A Comment About a Billabong Deal and a Chance to Place Your Bet

I was a bit surprised when VF’s preliminary bid for Billabong came as late as it did, and I was also intrigued by the partnership with Altamont. Why, I wondered, didn’t VF just buy Billabong itself? 

A couple of possible answers occurred to me. The first was that somehow they couldn’t afford it. But a review of their most recent balance sheet made me think that wasn’t the case. However, I did recall that they borrowed a bunch of money to pay for Timberland and had committed in their conference calls to reduce debt. Even though they could borrow the money to purchase Billabong, it might not have been a comfortable place to go for either VF or the analyst community that follows them.
 
Second of course is the fact that VF is primarily interested in the Billabong brand, and it’s a lot easier to just acquire that brand rather than acquire the whole thing and sell off the other brands. Here’s how they put it in the press release:
 
“VF’s primary interest in the transaction is in the Billabong® brand. This interest is consistent with VF’s stated intent to pursue acquisitions, particularly in the Action Sports category, to continue to build shareholder value. Altamont’s interest lies in acquiring Billabong’s other brands and related assets, and is predicated on the firm’s mandate to invest in situations where it can provide strategic and operational support to build business success stories.”
 
When it says Altamont’s interest is in “other brands and related assets,” I wonder what that means. Do the Billabong stores go with the Billabong brand? I guess Altamont would get West 49, though of course I don’t know that.
 
If a deal should be struck, Billabong shareholders would just get money, and they’d be done with it. But VF and Altamont would be the ones who would put up that money, and you have to wonder how they’d decide who put up how much.
 
They would have to agree on a value to the brands or assets being acquired by each of them. That certainly can’t be done before due diligence. How do you decide how much RVCA, for example, is worth before you know how much they are selling and have seen an income statement?
 
But even after due diligence it could be a bit of a hard thing to do. Valuation almost always has an element of subjectivity to it, and one might suspect that both VF and Altamont would want the assets their partner is taking to be valued higher so their partner’s piece of the purchase price was higher. Value also has to do with the future prospects of a brand and reasonable people can disagree on that.
 
Altamont is more what we call a financial buyer. That is, their valuation of an asset is based on what financial return they can expect. VF is more of a strategic buyer in the case of Billabong. By that I mean they look at the Billabong brand and look at how they can improve its operations and results by bringing their own strengths in, for example, sourcing to bear on it. They look for and expect synergies in other words. Read VF’s description of how they are managing their newest acquisition Timberland to improve its performance.
 
So VF might tend to come to a higher value for the Billabong brand than Altamont would, but it would be in their interest to convince Altamont that the value was lower. 
 
Not only, then, do VF and Billabong have a bias in favor of valuing the assets their partner is buying higher (so their own cost is lower), but it may not be easy to agree on those values because of differing perspectives. I imagine there would be ongoing discussions about this as due diligence proceeds. They really wouldn’t want to make a deal to acquire Billabong then find out that they couldn’t agree among themselves on who would pay how much.
 
I am sure you all realize I am speculating here, but I thought it might be valuable to think about the process that has to occur. But if you’re really interested in speculating, you can go to this Australian betting site and place your wager on whether Paul Naude and his group or VF and Altamont will snag Billabong. All bets are off if neither one buys it.

 

 

Aunt Jenny’s Egg Beater, Hoodies, and Water Heaters; The Evolution of Manufacturing, the Future of Fast Fashion and the Impact of the Internet

My Aunt Jenny died maybe 12 years ago at the age of like 97. I helped clean out her house and one of the things I saved was her egg beater. It was made by the Dazey Manufacturing Company in St. Louis. I don’t know if it’s 60 or 90 years old. The company is out of business. 

I didn’t keep it for sentimental reasons (I mean, it’s an egg beater). I kept it because it’s the best damned egg beater I’ve ever seen and I wouldn’t know what to replace it with. It’s made of heavy duty stainless steel. Except for some paint chips on the handle, it looks and works like the day it was made. It spins so effortlessly and smoothly that it keeps going for north of half a dozen turns after you release the handle and is well balanced and almost vibration free.   No planned obsolescence here.
 
I really miss products like this. I believe that paying more for a product that lasts a long time (if you can find them) is a better financial decision than paying less and having to replace it often.
 
So I was intrigued to find this article on a hoodie made by American Giant. I’ve ordered the full front zip one for $79.00 (shipping included). It’s made in the U.S., only available online, and is supposed to last a long, long time. The product is backordered due, I assume, to all the favorable publicity they’ve had.
 
They started by redesigning the hoodie from scratch, as you’ll read in the article. CEO Bayard Winthrop “…argues that by making clothes in America, he can keep a much closer eye on the quality of his garments, and he can make changes to his line with much more flexibility. An Asian manufacturer wouldn’t have been able to do all of the custom, intricate work that American Giant’s clothes required.”
 
Okay, hold that thought. Let’s move on to the water heater.
 
The December issue of The Atlantic has an article called “The Insourcing Boom” by Charles Fishman which you can read here. Anyway, General Electric owns something called Appliance Park in Louisville, Kentucky. It includes six factories, each as big a suburban shopping center, and it’s where GE use to make all its appliances. It employed 23,000 at its 1973 peak, but only 1,863 by 2011. They tried to sell it in 2008 but there were no takers.
 
But in February, 2012, they started a new line to make their high end GeoSpring water heaters there. On March 20, they started making high end French door refrigerators there. By now, they’ve probably started making a stainless steel dishwasher and they are working on an assembly line to make front loading washers and dryers, the article says.
 
Bringing certain products back to the U.S. to make has to do with higher Chinese labor costs and, for better or worse, lower U.S. ones.   But that’s not the whole story. When they took a close look at the GeoSpring water heater, they found it was a manufacturing nightmare that could only be justified when labor was $0.25 an hour. In their redesign, they cut out 20% of parts and reduced the cost of materials by 25%. They cut required labor hours from 10 in China to 2 in Kentucky. Quality and energy efficiency improved.
 
Okay are you ready for this? The Chinese made product retailed for $1,599. They were able to cut the retail price of the U.S. made one by 19% to $1,299. I assume they are holding their margins or they wouldn’t have done it.
 
Here’s what I said in a recent article talking about U.S. manufacturing.
 
“Once the labor cost differential isn’t so dramatic, then other costs become more important. Travel, freight, time to market (which impacts the amount of inventory you have to hold), communications issues, surprise delays, custom duties, control of intellectual property and quality control are among the costs that may be higher with foreign production. But most general ledgers aren’t set up to isolate those costs.”  I missed, by the way, energy costs which are also making the U. S. more attractive.
 
“It’s an accounting hassle, and no fun. But if you take the time to figure out those costs, you may find there’s a certain logic to making some formerly foreign produced products in the U.S.”
 
I’m guessing the CEOs of both General Electric and American Giant would agree with me.
 
The American Giant business model works because the product is only sold through their web site. They have no brick and mortar retailers. I may be willing to pay for quality, but if you had to add a retailer’s margin in there, it would be out of my price range.
 
Pretty clearly, the internet can facilitate the sale of higher quality products by avoiding a level of distribution and cost. I’m not quite sure if that’s completely good or bad, but it’s a fact. I’ve written before that I thought we were early in the process of figuring out the model for internet and retail coexisting. Here’s an impact I hadn’t thought of until now; it might facilitate U.S. production and higher quality. The benefits of having design, production, marketing and fulfillment in one place are, I suspect, significant. 
 
Let’s distinguish between fast fashion and supply chain and inventory management. Fast fashion (which I define as rapid turnover of artificially supply constrained product) is a marketing idea. Good supply chain and inventory management is necessary to fast fashion, but it would be a good idea even if nobody ever came up with the fast fashion moniker. It can never be bad to be able to react quicker to the market and hold less product in inventory.
 
Every company I write about these days is talking about managing their supply chain better, reducing their time to market and “micromanaging” their inventory. They don’t all use the term fast fashion, but to some extent that’s what they are reacting to or trying to emulate. It’s so universal it seems like a bubble.
 
I’m wondering if fast fashion isn’t a trend that will run its course. I understand the excitement it can generate, but once the novelty wears off, I am uncertain shopping more often for product that isn’t really that well made just because it’s “new” will support a long term business model. 
 
In the days of our ongoing economic malaise, it can be hard to find a lot to be positive about. But as I use Aunt Jenny’s eggbeater to make an omelet, wait with anticipation for a hoodie I expect will last a long, long time and wonder if I should be replacing my water heater, I’m feeling kind of hopeful about what might be an important long term trend back towards higher quality products and domestic manufacturing.

 

 

I Went to the Know Show. I’m Back

I haven’t been before, and I didn’t stay long, but that’s a really good thing because it’s an indication that the show is accomplishing just what it’s supposed to be accomplishing.

The show was full of focused retailers paying close attention to presentations by reps and, as far as I could tell and from what I was told, writing orders.  Sometimes there would be ten or twelve people sitting in a booth as the rep went through the line.  They were quiet and attentive.

The aisles weren’t jammed, there was no carpet on the floor and the booths were mostly not big and fancy.  There were no competing sources of loud music and not much in the way of in-booth parties and craziness.  Relax, it’s not like you couldn’t find a beer here and there.

If it wasn’t as upbeat at other shows I attend, that’s because it’s not supposed to be.  It’s not a marketing extravaganza.  It’s a place to attend to the nuts and bolts of business and people seemed to be doing just that.

So you can see why I didn’t stay long.  I wasn’t going to meet consulting clients there, senior executives were generally not attending, and the reps in the booth were busy talking to people who wanted to buy product from them, so why waste their time with me?

The Know Show was a preview of the snowboard product I’ll see at the end of the month at SIA’s show in Denver.  I saw Volcom’s shoes for the first time.  I knew they’d be making them, but I walked by wondering if there was anybody who wasn’t making shoes at this point.  Which made it about perfect when I walked by a booth for a company called Generic Surplus that also makes shoes.

There are so many nice shoes out there, and mine are so uncool (as I got told at my last trade show- you know who you are).  I am just going to have to break down and buy some new ones.  Boy, that will be a market top.

DC was exhibiting their snowboard hard goods under the slogan, “Snowboarding: Defined by DC.”  I don’t even know where to go with that.

I saw Canadians doing business with Canadians in a solid environment for doing business.  I liked it.

 

Quiksilver’s Year, Quarter, and Strategy; EBITDA Declines

Three days ago, Quik filed its annual 10K with the Security and Exchange Commission for the year ended October 31, so I’ve had the happy task of wading through it and rereading the earnings conference call from a few weeks ago. You can see the 10K here if you want.  

I’ll look at the results for the quarter and the year, but I want to talk about the company’s strategy first and its similarity to other industry companies.
 
Strategy
 
This is right from page one of the 10K. “Quiksilver,” it says “is one of the world’s leading outdoor sports lifestyle companies. We design, develop and distribute a diversified mix of branded apparel, footwear, accessories and related products. Our brands, inspired by the passion for outdoor action sports, represent a casual lifestyle for young-minded people who connect with our boardriding culture and heritage.”
 
They continue, “Our mission is to be the most sought-after outdoor sports lifestyle company in the world by inspiring individuality, creativity, and freedom of expression through our authentic products along with the lifestyle and culture of our brands.”
 
Last year they said “We are a globally diversified company that designs, develops and distributes branded apparel, footwear, accessories and related products, catering to the casual, youth lifestyle associated with the sports of surfing, skateboarding and snowboarding. We market products across our three core brands, Quiksilver, Roxy and DC, which each target a distinct segment of the action sports market, as well as several smaller brands.”
 
What I’d like you to notice is that there is an evolution in how they define their target market and competitive environment. They acknowledge, of course, their heritage in action sports, but the focus seems to be moving away from it towards the broader outdoor market. Their potential market just got a lot bigger, but so did the number and size of their competitors.
 
A couple of years ago, I started asking where Quiksilver would get its growth from. Here’s their answer to me; they are now an outdoor lifestyle company.
 
Also from page one, Quik has three long term strategies. They are “1) strengthening our brands; 2) increasing our sales globally; and 3) increasing our operational efficiency.”
 
Can’t disagree with any of those, though I find them a little general to be useful. To be fair, nobody in these public documents wants to give their competitors more information than they have to, so there’s a limit on what we can expect to learn. Still, those three strategies, if that’s what we’re calling them, are pretty much the same thing everybody in this industry is trying to do. Or in any other industry I guess.
 
Some years ago when Burton took the “Snowboards” out of their name, it was because they wanted to address the broader apparel and fashion market. That’s a difficult road to travel not just because Burton is so closely identified with snowboarding but because once you get out into the fashion world, the competitors get bigger and more sophisticated and fashion is a different market than action sports.
 
That’s not a perfect analogy because Quiksilver has never been a hard goods company like Burton and, at $2 billion in revenue, is larger than Burton (I don’t have any actual numbers on Burton- that’s my best guess).
 
Companies like Quiksilver may, in reality, not have any choice but to go after the outdoor market. The outdoor market is certainly coming after them and as somebody once said, “The biggest risk in business is to not take any risks at all.”
 
Okay, on to some numbers.
 
The Quarter
 
Revenues in the quarter ended October 31 were $559 million, up 3% from $545 million in the same quarter last year. The growth mostly came from the Americas, which was up 12% to $279 million. Asia Pacific was up 6% to $87 million. Europe fell 9% to $192 million.
 
“Q4 results also point to 2 areas of concern. First is that we need to be careful managing inventory in light of uncertain economic situations in some of our key markets. The second and related area of concern is the level of clearance sales and discounting we saw in Q4. We ended Q3 with past seasons’ product, representing 16% of our total inventory. We focused on liquidating this inventory in Q4. We had significantly higher volume and lower recovery margin on these liquidations than in Q4 last year. The volume and recovery of liquidating the past season’s inventory had a meaningful impact on our Q4 gross margins.”
 
“Gross margin fell from 52% to 46% and was down in all three regions. “The gross margin erosion was driven by several factors, including increased sales of prior season goods in our wholesale channels, along with lower margins on those sales; increased discounting in our retail stores; increased sales to larger multi-door accounts who typically earn volume discounts that erode our margin; currency exchange rates; and the impact of decreasing sales in Europe, which has traditionally generated the highest margins of our 3 regions.”
 
Sorry for the long quotes, but sometimes I can’t say it any better and don’t want to put words in people’s mouths. Europe’s a bit of a mess (no surprise there) and Quik’s inventory got bigger than it should have is how we might summarize. At the end of the third quarter, 16% of Quik’s inventory was from past seasons. By the end of the 4th quarter, they’d sold $40 million of the old stuff, and the total past season’s inventory remaining was down to 7% of the total. They note in the conference call that “…the store of Q4 is really that we overbought during fiscal 2012 and we had higher liquidations through the wholesale channel because of that.”
 
SG&A expenses were down $12 million to $236 million. They reduced marketing and other expenses but increased e-commerce spending. There were charges of $4.7 million for severance and $3.1 million for lease termination costs. 
 
Net income was $4.4 million during the quarter compared to a loss of $22.1 million in last year’s quarter. I don’t have all the numbers I’d usually have for quarterly results, so I can’t take a hard look at what caused that change. Let’s move on to the whole year.
 
Annual Results
 
Revenues for the year rose from $1.953 billion to $2.013 billion. Quik lost $11 million in the year ended October 31, 2012 compared to a loss of $21.3 million in the previous year. Reported operating income improved from $41.5 million to $57 million. But last year, above the operating income line, it had asset impairment charges of $86.4 million. This year those charges were $7.2 million.
 
If we just remove those charges from the income statement, last year’s operating income would have been $127.9 million and this year’s $64.2 million. That would represent a decline of $63.7 million or 50%.
 
Quiksilver shows adjusted EBITDA which is net income or loss before interest, income taxes, depreciation, amortization, non-cash stock-based compensation and asset impairment. As they calculate it, their adjusted EBITDA fell from $194.3 million to $140.6 million.
 
The Quiksilver brand represented 39% of revenues during the year, down from 41% the prior year. The numbers for DC are 30% and 28% respectively, and 26% and 27% for Roxy. Pretty good balance. Other brands, including Mervin Manufacturing, are up from 4% to 5%.
 
Wholesale business as a percentage of revenues fell from 76% to 73%. Retail was up from 22% to 23%. E-commerce doubled from 2% to 4%. Apparel’s percentage of total revenue rose from 61% to 63%. Footwear was up 1% to 24% while accessories and related products fell from 16% to 13%.
 
I was interested to see that Quik ended the year with 605 retail locations, up from 547 at the end of the previous year. 291 were what they characterized as full price. 194 were shop-in shops (within larger department stores) and 120 were outlet shops. Of the total, 110 were in the Americas, 271 in EMEA (which is primarily Europe), and 224 in APAC (Australia and the Pacific).
 
Talking about their sales strategy, Quik notes, “We believe that the integrity and success of our brands is dependent, in part, upon our careful selection of appropriate retailers to support our brands in the wholesale sales channel. A foundation of our business is the distribution of our products through surf shops, skateboard shops, snowboard shops and our own proprietary retail concept stores, where the environment communicates our brand and culture. Our distribution channels serve as a base of legitimacy and long-term loyalty to our brands. Most of our wholesale accounts stand alone or are part of small chains. Our products are also distributed through active lifestyle specialty chains.”
 
Gross margin for the year fell from 52.4% to 48.5%. “We experienced gross margin decreases
across all three of our regional segments during fiscal 2012, primarily due to increased clearance sales at lower margins within our wholesale channel compared to last year (240 basis points), increased discounting within our retail channel (80 basis points), and the impact of changes in the geographical composition of our net revenues.”
 
Selling, general and administrative expense (SG&A) rose 2%, or $20 million, to $916 million. As a percentage of revenue, it fell from 45.9% to 45.5%. The increase was mostly due to spending more on their online business and to non-cash stock compensation expense.
 
Overall, the balance sheet hasn’t changed that much in a year, but there are a couple of things I’d point out. Cash is down from $110 million to $42 million. Inventory is actually down a few million, from $348 million to $345 million. Receivables were up from $398 million to $434 million, pretty much consistent with sales growth. Average days sales outstanding (DSO) rose from 78 to 85. “The increase in DSO was driven by the timing of customer payments at year end and longer credit terms granted to certain wholesale customers.”
 
Inventory days on hand fell from 119 to 103 “…primarily due to the increased clearance sales that occurred during the fourth quarter of fiscal 2012.”    Long term debt was more or less constant. Equity fell by more or less the amount of the loss.
 
Quiksilver’s sales for the year rose slightly, but it sounds like if hadn’t overbought and then been forced into liquidating, revenues would not have been up. We saw the big impact on their gross margin. It’s hard to be a public company and not plan for revenue growth I guess, but I’d argue they would have been better off if that’s exactly what they’d done. Wonder what the bottom line would have looked like if they’d left revenues even but held their gross profit margin by not overbuying.
 
Actually, I guess there’s no reason I can’t figure that out at the gross profit line.
 
If revenues had been the same as in 2011 at $1.953 billion but the gross profit margin had held at 52.4%, then gross profit would have been $1.023 billion. That’s about $40 million higher than reported in 2012. I don’t know what the tax impact might have been, but I’m pretty sure they would have earned a profit.
 
How many years is it now I’ve been suggesting it was time to focus on gross profit dollars rather than revenue growth?

 

 

What’s Going on With Rip Curl?

I don’t generally have a way to get good information on Rip Curl, but somebody sent me the interview below with Rip Curl co-founder and owner Brian Singer. Why don’t you read it, then I’ve got a comment for you. 

Rip Curl co-founder and owner Brian Singer speaks exclusively to the Surf Coast Times about Rip Curl sale.
 
Rip Curl will only be sold to a company that looks after brands and the communities in which they reside and to which they are connected, according to one of its owners.
 
Following the announcement last week that the board of Rip Curl has appointed financial advisors Merrill Lynch to assist the business in exploring opportunities for whole or partial sale, company co-founder and part-owner Brian Singer spoke exclusively to the Surf Coast Times to reassure the community that Rip Curl would only be sold to a company that has the business’ and community’s best interests at heart.
 
“Merrill Lynch has got a clear objective in this,” he said.
 
“We’ve told them we’re interested only in a company with a track history of looking after brands and the people involved with them.
 
“We’ve had a couple of approaches from a couple of companies that have that track record, which led us to appointing Merrill Lynch to explore the opportunities on our behalf.”
 
Mr. Singer said should the business be sold, he could see no reason as to why the purchaser would change much about how the business is run – including maintaining Rip Curl’s global headquarters in Torquay.
 
“We see no reason to believe anything would change. If somebody or (a) company purchases it, why would they upset the apple cart? The company was born there (Torquay). Why mess with a formula that’s worked?
 
“The company’s had a long association with Torquay and the (Easter Rip Curl Pro surfing) competition at Bells Beach. We expect that the building would remain there and the people will remain there.”
 
Last week, Rip Curl issued a statement saying the company had grown its revenue compared to the year prior – in contrast to general surf industry performance – and the board had appointed Merrill Lynch to assist them in exploring opportunities available as well as assessing the merits of introducing a third-party investor to the group.
 
“The board recognizes that if any such investment were to occur it would need to be consistent with our objectives of ensuring our company values and brand values are respected – supporting our staff and being in the interests of our shareholders,” the statement read.
 
The company is valued between $480 million and $500 million and employs 260 staff in Torquay, making it one of the biggest employers on the Surf Coast.
 
Surf Coast mayor Brian McKiterick said he had spoken to Mr. Singer who had reassured him that the company would continue in Torquay if it were sold.
 
“He confirmed that they’ve been looking at some companies who made approaches,” Cr McKiterick said.
“He was adamant that it would be business as usual; the Rip Curl Pro would continue at Bells Beach and the business would remain operational in Torquay.
 
“He said they were very conscious that if it was sold it would have to be to a company who didn’t have a history of breaking up brands. “It’s very welcome news for the town, the surf industry and the shire as a whole.”
 
What I find intriguing about this is that it’s hard to imagine a buyer or investor paying full price for Rip Curl, or any other company, and agreeing in the contract not to move it or break it up and that it would be “…looking after brands and the people involved…” regardless of what assurances they might give outside of the contract. One has to believe that Merrill Lynch has told Rip Curl’s principals exactly that, as typically investment banks only get paid if the deal closes.   
 
I personally admire what Mr. Singer is saying and hope he can pull it off. Maybe Rip Curl doesn’t really need a deal or is so attractive that Mr. Singer can be very selective as to who he makes a deal with. If that’s not the case, he’d better lose the rose colored glasses. 

 

 

More on Winter Resorts Targeting Baby Boomers: I’m Not the Only One Who’s Worried

You may recall (or not) that about a month ago I wrote an article expressing some concern that winter resorts were targeting baby boomers. My point was that dependence on high income baby boomers couldn’t be an exclusive, long term strategy because, inconveniently, those people are going to get older sooner and stop snow sliding. When that happens, it would be nice if we had some other customers. 

Now, a gentlemen I’ve never met named Roger Marolt, a columnist at the Snowmass Sun in, unsurprisingly, Snowmass, Colorado has written a really good rant (I mean that in very positive way) on the same subject. He makes some points I didn’t make and it’s a pretty fun read.
 
So here it is. Go and read it.     

 

 

Trade Show Season or, “Hi Ho, Hi Ho, It’s Off to Sell We Go!”

My list this year includes Agenda, The KNOWSHOW in Vancouver, and SIA in Denver. Part of me would like to go to others, especially Surf Expo, part of me wouldn’t and, like all of you, I figure it out based on schedule, resources, expected results and, frankly, my tolerance for travel. 

I liked Agenda as usual. Also as usual, people think it’s a bit early but on the other hand it doesn’t conflict with another show and I expect they get a hell of a good price on the space given those dates which I hope they pass on to the exhibitors.
 
Here are a couple of things I noticed at the show:
 
Thinking About U.S. Manufacturing
 
I talked to four brands that are considering starting or increasing their manufacturing in the U.S. I’ll have more to say about this in an upcoming article, but I wanted to highlight it now as something maybe you should be thinking about too. Partly, it’s because Chinese wages have risen something like 17% a year for five years and are continuing to rise. And some of their factories have started to automate. But it’s also because U.S. wages, for better or worse, have fallen.
 
Once the labor cost differential isn’t so dramatic, then other costs become more important. Travel, freight, time to market (which impacts the amount of inventory you have to hold), communications issues, surprise delays, custom duties, control of intellectual property and quality control are among the costs that may be higher with foreign production. But most general ledgers aren’t set up to isolate those costs. 
 
It’s an accounting hassle, and no fun. But if you take the time to figure out those costs, you may find there’s a certain logic to making some formerly foreign produced products in the U.S.
 
The Great Skate Divide
 
When I go to Denver for SIA, I’m pretty sure I won’t find the snowboard companies that make pipe boards in one part of the show, and the ones that make all mountain boards in another. But at Agenda, I find the street skating companies in The Berrics, and the longboards mostly in one aisle far away.
 
Perhaps it’s just because of how the Berrics was organized and set up with Agenda. You know- institutional inertia. But I wouldn’t be surprised if there was still some left over and nonproductive stuff (I’m struggling here for a good word. You know me, I always want to be careful what I say) going on. A bit of a hangover from longboarding growing so much and street skating continually hoping it would go away?
 
I would like to remind us all (including myself) that we will never be the arbiters of how a twelve year old decides to roll down the street and have fun. The “stuff” we’ve got going on doesn’t matter to them. Can anybody say “plastic skateboards” or “scooters?”
 
I know longboarding is different from street skating like snowboarding in the back country or on groomed runs is different from being in the half pipe. But the snowboard companies all think they are in the same industry. I’m not sure I know how to get there, but the skate industry needs to think the same. Most of our retailers already do.
 
IASC
 
And speaking of progress, it isn’t a new development but it was great to see Steve Lake from Sector 9 and Monica Campana from Transworld sitting up there with the IASC board of directors at the open board meeting at the show. The meeting was well attended, but then they had a keg so what would you expect. They introduced a great new insurance product for skaters from Aflac at the meeting which is probably worth the cost of membership all by itself. You can find a link to it at the bottom of this page.
 
Hoodiebuddie
 
Hoodiebuddie is a couple of years old, but I chatted with them at the show and discovered some interesting business things (Full disclosure- they gave me a hoodie which I passed on to my kid, so he thought I was cool for almost 20 minutes).
 
As you probably know, they make the hoodie with the ear buds built in and you can put it through the laundry without removing them. The technology that allows them to make buds that can withstand the wash and dry cycle is patented.
 
That’s cool, but what really caught my attention was their business strategy. First, they do all the design, product development and marketing themselves. But they have a business partner that handles production, accounting and most of the back office. And the partner is big enough to defend their technology around the world as people try to rip it off. I like that arrangement.
 
More importantly, the company isn’t really just about a hoodie with washable ear buds. That’s their entry product that establishes their market position and gets them recognized as a brand. But longer term, they are building a product line that expands out from the basic hoodie, but is based on it. Essentially, they are trying to make hoodies into a category with a fashion component to it. This isn’t all that different from Clive in back packs and Nixon with watches.
 
It might be that they could have a nice little company just selling hoodies with ear buds, but I doubt that would be of much interest to their partner. The lesson for all of us is that the focus needs to be on the market position the product gives you, not just the product.
 
Okay, that’s it. See you at the next show. 
            

 

 

Abercrombie & Fitch’s Quarter and Some Consistencies with Other Retailers

I haven’t followed A & F as closely as I probably should. Too many companies (especially now that our market is something broader than action sports), not enough time. But A & E is the owner and originator of that iconic surf brand Hollister (heavy sarcasm). And especially after my recent post on cosmetics and skateboarding where I got into core versus having fun and giving consumers what they want, A & E seemed worth a look. 

Some of management’s comments in both the 10Q and the conference call also reflected concerns and strategies similar to other retailers I’ve recently reviewed and I wanted to call those out. I think maybe they are all reacting to trends that are going to become obsolete over the medium term. We’ll see.
 
I’m going to start with the October 27 quarter numbers, because you need them as a background to understand some of management’s comments. Sales rose 9% to $1.17 billion from $1.076 billion in the same quarter last year (foreign currency issues had a negative $7.9 million impact on sales). Cost of goods sold grew hardly at all, while gross profit rose $647 million to $732 million.
 
Obviously, the gross profit margin rose for that to happen- from 60.1% to 62.5%. It’s increase was “…primarily driven by a decrease in average unit cost and an international mix benefit, partially offset by a slight decrease in average unit retail and the adverse effect of exchange rates.” I think what they mean to say is that the price of cotton came down.   
 
Other expenses as a percentage of sales didn’t change much in aggregate, so those higher sales and gross margin improvements went right to the bottom line. Net income rose 40.5% from $50.9 million to $71.5 million. I should point out that for the three quarters ended October 27, A & E’s net income was down from $108 million to $90 million due to some issues with inventory and not being on trend as well as general market conditions.
 
A & F has four kinds of stores; Abercrombie & Fitch, Abercrombie (kids), Hollister, and Gilly Hicks. During the quarter, comparable store sales fell 3% after being up in 7% in the quarter last year. For nine months, comparable store sales are down 6% after being up 8% in the same period the previous year. Hollister, down 1%, was the best performing segment.
 
Hollister’s revenues rose from $518 to $602 million during the quarter. Abercrombie & Fitch stores rose only slightly from $436 to $440 million. Abercrombie stores fell $4.4 million to $100 million. Gilly Hicks revenues were up from $17.6 to $27.3 million, but you can see they are small as a percent of the total. Hollister accounted for 52% of total quarterly sales and without their growth it wouldn’t have been much of a quarter.
 
How did they get the 9% sales increase when comparable sales were down 3%? On line sales rose from $132.4 million to $158.3 million, and from 12% to 14% of total sales. And they opened 12 new international stores of which nine were Hollister. They did not open or close any stores in the U.S.
 
U.S. store sales fell from $725 to $709 million. International store sales were rose from $215 to $299 million (Obviously mostly Hollister). Operating income on the U.S. stores was $162.4 million, or 22.9%. For international stores, it was 29.16%.
 
For on line, it was 44%. That would certainly get my attention.
 
Okay, on to some of the common issues among retailers. I guess it’s obvious that the first one is on line business. There’s a lot of it, it’s growing, and it’s very profitable. The thing I don’t know, and I’ve asked the question before, is whether it is cannibalizing in store sales or helping them. We all hope and want to believe that there’s some strategy that creates synergy among all the ways we reach customers, but I don’t have evidence in hand that it increases total sales especially in this current economic environment which I expect to last a while.
 
(Preview of coming attractions: What has to happen in order for Gross Domestic Product to increase? Either the population has to increase or productivity has to rise. There are no other choices. How are we doing in those two areas?)
 
Abercrombie & Fitch “…believe the improvement in sales trend during the quarter is attributable to our inventory flow getting back on track, which produced newer more trend right merchandise.”
 
“Going forward, we intend to remain highly disciplined with regard to our strategy of starting with  conservative merchandising plans, shortening lead times and increasing the percentage of our "open-to-buy" that is available to chase current trends. In addition, we have sharpened our focus on capturing current street and runway trends.”
 
“Going forward, we continue to focus on our key strategic initiatives with regard to merchandising, inventory productivity, expense and average unit cost, insight and intelligence, customer engagement and targeted closures of under-performing U.S. stores [a total of 180 from 2012 through 2015].”
 
 
CEO Mike Jeffries put it like this in the conference call: “…we’re working to become faster and we’re doing that with conservative plans, shorter lead times and more dollars open to chase, which we have said is 60 to 105 days. I think that’s affecting the fashion content of our inventory. We’re also working hard to be different by brand. We’ve invested more in brand-specific design talent. And just in terms of fashion component, we’re reacting quickly to runway and street. And I think all those things are impacting our fashion assortments.”
 
You know, that’s an awful lot like what management at PacSun, Tilly’s, and Zumiez has said recently. They aren’t talking about big sale increases. They are trying to improve their supply chain to control inventory, manage costs, and be responsive to trends. They are trying to manage all the touch points with their customers.
 
They acknowledge that how they operate has a big impact not just on their bottom line but on the quality of their market positioning. And while they don’t say, “Fast fashion is eating our lunch!” it’s clear they are responding to that.
 
Yet I’m wondering if fast fashion is really going to have legs. I don’t mean it’s going to go away, but what, exactly, is it once everybody responds by being more trend sensitive and shortening their time from concept to delivery? Doesn’t the novelty of buying inexpensive new stuff all the time wear off after a while if that’s what everybody is trying to sell you.
 
(Preview of coming attractions number two: What do my Aunt Jenny’s egg beater, a particular brand of hoodie, and a water heater have in common? Hint: They all are made in the U.S. and are meant to last a long time.)
 
With Hollister, Abercrombie & Fitch have proven that you don’t have to be core to be cool. Fun, they’ve shown us with that brand, is cool. It’s not me saying Hollister is fun; it’s their customers and that’s all that matters.
 
But meanwhile, they’ve run into some of the same issues as our industry’s other retailers and are taking many of the same steps to respond. I’ve been a big fan of improving your operational efficiency to improve profits and market positioning for a few years now. Think what that might have done for your bottom line if you’d done it when sales increases were easier to come by. But once everybody is doing it, it’s no longer an advantage, and I’m unsure of the lifespan of the trend they are responding to.