuring. Concern over that dilution is probably the reason the stock price didn’t go up significantly in the wake of Ride’s healthy preseason order numbers.
 
            Ride has hired Ladenburg Thalman & Co. “ … as its financial advisor to provide advice regarding potential strategic alternatives available to the company,” says the 10Q. Negotiations are ongoing.
 
The Bottom Line
            If Ride had paid maybe two-million less for its factory, not hired quite so many people so quickly, and had paid some of them less, and not built the Taj Mahal in Preston, Washington, I suspect the managers at Ride would be smiling and looking forward to closing out their fiscal year June 30 with a twelve-month profit. But that’s not how it happened, and Ride was hardly the only snowboard company seduced by perceived endless growth.
 
            Ride’s market position seems sound and the product line complete and well received. Management and employees are industry experienced.          I still have some trouble with the financial burden of owning a factory, but Ride management has made its a marketing asset. So, strategically the brand seems positioned to succeed. By the time you read this, we’ll probably know if Ride’s managers pulled off the financial restructuring that will allow them to do it.

 

 

Chasing the Demographics; Pacific Sunware Focuses on Youth

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There’s got a way to make this story exciting. Oh the injustice of making me write about a company with a strong balance sheet, growing revenue and earnings, no meaningful litigation, and an experienced management team with a clear strategic focus. I’ve got to stir up some drama somewhere if there’s to be any hope that people will make it all the way to the end of the article.

The drama is in the execution of the strategy. Pacific Sunware started out as the store where young, white males could get the trendy, casual brands they wanted. Now, twenty two percent of their sales are to females. The new d.e.m.o. stores are focusing on cross cultural trends. Pacific Sunware sells snowboard clothing. They are selling their own private label brands.
 
Can they expand their target market, but keep their focus and their niche? Can they keep the loyalty of a notoriously finicky customer group? Inquiring minds want to know. But first, the boring stuff.
 
SIDEBAR
 
Pacific Sunware: A Snapshot
 
As of the fiscal year ended January 31, 1999, Pacific Sunware (PacSun, as they seem to want to be known) had 342 stores in 42 states. Their customers are young men, and increasingly women, between the ages of 12 to 22 who prefer a casual look. Revenues have grown from $85 million in 1994 to $321 million for the year ended January 31, 1999. Net income has climbed from $3.9 to $23.5 million during the same period. They had 4,058 employees of whom 3,822 were store employees. Of the store employees 2,700 were part time. Management is mostly in their 40s. Most of the team has been with the company since 1994 or before.
 
END OF SIDEBAR
 
 
PacSun by the Numbers
 
At May 2, 1999, the balance sheet was, well, boring. There’s eleven million dollars of cash and a current ratio of 3.16. There’s basically no long-term debt, and the total debt to equity ratio is 0.25. The piece of information I would like but don’t have is a way to judge the quality of the forty six million dollars of inventory. Obviously, when you’re selling trendy goods to young people, you’d better be right on your inventory selection. On the other hand, even if a chunk of that inventory were obsolete, this balance sheet would still be strong.
 
One caveat on evaluating the balance sheet of any fast growing retail business- comparisons from one balance sheet date to the next are difficult due to both growth and seasonality. Ratios will tell you the strength of the balance sheet, but getting a handle on operational efficiencies using the balance sheet is tough when, for example, inventory goes up a bunch, but so did the number of stores.
 
For the thirteen weeks ending May 2, 1999 sales were $81.4 million, up 33 percent from the same period the previous year. Income grew forty percent to $4.04 million. Gross profit margins were essentially constant in these two periods at 32.1%.
 
Similar trends can be seen in comparing the two years ending January 31, 1999 and February 1, 1998. Sales grew 41.4% to $321 million. Net income was up 43.7% to $23.5 million. Gross margin fell two tenths of a percent to 33.7. Operating expenses as a percentage of sales fell from 22.5 to 21.9 percent, largely as a result of the rapid growth in sales.
 
Also important to note is that the average inventory between these two dates was $37.3 million. They did $321 million in sales. So they turned their inventory 8.6 times, and that is a great place to move into how the PacSun’s market strategy and how it dovetails with their financial and operational strategies.
 
Setting the Stage
 
PacSun either figured out or fell into the fact that it’s not just surfers that buy surf wear, snowboarders that buy snowboard clothing and skateboarders that buy skate clothing anymore. The specialty markets are crossing over each other. Fashion and lifestyle are as important as participation in the sport that originally spawned the apparel. If it were just surfers who wore surf apparel, the company wouldn’t be planning to increase its square footage by forty two percent this fiscal year.
 
So Pacific Sunwear has positioned itself, it hopes, at the cross roads where everybody passes through but nobody is confused or put off by seeing surf/skate/snow in one place. The theory is that you aren’t selling out anymore as long as you’ve got the cool stuff to sell.
 
Trouble is that somebody keeps changing the road signs at the crossroad. Fashions come and go as fast as commemorative postage stamps. Faster, probably. How does Pacific Sunwear hope to keep its road map accurate?
 
Real Marketing!
 
It’s my personal observation that most action sports companies think advertising and promotional tactics are marketing. Pacific Sunwear doesn’t seem to suffer from that delusion. Chief Financial Officer Carl Womack described the two-hour focus groups they do each year in half a dozen cities and have been doing for seven or eight years. He explained that their on-line inventory reporting allowed them to see what was selling and what wasn’t on a daily basis.
 
“Not only does this allow us to manage our inventory on a day to day basis, but it helps us anticipate trends so we can respond on a timely basis.”
 
He emphasized the close relationships they had with suppliers as a critical source of market trend data. They share ideas regarding fashion trends and merchandise self through with their vendors. “We always pay our suppliers on time- sometimes even early if they need it,” he indicated. That ought to go a long way towards creating good working relationships.
 
They experiment with new colors, styles and items by ordering small number (maybe twelve dozen) and seeing how they sell.
 
To sum it all up, it seems that marketing (that is, figuring out what the customer wants) is institutionalized at Pacific Sunware. Everybody thinks about it all the time and is required, as described below, to react to what they learn.
 
Running the Business
 
So PacSun’s success depends on their ability to respond to the dynamic fashion whims of young people aged twelve to twenty-two. How do they run their business to accomplish that?
 
All the stores of a given class are the same in terms of size, fixtures and inventory. Nobody has to do a study to figure out how build out and stock a new store. It’s a good thing, since they plan to open 108 new stores in fiscal 1999. Sixty-seven are planned to be Pacific Sunwear stores, sixteen Outlet stores, and twenty-five d.e.m.o. stores.
 
Though stores have the same inventory selection, the timing of inventory receipt will vary according to store locations. It gets colder some places earlier in the year than in others.
 
The company manages inventory through what CFO Womack called “permanent markdowns.” Every two weeks, based on the daily sales data, the store managers get to work to find the markdowns already downloaded into their store registers. All they have to do is put up the “On Sale!” signs. No slow moving inventory is allowed to linger in the hope that it will suddenly become hot. The inventory turns quickly, and the customer doesn’t wait for big sales promotion before coming into the store.
 
Stores have daily, weekly and monthly sales goals against which performance is measured. Feedback is immediate, as are bonuses for meeting monthly goals. Yet the store managers have no involvement in the actual selection of merchandise, though of course their input and ideas are solicited.
 
So what’s going on here? Pacific Sunwear’s systems and operating procedures dovetail nicely with their marketing imperatives. Need to have the right inventory? Better have the systems to know what selling so you can move what’s not. Want to grow quickly? The stores better be more or less the same. Want to be on top of trends? Better get along with your suppliers. The financial results are good expense control, minimizing writedowns and inventory levels, and high margins.  And a strong bottom-line.
 
Notice how all the pieces work together. There seems to be a company wide strategic focus that makes it immediately clear to management when something is “right” and when it is “wrong.” I’m usually not this gah-gah over a company. What could go wrong?
 
I’d focus on three things. First, management could lose touch with trends. Age does that no matter how good your systems and marketing are. Second, defections from a management team that has been together this long could be a problem. I hope the golden handcuffs are reinforced with titanium, and I hope the district and regional managers have a lot of input. Finally, fast growth can cause problems all by itself, but that’s a risk it looks like we’ve going to have to live with.

 

 

Beset by Opportunities; How Can We Take Advantage of Them?

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There are sixty million kids people in the United States between the ages of 5 and 20. Over half of them haven’t entered adolescence yet. It’s the biggest demographic bulge since the baby boomers.

 
Every large, mainstream company in this country from Levis, to JC Penney to Fidelity Mutual Funds needs credibility and brand recognition with at least some piece of this generation. It’s not an over dramatization to say that their future depends on it.
 
They are struggling to figure out how to reach this generation. Some are doing better and some are doing worse. Some are screwing up unbelievably badly but don’t even know it. However well they are doing, they are changing skateboarding right long with other pieces of the action sports business. The resulting broader, growing market isn’t just about selling skateboards to skateboarders. It includes a growing number of customers, or potential customers, interested in the lifestyle, fashion, culture and attitude that’s being toned down and homogenized for this larger market.     
 
Is this an opportunity, an inconvenience or a big mess? Since it’s not going to go away, and many of these behemoth companies wouldn’t have a significant financial event if they suddenly controlled 100% of the skateboard market, I guess we better make it into an opportunity.
 
Marketing
 
Not running ads. Not going to trade shows. Not promoting team riders. Not sponsoring events. Those are promotional tactics. Maybe they are good ones. In the past, in most segments of action sports including skateboarding, they could pass for marketing because customer identification was simple. Anybody who bought skate product could reliably be assumed to be a skateboarder. It was an enthusiast market where your customer segmentation was done for you. You sold skateboards and skateboard products to skateboarders. There was nothing to figure out.
 
Now there’s a lot to figure out. It’s not only skateboarders buy skate shoes anymore, to use what’s probably the most obvious example. Who are your customers now if they are not all skateboarders, and why do they buy from you if it isn’t just to skateboard? Now we’re talking real marketing- something the industry has never had to do before.
 
“Figuring all that out sounds expensive, time consuming, like a pain in the butt and generally no fun,” you say. “It is,” I agree. “Well, I’m not going to bother,” you announce. “I’m going to sell what I’ve always sold to the people I’ve always sold to.”
 
No doubt that’s a viable strategy for some people. Why might it be right for fewer and fewer?
 
Competition by the Numbers
 
I guess this is either everybody’s fault or nobody’s fault, but hard goods have become a commodity. That is, they are easy to make, more or less the same, there’s too much product and manufacturing capacity, quality is generally high and uniform, and the customer knows it. Barring a major strategic breakthrough in how the industry functions or a technical breakthrough in how product is made, neither of which seems to be on the horizon, I don’t see that changing.
 
Soft goods have some of the same issues, though it seems to be easier to differentiate shoes and clothing because of distinct visual differences and new materials than it is with boards, trucks and wheels. It use to be conventional wisdom in the snowboard business that you sold boards first, and boots, bindings and soft goods would follow the boards right into the customer’s hands. When that changed- when the board became something you just needed to sell because you were in the snowboard business after all, then it was time to manage differently in the snowboard business. That’s where the skate board business is right now.
 
If you do business the same old way, you will be competing by the numbers. Here’s how the numbers can get you if you find yourself in that position. If you are perceived to be selling the same product everybody else is selling to the same people everybody is trying to sell to, then you’re competing strictly on price. Your gross margin will fall. To achieve the same level of profitability, you have to increase your unit volume. But the only way to do that in this kind of competitive situation is to reduce your price. It’s an ugly, vicious circle that ultimately forces a lot of people out of the business.
 
You may, of course, be determined to differentiate your product to avoid margin deterioration. If your product is actually not different from your competitors, the only way to differentiate is through advertising and promotion. Hype, to coin a phrase. But hype costs money. Lots of money. You may maintain your gross margin, but higher operating expenses will leave you with the same depleted bottom line, everything else being equal.
 
Sounds hopeless, but it’s far from it. Like I said in the title, we’re beset by opportunities if we just know what to do with them.
 
Marketing Again
 
Typically, competition by the numbers works only for one or two large players in each industry. So it’s a condition to be avoided- especially in an industry where there are no large players. What’s the choice?
 
Your only choice (other than to count on being lucky, which will work from time to time) is to be able to answer the following questions:
 
·         Who buys my product?
·         Why do they buy it instead of another brand?
·         What are the attributes of my product and, given those attributes, who besides my current customers might buy it?
 
What a pain in the ass. It’s such a pain, in fact, that I’ve heard executives of larger companies who have to find a way to deal with the emerging demographics say they have to earn their revenues from the baby boomers while positioning themselves with the kids.
 
It’s a great idea. But I anticipate the execution, if that’s as far as the analysis goes will leave something to be desired. If you try to appeal to everybody, you often end up appealing to nobody. It’s a seductively simple sounding solution. “There- I’ve done my market research.”
 
In skateboarding, the similar rationalization may be “My customer is the 13 to 17 year old male who hasn’t discovered girls or cars yet.”   That may be true for many companies and no doubt represents successful customer segmentation for some. But it can’t be valid for everybody and if you don’t remember why reread the Competition by the Numbers section and reflect on the overall profitability of the industry.
 
What to Do?
 
Retain a team of students from the local university MBA program to do a market research project for you. They may work nearly free, will get credit for the project, and they will be guided by a faculty member. Read some books on marketing. Get your team riders asking the people at skate parks some focused questions. Have employees canvas customers. Work with a shop to get fifteen of their customers together for pizza and ask them what they bought and why. Call up the brand managers or marketing people at Levis, Pepsi, Proctor and Gamble or another large consumer products company. Have lunch or a long phone conversation with them. You could help them figure out what’s up, and they could maybe help you structure your marketing research or even supply you with some data. I suspect you might uncover some mutually beneficial opportunities to work together. There’s a lot of that going on.
 
Once you’ve taken a shot at answering the questions posed above, be prepared to step out of your comfort zone. If selling the same stuff to the same people in the same way doesn’t represent a good business opportunity anyway, what do you have to lose?
 
Doing your marketing, and answering the questions above (or similar questions that seem more appropriate for your circumstances) will typically identify both opportunities and inconsistencies in your current market approach. Imagine being able to identify your most profitable customer groups and the marketing tactics they respond to. What’s that worth not only in incremental sales, but also in more efficient use of advertising and promotional dollars?
 
There was a time when straying outside the core specialty market threatened your credibility with that customer group. Maybe it still does, though to a lesser extent. In any event, if focusing on that core specialty market exposes you to competitive conditions where you can’t make any money, who cares?
 

Demographic changes, market homogenization caused by a fashion/lifestyle/cultural focus independent of actual participation in the sport, and the financial resources of large corporations are expanding your market. The catch is that you have to figure out what piece of that market you can compete in. Do your marketing

 

Fat Lady Sings. K2 Buys Ride

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K2’s purchase of Ride, announced on July 22 and expected to close within 100 days, is as close as we’ll ever get to a capstone on consolidation.

We all were intellectually aware of consolidation, but this makes you aware in your gut. Burton and K2 now control what I’d estimate to be 65 percent of the U. S. snowboard hard goods market. Add Salomon and Rossignol and the number jumps to north of 75 percent. The number two, independent, snowboard only brand in North America is now Sims
Three questions:
 
·         What the deal?
·         What does it mean for the industry?
·         How is K2 going to manage it?
 
The Deal
 
The only info we’ve got on the deal comes from the press release and Ride’s 8K filing with the Securities and Exchange Commission. K2 is buying the common stock of Ride. That is, it’s buying the whole company- not the assets like in the Morrow deal and so many other snowboard deals.
 
So K2 gets all the assets and all the liabilities, known and unknown. If a two-year-old Ride binding blows up, somebody is hurt, and Ride is sued, K2 will be responsible. In an asset deal, they typically would not be- which is one reason asset deals are often popular.
 
Ride’s stock will be acquired in exchange for K2 common stock. Ride shareholders will receive K2 shares “with an approximate value of $1.00 for each share of Ride stock owned.” Given the number of Ride shares outstanding, that means a purchase price of around $14.3 million. Both boards of directors have approved the deal. One of the reasons it will take so long to close is that Ride shareholders have to approve the deal as well.
 
The deal is being structured so it’s tax free to Ride’s shareholders. Ride’s directors have already agreed to vote their shares in favor of the deal.
 
To get Ride from the July 22 agreement date to closing, K2 has agreed to extend $2 million in interim financing to Ride in exchange of a promissory note that can be converted into Ride stock. The note’s initial interest rate is eight percent. That rate increases one percent every 180 days up to a maximum of eighteen percent on the unpaid portion of the note and any accrued interest, however the notes is payable in full on November 19, 1999.
 
The note is convertible by K2 at any time into Ride’s cumulative convertible preferred stock and is automatically converted under certain circumstances if the merger agreement between K2 and Ride is terminated. K2 would get one share of the convertible preferred stock for each dollar that is still owed from the principal and unpaid interest of the note.
If somebody else buys Ride, or agrees to buy ride, before the note is repaid or converted, K2 can demand to be paid in cash for up to a year based on the price of Ride’s stock (which could go up if a better deal comes along).
 
Ride, as a public company, has an obligation to consider any better offers that come along. This note is structured not only to give Ride working capital to get it through the period until closing, but to make it less likely that any such deal will come along. If the deal with K2 closes, there’s nothing but intercompany debt that gets eliminated in consolidation and doesn’t much matter.
 
As another step in keeping Ride operational until the deal closes, the two companies have agreed that K2 will acquire Ride bindings with an approximate cost of $700,000 and assume Ride’s obligations to ship Ride customer orders of approximately $8.4 million in bindings and apparel. K2 will purchase approximately $4 million in inventory from Ride’s vendors to fill these orders.
 
What’s it all mean? The two companies are getting so far into bed with each other before the deal closes that it’s unlikely it won’t close or that another buyer will come along.  
 
The transaction will be accounted for as a purchase rather than a pooling, and now I’ve put my foot in it because I have to explain the difference.
 
First, if you buy assets, you assign values to the assets based on what they are really worth. So is you’re buying accounts receivable for $100,000, but know that only 85 percent are collectible you’d “allocate” $85,000 of the purchase price to those receivables. After you’ve allocated as much of the purchase price as you can to the assets, the rest is allocated to goodwill. Goodwill sits on your balance sheet and has to be amortized (taken as an expense some at a time) over a period of many years, but isn’t deductible for tax purposes.   In addition, no bank ever thinks good will is worth anything when considering whether or not to lend you money.
 
Allocation of purchase price in an asset deal also has a major impact on who pays what tax when the deal closes, but since this isn’t an asset deal and I hate it when readers fall asleep, we’ll skip that. You’re welcome.
 
A pooling is a straight exchange of stock where the values on the two company’s balance sheets are added up. No goodwill is created. No assets are written up or down and there’s no allocation of purchase price. The only adjustments are the netting out of any inter-company debts (amounts the two companies owe each other).
 
K2 is buying Ride’s stock with its stock, but it’s not a pooling because Ride shareholders are getting a certain value per share- not just K2 shares with a value completely dependent on the market. It’s a purchase. That’s what the Financial Accounting Standards Board says, so that’s the way it is.
 
Once K2 knows exactly how many shares it’s exchanging for Ride, and the market price of those shares at closing, it will know how many dollars it paid for Ride by multiplying the market price of each share by the number of shares they are giving Ride shareholders. The accounting interpretation of the deal is that K2 is buying Ride’s equity, a balance sheet number. At March 31, that number was 16.1 million dollars. I’m sure it’s lower now. I wouldn’t be surprised if it’s around 14.3 million dollars.
 
To the extent that the purchase price is higher or lower than Ride’s actual equity at closing, other balance sheet items will be adjusted to reflect fair market values. For example, if the purchase price is $100,000 higher than the value of Ride’s equity at closing, the value of other Ride assets will have to be increased, to a maximum of $100,00 if what they are really worth justified such an increase. To the extent that those adjustments don’t account for the difference between Ride’s equity and K2’s purchase price, goodwill is adjusted. It looks in this case like the purchase price will end up being somewhere close to Ride’s equity, so adjustments should be minor.
 
That’s enough of that. This article is in serious danger of turning into a lecture on acquisition accounting.
 
So what’s the deal worth anyway? The easy answer is that it’s worth the approximately $14.3 million in K2 stock Ride shareholders are receiving. That’s not a bad answer, but let’s go a little further, keeping in mind that there’s rarely a right answer when you value companies.
 
Ride’s March 31 balance sheet showed thirty two million dollars in assets and sixteen million dollars in liabilities. K2 gets all those as part of the purchase. The assets include $8.5 million in goodwill and $5.4 million in net plant and equipment. If I were K2 trying to figure out the value of Ride, I’d call the goodwill zero. I’d write down the plant and equipment. How much would depend on what use I was going to make of the factory. Let’s say they cut it in half, making the realizable value of the Ride assets around $20 million. The liabilities, as usual, are all real.
 
Let’s say that K2 could liquidate the assets for $20 and pay off the liabilities for $16 million. It doesn’t work that way of course, but if it did K2 would have $4 million in the bank. So they would have paid stock worth $14.3 million less $4 million in net assets, or $10.3 million basically for Ride’s trade name and order book.
 
But you can’t realize the value of that trade name and order book unless you operate the business. To do that, you have to invest a certain amount of permanent working capital. Ride didn’t have the working capital it needed. In a nutshell, that’s why it had to sell. My guesstimate, depending on the expense reductions K2 can find to reduce overall operating costs, is that K2 is going to have to invest maybe more than$10 million in Ride in additional to the $4 million in net assets that’s already in there. My guess is that Ride’s bank (owed $8.5 million at March 31) is going to want to be paid off and certain unsecured creditors who have been waiting a long time for their money will also have to be paid. 
 
K2, therefore, may look at it’s cost to buy Ride as not only the value of the equity it gave up, but as the additional capital they have to invest to normalize the balance sheet- $24 million in total or maybe higher. If Ride had been capitalized normally, that whole amount, and probably more, would have accrued to Ride’s shareholders. But K2’s offer was based on what it would cost them not only to buy but to operate Ride regardless of whether it went to the shareholders or not.
 
Good deal or bad deal? K2 got a good deal. Did Ride shareholders get screwed? Not given the alternative. My sense is that Ride’s management found the buyer to whom Ride has the most value. Furthermore, Ride’s balance sheet and recent public information suggest that cash flow issues were severe enough that scenarios where shareholders got less than one dollar per share were possible. Like a whole lot less. Like the big goose egg.
 
All of the web whiners who are bitching and moaning about this deal ought to give Ride employees credit for performing some operational miracles under impossibly difficult circumstances not of their making.
 
If you want to blame somebody, check out the nearest mirror. The person you’re looking at bought an over priced stock in an industry facing an inevitable and predictable consolidation. 
 
Industry Impact
 
Ride and Morrow are gone as independent snowboard companies. Atlantis, Division 23 and Type A are, in my judgment, unlikely to resurface as strong specialty brands. To Forum, Sims, Palmer, Never Summer, Option and maybe a couple of other brands this could be an opportunity depending on retailers’ perception of the deal. One brand I’ve talked with is already getting calls from retailers who were prepared to buy Ride but are reluctant to buy “another K2 brand.”
 
The strategic line between the niche players and the big companies are as clearly drawn as you could ever expect to see. If any single action can be said to mark the end of snowboarding’s consolidation phase, this deal is it.
 
Specialty brands can exist in their niches and maybe grow a little. But it’s financially unlikely that anybody will start another one. Those niche brands that exist don’t have the economies of scale, distribution leverage, and marketing dollars they need to chase the big players. And as independent companies, they probably never will.
 
Then there’s Burton with something like forty five percent of the U.S. market. They are left standing alone with the cache of a niche brand, but on an international scale, and the leverage of a large company. Ain’t nothing to analyze there. My guess is that they are thrilled with this deal.
 
As I indicated, some retailers may have some resistance to putting more eggs in the K2 basket. But if the consumer wants Ride boards, and K2 offers good terms, prices, service, quality and promotion, the retailers will pretty much get over it. They have before.
 
I would expect the complete programs from Morrow and Ride to improve as a result of being part of a larger, financially stable organization. And the production of boards in China is going to produce some price points that retailers aren’t going to be able to live without.
 
Sean- I don’t really want to add here what you added. I think I ask and answer the question you raise in the next section.
 
K2’s Decisions
 
What I think was the opportunistic purchase of Morrow (it was too good a deal to turn down) seems to have transformed itself into a strategy with the purchase of Ride. Of course, we don’t know exactly what that strategy is yet. K2 now has five snowboard brands, with K2, Morrow, Ride, Liquid and 5150. How do they get positioned against each other? How many of those brands can you imagine one retailer buying? If I were doing it, I’d make K2 the ski shop brand. I’d retain Brad Steward (between movies, of course) to consult on repositioning Morrow as the quirky brand it use to be. Liquid would be for the mass-market channel, and Ride for specialty shops, but with a more mainstream profile and higher volume than Morrow. I’m fresh out of market positions and have no idea what I’d do with 5150. Whatever the positioning decisions are, I’ll be interested to see if all five are retained. I wonder what Cass would pay for Liquid? I’d really like to leave this in. Let’s talk.
 
Even excluding the distribution issues, managing five brands against each other in the same organization is tough. I’m reminded that one of Bob Hall’s first pronouncements on becoming CEO of Ride was that the company had too many brands.
 
Of course, some of the brands he eliminated didn’t have enough volume to justify the required advertising and promotional expenditures, and I don’t think K2 faces that. Still, there are some obvious conflicts as K2 works to restructure its organization to manage the five brands.
 
For instance, you just know that the financial guys at K2 are sharpening their knives to slice expenses and walking around muttering stuff about synergies. And certainly K2doesn’t need two warehouses, credit departments, computer systems, purchasing departments, etc.
 
Maybe they don’t need two factories. Yet maintaining brand integrity means keeping sales and marketing separate. Will they have separate customer service departments with people dedicated to brands or will the temptation to have one group that answers the phone “snowboard customer service!” win out? Will all the invoices the retailers receive look the same except for the brand name?   How many brands will be made in the same factory? Will the T-shirts and beanies all be the same but with different logos? In a thousand ways, none of which, by itself, probably matters, the identity of the brands can be subverted in the perfectly reasonable pursuit of operational efficiencies.
 
I’m not saying it will happen, but making sure it doesn’t is a hell of a challenge. It’s not easy to be passionate about five brands at once.
 
SIDEBAR
 
Things to Watch
 
1)             Who’s going to run what brands?
2)             What will happen to Ride’s factory?
3)             What will be the fate of the Device step-in system and the lawsuit with Vans (Switch)?
4)             How will be product development be managed among the different brands?
5)             I’m sure we’ll figure out some more to add.

 

 

I Feel a Whole Lot More Like I Do Now Than I Did a Little While Ago; My Take on ASR

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I’m not entirely sure what the title of this article means, but I’m pretty certain it applies to the skateboard industry. Conditioned as I am by the snowboard industry consolidation, I went to ASR expecting to observe a similar process. Subjectively, it seemed like the show wasn’t quite so crowded, and things were more business like, but there weren’t dozens of companies missing and multiple unused booths. And there were some small companies saying and doing the kind of things that made me think they might be around a while.

 
Don’t get too excited. Not for a moment am I going to suggest that skateboarding is in any way immune to typical business cycles. But there may be some forces at work that will allow the process of industry maturation be a little less painful, or at least draw out the agony over a longer period of time. I’m not sure if that’s good or bad.
 
So here’s the plan. Let’s decide what we mean by “the skateboarding industry,” review how consolidating industries change, look at a couple of industry trends that may make it easier to deal with, and then, to conclude with a happy feeling, look at some of the positive things I think I spotted at ASR.
 
Who Are We?
 
This use to be easy to answer. A company in the skateboard industry was any brand or retailer that sold skateboards and/or any other hard goods. Probably they also sold some soft goods but, at least in the case of the brands, those tended to be promotional and if they happened to make money on them, great. Now you’ve got skate shoe companies and skate clothing companies and shoes and clothing are an important component of any retailer’s sales. Are they still skate companies?
 
When you sold a skateboard, you could reliably assume it was to somebody who was going to actually go skateboarding. That’s not so clear when you sell a pair of skate shoes or some skate clothing. I’m going to guess that an increasing percentage of non-hard goods sales are going to people who don’t skateboard. Are companies who don’t sell hard goods and who sell a bunch of product to non-skaters industry companies?
 
Have a great time arguing over that. Since I seem to have a 5,000-word story I have to write in 1,500 words, I’d better move on. The point I’d like to make is that the industry has evolved so that, for better or worse, it’s no longer just defined by people skate, but by people interested in the image, attitude and lifestyle of skating. And by companies with a lot of money who are having a hard time understanding the sport. I’ll get back to this when I talk about industry trends.
 
Trends in Consolidating Industries
 
I’ve said this all before. Just check out the sidebar to refresh your memories, think about it for a minute or two, and we can move on.
 
SIDEBAR
 
Changes in Consolidating Industries
 
·         More competition for market share. Competitors become more aggressive because they realize their survival is at stake.
·         New products and applications become harder to develop.
·         Dealer margins fall, but dealer power increases.
·         Industry profits fall during the transition period. Cash flow declines when it is needed most. Raising capital becomes very difficult.
·         There is the danger of over capacity and turning the product into a commodity (Repeat after me- “Blanks are sure swell!”).
·         A new basis of competition is required for successful companies, but past industry euphoria makes changing difficult.
·         There’s a bunch of irrational competitive behavior. “It won’t happen to me” is an idea frequently expressed by companies waiting for their competitors to falter.
 
Industry Trends and Circumstances
 
Not all the changes in consolidating industries happen at the same time to all companies. Nor do they all occur with equal strength. In skateboarding, there are a number of reasons consolidation doesn’t seem to be occurring in a textbook way.
 
The industry is not extremely seasonal.   Retailers aren’t being offered 120-day terms by manufacturers. There are no long lead times on making and delivering product.   Inventory turns, let’s say, four to six times a year (my guess). Manufacturing technology is simple enough, or well enough established at least, that no huge investments are required and yield is high.
 
All those things mean that the working capital investment required in skateboarding is comparatively easier to manage than in some other industries. So the financial pressures on marginal players is less. It also means that it’s easier to get in, and to get out, of this industry. Due to extreme seasonality and the timing of the product cycle, there was never a good time for a company to exit snowboarding.
 
I’m not suggesting that things are easy financially. Low hard goods margins, blank decks, and difficulty differentiating one company’s product from another’s means you have to spend more on advertising ad promotion exactly when margins are declining. That creates a bias in favor of larger companies that move more volume because it gives them more gross margin dollars to work with.
 
But maybe financial pressures will be increasing. I talked to one large company that sells skate shoes (among other things) at the show that mentioned how they were starting to offer 60 day terms to select retail accounts. And so it begins.
 
There is no leading, clearly dominant company in the industry. My guess is that the single largest hard goods company sells no more than $15 million annually in decks, wheels, and trucks. In snowboarding, Burton, with a market share in excess of 50% a few years ago, had the market leverage to set the bar for successful competitors. An awful lot couldn’t get over it. Nobody can set that bar in skateboarding at this time. It’s interesting to note that some of the larger shoe and soft goods companies appear to be at least double the size of the hard goods leaders based on revenue.
 
Skateboarding is operating in a roaring economy, with income and spending growing, interest rates low, lots of wealth created in the stock market and jobs for anybody who wants one. Now add to that 60 million young people between five and twenty born between 1979 and 1994. Levi’s, Converse and Nike aren’t cool any more. But their long-term success requires that they make an impression on this group, whose spending habits aren’t formed yet and the largest chunk of who are still ten years or so away from adolescence. So they are interested in skateboarding and other activities that are part of this group’s culture. Not because they want t sell skateboards- they could take the whole skateboard hard goods business and it wouldn’t have a material impact on their bottom lines- but because they want their involvement with the sport/lifestyle/attitude to give them credibility with this group.
 
The (Probably) Good News
 
So we’ve got a strong economy, favorable demographics for the next ten years or so, and big money interested in the sport.   For the reasons I mentioned above, the financial environment could be a lot more difficult than it is right now. That’s especially true if you define the skateboarding industry to include clothing and shoes- which, to answer the question I raised earlier, I think you have to do.
 
Some smaller companies seem to be making some good decisions. At ASR I heard people talk about cutting teams to get costs in line with measurable financial benefits. There were comments like, “I’m not going to run an advertising campaign that drives me into the hole financially.” People were acknowledging the similarity of products from company to company and being thoughtful about how to differentiate themselves from their competitors.
 
I suppose you’re only surprised by such common sense ideas and comments if you were around at the peak of the snowboard feeding frenzy, when it was grow at any cost, take market share, find money for just one more ad. The perception was that if you didn’t “establish your position” you were dead meat. That was true. But the cost of establishing your position was as likely to kill you as not establishing it. Turned out it didn’t matter how you died- only that you were dead.
 
Pay attention to the trends in consolidating industries, but recognize that the rapid growth, maturity, and consolidation cycle is more typical of emerging industries. Skateboarding has been around a while. Hard goods, clothing and shoes are all part of skateboarding, but each seems to be at a different point in the cycle. I’d look at them separately. The lack of a dominant company in the industry and the fact that the business isn’t extremely seasonal suggests that more players can survive.
 
In the past, the attention of large companies caused a severe decline in skateboarding. Given the demographics we’ve got, and assuming that skateboarding doesn’t become “uncool” who’s to say that the industry can’t continue to grow at a rate that lets it at least keep its existing percentage share of adolescent males? That doesn’t mean a hundred new hard goods companies. That could only happen if some product innovation lifted margins on hard goods to the point where new, smaller players could compete. I don’t see that happening and expect the lion’s share of any growth in skateboarding to accrue, at least in hard goods, to the existing, larger, companies.
 
Interesting stuff. Let’s talk about it at the Industry Conference in April.

 

 

Hung Over, Jet Lagged, and Sleep Deprived; A View of the Industry from 37,000 Feet

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The specialty shop in Vienna was all snowboards and snowboard products. It was mostly last year’s stuff and was all on sale. Word was that financial problems were preventing them from getting new stuff.

Over at a big Intersport store, there was just as much space devoted to snowboard products and the deals were just as good. I’d estimate that roughly the same amount of space was devoted to snowboarding. Thought under construction for the upcoming season, it appeared well laid out, and the people I spoke with seemed knowledgeable.  New product was arriving, and it seemed that only Burton had any hope of holding high price points. New product board pricing for many brands was either at the high or the low end. Last year’s product is apparently taking over as the mid-price product, and there were a couple of boards of almost any brand you could imagine (Heavy Tools lives!)
 
I’m crammed in this tourist class sardine can with circulation to my butt cut off, and for reasons explained by the article title, only half my neurons are firing, but I don’t think the retail situation in the US is much different from what I observed in Vienna. And it’s consistent with what the textbooks and my own experience tell me happens in a maturing industry. Brands either become specialty players with clear market niches or they are larger volume, lower cost producers. If you get stuck in the middle, you’re, well, last year’s board in perpetuity.
 
The Good, the Bad, and the Ugly
 
Apologies to Clint Eastwood, but sometimes when an analogy fits, you just have to steal it. In no particular order we’ve got four classes of snowboard companies right now. Morrow, Ride and Sims are one class- the three companies that are arguably large enough and have enough brand recognition to survive all as specialty brands.  Burton is a class by itself. Third are the brands owned by large companies; K2, Salomon, Rossignol, Nitro and Mervin. Apologies to anybody I missed. Finally, there are the smaller brands that I won’t list. In my judgment, most of them are looking at the same fate at Lamar or Silence. They have enough brand equity to be milked, but the time when they could hope to grow and prosper independently is past. A couple have always focused on being small niche brands, and may be succeeding at that.
 
Morrow, Ride and Sims (place politically correctly in alphabetical order) have all had well publicized financial, management and brand positioning issues. During the feeding frenzy of a few years ago, they all sought to increase their market shares by rapid expansion of distribution. In the process, either by use of multiple brand names or sales through the wrong channels, they got some volume but reduced their brand strength. The impact on their brand’s market positions didn’t become apparent until growth slowed and the torture of consolidation set in. They tried to get big and they tried to be specialty brands. It turned out to be hard to do both.
 
Burton is both large enough and well enough established as a brand that it’s fairly secure as the industry leader. The word “fairly” is thrown in there in recognition of that the fact that although Burton is by far the biggest snowboard brand with the most brand equity, it’s still tiny compared to some other companies involved, or trying to be involved, in snowboarding.
 
Burton did a lot of things right, but two things stand out. First, they were well capitalized when most of their competitors were struggling to find enough dollars to print a decent catalog. Second, the expanded their franchise quickly into soft goods and are shielded, as a result, from some of the hard goods pressures even they aren’t immune to.
 
The smaller brands I didn’t list fit into one of two groups. The ones with a problem are those who use to be more visible in the market, but tried to grow and compete- to be a Morrow-Ride-Sims you could say. Now, they don’t have the money to market their brands and grow. It may be too late to succeed at that strategy anyway. At the same time, price pressures have pushed down their margins, and they have to increase volume to be profitable. They are caught between the proverbial rock and hard place.
 
A couple of smaller brands, like maybe Never Summer and Glissade, have always been focused on being smaller niche players. With a connection to a particular kind of rider or a geographic area, they never tried to be big and so don’t have to be. Consistency in your approach to the market continues to be critical for success.
  
Being a snowboard brand owned by a larger company offers both some opportunities and some challenges. On the one hand, you have the “security” of being part of a larger organization. You share overhead. You don’t need your own warehouse and computer system. You can earn lower margins and still be successful. You have access to some distribution channels that may help make it a little easier to increase sales.
 
On the other hand, you are not one hundred percent a snowboard company and are, to a greater or lesser extent, subject to the ebbs and flows of the overall company’s fortunes. Snowboard brands owned by ski companies have been directly impacted financially by the declining fortunes of the ski business. At least they are still here as snowboard brands. But they aren’t snowboard companies, and it’s likely that there will continue to be some “creative tension” between the snowboard and ski sides of the business. Skiing and snowboarding still seem to be separate changes that don’t entirely understand each other. Some things never change.
 
Which gets us, happily, to the point of the article. As an aside, I’d just like to say that it’s always gratifying to get towards the end and find myself somehow wandering towards the point I started out to make.
 
Snowboard industry evolution is not going to go the way of the ski industry. That is, I don’t expect the industry to work its way down to only half a dozen brands. Snowboarding may have become part of the winter sports business, but it still has some uniqueness to it. Unlike skiing, it’s still driven by lifestyle issues. Music, clothing, attitude are all part of snowboarding. Companies that have ignored that have gotten their asses in a sling. Witness the rise of Forum. Theoretically, it shouldn’t have been able to get started against all the large players in the industry. It is apparently adequately capitalized, is growing at a manageable rate that insures some artificial scarcity, and has a focused market strategy. Confusion, chaos and mistakes by other companies created a market niche for Ride when that brand was created a few years ago. Trying to grow too fast, in my judgment to meet the demands of wall street, cost it momentum and legitimacy in the market it had originally succeeded in.
 
Now other company’s mistakes have created an opportunity for Forum. It will be fun to watch and see if they have learned anything from history- like not to get too greedy. Brand success in snowboarding seems to require meeting the market’s expectations, but not exceeding them. You have to leave the customer just a little hungry.
 
The other reason there is room for more than a handful of companies is demographics. In spite of crossover, in spite of the increasing age of the average snowboarder, this is still a youth driven business, and the demographics suggest it will stay that way for at least the next five to seven years.
 
Retailers probably have to not get too comfortable with the brands they are carrying. What’s hot and what’s not will keep changing. Brands have to keep focused on snowboarding no matter who owns them. People who write columns for trade magazines will have lots to write about.
 
Over the last couple of years, the term “core” is perceived to have lost some of the passion, importance and legitimacy that was once associated with it. But the sport still has its roots there. And it looks like it will for the foreseeable future. Successful companies will have to sell beyond that core, but always have a focus there. That’s our biggest challenge and the reason snowboarding won’t become the ski business.

 

 

Reality Bites; The View from ASR

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There was a keg at the IASC hospitality suite at ASR the first evening of the show, and I was drinking a beer with Miki Vuckovich of Transworld Skate and Jim Fitzpatrick of IASC. Into this fairly typical trade show experience walks the comedian Gallagher with his entourage of one. He sits down with his own beer and ten minutes later we’re talking about his new line of educational toys for children based on sub atomic particles and meant to teach them about nuclear physics, or something.

 
I thought the toy line was a good idea, but there was a certain sense of unreality to the encounter and discussion I guess because of the venue and circumstances. And I guess that’s how I’m going to segue into making that chance meeting relevant to ASR and the skate industry; good ideas with a sense of unreality.
 
What They Said
 
Almost every skate company owner/manager I talked with at the show had basically the same things to say. They were concerned with the state of the industry and overall competitive conditions. Specifically,
 
1.     Growth seems to be slowing and profits are harder to come by.
 
2.     Deck margins especially are declining due to blanks and oversupply.
 
3.     There are too many companies with no business reason to exist.
 
4.     There are too many wood shops with too much capacity.
 
5.     The companies that are investing in team and marketing and benefiting the industry are giving a free ride to the companies that don’t.
 
6.     The top five to ten companies in the industry ought to cooperate to stabilize and rationalize the industry, but probably won’t.
 
7.     Differentiating your brand is getting harder. You are faced with the need to spend more marketing dollars exactly when it’s toughest to afford.
 
What’s Been Said Before
 
What they said was pretty much the same thing that’s been said in every industry that has experienced fast growth followed by a period of maturing and slower growth. For example, Harvard Professor Michael Porter in his 1980 book Competitive Strategy said it.
 
Professor Porter who, I am quite sure, hasn’t spend much time skate boarding, took a whole chapter to talk about the transition from fast growth to industry maturity. He noted the following tendencies, and that they are more or less the same in every maturing industry.
 
Slowing growth, he said, means more competition for market share. Because fast growth is no longer supplying opportunities for growth, the focus becomes on attacking the market shares of others. Competitors can become more aggressive, because they realize their survival is at stake. There are lots of misperceptions and irrational retaliations for the perceived and real attacks of others.
 
New products and applications become harder to develop. Don’t look now, but basically a skateboard is a skateboard. My money is on the companies who are continually finding small ways to differentiate their products.
 
International competition increases, according to Dr. Porter. I recently talked with a French snowboard factory that’s started taking shop orders for decks. Easy business he says. He can make money doing as few as fifty decks for a shop.
 
Dealer margins, according to Dr. Porter, will fall. But at the same time their power increases. Kind of makes sense when there are more companies, more products, and less perceived difference among product. Companies looking for a survival strategy will offer retailers lower prices, discounts, maybe some increased dating on orders to try and generate cash flow. Great for the consumer. Not so good for brands and retailers trying to sell a specialty product at higher margins.
 
Industry profits will fall during the transition period, and the fall can be temporary or permanent. Cash flow declines when it is needed most due to lower margins and greater expense incurred in trying to provide better customer service and differentiate “me too” products. Raising capital becomes very difficult. Companies with the smallest market shares are the most affected.
 
There is a danger of over capacity as more and more manufacturers rush in to meet the seemingly endlessly growing demand for this hot product. Over capacity accentuates a tendency towards price warfare. The result I’ve seen with the snowboard is that it became something of a commodity. And there’s a lot more technology and actual product differentiation in a snowboard than in a skateboard.
 
At the end of all this, the whole basis of competition in the industry has changed permanently. The euphoria that can characterize a company’s management style during the fast growth period has to change. Doing more of the same won’t work anymore. When you could grow quickly, raise prices and have high margins you could get away with anything. Hey, cash flow can hide a lot of mistakes.
 
I don’t want to belabor the point, but you might also pick up a copy of the March-April 1997 issue of the Harvard Business Review and read Professor George S. Day’s article called “Strategies for Surviving a Shakeout.”
 
Now I know it sort of stretches the bounds of reality to talk about the Harvard Business Review and the skateboarding industry in the same breath. I talked with professor Day and I think I can assure you he’s never been arrested for skating the railings at city hall. I also know he’s not Richard Novak or George Powell writing under an assumed name.
 
So how come he’s managed to write an article all about the evolution of the skateboarding industry (even though he never uses the word)?
 
What Needs to be Said
 
There’s one, minor, inconvenient, sort of annoying, little fact that has to be faced. Please pay attention. That fact is that skateboarding is no different from any other industry in how it will go through its growth cycle. The companies in the industry will respond to changes in the competitive environment just like companies in any other industry.
 
Every company in the industry will do what it perceives to be in its own best interest. Each will create a projected scenario explaining how it will be a successful survivor while its competitors succumb to changing competitive pressures. Failing companies will resist closing their doors even when every objective analysis of their risk and potential return indicates that they should. Ultimately, only companies with a clear competitive advantage under the new market conditions will survive.
 
Each will truly want to support the industry, but won’t be able to agree with other companies exactly what that means. As a result the “you first” principal will tend to prevail and each will wait for somebody else to step up to the plate as the leader. That is probably inevitable in an industry where there is no clearly dominant company.
 
What Should You Do?
 
My suggestion is that you start by accepting two facts:
 
1.     The basis for competition has changed and is changing in predictable ways. The “good old days,” if they ever existed, aren’t coming back.
 
2.     Fact one is really important.
 
If you accept this, then it’s time to start recreating your business to succeed in the new competitive reality.
 
Begin by not chasing market share. Not that market share is a bad thing, but blindly chasing it in a competitive frenzy often leads to a financial disaster. Remember that any company can get one hundred percent market share- all they need to do is give away the product. Unless, of course, somebody else does the same thing, in which case I suppose you’d have to pay the customer to take your product. But hey, you’d have a big market share!
 
Which is a somewhat sarcastic way of saying that your competitive strategy has to be tied to your financial capabilities. Try this. Realistically, what can you expect your gross profit margin to be? What are your general and administrative expenses for the year? What do you need to spend on sales and marketing to have a chance at a viable marketing position? What other money do you have to spend on interest, taxes, commissions, etc? Now add twenty percent to your total estimated expenses for stuff you couldn’t have imagined would happen in your wildest dreams.
 
Given your gross profit margin and these expenses, how much do you have to sell to earn a reasonable profit? Figure it out right now, on the nearest available piece of paper. It shouldn’t take more than twenty minutes. Given the risk you are taking and how hard you’re going to have to work is your business a good deal? Can you sell that much? To give you some perspective, recognize that if you’re earning five percent before taxes, you could be doing just as well in thirty year U. S. Treasury bonds with basically no risk. And no effort on your part.
 
So make some hard decisions. Some business decisions. Don’t let the hype of a trade show substitute for sound business judgment.

 

 

Life in the Real World; Hoisted by My Own Petard

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I’ve had the luxury, over the last couple of years, to be able to dispense advice and commentary from the relative safety of an observer’s perch. Suddenly and, amazingly, of my own choosing, I’ve given up a perfectly comfortable life style to reenter the snowboard management fray. I must be out of my mind.

I’ve done this at a time when the snowboard industry consolidation, if measured by the number of companies, is probably entering its final year. But we’ve become part of the winter sports industry. That industry is going through some hard times, and the continued scurry to embrace snowboarding as its savior is perpetuating some tough and irrational competitive conditions that aren’t going away quickly.
 
When I last sat in the management chair, in the early 90s, industry conditions were, well, just a bit different. Remember when we could sell everything we could get made, there weren’t enough factories to go around, and raising prices ten percent each season was a no brainer? Ah, those were the days.
 
Since that move from management to consulting, I’ve dispensed a bunch of advice in this space. I trust it was at least worth what you paid for it. Four ideas have stuck with me.
 
·       Protect Your Brand Name
·       Know Your Numbers
·       Find a Niche
·       Don’t Kid Yourself
 
How has the relevance of these ideas changed as the industry has involved? Maybe more interestingly, am I taking my own advice? Let’s see.
 
Protect Your Brand Name; It’s All You’ve Got
 
I’m there. I get an “A.” Maximizing sales isn’t the goal. Increasing sales at a respectable rate, selling out every year and earning a profit is. Growing too quickly can mean lower margins and higher short term working capital requirements. Who needs that? The best advertising and promotion that can be done is the kind where the retailers says, “Say, I sold it all at full margin, and when I called to order more, they were all out!” Next ordering season the poor sales rep, with any luck at all, will find himself faced with having to control the increases requested by the shops to make sure they sell out again. And you didn’t spend a single marketing dollar to get that.
 
Then there’s the issue of gray market sales. Avoid them, I’ve said. It’s not that simple. Your distribution can get better year by year, but it will never be pristine. The impact on sales if you arbitrarily cut off all the sales that might be gray market could be too severe. Every snowboard brand has some gray market sales. Everybody. And I think most of us know where they are. When the boards are going to somewhere Hitler and Stalin fought a tank battle, it’s pretty clear they aren’t staying there.
 
Four or five years ago, brand name hardly seemed to be an issue. If it was a snowboard, it sold. With hindsight, it looks obvious that those who succeeded managed to grow while controlling their distribution and bringing some brand equity to their name. It was a fine line to walk. One the one hand, you had to get out of the awkward “tweens,” that level of sales between, say, five and fifteen million dollars where you needed to act like a larger company, but couldn’t afford to. On the other hand, if you tried to push sales too hard, your credibility as a brand suffered. To put it succinctly, you had to perform and grow according to the market’s expectations, but no faster. Too slow or too fast and you were toast.
 
So building your brand was just as important, and difficult, as it is now. It just didn’t seem quite so urgent.   
 
Know Your Numbers; Cash Flow is Everything
 
Opps- so far, I’m only a Cplus to B minus on this one. I’ve got the numbers thanks to some good systems and people. In fact, even as I write this they’re sitting on the desk next to me waiting to be studied, analyzed and dissected (“Crunch me, crunch me!” I hear them whispering). But I’m finding that management issues during the first month or so have left me with precious little time to spend the consecutive hours required to really get into them. I can wing it pretty well because I already know the financial model of a snowboard company, but that’s no excuse.
 
They are also not “my” numbers yet. They’re somebody else’s. Cash flow, I’ve said, is a living, breathing thing. By creating your own model, working with it and thereby internalizing it, you develop certain instincts for how the money moves through a business. In a highly seasonal business like snowboarding, there’s probably nothing more important than the dance of the cash flow. I’m prepared to give myself something of a break on this issue, because I haven’t really been at it long enough to have the necessary gut instinct for this particular company’s cash flow.
 
At a time when everybody is struggling to make a profit, and so few are succeeding, knowing and managing by your numbers should be at the top of everybody’s management priorities. It always should have been there. Five years ago, however, flush with high margins, soaring sales, Japanese prepayments and COD terms to retailers, knowing and working with your numbers didn’t seem quite so compelling. In truth, it wasn’t. You didn’t have to invest as much money, and you got it back sooner. Boy I miss the good old days, where various management miscues could be hidden behind ravenous product demand.
 
 Find a Niche; Know Your Customers and How You Compete
 
I can console myself on this one by remembering that when I gave the advice, I acknowledged that it was not a trivial thing to do. In fact, I said it was time consuming, detail oriented, hard work to really figure out who your customer is. I know the market niche and the basis of the company’s competitive advantage. But as far as what kind of consumers are actually buying the stuff, I haven’t even gotten around to asking the question. Let’s give me an incomplete.
 
And let’s acknowledge that it will always be an incomplete. The process will always be never ending, unless the market stops changing.
 
A niche, it turns out, is a necessary survival mechanism. The hundreds of companies who didn’t have one, or the basis for creating it, aren’t with us any more. Creating a niche is a long term process, and it was five or more years ago, when it didn’t seem to matter, that you had to have begun the process if you wanted a niche you could defend in current business conditions. Some companies found theirs, then lost it in the struggle between growth and credibility I described above. Some stumbled on it, and kept it in spite of themselves.
 
Don’t Kid Yourself; Make the Hard Decisions
 
The rumors are always worse than the truth. Ignoring it won’t make it go away. Change is easier when you make it before you have no choice. Bullshit is inevitably dysfunctional to an organization. Etcetera.
 
We kidded ourselves as an industry for a long time. Sure there was going to be a consolidation, but it would be somebody else who would be the consolidatee. We were brainwashed by the wonder years. No hard decisions required. We couldn’t bring ourselves to believe that snowboarding was just another industry, as susceptible to competitive trends as any other.
 
Guilty. Along with most of you. In my first snowboard management incarnation I was a believer. Even though I knew better from my experience in other industries. The excitement was contagious, the opportunity apparently endless. The bullshit smelled great.
 
Never again. I’ll have fun, but I won’t lose my perspective and objectivity. May I suggest that you shouldn’t either?
 
Well, I guess these four ideas have held up pretty well. They weren’t any more or less valid five or seven years ago then they are now. The irony is that in the past they were easier to ignore, but paying attention to them then might have made consolidation a little more manageable for some companies. Like compounding interest, little changes can have a big impact given the advantage of time.

 

 

News from the North; Lessons for the Snowboard Industry from Canadian Resorts

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Last April, I headed to Tremblant for the Canadian Ski Council’s annual symposium on the state of the Canadian resort industry. Naturally, my naïve anticipation of great snowboarding had nothing to do with my decision to go.

Groomed hardpack with mud and rocks sticking through on narrow runs wasn’t what I’d expected. Thanks El Nino. At least it motivated me to go to most of the seminars and presentations. Nor did I miss a single dinner or cocktail party. I’ll be there again next year even if the snow conditions are lousy.
 
One of the presentations I attended was by a gentleman named Richard Basford of Integrated Marketing Strategies. He’d conducted for the Canadian Ski Council their annual Skier/Snowboarder survey and was presenting the preliminary results. Here’s some selected survey results that really jumped out at me.
 
First, Richard said that about 20 percent of the Canadian resorts’ winter visitors were snowboarders. No big surprise there. Then he announced that out of 4,293 responses, only 7 percent considered themselves beginners as skiers (three times skiing or less) and 9 percent considered themselves novices. That’s a total of 16% of the survey that’s just starting to ski. 
 
Now, the numbers for snowboarding were, respectively, 36 percent and 17 percent, for a total of 53 percent who are starting to snowboard.
 
Only fifteen percent of skiers have been skiing for two years or less. The number is 69 percent for snowboarders!
 
Go back and read that again, please. It’s okay- I can wait.
 
By the way, I’m pretty certain that a similar situation exists in the United States. Jim Springs of Leisure Trends presented some numbers at the SIA show in Las Vegas this year that supports that conclusion.
 
I looked around the room at the group of Canadian resort managers and owners who were attending the presentation. They were all sitting there calmly. Nobody asked a question, fainted, said “Oh dear!” or anything. I wondered if they were all hopelessly hung over from the previous evening’s business meetings. Some of them were definitely moving, so they weren’t all dead.
 
If you put a frog in cold water and raise the temperature slowly they say he’ll boil calmly to death rather than jump out. That same type of behavior-denial and perseverance during a period of change- seems to be going on in the winter sports industry right now.
 
For me, that stark, black and white survey was kind of an epiphany.
 
If the number of people starting to ski is relatively low, the drop out rate among beginners is high,and the number of existing skiers is declining due to aging, how many skiers will there be in ten years? In twenty? On the other hand, the percentage of snowboarders new to the sport is high. I’ll bet that the drop out rate is lower than skiing. I’m confident we aren’t starting to retire from snowboarding because of age. Snowboarding is growing, though not as fast as it use to.
 
But snowboarding is only twenty percent of the total. For every twenty snowboarders, there are still eighty skiers. It’s not clear to me that the industry can rely on the growth of snowboarding to make up for the decline in skiing, assuming current trends continue.
 
Somewhere in the bowels of some ski manufacturer or resort group the trends I’ve alluded to have been more thoroughly quantified and analyzed. In a more formal and systematic way, they have reached the same conclusions I’ve reached. That’s why there’s a proposal for the resorts and manufacturers to fund a three-year, $57 million promotional campaign. That’s why summer activities, tubing and mini skis are being embraced and promoted. That’s why individual resorts are upgrading facilities and creating more terrain even as, overall, their financial condition is not improving.
 
What are the implications for the snowboard industry? Two main ones, I think.
 
First, while much of the expected consolidation, measured by number of brands, may be behind us, competitive conditions are still very difficult. The brands may be gone, but most of the production capacity, with its need to keep producing something, still exists. If ski companies can’t make money selling skis (one projection is for pre season ski orders for 1998-99 to be down ten percent or more) they are going to continue to flock to the growing sport of snowboarding.
 
The evolution of the snowboard industry from its entrepreneurial roots as a distinct sport and market to a part of the winter sports industry is already being confirmed by the market segmentation that is occurring. There’s no longer a bias against snowboards made by ski companies and, with the exception of Burton, the success of every independent snow board company seems to be an uphill battle. More and more boards are sold by large companies to which snowboarding is just one of a number of product lines.
 
This industry evolution is consistent with most business theories that suggest you must either compete on price, as a volume producer, or by defining a market niche that will allow you to sustain your competitive position even though you’re more expensive. But the explosion of quality product at lower and lower prices has made it tough to be a traditional niche player. If everybody’s product quality and pricing is basically pretty comparable, that leaves marketing as the primary way to differentiate your brand. 
 
The second implication for the snowboard industry is that what the resorts are doing matters. We’re past the point where just the fact that they let us on the lift is enough.
 
Resort shops are charging manufacturers for space and displays like grocery stores charging for shelf space. Exclusive deals are being made to supply rental fleets- witness Rossignol and Intrawest. Joint promotional efforts are becoming more frequent. It seems like “resort marketing” should start to be a standard category in every snowboard company budget.
 
The Canadian Ski Council survey provided some additional statistics. They may be important as snowboard brands consider their marketing position given the increasing importance of resorts in building a brand. Sixty percent of resort visitors won’t be staying over night. Half expect to board/ski for only one day on a given trip. Seventy six percent live two or less hours from the mountains they visited.
 
Perhaps this says something about the location of the shops snowboard companies should focus on. Maybe there are products that can be developed just for the day boarder. Maybe we should be providing benches and lockers, or at least having banners, in the day lodges.
 
I’m beginning to believe that snowboard brands should be interested in building relationships with some local resorts and sharing information with them for the benefit both of the company and the resort. I’d try and use the resort’s perspective, and information they would hopefully share on the composition of their visitors, to help me differentiate my brand.
 
We’ve all talked about our period of consolidation ending. If that is measured by stabilization in the number of snowboard brands, we can expect to be there in less than a year. But the end of the brand consolidation should not be assumed to imply a return to a more rational competitive environment.
 
The snowboard industry is not the distinct industry it use to be. It’s part of the winter sports industry and subject more than ever to the trials and tribulations of the ski companies and resorts.
 

We can learn a lot by looking at who’s visiting resorts and what they are doing while they are there. Maybe we can even help the resorts deal with some of their own competitive issues

 

Building a Business; Issues for Would be Skate Entrepreneurs

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When a market gets hot, people start companies.   Where the capital costs and entry barriers are low, they start more rather than less. When there’s enthusiasm for the industry and the lifestyle, they often start them for all the wrong reasons, and without adequate or any business planning. It looks like easy money, but it usually isn’t. 

 
Well, God bless naïve, enthusiastic entrepreneurs because if everybody understood the risks and stresses of starting new businesses, none would ever be started. I don’t want to discourage anybody from starting their business, but I’d like them to know what they are getting into, what’s going to happen if they have some early success, and why it’s too late to begin when the market is already hot. The genius of the entrepreneur is in starting his or her business before everybody else sees the opportunity.
 
Just for fun, let’s say you want to start an independent street shoe company. Now? Today? Okay, okay, stop laughing. Pretend it’s two years ago.
 
In the Beginning
 
You’re a sponsored skater with a good reputation, and a following among local retailers. You don’t like the shoes available to you. Conversations with retailers you know make it “obvious” they’d be receptive to some new colors and designs. Response to your color sketches and description is positive. “Cool! We’ll buy them for sure,” they say almost without exception.
 
“Kaching!!!” you think. Easy money, here I come. Not that anybody gets into the business for the money of course…….
 
Let’s make this simple. Magically, you’re through the product development cycle and are ready for production. You did all the work yourself.   A friend introduces you to a manufacturer who loves you and your shoes so much he agrees to produce a thousand pairs with no up front money and to give you 60 days after delivery to pay. Orders from some retailers materialize, though not from everybody who said they would buy and not always as large as you’d like. You successfully grovel, taking the “I’m just a poor skate entrepreneur” approach to your new customers, and they reluctantly agree to pay you cash on delivery.
 
Your shoes arrive on time (right). All the people who said they’d buy your shoes buy them (sure they do). They all pay you cash as promised (uh-huh). You put the money in the bank and earn interest until you have to pay the factory that made the shoes for you. The shoes all sell through great (of course). Reorders flow in like water over Niagara Falls during the rainy season. What a terrific business this is. Here’s what your income statement for this little business looks like after the first 1,000 pair.
 
Net Sales                                                          $25,000            
Cost of Goods                                                  $15,000
Gross Profit                                                      $10,000 (40 percent)
 
Operating Expenses                                          $2.000
 
Pretax Income                                                   $8,000
 
Remember that everything went perfectly. Also, you worked for yourself for free and did everything yourself. Your operating expense was almost all for travel and communications. At the end of the day, you’ve got yourself a nice little 32 percent profit margin. Isn’t that wonderful!
 
Having run a distributor that was selling imported product, I am here to tell you that everything working right is a full-on, drug induced, hit your head while skating without a helmet, hallucination.
 
But it’s a great hallucination to have, so let’s assume it continues except for a couple of little things. You’re so hot that your next order is for 10,000 pairs.
 
The Next Step Up
 
Your supplier still likes you but, hey, this is business. With an order that size, he wants a letter of credit or a deposit up front, and you’ll have to pay him the balance when he ships the shoes. Remember, though, that this is a hallucination, so he gives you a break and says you just need to pay him when the shoes ship.
 
Your retailers still like you but, hey, this is business (you’re starting to hear that a lot as your company grows). They want 45 -day terms just like they say they get from the other companies. The 10,000 pair cost you $150,000 including freight and duty.  Your supplier says, “I’m ready to ship, send the money.”
 
Details like this can really put a damper on perfectly good hallucination. The bank won’t lend you any money, your credit card limit isn’t quite that big and none of those lottery tickets you’ve bought have been winners. You need $150,000 or you’re out of business. Let’s assume somebody comes along and lends you the money for only an exorbitant interest rate and doesn’t want 50% of the equity in your company to do it. Remember, this is a pleasant hallucination.
 
The shoes are delivered to you and, in turn, to your customers. You’ve sold the shoes, you’ve got the same 40 percent gross profit that you had when you sold 1,000 pair, but this time it’s 40 percent of $250,000 or $100,000.
 
Inconvenient Realities
 
The expense side looks a little different though. You had to get some help warehousing and delivering the product. Retailers want some service so you need some phone lines and somebody to answer them. Some promotional product has to go out the door for free. The guy you borrowed the $150,000 from wants interest. You’re still making money at the bottom line, but that 32 pretax margin has evaporated. Maybe if you’re lucky it’s still as high as 15 percent but heading south fast as you become an established company.
 
Oh, and by the way, you’ve got no cash. You retailers aren’t paying you for 45 days and, strangely enough, not all the cash shows up exactly on the 45th day. But the people you’re hiring to man the phones and deliver the product don’t seem to want to wait 45 days to get paid. It’s the lament of the entrepreneur to their accountant- if I’m making so much money, how come I can’t pay my bills!?!?!?!
 
Now, awaking from our dreamlike state, we find that the supplier wants a letter of credit before he’ll produce any more, and the order isn’t really big enough to get his attention anyway. Retailers are asking about your team and your promotion budget. Some shoes sell and some don’t. Certain retailers you really want to be in want a credit for the ones that haven’t moved. There’s so much to do that you need to hire more people to help you. The government wants you to fill out a bunch of paperwork, and they want their piece too. You’ve got every cent you can find invested in the business and it’s barely enough-for the moment.
 
Congratulations- you’re no longer an entrepreneur, you’ve a manager. Overall, your income has increased. But your net margin on each pair of shoes sold has declined as the cost of running the business gets bigger.
 
You didn’t do anything wrong. This is all normal stuff. Every time volume increases and margins decline, more working capital has to be invested in the business. Working capital is nothing but the money you have to spend to pay bills, get product made and market your brand while you wait for retailers to pay you. Almost every successful, growing business I’ve ever seen has working capital crunches as a normal part of growth.
 
Managing by the Numbers
 
What can you do to avoid this financial hang grenade?   Nothing. It comes with being in business. But you can try and minimize its impact by a little planning. Do it on a computer or with a piece of paper. Here’s a format I’ve used with some success in a variety of businesses. Don’t get fixated by the categories I’ve used. Change them to work for your business.
 
                                                            Jan.      Feb.     March. Etc.
 
Beginning Cash Balance
Sources of Cash
            Cash Sales
            Collection of Receivables
            Borrowings
            Other
Total Sources of Cash
 
Total Cash Available
 
Uses of Cash
            Product Purchases
            Payroll
            Rent
            Utilities
            Advertising
            Phone/Fax
            Etc.
Total Uses of Cash
 
Ending Cash Balance
 
The beginning cash balance is probably whatever is in your checking account. The ending cash balance each month becomes the beginning cash balance for the next period. Depending on how quickly your situation is changing, your estimate of expenses can usually be based on your historical experience. But remember that just because you get your phone bill in July doesn’t mean you pay it that month. Typical many of your operating expenses will be paid in the month following receipts, and your cash flow has to take this into account.
 
Don’t get too caught up in the process of creating a perfect model. Get it done and work with it. Modify it as you learn more. Look at your projections versus what actually happens. Creating the model isn’t really where you get the benefit. Using it and watching the variables change with each other is.  It’s a lot like learning a language. You only get better with practice and as soon as you stop speaking it, you start to lose it.
 
Rules to Live by
 
Rule one, then, is don’t try to grow your business faster than you can finance it.
 
Rule two for the budding skate entrepreneur is to know the difference between starting a company and running one. Get the help you need.
 
Rule three is that it’s easy to sell when you’re new and small, and harder as you grow. Know how you’re going to compete.
 
Follow these three rules and maybe the glamour of having your own company won’t wear off so quickly.