Spy’s June 30 Quarter; Things Are Getting Happier

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There are two things that really struck me in reading Spy’s June 30 10Q (which you can read here). You may not have seen them because, unlike you, I delight in reading small print and conference call transcripts. Perhaps “delight” is too strong a word. 

Anyway, the first thing I saw was that they had no (as in zero, zip, nada) sales of the “licensed products,” which, if you’ve been following the continuing adventures of Spy, you know was a distraction and cash flow problem for a couple of years. It hasn’t been a big deal for a quarter or so, but I look at this as the official end of all the crap Spy has had inflicted or has inflicted on itself in recent years. Now they just have to run the business.
 
Speaking of running the business, the second thing I noticed was that the cash flow from operations for the six months ended June 30 was a positive $1,077,000. In the first six months last year they used $3,860,000 in cash. I like positive operating cash flow. Sometimes, I like it more than an accounting profit because you can only pay your bills with cash- not with accounting based profit.
 
There’s still the small issue of the company not making any money, but the loss fell from $1.6 million in last year’s quarter to $574,000 in this year’s June 30 quarter. They accomplished that by increasing sales 5.6% to $9.96 million, improving the gross margin to 52.8% from 50.3% and reducing operation expenses by 15% from $5.83 million to $4.95 million.
 
Unsurprisingly, sunglass sales were 95% of total revenues during the quarter, with goggles being 4% and apparel 1%. North American sales (including Canada) were 88% of the total. What they define as closeouts of Spy product were $800,000 during the quarter compared to $500,000 last year. “A significant portion of the SPY ® sales growth was from sales of sunglasses into our North American optical and international channels, and from our optical frame product line and Happy Lens™ collection.”
 
The higher gross margin resulted from “(i) improved overall sales mix of our higher margin products partially due to increased levels of sales into optical channels; (ii) a higher percentage of lower cost inventory purchases from China; (iii) lower overhead as a percentage of sales partially due to the consolidation of our European distribution center to North America…” But they also had to increase inventory reserves, and that reduced the margin a bit. I’d really like more information on the composition of Spy’s inventory.
 
The reduction in operating expenses included sales and marketing that declined by 22% or $800,000 to $3 million. This came from “…(i) a $0.6 million decrease in advertising, public relations, marketing events, and related marketing costs; (ii) a $0.3 million decrease in sales and marketing salary and travel related expenses primarily for reductions in headcount. These decreases were partially offset by a $0.1 million increase in sales incentives and commissions…”
 
The balance sheet reflects both the improvement in operating performance and the continuing issue of too much debt. Over a year, cash rose from $821,000 to $948,000. Receivables were up from $6.39 to $6.45 million. Of course you expect some growth in receivables with sales growth, but I’d really need to see the composition of receivables last years and now to know how I feel about the change and current level. Specifically, I’d want to know how much was related to Spy brand product at both dates.
 
Inventory fell a bunch from $7.7 million to $5.5 million. That reduction is good to see, but some of that is due not only to liquidating the licensed brand product, but to getting rid of some old Spy inventory as well. Is the inventory now “right sized” for a more normally operating Spy business? I can’t tell, but it’s a lot closer than it used to be.
 
On the lower half of the balance sheet, we’ve got negative equity of $14.5 million, up from $13.8 million a year ago. Remember that the reason Spy has had a chance to try and pull off a turnaround is due to a major shareholder who’s been willing to pump in cash. Last June 30, long term debt to shareholder was $15.1 million. This June 30, the number is $23.2 million. However, current liabilities have fallen from $12.3 to $8.5 million, and total liabilities are up just 4.9% from $27.5 to $28.9 million.
 
In the conference call, CEO Michael Marckx talked about how Spy has “…become a much more effective organization, with the idea of Super Service at the heart of our company culture. This can be summed up with the ethos of being in service to our retail partners, the people who wear our products and to one another, inside and outside of the company. Our Super Service mantra is simple: How can we make people HAPPY? This mindset is not only evident in our customer service, it is apparent in how we market our brand…”
 
I know- that sounds a little like a big old platitude, but I don’t think it is. Let me finish quoting CEO Marckx before I explain why.
 
“…our efforts this half and moving forward stem from a focus and brand ethos that will help to further strengthen our unique positioning and product offering in ways that are mutually beneficial to our retailers. With a more diverse and unique selling proposition from SPY, our retailers are able to better serve their communities with higher quality, differentiated products from SPY, and do so knowing we bring an energy, strength and point of view that our competitors are not matching.”
 
What he’s doing is bringing continuity and clarity to the way the organization functions. Everybody knows how to spend their time. They don’t have to ask so often what to do and not do. They know how every stakeholder should feel after dealing with Spy- Happy.
 
They don’t focus so much on what the competition is doing as on how they can run their own business well. Without this focus I bet they couldn’t have increased sales and gross margin while cutting expenses.
 
Financially, Spy isn’t out of the woods. They are still losing money and their balance sheet, though showing operating improvement, is burdened with way too much debt. Solving that problem requires not just that they make a profit but that they grow that profit through increasing sales. I hope there isn’t pressure to grow sales faster than their market position permits. Our industry is littered with damaged brands who tried to pull that off.

 

 

A Quart of Paint

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If you’re a homeowner, you know that you can never complete your project list. All you can do is try to keep it from getting longer. At our house, outside projects are my job and in the Northwest, that means get them done in the summer.

In the spirit of shortening the list, I stopped by a Sears yesterday to pick up a quart of exterior primer paint for one such job.
And found that Sears no longer sells paint. HOW IS THAT POSSIBLE!?
When we first moved up here from the Los Angeles area north of 20 years ago (Yes, I do appreciate the irony of my having found my way into action sports by moving from SoCal to Seattle), there was a chain of home stores called Ernst. It was obvious they were struggling, but when they started to carry furniture and all kinds of other stuff basically, in my view, desperately putting on the floor whatever they thought might possibly sell, I knew they were toast. Shortly thereafter, they were out of business.
It’s no secret Sears has been struggling. But when I saw they were no longer carrying paint I said, “Okay, that’s it.”
Tactically, I’m sure their carefully conducted analysis showed that paint was a money loser for Sears. So they got out of it.
But it’s way more than a financial decision. It’s a decision about who their customers are and what they expect from Sears. Truth is, I mostly go to Home Depot and Lowes now because I know that whatever I want for home repair, maintenance, or remodeling they are likely to have it. But Sears was convenient, and I had a residual affinity for it as a home store. But somehow their not having paint flipped a switch in my fontal lobe and what was clearly a delusion on my part is gone.
Sears used to be the place where you could get everything. If not in the stores then through the catalog. For certain items, it could be the only choice for people in parts of the country, and they were happy with Sears even if it took weeks to get the product. It’s way easier to be a retailer when your customers have no choices and love you anyway.
Sears has a hangover from the party it threw while selling almost everything to everybody. Now, why would you choose Sears? It sells hardware, home improvement, clothing, shoes, appliances, electronics, towels and bedding and probably some categories I’m forgetting. Oh yeah- auto repair. Is it your first choice for any of those? Can you think of anybody else that tries to compete in all those categories? To make it worse, we can all think of places with better selection, prices, and/or service in any of those categories.
Sears competes with everybody. Which is impossible and maybe means they are not very relevant as a competitor. I’d also note that the chains I consider the closest overall competitors to Sears (Walmart, Fred Meyers, Target, etc.) are also carrying food; the one thing Sears seems to have stayed away from.
Sears is a hodge podge of unrelated categories no longer connected by a defined consumer need and I don’t think they do any of the categories particularly well. It’s a bad place to be. And, as we all know, it’s made worse by an economy where sales increases are harder to come by.
I’m not writing about Sears because I’m worried about them leaping into the youth culture business (though, hell, everybody else has). They are a poster child for two business conditions. The first is owning a market niche (a damnably big one in Sear’s case) and having the market evolve away from you. Markets, of course, always change, so you have to expect that. I also expect you aren’t going to be able to predict how they change.
The second, said before but worth saying again, is that when you try to be meaningful to everybody, you can end up being meaningful to nobody.
It’s certainly an old story to us. Credible, successful brand tries to leap beyond its customer franchise alienating existing customers, never really distinguishing itself with the new target customers, and finding the competition from the whales in the new ocean overwhelming. Or credible, successful, brand just continues to do what it’s always done and ends up screwed as the market changes and it doesn’t.
It has, I think, always been true that you couldn’t just sit in your niche. Neither could you infinitely extend your brand. But cash flow, I’ve said, covers up a host of problems and it was easier to do nothing, or do the wrong thing, in the old economy and get away with it for a while.
In our competitive thinking, we used to be over focused on what our competitors were doing. It was way easier than really figuring out who your customers were and why they were buying from you- that’s hard work. That really didn’t work and certainly doesn’t now.
To over simplify, you probably have to grow, but not too much. “Not too much” is different for every brand or retailer. Every product you decide to carry, every distribution decision you make has to be based on what your customer is doing and what they want from you.
Create a process to help you make those decisions. If you don’t, they will be overwhelming and you’ll find yourself wallowing around like Sears. Don’t stop carrying paint if your customers expect you to have it.

 

 

What’s Up at Sanuk? Oh- And Decker’s June 30 Quarter

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Deckers, as you know, owns UGG, Teva and some other smaller brands as well as Sanuk. At June 30, they had 89 retail stores as well. 

In the quarter ended June 30, Deckers reported sales that fell 2.5% to $170 million compared to last year’s June 30 quarter. The gross profit margin declined from 42.2% to 41.1%. Selling, general and administrative expenses rose 10.1% from$102.3 million to $112.6 million. There was a net loss of $29.3 million, up from a loss of $20.1 million in last year’s quarter.
 
With that cheery news behind us, let’s jump right to a breakdown of Decker’s revenue and operating income by segment taken right from their 10Q, which you can view, if you’d like, right here. The chart below is from page 9.
 
 
You can see that UGG wholesale business was down 20.7% and Teva wholesale fell 9.5%. Sanuk was up 4% at wholesale, ecommerce grew 34% and retail 29% due to new store openings since last year. Sanuk’s ecommerce sales rose from $1.26 million to $2.09 million. Their sales through Decker’s retail stores were up from $0 to $218,000. Total Sanuk sales in the quarter were $30.1 million.
 
It always intrigues me that there’s never a discussion of how, for better or worse, the direct to consumer business impacts wholesale business. It almost seems like there’s a conspiracy of assuming that it’s inevitably a good thing. I suppose, in the case of ecommerce, brands have no choice but to be involved in it, so you might as well assume that’s true. In the case of retail, I’m not quite so sure and never have been. I’d love to be a fly on the wall as companies try and decipher how their wholesale and direct to consumer businesses influence each other.
 
Back to the chart. In its bottom part, we see income from operations for each segment. Only ecommerce and Sanuk grew their operating profit. UGG actually lost a little money, and the retail stores more than tripled their operating loss. Opening more stores and losing more money doesn’t seem like a good plan.
 
But back to Sanuk’s wholesale results. You can see they grew operating profit during the quarter by 143% from $2.7 to $6.5 million even though sales were up only 4% or $1 million. How’d they do that?
 
Off to the fine print.
 
As background, Deckers acquired Sanuk in July 2011 for, uh, a lot of money. The contingency payments include 36% of Sanuk’s gross profit in 2013 and 40% in 2015 with no upside limit (no payment in 2014). Deckers has to estimate what these payments may be. They are included on the balance sheet in other accrued expenses and long term liabilities. At least some of the amount impacts the income statement. It’s interesting, given Sanuk’s recent results, that “The estimated sales forecast [for Sanuk] includes a compound annual growth rate (CAGR) of 17.3% from fiscal 2012 through fiscal 2015.”
 
Anyway, Sanuk’s big operating income improvement “…was partially the result of decreased expense related to the fair value of the Sanuk contingent consideration liability of approximately $5,000,000 partially offset by increased selling and marketing expenses of approximately $3,000,000. The increase in income from operations was also due to the increase in net sales and resulting gross profit.”
 
To some extent, then, Sanuk’s improved operating profit  from its wholesale business during the quarter is partly the result of Decker’s reduced expectations for the brand through 2015, resulting in a reduced accrual of the earn out. Isn’t accounting wonderful?
 
I’d also note that of the net goodwill of $128.7 million carried on Decker’s balance sheet, $113.9 million is related to Sanuk. At some point, if Sanuk’s performance doesn’t meet expectations, that will have to be written down. Don’t know how much. It would be a noncash charge, but still a hit to income.
 
We also learn that Sanuk’s wholesale sales “…increased primarily due to an increase in the volume of pairs sold, partially offset by a decrease in the average selling price. The decrease in average selling price was primarily due to increased closeout sales, as well as a change to the discount program for prebook and re-orders.” The volume increase was about $1.5 million, but the discounting cost them $500,000.
 
I’ve been writing and speaking lately about how hard it seems to be a public company in our space. I’m beginning to worry that Sanuk is another example of what happens when an excellent brand is acquired for a high price by a public company that has to meet Wall Street growth expectations, but doesn’t really understand our space.
 
Deckers CEO Angel Martinez, in the conference call, talks about Sanuk this way:
 
“…the Sanuk brand started off as a predominantly male one-season surf brand when we acquired them in 2011. Now we’re transitioning the Sanuk brand into a lifestyle brand that will be featured in department stores, sporting goods and outdoor retailers in 2014.”
 
He says that so easily. But as I think about why Sanuk succeeded and what the brand stands for, I think he may be surprised just how hard it is to accomplish that transition without damaging the brand. It’s not that it can’t be done; I am just not sure it can be done as quickly as a public company might require. I am sure that “department stores, sporting goods and outdoor retailers” is way too broad a definition of the target market to be useful, and I assume appropriate slicing and dicing is ongoing at Deckers. 
 
Deckers is taking Sanuk into new markets, they are taking it into new, broader distribution, they are trying, according to CEO Martinez, to “…allow our Sidewalk Surfer-loving customers the ability to wear their favorite styles deeper into the year [UGG by Sanuk?],” and, he says, they want to “transition the brand from primarily hanging footwear merchandise brand to a meaningful player on the footwear wall in our surf, outdoor and footwear specialty channels, during what has traditionally been the brand’s off season.”
 
I seem to remember a successful, fast growing, quirky, male surf brand called Sanuk. Whatever happened to that brand anyway?
 
It feels like Deckers is trying to change and grow Sanuk to meet Wall Street requirements and to justify the price they paid for the brand. But they now expect Sanuk sales during the year “…to grow approximately 5% versus our previous expectation of between 10% and 13%.” My hope is that they don’t see the reduced sales expectations as a reason to push some of these transitions even more quickly. I’d suggest they consider that some part of the lower sales is the result of what they’ve done already. Hope I’m wrong and that they listen to the people they’ve recently hired.

 

 

VF’s June 30 Quarter; Net Income Down, But Kind of Not Really.

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VF’s net income fell 11% from $155.4 million in the quarter to $138.3 million in the same quarter last year. But last year’s quarter included a gain of $41.7 million from the sale of the John Varvatos brand that was booked under Other Income (Expense). In this year’s quarter, instead of a gain of $41.6 million, that line showed an expense of $1.5 million. Without that gain from the sale, net income would be up over last year’s quarter. 

Which is what you might expect with total revenues up 3.7% to $2.19 billion and the gross margin rising from 46.1% to 48.5%. As we’ve gotten used to, VF’s Outdoor & Action Sports segment (that includes Reef, Vans, The North Face and Timberland) led the way. Below is a table from the 10Q with the revenues and operating profit for each segment. And, while we’re at it, here’s the link to the 10Q for anybody who wants it. I always wonder if anybody but me ever looks at them.
 
 
As you can see, Outdoor & Action Sports (OAS) represented 49.7% of revenue and 37.3% of operating profit. The result in Jeanswear is impressive, delivering a bit more operating profit than OAS on only $612 million in revenue.
 
North Face revenue rose 5% in total. There was “…moderate growth in the wholesale sales, a 15% increase in the brand’s D2C [direct to consumer] business and a more than 20% increase in international sales.” In the Americas, wholesale revenue declined in the mid-single digit range. D2C there rose in the mid-teens.
 
Vans revenues grew 15%, with growth balanced between wholesale and D2C. Outside of the Americas, Van’s growth was over 20%. D2C growth was over 40%. They don’t tell us what Van’s growth was in the Americas, but obviously it was below 15% since outside of the Americas, it was 20%. I thought their take on Van’s apparel was interesting. “By taking classic action sports products the consumers are already connected to and adding performance benefits to them, such as weatherization, we’re equipping the Vans consumer with a whole new level of quality and technology in both warm and cold weather. This allows us to have more relevant, year-round offerings as we extend our reach into cold-weather months and cold-weather markets.”
 
We hear that Reef’s results were “solid,” but aren’t given any details. Timberland’s global revenues fell 3%. They were up low single digits in the Americas and down high single digits in the rest of the world. They expect revenue to be up for the year. We’re into VF’s second year of ownership of Timberland and to some extent it’s still a work in progress.
 
The 3.7% total revenue growth included 3% in the U.S. and 6% internationally including 10% in the Americas not counting the U.S. and 2% in Europe.
 
The gross margin improvement of 2.4% resulted from “…lower product costs and a favorable mix shift towards higher margin businesses.” Partly that’s due to growing D2C business. They don’t tell us anything about exactly how the lower product costs came to be. I wonder if there isn’t some benefit from the fall in cotton prices included there. I’d just like to know what part of it reflects good management and what reflects factors over which they have no control.
 
Inventory fell 3% even with the sales growth and certainly reflects good management. Inventory management is something they noted several times as an area of focus. They characterize their supply chain as a competitive weapon. “And as others are feeling the pinch of higher costs, we’re in many, many cases able to offset those costs through efficiencies in our own plants.”
 
They specifically connect inventory and supply chain management to marketing when they note that they are very satisfied with their retail inventories because it gives them “…the opportunity to really get our new product well positioned and upfront for the consumer as it starts to ship into our dealers…” That’s an important idea.
 
Marketing, administrative and general expenses rose 1% as a percentage of revenues. Half was for their D2C business and half for “…increased marketing investment in our brands.”
 
If VF has issues, and isn’t growing as fast as it used to, those issues are pretty much the same ones all retailers and brands in our industry have. Europe is weak, and VF especially calls out problems in Southern Europe. Hardly a surprise with unemployment rates north of 25%. The U.S. is recovering slowly, but consumers are cautious in their spending. “Retailers,” they note, “Are buying much closer to demand.”
 
But VF points out that their pension plans are almost fully funded (that’s a big deal, though you don’t hear about it much), they are paying down $400 million in Timberland related acquisition debt in the third quarter, and they will be out of the commercial paper market by year end. Their long term debt is down $400 million from a year ago. That leaves them with a balance sheet with which they can consistently pursue their strategy. Not everybody enjoys that. 

 

 

A Brief Update on Billabong

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As you are probably aware, Billabong yesterday published a press release announcing the expected resignation of Launa Inman as CEO and of Paul Naude as a director and employee. It also said that, “Discussions with Scott Olivet regarding his appointment as CEO are continuing but have not been finalised as we await the outcome of the Takeovers Panel’s deliberations.” 

In the meantime, Scott is a consultant to Billabong and Peters Myers is acting CEO. You can see the press release here.  It’s the first item under “Recent News” called “Billabong Management Changes.”
 
Scott Olivet is the executive Altamont is bringing in as part of the overall deal with Billabong. One would assume that the deal with Scott was finalized before Altamont’s deal with Billabong was closed since Altamont wants Scott as CEO. You may also recall that Scott was investing a couple of millions of his own dollars in Billabong as part of the deal. I’m guessing here, but I can imagine that maybe Scott doesn’t want to commit his own funds until he knows what the Takeover Panel decides.
 
The investors who owned Billabong’s debt were paid off by Altamont when the deal with Billabong closed. They appealed to the Australian Takeover Panel because they didn’t like the deal. “Didn’t like” probably means they were hoping for a better deal themselves than just getting paid off.
 
Here’s a link to the Takeover Panel. When they publish a decision, we’ll be able to see it here. According to the site, “it takes a little over 2 weeks (16 days) for the Panel to make a decision on an application.” The average days from deciding to review to publishing their decision has been about 10 days in 2013. Billabong says it may be a week or more until we have that decision.
 
Meanwhile, Billabong has announced that their preliminary earnings presentation for the year ended June 30 will be released on August 27th. As I’ve said, I’ll be very interested to see their balance sheet.  Seems to me that in the past, they haven’t called it ‘preliminary." 
 
Okay, that’s it. I really wish this wasn’t all going on and that Billabong was just going about business, but it sure is interesting. 

 

 

Selling Less In a Good Cause; Skullcandy’s Strategy and Quarter

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In the quarter ended June 30, Skull’s sales fell by 30% to $50.8 million from $72.4 million in the same quarter the previous year. Their gross margin fell from 48.6% to 44.9%. Selling, general and administrative expenses actually rose slightly from $23.5 to $24 million, but if you exclude the almost $1 million that’s included for the move from San Clemente to Park City, it fell a bit. Net income, not surprisingly, declined from a profit of $6.8 million to a loss of $689,000. 

It’s not that I’m thrilled to see these results, but I think they are indicative of Skull pursuing the only strategy they can reasonably pursue. Here’s how CEO Hoby Darling puts it:
 
“While I do not believe we will turn our sales trajectory positive this year, we’re decisively taking action based on learnings from some historical missteps and being more disciplined around distribution, retailer and product segmentation, discounting and importantly, the alignment of product, marketing and sales. These are necessary first steps to protect the brand and set us up for long-term healthy growth.”
 
You remember that last quarter Skull was cutting back on the sales through off price channels (year to date those sales are down 50%). Now we find out they’ve actually held back some product from some retailers to protect their brand position. As CEO Darling puts it, “We need a clear distribution channel and to have retailers and consumers seeking out our products.”
 
One more quote:
 
“We will continue to aggressively rebalance our distribution pyramid so that demand and supply are more closely matched. This includes minimizing the end-season product sales in the off-price channel, protecting our map pricing policy and supplying our retailers with the right amount of product to match healthy demand. We will continue to protect profitability, while investing in our most important growth initiatives in demand creation.”
 
Oh hell, just one more:
 
“As we think about our future, the main tenets of our strategy are based on the following: first, transforming the marketplace. This includes rebalancing and segmenting our distribution pyramid to amplify with winning retailers and match supply to market demand and clarifying our brand message, with a strong focus around digital and planned sale.”
 
Regular readers will know why I’m all a dither about this strategy. I’ve been pushing for some years the idea that with sales growth harder to come by, gross margin dollars and control of operating expenses was where you needed to focus to improve profitability. I’ve said that distribution and deciding who to sell to is way harder than it used to be. But I’ve also said that if you recognize the relationships between operations (especially inventory management) on the one hand and sales and marketing on the other, you can achieve better results while spending a lot less.
 
Like Quiksilver and Billabong have done and are doing, Skullcandy is also working to “…create a cohesive organization by removing the operating silos that were hampering communications, alignment and culture between different areas of the business." CEO Darling, by the way, thinks they can probably spend less on demand creation. He makes that comment in kind of an offhand way, but if the company approaches their customer segmentation, pricing, and distribution in the way he describes, it might be a lot less. Overall, what Skull is doing kind of reminds me of Spy’s strategy. And the bottom line is that Skull is going to have to reduce its SG & A spending as a percentage of sales unless sales grow way faster than they seem to expect.
 
There’s just one fly in the ointment. Like Billabong, Quiksilver and Spy, Skullcandy is public. These are four companies that would be better off if they were private and free to pursue brand strategies unconstrained by the need for regular, quarterly growth. Skull is purposefully restricting sales to defend and strengthen their brand and market position and, I’m expecting, greatly improving their overall profitability. Great decision.
 
But there’s that pesky Wall Street revenue growth bias out there. What to do? Skull expects that their current actions will increase their sales in their core market, though not until 2014. CEO Darling describes the brand as “…fun, young and irreverent, woven in with creative and active.” Good definition. “As small and creative company, we have the opportunity to be special and more unique than our larger competitors.” I agree. But that focus also limits growth because it limits your available customers.
 
What to do? Product extensions, which the analysts ask about every quarter, are one answer. Sell more to the same customer. The Air Raid Bluetooth speaker will be in retail in the fourth quarter. And you also look for growth by “…expanding beyond our core audio headphone market and partnering with other brand leaders and their respective consumer categories will assist in broadening our region appeal to give Skullcandy added legitimacy outside of our core market position.” They use a deal they are making with Lululemon as an example. Sell more to a new customer.
 
Let’s assume that as a result of implementing these strategies I like that Skullcandy solidifies its position in its core market, grows sales slowly (slower growth initially is implicit in its strategy), and improves its profitability on those sales significantly. As a private company, that might arguably be a great result. As a public one, not so much. So along come the brand extensions and the partner deals “to give Skullcandy added legitimacy outside of our core market position.”
 
How’s that worked out in this industry in the past for public companies? As I’ve pointed out, Zumiez is the only action sports based company that’s public and doing well. Others are all having difficulty or have been acquired.
 
Skull has the balance sheet to pursue its strategy. They’ve got no long term debt, $30 million in cash (up from $7 million a year ago) and a strong current ratio. Operations provided $12 million in cash flow during the first six months of the year compared to using $8 million in the first six months of last year. Inventory over the year fell 17% from $50.5 to $42 million. I might have expected a larger drop given the sales decline. They tell us the decline wasn’t greater “…due to higher gaming inventories support retail and the building of inventory in China to support our direct sales model there.” I’d be interested to know how much of their existing inventory is price point product they still need to move.
 
Much of the sales decline was due to a reduction in the off price sales, but they also mention “…lower sell-in at a key customer and a decline in sales to several of our specialty retailers.” They have one customer that represented 18.3% of sales during the quarter compared to 11.4% in last year’s quarter. While I imagine that increase is explained by their decision to reduce price point sales, it’s still quite a concentration.
 
They make the interesting comment that they see some market movement from over the ear product to in ear. They don’t tell us the extent of the change. That’s interesting because in their last call they talked about moving towards higher priced but lower margin (generating more margin dollars) product that was largely over the ear. I was surprised no analyst asked about that.
 
Skullcandy has a strategy I fully support, but wonder how it will be received in the public markets. They have some personnel, relocation, and operational changes going on that it’s just going to take a little time to work through. I will wait to see how their product extensions work out. I hope they aren’t too aggressive in that area.

 

 

Relaxed Fit

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Maybe a month ago, I was walking through a local mall visiting all the usual retailers to see how things looked. I stopped at a PacSun store and was attracted to a table with some Volcom shorts on it in colors I really liked. There was a sticker on the shorts that said, “Relaxed Fit.” 

I paused for a moment, looked around the store to clear my head, and then read the sticker again. Yup, it said “Relaxed Fit.”
 
There was a moment of mental paralysis, then the thoughts all poured out at once. “This must be some sort of cool marketing trick I just don’t understand, the stickers are there by accident- some clerk is screwing around with my brain (and it’s working), is this really where our market is going, there’s some kind of new trend I don’t know about, yes, that must be it, maybe it means to be fit and relaxed, Kering (Volcom’s owner) is making them do this, no, wait, somebody slipped something in my soda…”
 
I walked out of the store determined to pretend this had never happened. But three weeks later, in another mall in another city I made the mistake of checking again and there the shorts were with that same diabolical sticker. My attempt at denial was foiled.
 
But happily I was saved by my ever vigilant research department that sent me this New York Times article called “Three’s a Trend | Men’s Shorts That Are Loose, but Refined.”
 
“Loose, but Refined” is conceivably a perfect (and hopeful) description of Volcom owned by mostly high end fashion company Kering. Grabbing at straws as I am, I’ve decided to believe that Volcom’s “Relaxed Fit” sticker is just a bow to this fashion trend shaped by their large corporate owner. See, I don’t know a lot of surfers, skaters and snow sliders that need relaxed fit clothing.
 
Okay, I’ve had a little fun with this, and I’m sure Volcom isn’t the only one doing it. I suppose I need to recognize that all our customers can’t be teenagers and that body shapes change with age (not mine of course). Yet in our push for growth, we get further and further from our roots. The ASC conference the day before the Agenda Show celebrated the importance of authenticity, but I wonder just what kinds of customers we can make product for before we begin to lose it.
 
I hope Volcom can stay loose.