The Buckle May 4th Quarter

There’s never time to write about everything I want to write about, and The Buckle is one that has often slipped through the cracks. And while there’s nothing dramatic to report, I thought it might be time to take a short look at their results. 

At the end of the quarter, The Buckle operated 443 stores in 43 states. They sell “…medium to better priced casual apparel, footwear, and accessories for fashion conscious young men and women.” Denim is about 45% of their business. Tops are 28.3%, sportswear/fashion 10.8%, accessories 7.5% and footwear 6.3%. 31% of their revenues for the quarter were from proprietary labels.
 
Sales grew 2.3% from $264 to $ 270 million. Comparable store sales rose 1.2% compared to the same quarter last year. Online sales, which aren’t part of comparable store sales, were up 6% to $20.9 million. For all companies that report comparable store sales, there’s some thinking to be done about how to manage online sales. Should they be part of comparable store sales? Everybody believes that online and brick and mortar sales have an impact on each other. Now if we could just figure out what, exactly, that impact was.
 
Gross profit margin stayed approximately the same, rising from 43.3% to 43.4%. Selling expenses as a percentage of revenue were constant at 17.5%. General and administrative expenses were, well, pretty much the same rising from 3.8% to 3.9% of sales. Operating income was- yeah, you guessed it- constant at 22% of revenue. Obviously, those expenses rose in total dollars commensurate with the sales growth.
 
Income tax provision was, uh, almost unchanged at $22 million. Wait, here’s something! Other income fell from $1.81 million to $350,000. The decline was due to “…the reduction related primarily to certain state economic development incentives received during the first quarter of fiscal 2012.”
 
Well, that’s exciting! Isn’t it? Okay, maybe not so much.         
 
Net income was down (you guessed it!) very slightly, from $37.8 to $37.6 million. So I’m beginning to get a sense of why I don’t write about the Buckle that much, though I’ve been intrigued by the merchandising in their stores.
 
Maybe there’s something exciting happening over on the balance sheet. Well, not really exciting. Cash and short term investments fell from $220 million on April 28 a year ago to $144 million on May 4. That’s a decline of 35%, but it hardly leaves them destitute. That pulled the current ratio down from 3.69 to 2.71, but it’s still in great shape. They note that “Capital spending for the corporate headquarters and distribution center during the first quarter of fiscal 2013 includes $5.4 million for the purchase of a new corporate airplane as a replacement for a plane that was sold by the Company in the fourth quarter of fiscal 2012.” Those expenses explain some of the decline in cash.
 
“…inventory on a comparable-store basis was up approximately 7%, and total markdown inventory was up compared to the end of the first quarter last year,” we’re told in the conference call. We don’t get any details on that mark down inventory.
 
Total liabilities to equity rose from 0.38 to 0.51 with the decline in shareholder’s equity from $398 to $320 million. There is no bank debt.
 
Well, that’s kind of it. I guess The Buckle headline for the quarter is that there’s nothing that’s particularly thought provoking or dramatically good- or bad- to write about.

 

 

Tilly’s Quarter; Income Down on Higher Sales.

For the quarter ended May 4, Tilly’s sales were $109 million. In last year’s quarter ending April 28, 2012, sales were $96.5 million. That 13% sales growth. But further down the income statement, we find that income before taxes fell 35% from $5.9 to $2.3 million. What went on? 

NOTE: Net income fell even more, from $5.9 to $2.3 million. In last year’s quarter the company wasn’t public yet and, due to a different corporate structure, showed only $68,000 in income tax expense. In this year’s quarter, as a public company following the change in legal structure, income tax expense was $1.56 million. Now that’s a real expense, but it does sort of screw up the comparison. They provide some proforma numbers that show their net income last year would have been just $3.6 million with the same tax situation they have now. That’s a drop of 36%. 
 
Okay, back to what went on. $11.6 million of the sales increase came from opening new stores that weren’t open in the quarter last year. Comparable store sales were up 1.1%, or by $1 million. They rose 4.3% in last year’s quarter. Ecommerce sales rose 16% from $10.9 to $12.6 million.
 
They ended the quarter with 175 stores in 30 states compared to 145 at the end of last year’s quarter and expect to open at least 25 new stores in this fiscal year. They “…plan to continue opening new stores at an annual rate of approximately 15% for the next several years…”
 
Average net sales per store in the quarter fell from $605,000 to $565,000.  
 
The gross profit margin fell from 31.5% to 29.5%. “The decrease in gross profit margin was due to a 1.1% increase in product costs as a percentage of sales due to increased markdowns and a 0.9% increase in buying, distribution and occupancy costs as a percentage of sales due to costs increasing faster than the growth in net sales.” That doesn’t sound good.
 
 Selling, general and administrative expenses as a percent of sales rose from 25.3% to 25.9%. Within this increase of $3.9 million or 16%, store selling expenses accounted for $2.6 million of the increase. The specific causes were: 
 
“• store and regional payroll, payroll benefits and related personnel costs increased $2.3 million, or 0.7% as a percentage of net sales, as these costs increased at a higher rate than net sales due to a relatively small increase in comparable store sales and a greater proportion of the store base this year comprised of newer stores with immature sales volumes”
 
“• marketing costs, credit card processing, supplies and other costs increased $0.4 million, which represents a decrease of 0.2% as a percentage of net sales, due to these costs increasing at a lower rate than the net sales.”
 
The biggest chunk of the general and administrative expenses increase was stock-based compensation expense of $0.9 million, which they didn’t have last year because they weren’t yet public.
 
In the conference call, President and CEO Daniel Griesemer described the quarter’s results this way:
 
“…our business performance was better than expected as we achieved positive comparable store sales and net income of $0.08 per diluted share reflecting the strength of our business model and the diligent execution of our team in support of our growth initiatives.”
 
There are no balance sheet issues to discuss. The balance sheet improved markedly as a result of the public offering as you would expect. They went public on May 12, 2012. Of the $107 million raised, $84 million went to pay notes previously issued to the pre-offering shareholders.
 
Total inventory rose consistent with the opening of new stores but was down 6% on a per square foot basis. They note they “…have always committed to in season not carrying forward into future seasons. So you know we begin each quarter with inventory that’s clean and current and ready to do business for the forward season.” I like that policy, though of course it’s no substitute for picking the right inventory in the first place.
 
For the current quarter, Tilly’s expects “…comparable store sales growth in the range of flat to a positive low single digit increase…” This compares to a 5.1% increase in last year’s quarter. They tell us that “…the 2013 fiscal calendar shift will cause the first week peak week of the company’s back-to-school season to fall on the last week of the second quarter this year compared to being the first week of the third quarter last year. As a result we expect an estimated $8 million to $9 million in sales will shift into the company’s second quarter from the third quarter when compared to the 2012 fiscal calendar.”
 
So their second quarter prediction of comparable stores sales growth of “flat to a positive low single digit increase” includes that additional $8 or $9 million in revenue.
 
Tilly’s has a strong balance sheet and it’s great to see any comparable stores growth. But the increase in expenses, decline in gross margin and resulting drop in income (even adjusting for the impact of the public offering) tells me this is a work in progress.

 

 

Whether to Laugh or Cry; Tommy Hilfiger Debuts Surf Line

It’s Friday evening, my wife is out of town, and a friend sent me this article from May 20 announcing the debut referenced in the title. I’ve had a glass of wine and think I’m going to break a rule and have another one as I write this. Or more. God knows what I’ll end up saying. If you search the subject, you’ll find some additional information.  

According to this article, the line will include limited edition surfboards as well as men’s and women’s apparel and accessories “…including beachwear, footwear, sunglasses, watches and bags.” I guess that about covers it. If it catches on, I’m sure there’ll be an SMU for Costco.
 
Here’s what another article says. “Tommy Hilfiger is launching a new collection that finds inspiration in the carefree, seaward lifestyle: The"Surf Shack" capsule features gorgeous, après-surf lifestyle pieces — colorful, breezy, and always with that trademark prepster twist.”
 
“Expect cozy, striped Baja pullovers, lightweight anoraks, crisp shirtdresses and chambray playsuits, plus a line of accessories like watches, shoes, scarves, and bags. (Prices are reasonable, too! A pretty striped clutch clocks in at a cool $68; a bikini at $128.) And, for those who might actually make it off the sandy sidelines and into the waves [Damn few I imagine], the collection also includes a range of surfboards created by American artists Lola Schnabel, Richard Phillips, Scott Campbell, Gary Simmons and Raymond Pettibon.”
 
They’re featuring artists, with shapers apparently an afterthought- or no thought at all. Okay, I’m going with laugh, because my other choice is throw myself off a tall building, and I got a lot of stuff to do tomorrow. I’d really be laughing if we didn’t have Hollister as an example.
 
I don’t know why I’m bothered by this. I’m supposed to be a business guy and I’ve spent a few years telling anybody who’d listen that it’s not different this time (or any time), that business cycles happen and that growth in the wrong way can be dangerous. But with all the issues in the surf industry and some of its companies right now this is just the last thing I needed to hear.
 
As an industry, surf starts to lose credibility as soon as it moves beyond its core consumer.  There is, of course, a balancing game there for each company; how far towards fashion and aware from surf  can you move and how quickly and still be credible with the core.  You can do that for a while, but there’s a limit.  Tommy Hilfiger doesn’t care about the core I’m guessing.  Their target consumer won’t be surfing.  But they are happy to take advantage of the market opportunity that’s been created by the surf industry until it’s not an opportunity any more.   
 
I suppose that as an industry the only thing we could have done to prevent this is not grow beyond the core surf market. Then we could have maintained our distinctiveness and some more brands could maintain a competitive advantage. But that wasn’t going to happen in surf any more than it happened in skateboarding or snowboarding. Every company does what it perceives to be in its own best interest.  But the longer term result is that the core companies create the opportunity that the large fashion based companies can take advantage of and with whom the core companies have trouble competing for the customer who’s more distant from the core.
 
So we’ll go through (are going through) what I guess is, unfortunately, the inevitable cycle where the styles represented by surf (or skate or snow) won’t  be very differentiable and won’t attract all the nonparticipants who don’t really care about surfing (or skating or snowboarding). We’ve got companies like Tommy Hilfiger yelling “More Cowbell!” And if you don’t know the Saturday Night Live skit I’m referring to, here’s the link where you can see it.
 
People who want to surf, skateboard, or snowboard are going to go right long doing it. And happily, they’ve all got great product to do it with. But meanwhile, we don’t need "More Cowbell!"  We need less.
 
I hope that analogy sounds goods in the morning.
 

 

 

PacSun’s May 4th Quarter; A Couple of Items to Discuss

This, happily, won’t be like the short novel I had to write for Quiksilver. There are some interesting conference call comments and two income statement entries crying out for a brief discussion, but that’s pretty much it. Let’s get going. 

Sales rose 4.7% from $162.3 in the quarter last year ended April 28, 2012 to $169.8 million in the quarter ended May 4, 2013. Ecommerce sales were up 11%. Gross margin was up from $38.1 to $42.7 million. As a percent it rose from 23.5% to 25.1%. Selling, general and administrative expenses (SG&A) fell from $55.9 to $53.8 million. As a percentage of sales they fell from 34.5% to 31.6%. The operating loss fell from $17.8 to $11.1 million. They ended the quarter with 638 stores compared to 729 a year ago and expect to close 20 to 30 by the end of the fiscal year.
 
Okay here’s the first thing that needs to be discussed. The 2012 annual reporting period had an extra week in it. Here’s how Zumiez’s describes the impact:
 
“The first quarter of fiscal 2012 included a lower volume week and the first quarter of fiscal 2013 included a higher volume week as a result of the 53rd week retail calendar shift. This resulted in an approximately $6 million increase in net sales, 1.5% improvement in gross margin…”
 
Of the total sales increase of $7.5 million, $5.6 million, or 75%, resulted from the 53 week retail calendar. The reminder was the result of a 2.7% increase in comparable store sales offset by a 0.8% decline in non-comparable sales. The gross margin increased by 1.6% and you can see all that increase came from calendar shift. They also note that the merchandise margin rose from 51.4% to 53% and that 0.5% of that increase was from the calendar shift.
 
You can see you have to keep that shift in mind when comparing last year’s quarter with this year’s.
 
Right under the operating loss line is a $9.3 million loss on derivative liability. In last year’s quarter that was a gain of $6.3 million. That’s a $15.6 swing from one quarter to the next, so it requires a brief explanation. Here’s the link to the 10Q just in case you want to read a couple of footnotes with me.
 
Back in December 2011, PacSun got a $60 million term loan from Golden Gate Capital. The loan is due to be paid in December of 2016. As part of that deal, PacSun issued 1,000 shares of series B convertible preferred stock recorded as a derivative liability with a fair value of $15 million at the time it was issued. 
 
“The Series B Preferred shares are required to be measured at fair value each reporting period. The fair value of the Series B Preferred shares was estimated using an option pricing model that requires Level 3 inputs, which are highly subjective…”
 
Level three values are based on “unobservable inputs.” An amusing term, I’ve always thought. Anyway, this is noncash and goes up or down every quarter influencing the financial results as it does so.
 
The reported net loss for the quarter rose from $15.6 million to $24.2 million. Both the derivative liability and the calendar shift have significant impacts on how you look at PacSun’s results.
 
PacSun used about $30 million in cash for operating activities in the quarter. In last year’s quarter, it was $31 million. The current ratio has weakened from 1.53 to 1.21, and total debt to equity has jumped from 2.37 times to 6.13 times as losses have reduced equity from $98 million to $41 million. Long term liabilities are essentially unchanged.
 
On to the conference call. Let me start with a rather lengthy quote from CEO Gary Schoenfeld.
 
“We have spoken before about the decline in certain heritage brands that had become strongly associated with energy drink collaborations, which have largely gone away. Those brands will hopefully rebound over time, yet we continue to feel the effects of their decline, along with some of our other heritage brands as well. Within shorts and board shorts, Hurley continues to perform, as are our most — more basic Volcom and Modern Amusement shorts. Yet as our customer’s embracing more aggressive print and pattern trends in tops, it has been pretty much just the basic shorts that are selling and similarly, what we would consider to be the more fashion-forward board short ideas within our assortment, those are also underperforming compared to what we’ve seen in prior years.”
 
It isn’t just PacSun, of course, that’s reported some concern about heritage brands and that’s focusing on new and different brands. As I see it, it feels like they are favoring brands that are more fashion or youth culture and less action sports based. I also hypothesize that some of the older brands are aging up, and don’t hit PacSun’s target customers (17 to 24 in women’s) the way they used to.
 
Next, here’s a question that Berry Chen from Wedbush asked:
 
“…in terms of the Men’s heritage brands…is the team’s idea to continue to add some of these emerging brands that are doing well? And when do you expect some of that pressure from the heritage brands to kind of start to diminish?
 
Here’s Gary’s answer:
 
“…the shift to embracing the newer emerging brands and street wear as a trend has been critical. And if — had we not been successful in those efforts as well as expanding footwear and other accessory categories, our Men’s business would be in a much tougher position. There’s a lot of change happening within sort of the longer-standing brands. There have been significant executive changes at a number of key players. And so to answer your question, I can’t be specific in terms of exactly when that pressure lightens up. But obviously, we continue to focus on what we can control, which is continuing to work with the mix of brands that we have, both emerging and heritage, continuing to also bring the best that we can in terms of our proprietary design and in denim, in particular, to support changes in trends.”
 
Gary also noted “…the complete rethinking of design and development, as speed to market has become critical to sustainable performance.”
I’ve been reading that consumers are more willing to accept and trust new brands then they used to be. I’d expect this evolving consumer behavior coupled with the need to be quick to market to bias some retailers towards proprietary brands, and I think that’s happening.
 
It’s good to see the store closings finally tapering off. That’s a drain on resources PacSun could put to a better use. I agree with the market trends PacSun has identified and is focusing on. But as I asked back before Gary Schoenfeld even became CEO, can they make PacSun “cool” again and a place their target customers want to shop? There is certainly progress, but it’s still a work in progress and it needs to continue so the balance sheet doesn’t weaken further.

 

 

Quiksilver’s Quarter and Strategy Update

Quiksilver reported a net loss of $32.4 million in the quarter ended April 30 compared to a loss of $5 million in the same quarter last year. They also released information on their efforts to reduce costs and refocus the business. 

To start, here’s a link to the press release in the 8K with the financial statementsHere’s the 10Q which, to my surprise, came out the day after the earnings were released. Next, here’s where you can see the company overview they released. Among other things, it discussed their profit improvement plan. Just click on the link to open it as a PDF. Finally, here’s where you can read the conference call. I’ll be quoting from that document quite a bit.
 
Let’s Review
 
If you’re a regular reader, you know I’ve been harping on the following themes (which you may or may not agree with) for a while:
 
1)  Focusing on gross margin dollars and operating income is important because sales increases are hard to come by.
2)  Operating well is the price of getting a chance to compete.
3)  Being a public company in our space is damned difficult because of the revenue growth expectations. 
4)  The actual action sports market is a small market.
5)  Having a strong brand requires some discipline in distribution because your brand is all you have and product differentiation is hard to come by.
6)  The further you get from action sports and the more dependent on fashion/youth culture the tougher is your competition. The target customers may know your brand, but they don’t know your story.
 
Now, I’d like to remind you of a couple of things I wrote about Quiksilver in the past:
 
 In March of 2011, I wrote “Quik bought a great brand in DC and has managed its growth impressively. I just hope, with the Roxy and Quiksilver brands not growing as well right now, that they don’t expect more from DC than it can deliver. Their goal is to double DC’s revenues in five years.”
 
In April of 2010 I said, “The source of their future revenue growth…is not clear to me. I’ve said that a couple of times before in comments on their filings and it’s still true. Like all of us, they are dependent on and hoping for a recovery in consumer spending. They’ll get- are getting- some. Like all of us, it won’t be as much as we’d like or have gotten used to. But what they really need are some new places to sell their products. At least in the U.S., I don’t know where else they can go with their distribution. Maybe there are some opportunities in the rest of the world.”
 
Next, let’s summarize the numbers then get on to the strategy.
 
Results for the Quarter- Income Statement
 
Reported revenues fell 6.8% to $458 million from $492 million in the same quarter the prior year. They were down 5% in constant currency. Below is a chart from Quik showing the results by operating segments as reported. EMEA is Europe and APAC Asia/Pacific.
 
 
As reported, revenues in the Americas were up 3%. That was due, we’re told to strong sales of Roxy, but also to “…increased clearance sales of DC product in the wholesale channel…” Opps.     
 
They were down 16% in EMEA. It was mostly in the wholesale channel and all three brands declined. Part of the problem was poor weather and lousy economies. Net revenues in Spain “…declined in the high twenties on a percentage basis.” It was a high single digit decline in France and low double digits in Germany. But the biggest chunk ($16 million) was due to a system conversion that was supposed to stop shipping for a week but ended up stopping it for two weeks and “…resulted in cancelled orders from wholesale accounts.”  They lost some business and had to offer additional discounts to get some of it back.
 
The revenue decline was 14% in APAC. The Roxy and Quiksilver brands were down and both wholesale and retail declined. DC continued to grow in this segment, as did ecommerce. “Net revenues from Australia, New Zealand and Japan declined in the low-twenties on a percentage basis versus the prior year, although the decline in Japan was only high single digits in constant currency. These declines were partially offset by net revenue growth in all other APAC countries.”
 
The numbers look slightly better in constant currency, being up 4% in the Americas, down 14% in EMEA, and down 9% in APAC.
 
By brand as reported, Quiksilver fell 12% to $182 million, Roxy by 6% to $129 million, and DC by 1% to $129 million. Wholesale decreased 9% to $344 million. Retail was down 7% to $91 million. Same store company owned retail sales were down 4% on a global basis. Quik finished the quarter with 564 owned retail stores compared with 549 in last year’s quarter. There are 296 licensed retail stores worldwide. Ecommerce revenue grew 31% to $23 million, representing 5% of total revenue for the quarter. More than 60% of revenue came from outside the U.S.
 
Gross margin percentage declined from 49.2% to 46%. As you see above, it fell in dollars in all three segments. In the Americas, it fell from 44.2% to 40.5%. In EMEA, it was from 55.7% to 53.2%. It rose in APAC from 48.6% to 49.5%. There were, they tell us, four reasons for the overall decline.
 
 “a) increased discounting and clearance sales of our DC brand within our wholesale channel to clear slow-selling product, primarily in the Americas segment.” They expect that to continue in the second half of 2013.
 
“b) increased discounting in our EMEA segment across all three core brands associated with shipping delays encountered with our implementation of SAP; c) $3 million of additional inventory reserves recorded related to certain non-core brands and peripheral product categories that were discontinued.” They characterize that as a one-time issue.
 
“d) a net revenue mix shift from the higher gross margin EMEA segment toward the lower gross margin Americas segment. These unfavorable factors were partially offset by improved gross margin in the APAC segment, particularly within the retail channel and the Roxy and Quiksilver brands.”
 
Selling, general and administrative expenses SG&A) declined from $224 to $218 million but rose as a percentage of revenues from 45.5% to 47.6%. As you can see in the chart, they fell in all three operating segments, but rose in Corporate. They had noncash asset impairment charges of $5.3 million compared to $0.4 million in last year’s quarter.  These charges “…were related to certain underperforming retail stores and certain other assets associated with non-core denominated assets of our European subsidiaries and, to a lesser extent, certain foreign currency exchange contracts.”
 
Quik reported an operating loss of $12.4 million compared to an operating profit of $17.7 million the prior year. It fell from $8.9 million to $2.4 million in the Americas segment, or by 73%. In EMEA, it was also down 73% from $25.8 million to $7 million. APAC went from an operating loss of $4 million to a loss of $6.1 million, a change of 52%.  
 
Interest expense at $15.3 million was essentially the same as last year’s quarter. They had a foreign exchange gain of $2.6 million- $2 million higher than in the quarter last year. At $7.1 million, their provision for income taxes was more or less the same as last year in spite of having a pretax loss in the quarter.    
 
The Balance Sheet
 
Neither current assets nor current liabilities changed much in total over the year. Cash fell from $79 million to $48 million. Trade receivables rose from $371 million to $375 million. The allowance for bad debt on those receivables rose from $42 million last year to $57 million. Days sales outstanding (how long it takes to collect) rose by 10% “…driven by the timing of customer payments, longer credit terms granted to certain wholesale customers and the net revenue decrease during the first half of fiscal 2013.” I guess that given the sales decline, that might not have been what I hoped to see.
 
Ditto for inventories, which rose the slightest bit from $359 million to $366 million since a year ago. Inventory from prior seasons was 10% of total inventory compared to 14% a year ago.
 
On the liability side, I’d note that lines of credits and long-term debt rose from $769 million to $814 million over the year. Total liabilities to equity rose from 1.87 to 2.08 as equity fell from $591 million to $546 million. Net cash used in operating activities during the first six months of their fiscal year was $18 million- the same as the six months in the previous year.
 
What’s the Plan?
 
Like most companies in most industries these days, when revenue increases are harder to come by, managers are looking to operate more efficiently and cut expenses. Quiksilver is no exception.
 
CEO Andrew Mooney starts by reminding us of their three core strategies: strengthening brands, expanding sales, and driving operational efficiency. There’s nobody at any company that isn’t in favor of all those things, but Mr. Mooney increased my confidence level dramatically when he noted in the conference call that “…the plan is quite detailed with tactics and areas of responsibility clearly defined. It includes 71 specific initiatives. These initiatives are being tracked and monitored by our project management team, which has been implemented and is being led by one of our senior staff that has accepted this position full-time.”
 
So responsibilities have been identified and assigned, there is specificity as to goals, and progress is being measured. Good. “…the plan,” he continues, “calls for an increased focus on our 3 flagship brands of Quiksilver, Roxy and DC, each with a clear plan and a clarified brand positioning. Modest sales growth [2.5% a year, though they believe that conservative], improved cost structure and increased investment and demand creation. We believe the plan, when fully implemented in 2016, will improve EBITDA by approximately $150 million compared to fiscal 2012 results.”
 
As we talk about driving operational efficiency, I want to share with you what CEO Mooney calls an extraordinary statistic. I was kind of past extraordinary to jaw-dropping and I’d love to know what his reaction was the first time he heard this.
 
Quiksilver “…purchased 100 million units of products annually, but our average order placed at the factory level is only 1,400.” The silver lining in that humongous cloud is that it gives some credibility to the goal of $150 million in additional EBITDA by 2016. There’s got to be an awful lot of money to be saved there.
 
In the process of changing that, the company will go from a regional to a global organization. They expect to go from 620 to 230 vendors and from 51,000 styles developed annually to 31,000. They’ll have global rather than local design and sourcing (going from 21 to 2 locations where those functions are carried out) and will consolidate warehousing by eliminating those that are redundant under the new structure.
 
Operationally, this plan is similar to what Billabong CEO Launa Inman is implementing at that company. In fact, you’ve probably noticed that lots of companies, and not just in our industry, are trying to drive more dollars to the operating income line by getting more efficient.
 
CEO Mooney had an interesting comment on marketing I’d like to share:
 
“In the area of marketing, we have exited or canceled most event sponsorships and released a significant number of sponsored athletes who we were not able to activate [They’ve still got 500]. Over time, we expect to further reduce both the number of sponsored athletes under contract and the events we sponsor. Importantly, we will redeploy the marketing savings to focus on permanent and seasonal in-store display, print advertising and social media.”
 
My interpretation of that comment is, “We’re focusing on the fashion business rather than the action sports or surfing market.” As a public company, that’s probably what they are required to do and I know it. However the danger, as I’ve written, is that they are going to find themselves competing with way bigger companies for customers with whom their brands don’t resonate in the same way they do in surf/action sports. I’ve proposed a solution for the problem (See Let’s Review above) but it’s hard to adopt as a public company with pressure to grow revenues. I take solace in their planned growth rate of just 2.5%.
 
And I also take solace in how Andy Mooney talks about what happened to DC and what they are doing differently.
 
“The other growth that was generated 12 months ago [By DC] was really driven by moving fairly aggressively into the mid-tier channel. With hindsight, that could have been done a little bit more thoughtfully in terms of segmentation strategy. So we’re committed to having a multichannel strategy. But going forward, we definitely need to be more considerate in the segmentation of the product line so that each of the channels can meaningfully coexist and continue to have good sell-through.”
 
Those are the words of somebody who understands that distribution is complicated and matters, and who realizes that one of his brands was pushed to grow a little too hard. Or at least that what I hope he thinks. He specifically states later on that they don’t expect to push the Quiksilver brand into new channels.
 
That there is a ton of money to be saved at Quiksilver by rationalizing and coordinating design, production, and logistics and reducing SG&A I don’t doubt. Wish they’d started sooner but, as is often the case, it just took a new management team. I am still unsure where growth is going to come from. However, it sounds like management is cognizant of the importance of distribution as a brand building tool, as indicated by the low level of expectations they are creating for revenue growth. If they can be patient with their distribution, we may all be pleasantly surprised with the results down the road.

 

 

Billabong Update: The Deal is off, or at Least Changing

What We Know 

Billabong announced yesterday that there would not (at least at the present time) be a sale of the entire company to either the Sycamore Consortium (which includes Paul Naude) or to the Altamont/VF group. The company further announced that they were still talking to both groups “…regarding proposals presented to the Company for alternative refinancing and asset sale transactions, the proceeds of which would be used to repay in full the Company’s existing syndicated debt facilities.”
 
Billabong also lowered its guidance again, indicating they now expect EBITDA for the year of $67 to $74 million AUD (Australian Dollars). That’s before any “…share of Nixon NPAT and before Significant and Exceptional Items.” The last guidance the company offered was in February, when they indicated an EBITDA of $74 to $85 million AUD including $4 million AUD from their share of Nixon at the upper end. Ignoring Nixon and taking the midpoint of both ranges then, guidance has been reduced by about 9%.
 
They especially point to poor conditions in Australia and startup losses of $4 million AUD higher than expected for SurfStitch in Europe. Australian wholesale is on plan, but retail declined. Comparable store retail sales are 5.4% below “…the previous corresponding period and gross profit is 2.3% below…” The Americas are noted to be slightly ahead of plan and Europe remains weak, especially for the Billabong brand as was anticipated in February.      
 
You can see the announcement here. It’s under “Recent News” and is called “Company Update.” Trading in the stock started again and by the close of the day (Australian time) it had fallen to $0.23 a share in (AUD) on very high volume of 65 million shares.
 
The other information we have is that there are ongoing layoffs, West 49 is up for sale and, according to Billabong Chairman Ian Pollard, they are “…aggressively reducing costs across all our global operations.” Restructuring and reducing costs, of course, has been part of the plan since Launa Inman became CEO, but it’s starting to feel less like a strategy and more like a financial necessity.
 
The other thing I think we know is that the banks, which have Billabong’s assets as collateral for its loans, wants to get paid off and will “encourage” deals that contribute to that end.
 
What We Don’t Know
 
The first thing we don’t know is why there was no deal. Obviously the reduced guidance had something to do with that. It might be that the required lease payments on all the stores (that don’t show up on the balance sheet) were also a concern.
 
But strategically, if I were a potential buyer, the most important thing to me might be the prospects for the Billabong brand itself. I’d know that if I bought the whole company, I would expect to sell some brands, but I’d have to believe I could maintain and grow the Billabong brand or why make the deal?
 
For its part, the Billabong Board of Directors might not have wanted a formal offer if it was really low. If they thought such an offer reflected only current circumstances and not the fundamental value of the company and its brands, they wouldn’t want to disclose and then reject it. Assuming, of course, that they think they have a choice.
 
That choice pretty clearly doesn’t include selling more stock right now. But, given the conversations we’re told are now going on with Sycamore and Altamont/VF, Billabong’s choices may include selling assets and raising some more expensive debt that lets them pay off their banks.
 
Actually, I guess their choices do, not may, include selling assets; the question is just at what price. Billabong would certainly prefer not to be selling under these circumstances, while Sycamore and Altamont/VF (and other potential buyers that might pop out of the woodwork if certain brands are for sale?) will hope they can get a great deal.
 
Meanwhile, lenders like Sycamore and Altamont/VF might be thinking, “Well, I’m not ready to be all in on this one at any purchase price we can negotiate, but if I lent Billabong some money in the form of convertible debt, it might work out.”
 
The lender would earn a nice interest rate and be in a position to control a chunk of stock when the company recovered. If things went south, they’d be a lender and not a common equity holder protected to some extent by the value of the assets they’d have as collateral.
 
Now this all depends, as it does in any deal, on the cash flow making sense for Billabong based on the asset purchase prices, the interest rate, and the amount lent. We have no idea how that looks. Still, it feels like Billabong and either of these two potential partners might be more likely to have a meeting of the minds in a debt and asset sale scenario than a purchase. I don’t know why I said “feel.” That’s what Billabong told us in their update. Maybe now you understand a little better why.