Zumiez’s 10/31/06 Quarterly Report: Pretty Much Nothing But Good News

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Well hell, this is a lot more fun when there’s something negative or at least controversial to gossip about. All I’ve got to go on is the 10-Q for the quarter ended October 28th and things seem awful solid. No executives fired. Sales growing, margins holding up, no interesting litigation. You might as well go read another article.

Net sales for the quarter were up 43.3% to $82.3 million. Comparable store net sales were up 10.7% compared to being up 9.8% in the same period the previous year. So not only are same store sales growing, but they are growing faster than they were in the same quarter last year.
 
Gross margin fell from 37.3% in same quarter last year to 36.8% in the quarter ending October 28th this year. For nine months, it’s up to 34.6% from 33.8%. They explain the fall in gross margin for the quarter as being “due primarily to occupancy costs related to the 32 new stores we added in the three months ended October 28, 2006 compared to 14 stores added in the three months ended October 29, 2005.”
 
That’s easy to quote. What does it mean? You open all these stores. The occupancy costs begin immediately. Landlords are funny. They want to be paid every month no matter what you sell. On the other hand, the customers may not rush in quite as quickly as you want. If, therefore, you include certain occupancy costs for new stores as a cost of goods sold, you are going to reduce your gross margin a bit if you are opening a lot of new stores.
 
Interestingly, Zumiez states that the way they calculate cost of goods sold may not be the same as the way other retailers do it. They kind of go out of their way to do that. If you know much at all about accounting, you know that while there are rules, there are often choices, or maybe judgments is a better word, to be made about how to account for things.
 
I have the perception that Zumiez has been mindful and focused on the choices they have made when they set up their accounting system. I’m guessing it’s contributing to their success. We can tend to look at our accounting system as a necessary inconvenience and generally a pain in the ass. A good system that gives you the management information you need to make decisions is as important as your brand image. No, I don’t think I’m overstating that.         
 
They also said their gross margin had been reduced by their “stock based compensation expense.” That is, the value of certain stock options has to be included as an expense. This is the first October quarter in which accounting standards have required that be included as an expense.
 
These costs that reduced gross margin were partially offset by an increase in margin because their larger purchase volume allowed them to get better prices from vendors. I’m sure we’re all stunned to hear that.
 
They also said gross margin was positively impacted by lower markdowns because of less aged inventory (an indication of good purchasing) and “our ability to leverage certain fixed costs, such as distribution, and product teams over greater overall net sales.”
 
The balance sheet is strong, though their cash and marketable securities have declined and inventory has grown, consistent with their growth including the acquisition of the twenty Fast Forward stores.   I mean, financing growth is what they had those liquid assets sitting there for.
 
Net income for the quarter grew 29.3% to $6.83 million, or from $0.19 to $0.25 cents a share before dilution. Net income as a percentage of sales was 8.3%, down from 9.2% in the same quarter last year. 
 
I’ll be waiting to see Zumiez’s filings in the next couple of quarters. It will be interesting to see if any of the issues impacting other public action sports companies will affect Zumiez. Right at the moment they are kind of in their sweet spot in terms of their size and growth. Hopefully, they can continue that.

 

 

Make Love, Not War; Blanks and the Park and Recreation Convention. What’s a Skate Brand to Do?

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First time I’ve ever had two subtitles. That must be meaningful. Either I’ve been thinking a lot about this, or I’ve got nothing to say and am desperate to use up space. I suppose each reader will decide which it is.

 Not long after I read Cullen Poythress’s article “The War on Blanks” in the September issues of this publication, I went to the Park and Recreation Convention here in Seattle. Basically this is the convention of people who sell stuff to playgrounds, and I can only say that I wish I was a kid again. Lots of cool stuff that’s beyond what I could have imagined when I was of an age to use it.
 
I saw Per Welinder from Blitz there, manning the IASC booth and promoting skate parks. I walked around a corner and came face to face with Beau Brown, formerly of Sole Tech and now COO of Radius 8, a seller of portable skate ramps. His face was all aglow from the huge number of business opportunities he thought he had at the show. As we talked, a guy from some municipality came up and, apparently amazed to learn that portable ramps existed, asked how quickly he could get some. He guessed at the price, kind of suggesting that one might cost $3,000 as I recall. Beau, who seems to have a nasty ethical streak he needs to get over, told him that no, the one he was looking at was only $300. The guy scurried away to get his boss.
 
Anyway I know this article is about something besides vignettes from a trade show. I guess I’ve got to go back to Cullen’s article to get to it.
 
I thought it was a good article. Balanced, dispassionate, and talking about an important issue. I would have liked to see some numbers comparing costs, prices and margins on blanks and branded decks, but that was really my only criticism of the article. And I agreed that the brands are critical to building and supporting skating and that blanks undercut their financial ability to do that.
 
I talked to some other business people in the industry who seemed to share my perspective, and were as surprised as I was by the outpouring of concern and criticism the article engendered. That got me thinking and the convention helped that thinking to jell.
 
What would I do if I was running a skate brand?
 
Congratulations!
 
First thing I’d do is recognize that I’d had something to do with skateboarding having broken through and becoming a growing, recognized, and broadly accepted activity. I’d made some money, had some fun, and did it while being involved in something I loved. I’d helped position skateboarding so it probably wasn’t in danger of disappearing like it nearly has before.
 
Good stuff.
 
But after the sweet glow of success had worn off, I’d recognize that the “good old days” weren’t likely to come back, that blanks would be here to stay as long as skaters wanted to buy them, that hard good brand have had a hard time being successful in shoes or apparel (Fallen and Element are the exceptions I can think of), and that the financial model in the “core” part of market, where most hard goods brands are positioned, has gotten tough.
 
And that’s bad stuff.
 
But you know, it’s just business. And when an industry evolves, as it always does, the question isn’t usually how do you turn back the clock, but how you react to the new circumstances to make your business successful. I’ve got a couple of ideas. Maybe not the best ones, and certainly not the only ones, but you got to start somewhere.
 
New Areas of Focus
 
In 1995 I wrote in TransWorld Snowboarding Business (May it rest in peace) that it was time for every serious snowboard brand to hire a Director of Resort Relations. In what can only be characterized as a flash of brilliant insight I said, “Uh, don’t a lot of people snowboard at resorts? Maybe you should be doing something with the people who run them.”
 
I know that people do an awful lot of skating at places other than skate parks. I wouldn’t begin to try and estimate how much skating is done where. Still, the skate industry is doing everything it can to support the improvement and growth of skate parks. There must be some business opportunities there.
 
How about appointing a Director of Skate Park Relations? That person might start by identifying the 100 most important skate parks in the country. Find somebody who regularly skates each park. Make him/her your representative. They get free equipment and a commission on anything they sell at the park. I’ll bet you’d find a few who would really shine. They might find kids they know who would take responsibility for smaller parks in their area. Hell, pretty soon you’d have the Amway of skateboarding going on.
 
Consider creating a Director of Park and Recreation Commissions Relations. Visit the people who run them. Find out their level of commitment and plans for skating. See how you can help them. Help them make good buying decisions. Offer to sell them some decks co branded between your brand and the new park. Call Microsoft and see if they’d pay to have the Xbox logo on the bottom of a skate bowl, and keep a piece of the action while helping the Commission pay for part of the cost of the park.
 
I have no idea what opportunities there might actually be, but I bet 20 meetings with different Park and Recreation Commissions would turn some up. It’s worth a try. If you’re already doing it, never mind.
 
Improving Brand Positioning
 
It’s all about your brand. At the end of day, still lacking any meaningful product differentiation as perceived by consumers, your brand is all you have. Skate companies may be well positioned in the core skate market. But I think that market is a shrinking percentage of the total skate market as I would define it.   Taking advantage of skate’s growing, and more diffused, audience requires you to expand your market positioning.
 
The people who skate, or who just like skate, but are outside the core market need to know who you are and understand why you are credible. How do you do that? Depends on your brand. I’d suggest you start by studying other companies who have done it. How does Reef manage to sell its sandals at Nordstrom and still be a core surf company? Why can Burton sell its hard goods almost anywhere and still be so credible in snowboarding? What’s Volcom’s plan for expanding its very successful franchise without losing its core credibility? How do the skate shoe brands do it?
 
Now if somebody was to say, “It’s not the same. Skate is different,” I’d probably agree with you but with two caveats.
 
First, it’s never the same. Nobody’s business model is ever exactly the same as your’s and soft goods are different from hard goods. But these companies have made, or all still making I guess, a transition that skate companies probably need to make. So you might think about how they’ve done it.
 
Second, skate is different, and that’s part of the problem.   It’s different enough that it’s impeding the ability of brands to break into the wider skate market. Over twenty plus years, skate brands have made an implicit decision to stick to the core market. For the longest time, there wasn’t much to decide because that was the whole market. Now it’s not, and there are two choices.
 
You can stick to the core market and figure out ways to get skaters to buy more branded product. Or you can do what other successful action sports brands have done and expand your brand’s recognition and franchise to the larger market you’ve helped create. Any skate brand that was able to do that could be successful in the soft goods market. The Tony Hawk brand comes to mind.   
 
If you study the action sports brands that have made the transition to the broader market, the first thing you will notice is that none of them did it quickly. They were all around years before it happened. At some point in the action sports business, when you’ve been around five years or maybe longer, it’s suddenly possible for you to expand your distribution without losing your credibility with your historical customer base. Skate brands mostly qualify from this point of view and then some and that’s good news.
 
I was talking to Jamie Stone at TransWorld on another subject and he had what I thought was a good idea about building skate brands. Jamie’s concern was that pro graphics were changing too quickly. There was never a chance for the skater to build a bond among the brand, the skater, and the graphic. “What if the graphic lasted a year?” Jamie asked. “Then wouldn’t you have a chance to build a marketing campaign around it?”
 
Good question. It reminds me a bit of when the snowboard companies kept expanding their lines in response to what their competition was doing. They were focused on their competitors- not their customers.     
 
I hope there’s a strategy that reverses or at least halts the rise of blanks and shop decks. I know the industry is working hard to find one. But I came out of the Parks and Recreation Convention blown away with the new opportunities there can be for skate brands. Think about it. And go to that convention next year.

 

 

The Relationship Between Marketing and Business Risk; Do One and Reduce the Other

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Have you ever noticed how often the group of people who create ads, run promotions, and manage sponsorships are called the marketing department? That’s always struck me as kind of odd. I think marketing is the process of figuring out who your customer is, or can be, and why they buy your product. Advertising and promotion are the tactics you use to reach and attract those customers after you’ve reached some decisions about your customer based on your marketing.

I suppose it’s so obvious it shouldn’t have to be said, but if your advertising and promotion isn’t based on solid marketing you can spend a lot of money and damage the only real asset you have in this business- your image. We’ve all seen retailers and brands do it.
 
The thesis of this article is that good marketing reduces business risk and the perception of business risk, perhaps helping you to think in a way that facilitates recognizing new customers and markets.  It’s critical if you’re shop or brand is going to stand out in a crowded and highly competitive market.
 
The Status Quo and Its Downside  
 
 Right now, in this industry, everybody pretty much does the same advertising and promotion stuff. You all know what’s on the list of the ways we compete and I won’t bother repeating it here. I recognize that sometimes somebody’s ad is cooler than somebody else’s, or a particular team rider breaks out from the crowd for some period of time. But at the end of the day if we’re all doing the same stuff, and our products are more or less all the same, how do you, as a shop or a brand, break out from the crowd?
 
Answer- you don’t. If you’re doing the same as everybody else, and your product is no better, the best you can do is to be as good as they are. The exception, of course, is that you can do more of what all the others are doing. It may not be better or different, but it has an impact. But to do more, you have to have more- dollars that is. Then it’s only the big guys who win.
 
It probably hasn’t escaped your attention that the big are getting bigger and controlling more and more of the market. I’m suggesting that’s inevitable- in any industry- if, lacking solid marketing, the only basis for doing better over the long term is to spend more on advertising and promotion and cut prices. That tendency is exacerbated by the fact that it’s the larger businesses that are most likely to really do good marketing.
 
The Perception of Risk
 
I suppose this article had its genesis over a year ago when I talked to Santa Monica based ZJ Boarding House co-owner Todd Roberts at ASR. In the course of talking about a whole bunch of stuff, we got around to the ongoing travails of smaller retailers and what they needed to do. Todd said, “Jeff, you can’t be afraid to take some risks.”
 
I thought he was right. Still do. But at the time, I didn’t know where to go with it. It didn’t seem useful to say, “Take more risks!” unless I could explain why the risk was worth the potential payback and how it could be controlled.
 
Still, it seemed an important point, so I put it in whatever the part of my brain it is that holds ideas to be thought about and addressed later. It recently popped out more fully formed.
 
In helping businesses in this industry manage transitions, I’ve known for a long time that we all, including me, like to do what we’re comfortable with and have done successfully in the past. It’s human nature. So we go with the flow in running our businesses, following the annual schedule for developing ads, sponsoring events, attending trade shows and all the other stuff. It feels low risk, doesn’t it? That’s because it’s what we’ve always done.
 
Conversely, from time to time, really new ideas for advertising and promotion come across our desks. But they don’t fit our frame of reference. There isn’t a place for them in the annual advertising and promotion schedule. Other companies aren’t doing them. Doing the new things seems risky. Doing the same old stuff doesn’t.
 
Granted, it’s also a matter of available funds. It’s much less risky to do something new when you don’t have to cut out something old to try it. Another advantage to bigger companies with strong balance sheets.
 
We tend to perceive low risk in doing what we’ve always done. We perceive higher risk in doing new things. I think it’s the other way around. Industry conditions and the difficult competitive environment require that you do some of these new things if you are going to succeed. If you don’t, you have no opportunity to be better than anybody else.
 
And that gets us to marketing as a competitive tool, a money saver, and a way to fix your perceptual problems.
 
Doing Marketing
 
Sometimes I just have good karma. I’d been working on a talk I had agreed to give on how we compete as an industry and how we can do it better. Before I finished preparing, I flew off to ASR. I walked into the room late, but managed to hear most of Mikke Pierson’s (the other co-owner of ZJ Boarding House) talk on how to utilize your data base effectively. I know this article is turning into a damned ZJ Boarding House promotional piece, but sometimes you just have to go with the flow.
 
So here I am, thinking about how the industry competes, why brands and shops need to take some risks, and why they often seem reluctant to do it. Having managed to put off my article deadline until after ASR, I was getting desperate for a good way to tie this all together in the real world.
 
And Mikke saved my ass.
 
To make a longer story short, he said, “We spent $4,000 with Customers First to clean up our mailing list and plot our customers on a map so we knew where they were coming from. We did our usual promotional mailing at a cost of $16,000 and it generated $135,000 worth of business. The cost of doing the mailing was a whole lot lower because we knew who we were mailing to and why. We didn’t have to pay the post office for returns, and we didn’t waste money on duplicates, people who weren’t interested, or who were too far away to come to the store.”
 
The $4,000 spent with Customers First is real marketing. And I want you to notice the following things.
 
  • It wasn’t some esoteric, company wide, long term, epic undertaking that produced a ream of data that nobody knew what to do with. It was practical, cheap, quick, and the return was immediate and measurable.
 
  • It reduced risk. They knew much better who they were doing a mailing to and why. Maybe just as importantly, it also reduced the perception of risk.
 
  • It generated additional sales- quickly.
 
  • It didn’t cost them money- it saved them money.
 
  • It wasn’t some change of direction, risk the company strategy. It was a fairly minimal, common sense sort of thing. If it hadn’t worked out they would have been out $4,000 and a little time and would have learned something.
 
  • It focused on their customers- not on their competitors and not on the industry.
 
What I said I was trying to do at the start of this article was demonstrate the relationship between marketing and business risk. The relationship is both perceptual and practical. Good marketing reduces your business risk. It also reduces the perceived risk because your actions and decisions are based on good data. That means you are more willing to try some new things.
 
And I don’t think you have much choice. Focus on your end customer and why they buy from you. Think of a dozen questions you’d like to have answers for and how those answers would make it easier to reach those customers. Answer just one and see what you can do with the information. The risk of not trying is just too big. Like Walt Disney said, “You don’t build it for yourself. You know what the people want and you build it for them.”

PacSun Quarter and 9 Months Ended 10/28/06- Good Tactics. What’s the Strategy?

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         Pacific Sunwear’s (NASDAQ: PSUN) official SEC filing isn’t out yet (I’m writing this November 26 because I love working Sundays), but I’ve read the press release, reviewed the associated financial statements for the quarter and nine months ended October 28, and listened to the conference call. Let’s look at the numbers first, and then talk about the conference call.

 The Numbers
        The quarter showed a slight decline in sales from $377 to $375 million. But gross margin fell from $144 to $106 million—or from 38.2% to 28.3%. Selling and General and Administrative expenses rose from $81 to $93 million. Net income fell from $40.5 to $9 million or from $0.54 to $0.13 per share on a fully diluted basis.

         On the balance sheet, the current asset fell from 3.45 a year ago to a still strong 2.34 at the end of this October. The only other thing I’d note from the balance sheet is that, even after a write down, inventory—at $253 million—was still nearly $10 million higher than a year ago.

         In the mix was a same-store sales decrease of 6.7% and the ten cents a share inventory write down—primarily for footwear and accessory categories. The CEO resigned and was replaced by Company Lead Director Sally Frame Kasaks as interim chief executive officer. At different times in her career, Ms. Kasaks was Chairman and CEO of Ann Taylor Stores, President and CEO of Abercrombie & Fitch, and Chairman and CEO of Talbot’s, Inc. I think we can conclude she knows a bit about specialty retailing.

         With financial results like that, the stock must have cratered, right? Nope. The press release was dated November 9. The stock closed that day at $17.27. The next day it rose to $18.56—a 7.47% gain on volume that was 3.76 times the average volume. The company’s most recent closing price as I write this was $19.48. The conference call was held on the November 10 at 5:30 in the morning Pacific Time. No, I did not listen to it live.

       Clearly some people were pleased with what they heard on that call, and maybe had been expecting quarterly numbers that were worse than they were. But what made them so happy?
 
The Conference Call
        I wish they made transcripts of conference calls available or—if they do—I wish I knew where I could get them. Trying to write down all the good things Ms. Kasaks said they were doing as quickly as she was talking was a real pain in the butt. I kept trying to stop and restart the replay, but Media Player isn’t built for rewinding fifteen seconds. And another thing, left-handed people with lousy writing should not be allowed to own fountain pens—much less try and take fast notes with them. Uh, I seem to have gotten off track.

         Anyway, Ms. Kasaks highlighted three key big ideas for Pac Sun to focus on. They were:
      1. A commitment to build the juniors business to increase sales and store productivity.
      2. A focus on improving the in-store presentation of merchandise.
      3. A strategic assessment to understand how they can reconnect with their customers.
 
These three big ideas followed a list of initiatives Pac Sun was undertaking. I want to quote one of those initiatives: “Put more focus on transitional merchandise with the implementation of our spring floor set at the end of January. This will insure that our spring product is presented earlier than last year while being merchandised with more wear now product than in the past.”

         I thought this initiative required a little explanation and discussion.
 
Transitional merchandise is product that’s brought in during one season (winter in this case) and can be worn in that season, but can also be worn during the upcoming season (spring). Sweaters in spring colors might be an example. You sell it now and wear it now—but they carry over into the next season.
         The reason you do this is that it has the potential to improve your sales in the existing quarter. The danger is that if you don’t do a really good job in selecting merchandise, picking the right quantities, and merchandising it well, you may get to the next quarter with assortments that are old.
         In other words, at the extreme, you could theoretically end up just transferring sales from one quarter to an earlier one. PacSun spent some time on its conference call discussing some issues in just these areas, so it will be interesting to watch them implement this initiative.
         I think there were seven initiatives in total, including the one I quoted above. Somehow, I’ve managed to write down nine. I was either listening too slowly or writing too quickly. They included a review of the company’s customer communications program and in-depth customer research. Other initiatives will focus on inventory and in-store presentation. They want to reduce inventory density in their stores “to provide assortment clarity and in store presentation.” They noted a decline in their sneaker business and have plans to improve their assortment.  They will review it “to be in line with customer preferences.”
         They have plans to improve their merchandise presentation “without undertaking a major investment in time and capital.” They are utilizing something they called a “refresh” format that involves certain new design and layout elements. And they’re trying to improve the process by which they update their monthly floor sets.
         Due to time and cost constraints, you can’t wave a magic wand and have all 1,169 stores (835 are PacSun) updated. They are working to figure out what seems most likely to work and to implement the changes as time and capital permit. They are developing a new logo and new layout that provides what they characterized as a much more sophisticated look, and expect to do 30 to 40 remodels utilizing this concept next year. Sounds like the right direction and right process to me.
         That they are doing this isn’t a surprise to anybody who has been in a PacSun, Zumiez, and Hollister store lately. In Hollister, there’s a certain calmness that makes you feel like you’re on the beach. Their attempt to connect to the surf market—and they seem to do it pretty well—is clear. Zumiez carries hard goods. That has given them credibility in the market even as their store numbers expand. PacSun has the right brands and competitive prices but needs, in the words from the conference call, “To understand how they can reconnect with their customers.”
         During the conference call, Ms. Kasaks acknowledged that she doesn’t think PacSun can be authentic at their size. While that may cause a gasp of dismay and prognostications of their demise in some action-sports circles, I found it refreshing. It’s inevitably true for a company with this many stores. So you recognize it, work on evolving your inventory and your look, and undertake a strategic reassessment.
         So what’s the strategy? That’s what PacSun management is figuring out. They’ve done an awful lot in three months. They’ve been open about their issues and have moved to implement tactics that address them. I can’t wait to walk into one of their remodeled stores and see where the strategic reassessment came out. In the meantime, we’ll all keep watching PacSun as a barometer of what’s happening in the broader lifestyle market and worry about how their initiatives impact orders and sales of our brands.

 

Globe Annual Report and the Pacific Brands Deal

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Being traded on the Australian Stock Exchange, Globe doesn’t have to file the usual reports with the Securities and Exchange Commission here in the U.S. But they did file an annual report (109 pages, but happily for me full of pretty pictures and big type) and, in conjunction with the announcement of the pending sale of its Australian and New Zealand street wear apparel division to Pacific Brands for a maximum of $42 million Australian Dollars, it was worth taking a look at.

 
By the way, all the numbers in here are in Australian Dollars. Currently, an Australian Dollar will get you about $0.76. Do your own math. Oh, and just so I don’t have to say it continually, Globe’s fiscal year ended June 30, 2006. The annual report was released October 13th.
 
The first thing I want to say is that I like these guys. I mean, thanks to them, I now know how to bounce quarters into a glass. You know who you are. Maybe more importantly is that I love any management that starts off its annual report directly and honestly with the Chairman and CEO saying, (I’m paraphrasing here) the first quarter in North America really sucked, but the brands are in better shape and we’ve got our financial and management ducks in order, but we didn’t make as much money this year as we’d hoped. All you can ask of any management is competence, honesty and integrity.
 
Sales fell in 2006 from $204.5 to $197.3 million. Net Income dropped from $3.3532 to $0.471 million. There’s no way to make that look like a good result. However, the improvement they talk about in the annual report is better seen in the cash flow. There we see that in 2005, operations used $7.381 million in cash. In 2006, operations generated $2.780 million. And that is almost entirely the result of increased receipts from customers. That’s a good thing, and suggests they are doing all the appropriate management things that a company has to do when things aren’t going its way- controlling inventory, collecting receivables, being tough on spending. Let’s see if the balance sheet bears that out.
 
Inventories and receivables both down a bit. Good. Payables down almost $10 million. Great. Current ratio went up from 2.43 to 2.83, a 16.5% improvement. That’s a strong current ratio. My only caveat is that a current ratio is as of a moment in time (June 30 in this case) and seasonality, to the extent Globe has it, can wreck havoc with that. As a former President of a couple of snowboard only brands, I am justifiably paranoid about that.
 
Meanwhile, back on the cash flow, I see that Cash Used in Financing Activities fell from $11.1 to $0.3 million. Of course, $8.3 million of those savings came from not paying dividends in 2006 that they paid in 2005 and I suppose the people who use to get those dividends aren’t that thrilled, but I imagine it was the right thing to do.
 
The bottom line is that while they used $22.2 million in cash in 2005, they used only $3.0 million in 2006. The conclusion? They responded appropriately to their business conditions, but now they have to improve their bottom line by selling more at better margins.
 
There’s a limit to how much you can accomplish that by controlling spending. So they are taking the strategic step of making the apparel sale to Pacific Brands. The brands being sold “…include Mooks, M-ONE-11 and Australia and New Zealand licensed brands together with eight concept retail stores in Melbourne and Sydney and two Direct Factory Outlets stores,” according to the Melbourne newspaper The Age. The same article says these assets represent about 35% of Globe International’s group revenue.
 
Certainly, this sale gives Globe some additional resources to use in focusing on its core brands. Apparently, it’s the result of the strategic review that Globe announced it would be conducting last February.
 

The interesting thing to me is that this leaves Globe with a bigger percentage of its revenues in skate hard goods- a tough market for anybody. Hopefully, the tighter focus and proceeds of the asset sale will help them improve their performance there.   

 

What Forward Thinking Retailers are Doing: Trends That Probably Won’t Surprise Anybody

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The issues that smaller retailers are facing haven’t changed much. There are too many retail stores, pressure from chains, brand stores and big boxes, a tough financial model, the challenge of keeping margins up, lack of product differentiation, increasing costs, over distribution.

 
That’s a cheery environment, isn’t it? You’ve got a choice. You can bemoan the unfairness of it all or you can take advantage of this tough environment that’s putting a lot of pressure on your competitors and do some things to stand out and that help you address these issues.
 
Here’s what I’m seeing successful retailers doing.
 
One- They Are Growing
 
Higher costs, more competition and margin pressure, too much similar product in too many places means that you need more revenue to make it. This seems so non controversial as to make this a really short section. It’s basically an equation; a fact. It just is.  But I’ve put it first because it’s the ultimate motivating factor for the other actions I discuss below. You have to make a profit if you expect to be around very long.
 
Two- Making Themselves Important to Their Brands
 
How does a shop do this exactly? Well, for a start, it pays its bills to the brand on time. It’s absolutely honest with the brand’s sales reps and management. It merchandises the brand well. It includes the brand in its own promotions. It provides feedback (good and bad) on what’s selling, why, and on trends it sees emerging. It does not abuse the brand’s warranty and return policy. And finally it does not let the brand talk it into buying products it doesn’t think will sell well or order sizes it doesn’t think it can move. As we all know, the season end conversations such moves engender are not helpful in building a relationship.
 
It may have occurred to you that growing (point one) contributes to making a shop important to the brand (point two). Could be a trend emerging here.
 
Three- Gives Credibility to the Brands They Carry
 
The best shops are the ones the brands just have to be in. The shop gives the brand credibility- not the other way around. Any brand carried by the shop is, by definition, credible. For a shop this can translate into flexibility in your relationship with the brand. That may mean, among other things, better terms and conditions, priority in new product and shipping, patience from the brand if you hit a rough spot, support for your community based activities, faster and more positive response from management, and more ability to pick the products and categories you carry. Obviously, it’s kind of a subset to point two above. However, I chose to separate it because at the extreme, when a shop really does this well, there is pretty much no brand they absolutely have to carry to be successful. And that ties in with……………….
 
Four- Expanding Their Circle of Influence
 
When it’s the shop that gives the brand credibility it’s because the shop has become acknowledged as an arbiter of trends and technical product attributes. They are a destination store for their customers. They are part of their community, but of course the definition of that community has changed. It no longer means just the geographic community, but a community of people with shared interests and lifestyles.
 
A customer’s awareness of an established brand is typically the result of that brand’s advertising and promotion programs. Those programs may have a lot to do with getting the customer into the store. But the decision to purchase that brand, in a shop with this kind of stature, can be heavily influenced by the experienced and knowledgeable sales people. You can hear the conversation in your head- “Brand X is a great brand and that deck would certainly work for you, but here’s a couple of others you might consider based on what you’ve told me about your style and level of experience.”
 
And that product, whatever it is, doesn’t necessarily have to be one the customer has ever heard of. If it’s in this store, it must be good. Kind of frustrating to a big brand, I suppose, to think that all their work advertising and promoting their brand and getting the customer into the shop turned out to be a chance for the sales person to sell a brand the customer has hardly heard of.
 
On the other hand, it might give hope to smaller, new brands. The support of shops like this ideal type shop I’m describing may be the best chance such brands have to prove themselves.
 
Five- Buying Together
 
I can’t tell you this is a wide spread trend, but I did have a conversation with one European retailer who was very happy with the result. He was a specialty shop in, I think, Southern Austria. He was practically chortling as he explained to me the happy circumstance he found himself in as part of an 11 store buying group. You see, it happens that the other ten stores were all in Northern Austria. So while all eleven stores got the benefit of better prices from buying together, the ten in the north suffered from the possible disadvantage of all having the same product. He, happily segregated in the south of the country, didn’t have to worry about that. No wondered he positively glowed as he described the scheme.
 
Of course, if you’re getting better pricing through some cooperative buying, maybe the pressure for growth (point one) declines a bit, and lord knows you’re becoming more important to the brands (point two). Maybe not more popular, but more important.
 
Interestingly, my advice to brands has always been, “Europe is different from the US. You can’t think of Europe as one market. You can’t even think of Germany as one market.”
 
That’s still good advice, and I expected it to apply to specialty retailers as well. I thought retail in Europe would be “different” from retail in the US. Imagine my surprise when, in the two years I just spent in Europe, I discovered that it really wasn’t- at least not in terms of the challenges European retailers were facing.
 
 Wow- wherever you go, there you’ll be.
 
By which I mean Europe seems to have the same damned problems we have, and I suppose if we can take any comfort from that it’s because it means we here in the US haven’t done anything egregiously stupid that Europe somehow avoided.
 
Finally- Taking Risks, But Not Really
 
I hope I’ve made the point that these five operational imperatives, to coin a really pompous sounding phrase, don’t stand in isolation from each other. Nor do they stand in isolation from the specialty shop’s retail environment I briefly described at the start of this article. There are as many tactics as you are clever enough to think of that you can try to move your shop towards the market position I’ve described.
 
I’ve talked to lots of retailers who were cautious about trying them. They cost “too much,” had never been tried before, there wasn’t time to do them, etc. In a word, they were risky.
 
And you know what? They are risky- especially if you try and implement them on a piece meal basis. It might even be true that it would be a waste of time.
 
What I’ve tried to demonstrate in this article is that the operational imperatives are related to each other and in fact support each other. Each of them is comprised of a group of tactics that each shop needs to identify based on its particular circumstances. There is a certain momentum you build as you support a tactic from one imperative with a tactic from another. You don’t increase risk by doing more- I think you reduce it.
 
Or look at it another way; If you agree that you got to have a financial model that makes sense, and you are struggling with your current one, and you agree that your business environment isn’t getting any easier and calls for some change, then even if there is some risk here, isn’t it less risk than doing nothing?
 
I’m going to use a word here I usually avoid because (at least for me) it frequently engenders serious confusion about what it means accompanied by a sense that it’s futile to try and figure it out and implement it. The word is strategy.
 
But of course we’re all following one even if we don’t know what it is, speaking of risk taking. And if, like me, you’re just a bit intimidated by “strategy” because you’re not quite clear what the hell it is, maybe we can get some clarity by just considering it a bunch of related tactics.
 
My five operational imperatives, or rather the tactics that would make them up, are a strategy to deal with the existing retail environment. You don’t have to say, “It’s time for a new strategy,” but you might consider picking some appropriate tactics for each operational imperative and start doing them. Might be fun, probably wouldn’t cost much, you might find that the results are cumulative and often quick to see, and there’s not much risk involves. Your business environment requires you give it a shot.

 

 

The Last Intrawest Annual Report: One Benefit of Being Bought

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I’ve always admired Intrawest’s ability to combine and coordinate its real estate activities with the development and management of its mountain resorts. It always seemed like they managed to choreograph the two to maximize the value of both. That didn’t mean, however, that I looked forward to reading their annual  Form 40-F filing with Security and Exchange Commission and now that they are about to be acquired by Fortress Investment Group (probably a done deal by the time you read this) I guess I won’t have to do it any more.

 
But I’m a sentimental kind of guy. Just for old time’s sake, I decided to slog through the last one when it came out. And as long as I was being sentimental, I thought I might as well try and figure out exactly why Intrawest decided to sell to Fortress.
 
This all began with a February 28, 2006 press release in which Intrawest announced “…that it had initiated a review of strategic options available to the company for enhancing shareholder value…” Intrawest Chairman Joe Houssian is quoted as saying, “It makes sense for us at this time to evaluate all of the different ways in which we can capitalize on the opportunities in front of us for the benefit of shareholders, and to ensure that we have the bets possible capital structure in place.” Here’s a link to the Intrawest site where you can click through to see the press release: http://www.integratir.com/newsrelease.asp?ticker=IDR
 
Okay, well enhancing shareholder value is a fine thing. Who could argue? But my question was why they thought they had to go through this process to do it. Couldn’t they just run the business themselves? Did they need more capital than they could raise on their own? Were they concerned about softness in the real estate market? Did the diversification of their business (only 32% of revenue now comes from mountain operations) require a different kind of support? The release didn’t say.
 
By way of background, Intrawest went public in June of 1997 at $16.75 a share. The stock bounced around for some years, closing at $18.94 at the end of September, 2004. From there, it moved up smartly, closing at a high of $37.60 the week of May 5, 2006. It then reversed course and went down for eleven of the next thirteen weeks, closing at $26.70 the week ending August 4th. Then the sale of the company was announced and the stock rocketed up to $34.50 ($35.00 a share is the purchase price) and has stayed near that price since.
 
The June 30, 2006 balance sheet is hardly changed from the previous year and the changes are positive. Total assets are almost identical, while liabilities are down and equity is up.
 
Net income rose from $33 to $115 million. The contributions from resort and travel operations fell 11% to $89 million. Management services contribution fell 14% to $37 million. The real estate contribution, however, more than doubled to $143 million. That component of Intrawest’s income can swing around a lot from year to year. I guess it’s normal for that business, but it makes year to year comparisons a little difficult.
 
I thought a telling section of their Form 40-F was the section called “General Development of the Business. It listed what they consider to be “key developments” during the last three fiscal years. There were thirteen accomplishments listed and every single one of them was raised money, sold this, bought that, refinanced this, retired that debt, started our review of strategic options. No doubt these were key developments, but I thought it was interesting that not a one was focused on running and improving the core business operations. I mean, they must have done some good things in those areas. They’ve been doing them for years. 
 
You read the press releases, scour the documents, and listen to the conference call. You still don’t get a specific and satisfying explanation for why Intrawest sold.
 
But if you go to the web site of the Fortress Investment group (http://www.fortressinv.com/) and spend just a few minutes reading about it, you will learn that they are a large, diversified organization with access to capital and the ability support companies in putting in place financial structures that allow those companies to take maximum advantage of their opportunities. Whatever Intrawest can accomplish on its own, it can do more with the support of Fortress. With the support of Fortress, management’s time won’t have to be focused on refinancing, buying, selling and restructuring. They can worry about running the business.
 
If you read a bit about Fortress, the apparent generalities which Intrawest used to explain the motivations for the transaction make a whole lot more sense.       

 

 

PacSun’s Quarter Ended 7/29/06; Numbers and Industry Implications

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I guess if you’re going to talk about a quarterly earnings release, you have to mention the numbers. Okay, fine. PacSun’s net income for the quarter ended July 29, 2006 was $0.14 a share compared to $0.28 a share for the same quarter the previous year. For the six months ended the same date, it was $0.30 a share compared to $0.51 for the same period the previous year. Those are drops of 50% and 41% respectively. Sales for the quarter grew only 1.3% from $309 million in the same quarter the previous year. Sales for the six month ended July 29, 2006 were up only 4.2% to $614 million.

 
What happened? Gross margin fell and expenses rose while sales were flat. That will put the kibosh on the old bottom line every time. On August 31st, PacSun announced that August sales were down 4.0% from August of last year and that same store sales for the period were down 9.4%.
 
If you’ve ever looked at PacSun’s stock chart, you maybe weren’t all that surprised by this. The stock fell about 10% the day after the announcement of the quarterly results, but the trend had been down for a while. The stock peaked at $29.05 way back on March 7, 2005. It fell as low as $20.33 on May 12, 2005, rallied back to almost $28 in November and has been mostly falling since. People who study this stuff tell me that a stock’s chart often shows weakness before the company’s fundamentals turn over. Speaking more generally, the stock market often leads the economy.
 
I hasten to add that PacSun’s chart doesn’t look much different from some other industry public companies, which is maybe a good way to move on to implications for our industry.
 
In its conference call on the quarterly results, PacSun acknowledged that business was tough, and that they were taking the usual and appropriate measures to respond. These included watching costs closely, controlling/reducing inventory and being cautious about their orders. Well, what would you expect them to do? They sounded like a competent management team in touch with reality. I imagine that’s because they are.
 
They also talked about meeting with the leading brands more often and earlier because of the challenging environment. They said they were trying to be “more responsive to their [the brand’s] insights around product.”
 
They talked about weakness in branded fashion denim sales, with the exception being Levis. They indicated they had added a specially designed selection of Levis for back to school in 200 stores and that the results had been “very positive.” They also talked in general about adding new brands for back to school.
 
This caused one analyst to ask whether PacSun was expecting to transition its business away from the core skate/surf brands. I seem to recall a reference to Volcom in the question.
 
PacSun’s answer was that the addition of new brands was a normal, ongoing, practice, that orders had been reduced consistent with the decline in business, and that they had no intention of transitioning the business away from the core brands.
 
But I think the analyst’s question went, or should have gone, deeper than that. What they were really asking was, “PacSun, what are you? Are you a skate/surf/lifestyle brand committed to the same market you’ve always focused on, or will a slowdown in that market’s growth and a saturation of its selling opportunities require that you expand your appeal? If so, how do you do that without losing your original, and very successful, franchise?
 
I think it was four years ago at the Surf Industry Conference where Bob McKnight warned us that the uptrend wouldn’t last forever. If the trend has stopped upping, is it a hiccup, or the beginning or a new kind of market? I don’t know. PacSun, and hopefully lots of other companies, are taking the appropriate tactical steps to manage it in the short term. But the longer term question is the one the analyst may have meant to ask but didn’t quite- What are you?

 

 

Volcom’s Quarterly Conference Call: It Didn’t Sound 29% Bad to Me

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         I’m just back from two years In Ireland, where I made a futile attempt to have one pint in every pub in Dublin. I’ve missed a bit, but I did hear about Volcom’s quarterly conference call last Friday, the 29.4% decline in its stock that followed, the industry discussion that has ensued about the reduction in Volcom’s projected third quarter sales at PacSun, and the apparent concern over the ability of industry companies to sell their denim and other brands if PacSun was to change its branding strategy. 
         So I listened to the conference call. All one hour, 32 minutes, and 19 seconds of it. Moan. Volcom beat estimates for its second quarter, held to its guidance for the year, and announced what I took to be some very positive developments in new products, distribution and retail.
         But Volcom reduced guidance for the third quarter from 45 to 38 or 39 cents and said it expected sales to PacSun, its biggest customer representing 29 percent of last year’s revenues, to decline in the third quarter.
         When asked for some specifics about why this was happening (some “color” as the analysts call it) management just repeated the same non-specific answer about how they had a great relationship with PacSun, considered them an important customer, looked forward to a continued good working relationship with them and were all over it.
         I didn’t think much of it at first, but by the fourth time they gave that answer and no details I was wondering if there was something more to this. (Apparently, judging from the stock’s performance, so does the stock market.) Is there? I have no idea. But I might have approached the issue a bit differently.
         Before I tell you how, go check out a daily stock market chart for Volcom and some of the other publicly companies in our industry. Notice that many of the prices aren’t exactly up. They are kind of unup. Well, actually they are down and it’s hard to put a positive spin on that.
         Is it industry related? Maybe. But the whole stock market has been in a downtrend since early April. Investors Business Daily regularly points out that three out of four stocks follow the market direction. So anybody who might be concerned that any of Volcom’s comments (or lack of comments) with regards to PacSun caused a decline in industry stocks needs to look at the longer-term trend and general market conditions as well.
         If you’re a public company and the analysts think you didn’t quite provide a good answer to a question they think is important, and you reduce your guidance for the coming quarter, your stock goes down. But not, one would think, by 29 percent when you have some good news as well. If I were Volcom, I might have suggested that questions about PacSun’s brand strategy be directed to PacSun.  I might have suggested that if PacSun was going to focus on brands like Levi (and its own brands for that matter—not news) that over time Volcom’s sales to PacSun might, in fact, become less important given Volcom’s distribution strategy, which they characterized (correctly, I think) as cautious. And I would have focused on all the other positive initiatives Volcom highlighted and how they might, over time, reduce the company’s dependence on PacSun.
         If you’re a public company, then you are to some extent a prisoner of the quarterly filing cycle. That’s life. But it seemed to me that a reduction of Volcom sales (at least as a percentage of total sales) to PacSun could be seen as strategically positive if PacSun is changing its brand strategy in a way that’s not consistent with Volcom’s market positioning.
         And (of course) if it’s not too big a reduction. No matter what your strategy is, it’s damn hard to get profit growth without an overall growth in sales.
         Somehow, all the good things Volcom had to say were overshadowed by the implications of the third-quarter decline in sales to PacSun and the possibility that there was more to it than Volcom explained. I just wonder if the question couldn’t have been answered so that the decline in the stock wasn’t so dramatic.
         Unless of course, there was more to it than Volcom explained.

 

What’s Happening to Core Retailers? Things We Won’t Argue About- and What They Mean

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Not long ago, I finally came up with a definition of core retailer that I liked. I was really proud of it because it had taken me about 13 years to settle on one I thought was accurate and useful.

Now, not all that long after I accomplished that feat, I’m not sure it really matters. I’ve begun to be concerned that the traditional concept of core stores is of diminishing importance (or at least they are being treated like they are of diminishing importance), and changing that is what this article is about.
 
I’d been thinking about this for a while.   But there were three pieces of information that finally made me decide to tackle it even though I knew it might not be too popular a point of view. In my endearing naiveté, I think that what’s important is that you consider the business issue being raised regardless of whether you believe I’m right or wrong. 
 
The Three Pieces of Info
 
Anyway, the first piece of information was the announcement that VF Corporation, the owner of the Nautica, Lee, Jans Sport, Vans, Wrangler, Reef brands, and a whole lot of others for that matter, was planning to go from 600 to 1,200 retail stores over five years. I didn’t even know they had 600 retail stores.
 
The second was a Business Week online article that talked about brands opening their own stores as a “survival strategy” response to big department store chains having fewer store fronts due to consolidation and chains getting better and better at designing and selling their own higher margin private label brands.
 
These two pieces of information made me realize how wrong I’d been two years ago when I asked a panel of specialty retailers at the Surf Industry Conference what they were going to do when there were 5,000 company stores in the U.S. I should have said 10,000.
 
The third was reading through the prospectus for Zumiez’s very successful initial public stock offering and noting that the company’s gross margin for its last complete fiscal year was 32.8 percent. Pac Sun’s, by way of comparison, was 36.4 percent. Both are doing a fabulous job and they do it with a gross margin that would put a traditional specialty retailer out of business in about 20 minutes. Don’t like Zumiez or Pac Sun for whatever archaic, incestuous action sports reason? Get over it. Their many customers like them and that’s what matters.
 
The Things We Won’t Argue About
 
So small core shops can not sell the same product as specialty chains at anywhere near the same gross margin and expect to survive. That’s the first thing in this article that I don’t think anybody can argue with.
 
Just for clarification, when I say “small core shop,” I don’t mean the guy with five store fronts or with one store doing $6 million annually. It’s not like it’s a walk in the park, but they can do well or even prosper. The second thing we can agree on is that there are fewer of these small core shops than there use to be. A lot fewer I think. I wish I had numbers on that. And no, I don’t know how many store fronts you have to have before you become a chain.
 
The third thing I don’t think anybody will argue with is that fewer brands are accounting for a larger percentage of total sales. Next is that these brands all want to grow. How’s that for a blinding glimpse of the obvious? And I don’t think I’ll get much disagreement if I suggest they are very interested in the broader lifestyle market as the major source of that growth- because after a certain size, that’s the place much of it has to come from.
 
The Brands’ Perspective
 
Given these “things we won’t argue about,” what might the motivations of larger brands be. How might the specialty stores fit into their plans?
 
The law of large numbers tells us that it gets tougher and tougher to get big percentage growth as your base starting number gets bigger and bigger. What that means is that even if a larger brand gets good increases from core retailers, it just won’t move the revenue or profit numbers as much as it use to. If you just talk about the small core retailers, it moves those number even less- perhaps not enough to really matter? I suppose, though you may be getting tired of my saying this, that that’s another thing we won’t argue about.
 
From a strict financial point of view, then, I can imagine that the larger a brand gets, the less it is focused on the core shops- especially the smaller ones. Most brands believe, I think, that core shops still have an important role to play in developing new brands, identifying industry trends, creating excitement, building the foundations of the sport, and defining the lifestyle. They want them to succeed. 
 
But there’s all this qualitative stuff and then there’s the sales manager sitting there with a budgeted sales increase she really needs to make. And the larger the company, the bigger the number in dollars. Where’s it easier to find those additional sales dollars? From a bunch of small shops or from one chain of 50, or 500, stores?
 
The sales and marketing people recognize the importance of the qualitative factors in establishing their competitive position and keeping on top of the market. Maybe the brands with their own stores think they can get some of the same kind of input through those stores that they can get through core shops. I don’t happen to think that’s true.
 
If I were a larger brand, I’d select, let’s say, 50 shops in Europe that are established, well run, influential, and on top of their market and its trends. We’d all probably pretty much pick the same shops for that select list.  Maybe it’s shorter than fifty. The greater your presence in those shops the better. I’d make sure my brand was well represented in those shops even to the extent of making some deals I would not necessarily make with a shop that’s not on my list. I’d utilize my relationships with those shops to gather much of my core market and retail trends information.
 
If your brand’s sales increases are less likely to come from smaller core shops, your customer base is increasingly broader than those that they appeal to, you believe you can get the marketing and trend information you need from a smaller, select group of shops and the dangers of broader distribution have declined dramatically, where would you focus your time and effort? I know where I’d focus mine.
 
The Good News
 
Maybe I should have started with this section so small shop owners weren’t rushing to their doctors for lithium prescriptions for depression by the time they got here. 
 
There’s no advice leading to a miracle fix here. Hard goods are tough, shop owners need to run their shops like businesses, margin and competitive pressure is real, and your revenue level needs to be higher than it use to be for you to have a viable financial model.
 
But I want you, on the other hand, to consider the size of the potential market out there and all the people who want cool shoes and clothing but aren’t ever going to buy a skate board. My god, it’s huge. If it wasn’t, frankly, you wouldn’t have these problems- or these opportunities.
 
Do what I do from time to time- wander into a shop in a chain you think is doing a good job. Not for a five minute walk through. Talk to the sales people. Engage the manager in a discussion about how they do things and why. Look at their layouts and their use of wall space. Watch who their customers are. Make some notes about their pricing. Rigorously compare what you carry with what they carry. I do this to gain information (not often enough) without saying I’m writing an article or making an appointment or anything. I just engage whoever’s around in a conversation about the store and the industry.
 
Who on your list of the absolutely best shops is in your area? Go visit them and do the same as with the stores above. How come the biggest brands are so focused on those stores? It goes beyond sales volume I think you will find. Ask the owners, who will probably be willing to talk to you if you call them in advance and if you aren’t too direct a competitor, how come they are so successful.
 
Look, you do have a certain level of legitimacy that the chains don’t have and there’s a huge potential market out there. You can go after your piece of it without losing your vibe, or coolness, or whatever the word is to explain your distinctiveness. In fact, you have too. It may look risky, but consider the alternative. Do what you have to do to be one of the stores that major brands feel they just have to be in.