Billabong’s Annual General Meeting

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On October 26th, Billabong Chairman Ted Kunkel and CEO Derek O’Neill made speeches at the company’s annual meeting.  Together they only run to to seven pages of big, easy to read, type.  You should read them, and you can read them here.  There’s a lot of good, succinct information on why fiscal 2011 is a transition year, the performance of their acquisitions, the evolution of their retail business (now almost 40% of their revenue), the impact of currency fluctuations, market conditions, and their continued focus on operating efficiency.

In a lot of ways, it’s a convenient, easy to ready, summary of the annual report that came out a couple of months ago.  It lays out their results, strategies, and issues without being too detailed and dense.

I did a detailed analysis of their annual report when it first came out and if you’re curious, and haven’t seen it before, it’s here.

 

 

 

 

Action Sports Market Evolution as Reflected in VF’s Quarterly Results

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VF released its earnings and held the quarterly conference call yesterday at 8:30 Eastern time. I’m not quite dedicated enough to listen to it at 5:30 AM on the West coast, but I did listen to the replay later in the morning. You can see the press release here. Remember, we don’t have the SEC filing on the quarter yet, so though the numbers are the same as what you’ll see in the 10Q, we do get management’s spin on things- their “happy dance,” as I like to call it.

The Numbers 

There’s no doubt VF had a good quarter.  For the quarter ended September 30, revenues were up 7% to a record $2.2 billion and gross margin at 46.5% was the highest ever. Net income for the quarter was up 11.4% to $243 million. For nine months, sales have risen 5.1% to $5.576 billion and net income is up 31% to $517 million. They accomplished this while increasing marketing, administrative and general expenses in both the quarter and the nine months compared to the same periods the prior year. The balance sheet is very strong with $403 million at the end of the quarter. They’ve got no real financial limitations in carrying out their strategy.
 
You may recall that VF divides their business into six segments they call coalitions; outdoor and action sports, jeanswear, imagewear, sportswear, contemporary brands, and other. The table below, taken from the press release, shows sales and  what I think are operating profits for each segment, though they just call it profit. As you can imagine, they were almost giddy with the
 
 
results and opportunities they see in outdoor and action sports.   They said that revenues for the North Face and Vans rose in the quarter by 17% and 19% respectively. The whole coalition rose 14%. The coalition’s growth for nine months was 12%. For the quarter, the outdoor and action sports coalition generated 59.3% of total coalition profits and 46.9% of sales. For nine months, the numbers are 50.5% of profits and 41.4% of sales.
 
You can understand the focus on outdoor and action sports. The other coalitions didn’t perform as well and aren’t as large. Jeanswear is actually down for nine months and up only slightly in the quarter. That was impacted by VF exiting the jeans mass market segment in Europe. Imagewear revenues are up 10% for the quarter but just 5% for the year. Its profit, however, increased pretty dramatically as you can see.
 
Sportswear revenues were down for both periods and profits fell rather precipitously, especially in the quarter. This is explained partly by some Nautica shipments being moved from the third to fourth quarter.   Contemporary brand revenues were up 11% for nine months, but pretty much level for the quarter. But profits in that segment fell hard in both time frames.
 
You can see why they spent so much time on outdoor and action sports. It’s the biggest chunk of their business, it’s performing well, they see lots of opportunity, and the news in some of their other segments isn’t as good.
 
Implications for the Action Sports Market
 
What I really found interesting- more than the financial statements- were a handful of observations made about their business. Those included:
 
  • They have 779 retail stores (retail comps were up about 3% for the quarter) and are on track to open 85 stores for the year. Direct to consumer revenue was up 10% for the quarter (18% in outdoor and action sports).
  • Marketing spending is up 35% for the quarter. Year to date they’ve spend an additional $50 million and expect to spend an incremental $45 million in the fourth quarter. Half of this will go to the North Face and Vans.
  • They are “…adding top freeride and slopestyle skiers, and halfpipe snowboarders to our athlete team to extend the reach of The North Face(R) as a snowsports brand during the upcoming winter X Games.”
  • In the fourth quarter and going forward into next year, they expect gross margins to be “stable.” That is, not up though in another context they note it is improving in retail.
  • They expect that their average wholesale price will be up next year. There was a lot of discussion about the cost of cotton.
I slept on this to see if an eloquent way to tie all this together would explode fully formed into my brain. It didn’t, so I guess I’ll just start writing. The North Face as a snowsports brand just sort of stopped me in my tracks. Can any brand that makes anything to be in cold weather become a snowsports brand if they have enough resources to establish the marketing position? If you’re a snowsports brand, are you an action sports brand?
 
Just what is the action sports market these days anyway? I don’t think the action sports market grows just because VF (or Nike, or Billabong, or Burton, or Quiksilver, etc.) sells one more piece of stuff to one more person who’s never been near a skateboard, snowboard, or surfboard. I know that there’s still a meaningful connection between some people who don’t participate and the “core” market of those who do, but as you get further and further from that connection and deeper and deeper into the distribution can you still talk about being an action sports brand in a meaningful way?  That is, in a way that helps you run your business.
 
Growth in the action sports market is related to growth in participation, and I don’t think we’re seeing much of that right now. As a brand, it’s dangerous to believe yourself an action sports brand once you move beyond the participants and its relatively immediate environment because you just won’t have the customer connection you think you have. 
 
VF, of course, doesn’t see itself as an action sports brand, but as a portfolio of brands some of which are in action sports. Maybe they’ve got the resources and management to make The North Face into a snowsports brand (Please, no North Face snowboards).   That won’t make it an action sports brand, but it will contribute to the confusion (at least to my confusion) about what this market is and is becoming.
 
Meanwhile, they’ve got 779 retail stores and counting. And speaking of confusion, which brands will they carry in their stores? Just their own or brands they don’t own as well? Will the brands they carry but don’t own want to be in those stores? Can they afford the possible sales decline that will occur if they aren’t in those VF (or Billabong, or Nike, or Quik) owned stores? Do more brands have to open more retail stores as a strictly defensive move to preserve their sales volume? 
 
And this is all going on while cotton costs are going to lead to some inevitable price increases and no growth in gross margins while consumers are cautious about their spending. This is happening to VF (and others, we already know) even with their sophisticated systems, supply network, and negotiating power. How will it impact smaller companies?
 
Those of you who have been around a while remember when it was clear what was and was not the action sports business. You knew who your customers and potential customers were. My suggestion, if you really are and want to be in the action sports business, is that you go back to that.   I’m not saying don’t grow. But don’t delude yourself into believing that the real action sports market and your target market is $10 billion or $20 billion or whatever the apparel/fashion/lifestyle market is. That is not the action sports market no matter how many big companies with their very own retail chains say it is.

 Dance around the 800 pound gorillas. Not with them.  

 

Vail’s Annual Report; What’s the Future of Resort Real Estate?

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This 10K was filed a couple of weeks ago for the year ended July 31. There are about 760 ski areas in North America. Vail owns five major ones that accounted for 7.7% of skier visits (about six million) during the last season. We don’t get many chances to see individual data from many of them, so taking a look at this is worthwhile. It’s particularly interesting, in our current economic circumstances, to see how the real estate component of Vail’s business is faring.

 Numbers by Segment

 Let’s start with a little table that shows Vail’s revenues over the last five years broken down by its three business segments; mountain, lodging and real estate. The numbers are rounded to the nearest millions of dollars and are for the years ending July 31.
 
                                                2010       2009       2008       2007       2006
Mountain                               638         615         686         665         620
Lodging                                169         176         170          162         156        
Real Estate                            61         186         297          113            63
Total Revenue                      869        977     1,152           941          839
 
Here the operating expenses for each segment:
 
                                                2010       2009       2008       2007       2006
Mountain                                456         451         470         463         443
Lodging                                  167         169         160         144         143        
Real Estate                              71         142         251         115           57          
Total Expense                       694         763         882         722         642
 
And here is the EBITDA (earnings before interest, taxes, depreciation and amortization) for each:
 
                                                2010       2009       2008       2007       2006
Mountain                               184         164         221         202         177        
Lodging                                   2              7            10           18           13
Real Estate                             (4)          44            46             (2)           6
Total EBITDA                        182         215         277         218         196
 
Some of the above numbers don’t add precisely because of rounding and some minor accounting stuff. I’ve ignored that to minimize the eyes glazing over factor.
 
The Mountain segment “…is comprised of the operations of five ski resort properties as well as ancillary services, primarily including ski school, dining and retail/rental operations.” Lift tickets are about 45% of revenues there. Of the three segments, it contributes by far the most revenue and EBITDA. You can see that segment revenue in 2010 is only about 3% ahead of where it was after peaking in 2008.
 
Lodging revenues come from owning and managing hotels near their resorts. It also includes revenue from golf and a transportation company they own. It follows a pattern similar to the Mountain segment, peaking then falling in the recession and ending up just 8% higher than it was at the end of fiscal 2006. I should note that the Lodging revenue numbers include $19 million and $18 million in 2010 and 2009 respectively for transportation. That’s from a company Vail bought and there were no transportation revenues in earlier years. One could argue that lodging revenues are really up only about 3.5% over five years, similar to the Mountain segment.
 
Real Estate
 
Real estate is the development and sale of homes and condos of various sizes. Look at the 2008 peak in real estate revenues in the chart above. 2010 real estate revenue, at $61 million, is only 3% below the 2006 amount of $63 million. But the 2008 real estate revenue peak of $297 million is almost 5 times the 2006 or 2010 levels. You don’t see that level of rise or fall in either the Mountain or the Lodging segments.
 
Though accounted for separately, the three segments are closely related as Vail discusses. Selling real estate and increasing the lodging options increases the bed base and options for customers. Putting in a new high speed lift or opening new restaurants or retail makes the resort more attractive and may increase the value and desirability of the real estate. At the risk of oversimplifying, mountain development makes the real estate more attractive and real estate development can make the mountain more attractive. The trick is to coordinate development so as to maximize the value of both. 
 
The real estate revenue stream is highly variable due to the nature of the business. Even when you get deposits and sign sales contracts for a property, you don’t recognize any revenue until the title to the property passes to the buyer. Your revenue depends on when you start the project, how big the project is, how well it sells, and any delays you incur in completing it. When you do close a sale and recognize the revenue, it’s in amounts of at least hundreds of thousands of dollars (the recently completed One Ski Hill Place project had an average selling price per unit of $1.4 million). You don’t have thousands of closings of similar, smaller amounts like you were selling lift tickets.
 
With that as background, what’s Vail’s take on real estate and real estate development? The first thing I’d note is that “Real estate held for sale and investment” was $422 million at July 31. That’s up 35.7% to $311 million from the same date last year. The amount the previous year was $249 million. Vail specifically states that “…we currently do not plan to undertake significant development activities on new projects until the current economic environment for real estate improves. We believe that due to our low carrying cost of real estate land investments combined with the absence of third party debt associated with our real estate investments, we are well situated to time the launch of future projects with a more favorable economic environment.”
 
Talking about their One Ski Hill Place project, they note that they “… closed on 36 units, or 61% of the 59 units that were under contract…while 23 units that were under contract defaulted. Additionally, we have another real estate project substantially completed (the Ritz-Carlton Residences, Vail) which units under contract will begin closing during the first quarter of Fiscal 2011. We have increased risk associated with selling and closing units in these projects as a result of the continued instability in the credit markets and a slowdown in the overall real estate market. Certain buyers have been or may be unable to close on their units due to a reduction in funds available to buyers and/or decreases in mortgage availability and certain buyers may successfully seek rescission of their contracts…We cannot predict the ultimate number of units that we will sell, the ultimate price we will receive, or when the units will sell. Additionally, if a prolonged weakness in the real estate market or general economic conditions were to occur we may have to adjust our selling prices in an effort to sell and close on units available for sale, although we currently have no plans to do so."
 
Back in April, when I wrote about Vail’s January 31 quarter, they had reported that 13 holders of contracts to purchase Ritz-Carlton Residences had sued to get out of the contracts and get their deposits back because of a disputed delivery date. I wrote,
 
“If you really wanted your new 2nd home, you probably don’t sue because it’s a little late being finished. Maybe you negotiate for some free upgrades (heated toilet seats?), but you don’t sue to get out of the deal. Unless, of course, you can no longer afford to buy the place and/or it’s now worth a lot less than you’ve agreed to pay for it.”
 
The problem appears to be worsening and I’m quite certain Vail isn’t the only resort that develops real estate that has these kinds of issues.
 
The Financial Statements
 
I hate resort balance sheets. When you see a current ratio that’s deteriorated from what, in traditional financial analysis, would be called a dangerous current ratio of 0.91 to an even worse 0.51 over the year you get worried. But then you remember (especially if your introduction to this industry was trying to run an equally seasonal snowboard company) that it’s all about cash flow, and you don’t borrow money and pay interest just to make your current ratio look better at the end of the year.
 
The total liabilities to equity ratio improved slightly from 1.44 to 1.40. Debt maturities are only $1.87 million in 2011, but increase to $35 million in 2012.
 
The decline in current assets is almost completely the result of a fall in cash and cash equivalents from $69 million to $15 million. Total liabilities have hardly changed at all.    I would note that cash flow from operations has fallen from $217 million in fiscal 2008, to $134 million in 2009 to $36 million in 2010.
 
You’ve seen the revenue and expense numbers by segment in the table above. Vail worked hard to reduce and manage its expenses, but income was down.   Operating income was $69 million, down from $106 million the previous year and $176 million the year before that. Net income was $30 million, down from $49 million in 2009 and $103 million in 2008. Net income as a percentage of revenue fell from 8.9% in fiscal 2008 to 5.0% in 2009 and 3.5% in 2010. 
 
As explained above, Vail’s three business segments each support the other. The Mountain and Lodging segments took a hit in the recession and are still impacted, but are starting to recover. The real estate is not and I don’t see that happening in the immediate future. As Vail management notes in the lengthy quote above, real estate development is off the table until the economic improves. They are uncertain about their ability to sell or close on sold properties and are concerned that prices might have to be reduced. They’ve got a lot of cost in completed units and undeveloped property and at some point could have to recognize some reductions in carrying value.
 
As I said when I started, we don’t get to see the numbers for most of the large resorts. The value in looking at Vail is not just in knowing how Vail is doing, but in understanding some of the pressures that any resort with real estate is likely to be under.         

 

 

An Insider’s History of the Surf Industry; Good Reading!

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Part of my weekend was spent reading Phil Jarratt’s excellent book, Salts and Suits; How a bunch of surf bums created a multi-billion dollar industry…and almost lost it. Phil has worked in surf publishing and the surf industry for more than 35 years, including five years as the head of marketing in Europe for Quiksilver. He seems to know and have talked to everybody in the industry over a period of years, but just got around to putting it all together in this book, published in Australia around April of this year.

It’s very Australia centric, though anybody in the industry will know of or have met many of the individuals who figure prominently in it. It has not been released in the U.S. and you can’t, to my amazement, buy it at Amazon. However, it looks like you can order it from Australia and here’s one link where you can get it.

The sense of history and the perspective it gives you on the origins and evolution of the surf industry is very valuable. And the stories of how our most respected industry players got into the business, along with descriptions of some of their antics and foibles is a lot of fun to read.
 
It also reminds you that for all the changes, some things just haven’t changed. Here’s a quote from the author’s 2005 interview with Duke Boyd who, in 1960, was trying to sell some early board shorts.

Most of the surf shops sold boards and wax, and that was about it. I knocked on Dewey Weber’s door twenty times before he’d talk to me, and then he goes, ‘Okay, I’ll take them, but only white and only in my size, in case they don’t sell.’ Then one day I had a coffee with the guy at Hobie’s and I told him my trunks would make him forty percent of the sale price. I asked him how much he made off of a surfboard sale. It was half that, and the boards were taking up all the space! He got that, and soon all the guys started to realize that trunks would pay the rent.

So it seems that the issue of margin on hard goods goes back at least fifty years.
 
The hardest thing for me was not skipping to the end of the book where the Quiksilver’s hiring of Bernard Mariette, the Rossignol deal, and its aftermath are described in, if not as much detail as I would have liked, more than I’ve seen anywhere else.
 
Anyway the book is fun, evocative, entertaining, and educational and I hope Phil Jarratt brings it out in the U.S. soon.
 
Maybe I should offer to be his distributor. 

 

 

Never Summer’s and Mervin Manufacturing’s Little Patent Brouhaha

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I guess I should start by admitting that I’m not an expert on snowboard technology, and I don’t have a strong opinion (any opinion, actually) on which kind of camber is best and I don’t know who made which claim first. I also haven’t read, and don’t intend to read, the patents.   I figure I suffer enough just having to read the public company’s SEC filings.

Having followed some of the discussion on various web sites, it’s clear that you don’t have to know all that much to have an opinion. But I’m going to cleverly stick to history, marketing and industry strategy. Those are subjects which I do know something about in this industry, or at least it’s hard to prove that I don’t.

Let’s start with a little history. Months and months ago, before my new web site was up and running, I posted an article on Facebook that talked about alternative camber and my personal experience with it. It also included some information from an interview with Mervin’s Mike Olson. It might give you some perspective on what’s going on and you can view it here.
 
Meanwhile, I’d like to remind you that I’ve said from time to time, “What’s the Goal? Begin With the End in Mind.” What’s the goal for Mervin and Never Summer in this dispute? It’s not to see who can spend the most in legal fees. It’s not to beat the other one in court and have their patent proclaimed the winner. The goals are to build their respective businesses, earn a return for their shareholders and grow snowboarding by making it easier and more attractive to learn and participate in.
 
How does a business do that? At least in snowboarding, we can say that having the best patented technology first is no guarantee of success (see the above referenced article). I’d argue that’s also true in skateboarding and surfing. Not to mention in software, semiconductors and most any industry you can name. First off, it’s the consumer who decides what’s “best” and they can sometimes have a different perception of our innovations, technologies, and patents than we in the industry do. Second, companies in this industry have spent a lot of time and a truly unbelievable amount of money creating their brands’ market position and image in the hope that the consumer will purchase their branded product based on that image. Even with a patented innovation, a consumer may go with a brand image. Because, let’s face it; there’s no bad snowboard product out there anymore.
 
We all talk to each other too much. This, like all industries, is a bit incestuous. Too much of the discussion, perhaps because a confrontation is so intriguing, seems to be around whose patent is better, who’s got the best lawyers, and who might “win.” I really hope it doesn’t come to that.
 
As two niche brands with long histories and both making product in the U.S., Never Summer and Mervin have a lot in common. Mervin, owned by Quiksilver has done very well the last couple of years. I imagine, given Quik’s situation, that Mervin is under some pressure to grow and I hope that doesn’t impact the resolution of this dispute. Never Summer, because of its reputation for quality and long standing control of distribution is also in good shape. I’m hoping Mervin and Never Summer don’t get caught up in the partially industry generated controversy and forget to ask how this technology can best serve the snowboarders to the benefit of both companies and the industry. There must be a royalty or cross licensing agreement or something somewhere in our future.
 
I know it’s business, and I don’t want to sound naïve. I don’t know who’s “right” and who’s “wrong” but I am pretty sure the interests of both companies and the industry are served by a deal.
 
I read Transworld Business’s excellent interviews with Mervin’s Mike Olson and Never Summer’s Tracey Canaday (you can read them here) and was stunned to hear they’d never met each other. I lived in Ireland for two years and learned that there’s nothing that can’t be settled at the pub. I’d be happy to introduce you two and help you make a deal. I work for beer and I’m hopeful this isn’t more than a four or five pint problem.