The Disaster of Negative Interest Rates

On October 31, I posted an article called “What’s Wrong with Capitalism?” After a couple of paragraphs of me ranting and raving there was a link to an article that described what Ben Hunt calls the “financialization of Texas Instruments.  It was disturbing to a few people I heard from and, I hope, to some others I didn’t hear from. 

In the spirit of continue to disturb you in a good cause, here’s another article you should read called, perhaps not surprisingly, “The Disaster of Negative Interest Rates” published by the Mises Institute.

If you’ve never heard of the Mises Institute, named after the economist Ludwig von Mises, you might consider adding their web site to your favorites or even signing up for their free occasional emails.  This is another of my attempts to get you information you really need but won’t find if you rely on mainstream media. 

The point of the article is not just that negative interest rates are a business and economic disaster if maintained too long, but that they threaten the structure and functioning of our republic.  Here’s the link to the article.

Hibbett Sports: Annual Results and Omni-Channel Progress After a Remarkably Late Start.

“At the end of the second quarter of Fiscal 2018, we successfully launched our e-commerce website,” Hibbett Sports (HS) tells us in their 10-K for the year ended February 2nd.  This isn’t news.  I wrote about it last October when I discussed their quarterly results.

If you’re not already familiar with HS, you might review that article before continuing.  My goal is to bring you up to date based on their full year results and new information in the 10-K.  Let’s start with this chart.  It shows HS’s annual results for the last five year.

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Strategy, Housekeeping and the Numbers: VF’s June 30 quarter.

It’s interesting to review this recently released 10-Q, as it discusses VF before the recent announcement that they will spin off the jeans business as a separate public company.  With hindsight, you can see how their strategy would lead to that decision.  I’ll also outline the company’s change in their business segments and, of course, review the numbers.  Let’s get started.


Here’s what CEO Steve Rendle says in the conference call.

“…we all see that the U.S consumer continues to be open to and motivated to interact with powerful brands, brands that they connect with, brands that provide products and experiences that are relevant to who they are. I don’t think we’re sitting here saying that this is easy…but we — what we’re seeing is that we have a clarity of focus on what our brands stand for, that we’re bringing the best product. And more importantly, big learnings over the last couple of years is really elevating the brand experience in connecting more emotionally with our consumers. We are able to stay at the forefront of the decisions that they have and where they choose to spend their time and money. We see the same to be true in Europe, and we see the same being very true in Asia and I think as we really focus our attention against those key drivers and platforms within our portfolio, we will continue to see our opportunity to connect and maintain those long-term loyal relationships.”

I’d say that’s not the jeans business he’s describing.  Like I said, hind sight is wonderful.

Steve is the second industry CEO I know of who’s trying to help the analysts focus on asking the important questions.  I was hoping for follow up questions about systems and the different quality of information, changes in how and how fast they make decisions, their view of risk taking and how better/different customer information is leading to changes in logistics and inventory management.  Oh well.

Later, talking specifically about Vans, CEO Rendle makes some related comments.

“The strength and understanding of the consumer, that the team has gained through our consumer insights and brand building focus, they just have gotten stronger and stronger, more focused on who they are and more importantly who they are not. We are in exceptional moment where we’re seeing distorted growth. Some of that could very much be some trend, level of trend. But honestly, the way we look at it, we are resetting the rightful level of penetration that this brand has with the consumer and within the wholesale channel and as you — as we do our channel checks, you can see the brand has just taken a larger footprint both on the footwear wall, the tables in the footwear section, but we’re also now starting to place really relevant assortments of apparel. So that the better this brand begins to understand…its consumer, the more thoughtful we can be on placing the right products at the right time. The disciplined franchise management, channel management segmentation just gets stronger and stronger and it really is disciplined of how that team operates… This isn’t an exceptional moment of time that likely has a downward cycle in the back and this is just a reset of its rightful position as one of the top footwear brands in that active lifestyle component of the consumer’s choice.”

You can see Steve alluding to using the same tools/approach for Vans he discussed in the first quote.  No surprise there.  He also talks about Van’s current growth as “exceptional” and “distorted.”  They’re using that as an opportunity for “resetting” the brands penetration and positioning.  They are being thoughtful and purposeful in how they distribute the brand.  Good.

They see a particular opportunity in Vans’ apparel.  It sounds like some cautious management of the brand even as it grows is creating, as they see it, the opportunity for apparel.  What I think I hear, and what I imagine they’d like Wall Street to pick up on, is that even if (when?) revenue growth does slow, they could continue to grow the bottom line.

But he doesn’t see that this time of “exceptional” growth as one that will have a “downward cycle in the back.”

Well, that’s walking a fine line.  I have endless respect for what VF has accomplished with Vans.  If he means the brand isn’t in danger of the kind of blowup we’ve seen in other industry brands, I can buy that giving their management process for the brand as they describe it.  But there’s an implication that any kind of turn down isn’t going to happen.  That would be somewhere between unusual and unprecedented.  Even Nike had its hard times.  I continue to believe there’s a limit to one brand’s market share.

If they are saying that by careful distribution, positioning of the brand, and paying attention to the consumer, they can manage and minimize a downturn when it comes, I’d think that right.  They may be well positioned to benefit from the inevitable recession.

Vans is taking advantage of its exceptional revenue growth to position the brand for success even when that revenue growth is not quite so exceptional.  Good plan.


VF has changed its reportable segments, joining other companies who have stopped referring specifically to action sports.  The new segments are:

  • Outdoor, which includes The North Face, Timberland, Smartwool, Icebreaker and Altra.
  • Active, which includes Vans, Kipling, Napapijri, JanSport, Reef, Eastpak and Eagle Creek.
  • Work, which includes Dickies, Bulwark, Red Kap, Timberland PRO, Wrangler RIGGS, Walls, Terra, Kodiak and Horace Small.
  • Jeans, which includes Wrangler, Lee and Rock and Republic.

As we know, those four segments will become three after the spinoff of the jeans business.

CFO Scott Roe tells us why they made the change.  “Our Outdoor Action Sports business has become so large that we felt it was good for you the readers to have one click down one more level of visibility rather than having one giant segment, especially given some of the different financial characteristics of the two as you can see, right. And really that’s the driver in the guidance is companies with like characteristics are grouped together and it’s really no more or less than that.”

Makes sense to me.

The Numbers

Net revenues rose 22.9% from $2.269 billion in last year’s June 30 quarter to $2.278 billion in this year’s.  The table below shows revenue and operating profit by segment.  You can see that the active segment, where Vans lives, is still the largest segment, though not as large as before the change described above.  Vans was up 35% for the quarter, speaking of unsustainable trends.  The big jump in work came from the Dickie’s acquisition.  The North Face revenues rose by 8% and Timberland was down 1% despite a 4% boost from foreign currency.










11% of the 22.9% revenue growth came from acquisitions, and 3% from favorable foreign exchange trends.  Direct to consumer revenues rose 22% and were 31% of total revenues.  Acquisitions accounted for 6% of that growth and foreign exchange 2%.  Ecommerce rose 54% including 4% from foreign currency and 21% from acquisitions.

International revenues represented 38% of quarterly revenues and rose 27%.  5% of the increase was from foreign currency and 13% from acquisitions.

56.6% of revenue growth in the quarter came from acquisitions and foreign currency.  The table below shows the sources of revenue and operating for both quarters by segment.  This is worth spending a minute on.









The gross margin rose from 49.6% in last year’s quarter to 50.3% in this year’s.  “Gross margin was favorably impacted by a mix shift to higher margin businesses, increases in pricing and foreign currency changes, partially offset by lower margins attributable to acquired businesses, acquisition and integration costs and certain increases in product costs.”

SG&A expenses as a percentage of revenue declined from 42.6% to 42% due to spreading these expenses over a bigger revenue base.

Net income rose 45.6% from $109.9 to $160.4 million.

One other financial comment that may be of interest to some of you.  VF has a defined benefit pension plan, which is becoming something of a rarity in this country.  Looking at Note 10 in the 10-Q on that plan, I saw that the discount rate they are using to determine pension obligations was about 4.25%.  “So What?  How else are you going to bore us today, Jeff?”

I just wanted to congratulate VF on having a reasonable discount rate.  The lower the rate, the more it costs them to fund the plan.  In the public sector, discount rates of 7 or 7.5% are more common, because, I guess, the politicians know they won’t be around to deal with the blow back when the impact of the underfunding hits (as is starting to happen now).  Unless “This time is different,” the business cycle suggests that the markets are not going to support those higher returns over the next decade or so.  Honestly, I’m afraid 4.5% may prove to be too high.

Anyway, it’s good to see VF in touch with reality on this one.

CEO Rendle had this comment about how VF was becoming more “retail centric.”

“…you’re seeing greater attention to thinking and acting like a retailer, focusing on sell-through and getting our very best products on the floor at the beginning of the season, working dynamically to make sure those products are selling through and just keep the offer fresh, balanced with better and better marketing.”

I circled the term when I read the conference call and wrote “inevitable!” above it.  It struck me that the need to become retail centric had started to appear perhaps 20 years ago, even if we didn’t identify it as such then.  Basically, the requirement to address a customer who shopped a new way and had different priorities and sources of information made it necessary for brands to move in that direction and, finally, to become retailers.  The ones who manage that well will be successful.

Retail Jobs, the Internet, and the Role of Customer Service

I want to introduce you to a web site I subscribe to called Wolf Street.  It’s free and you can sign up for emails if you want.  Here’s the link  the chart below comes from.  You don’t have to read Wolf’s article to follow what I’m discussing, but you might take a look at it.

If you did go through the article, you’d see that there were 15.8 million U.S. retail jobs at the end of April as reported by the Bureau of Labor Statistics.  In terms of total number of jobs, that’s second only to health care at 15.9 million.

Retail has added 76,000 jobs in the last 12 months, the BLS tells us.  From our more focused industry perspective, the picture is a bit different.  Here’s the chart from Wolf’s article.

Look, I had my “Aw shit” moment when I saw this.  But I’ve shaken it off and you should too.

First, it’s hardly a surprise.  We’ve known for some time now that we were over retailed as a country and an industry.  We’re going through an unpleasant but necessary process (The economist Schumpeter called it “creative destruction”) that I see ending with the next recession, whenever that happens.

Second, some part of the decline, as you can see above, is being offset by growth in ecommerce jobs- what the chart calls “Nonstore retailers.”  That may not make you happy if you’re the business closing stores or going out of business, but I can assure you it makes the people getting those jobs happy.

Third, brick and mortar is obviously not going away.  But it is evolving in response to the growth of ecommerce, improvements in distribution, and accelerating knowledge and connectivity among consumers.  You can see in the chart it’s growing in those industries that don’t lend themselves to ecommerce and declining in those that do.  Big surprise.

Fourth, talking about brick and mortar “declining” or “growing” misses the point.  If you follow Tillys, The Buckle, Zumiez or other industry retailers you will certainly see a reduction in the rate at which they open stores or even, net of closings, no new stores openings.

Opening new stores, by itself, is no longer the obvious, standalone path to growing revenue and profitability.  You know that.  Retailers are struggling (a fair word I think) to figure out where to place stores, how to structure them, and what their role should be in an increasingly seamless, interconnected retail market.

Let me put this another way.  If you forget about making a distinction between brick and mortar and ecommerce revenues, how do you use your store locations, budgets, staff and layouts to maximize the bottom line?  What is a “store” and what is it supposed to do?

If you figured that out, based on your excellent and improving customer information systems, it might just be possible to improve revenue, or at least the bottom line, with fewer stores.  I’m already certain it’s required, for both financial and customer relation reasons, that stores absorb much of what used to be thought of as the standalone ecommerce costs.  Here’s why.

We’ve all known for years that ecommerce is expensive.  The now obviously inadequate challenge I made years ago was to make sure your incremental operating profit from ecommerce operations at least covered those ecommerce costs and to not cannibalize your existing sales.

What I now know you need to do is make the issue of cannibalization irrelevant.  The only way to do that is to have an organization structured to see no difference between online and instore sales and to place as much of the ecommerce cost structure as possible within the brick and mortar footprint.  That might include, for example, eliminating any difference between ecommerce and brick and mortar inventory, making brick and mortar sales people responsible for the customer relationship online or in person, and no doubt a dozen other things I haven’t thought of.  It’s already happening at many retailers.

If you do this well, can you grow your revenue?  Probably.  Can you reduce costs and improve the bottom line?  Yes.

The very related activity I see changing is customer service.  I started thinking harder about it when I read and pointed you to these articles on some emerging retail technologies, including 3D printing, and the millennials’ approach to money.

So what does the customer need you to do that we might call customer service?

Find and compare prices? Compare one brand with another? Locate the product? Understand features?  Find out how the product wears/functions and what others think about it?  Oops.  That sounds more like the list of things they don’t need you to do any more.  What should you do?

On May 3rd the FDRA (Footwear Distributors and Retailers of America) held an executive summit called Retail Footwear Revolution: Succeeding in the Age of Consumer Chaos.  Good title- though it’s only chaos for the brands and retailers.  The consumers are just fine.

Among the speakers was Footlocker CEO Dick Johnson.  SGB Executive reported here on what he said.  I couldn’t find a transcript.  I strongly recommend you read it.  It will resonate with all of you.

Among the interesting things he notes is that Footlocker has closed 1,000 stores in the last ten years, but overall square footage has grown.  That, I think, is because the function of stores has changed.  As he puts it, “…we’re building more exciting space.”

Also more expensive spaces I’m thinking.  And just what does “exciting” mean?  We all continue to try and figure that out.

The article continues, “Johnson said the discovery phase used to be heading to Foot Locker to find out ‘what was cool’ and that you ‘had to know the guy who knew the guy’ to find out about launch products.  ‘Not anymore,’ said Johnson, ‘Discovery and researching happens constantly with our consumer. They know more than we know sometimes.’”  Yes, they do.

The article notes that Footlocker is “…leveraging data to bring a higher level of personalization…Johnson said one of the biggest investments Foot Locker is making is in data, which is being used to drive messaging, merchandise decisions on its website and stores, product buys and even service levels and the overall customer experience. The focus is on tapping algorithms and machine learning ‘so we can learn faster’ and more quickly adapt toward where consumer preferences are heading.”

Wow.  Is that customer service or customer management?  Consumers, I’ve written, have found themselves in control.  Retailers and brands want to (have to) respond to consumer demands, but it feels like they are also trying to get some of that control back.  I don’t blame them.

Finally, the article reports, “Foot Locker plans to invest in local content and local artists to ‘change the way that people think about our stores.’ More experiences, such as bringing in a barber chair for a special promotion, or offering sneaker cleaning on certain days in exchange for loyalty points, will help local stores stand out. Data will be tapped to ensure marketing and product assortments are tailored to local tastes. Said Johnson, ‘Not every market is treated the same.’”

Can you, then, have hundreds and hundreds of stores and each of them, to a greater or lesser extent based on improving data, each act as a specialty store?  That certainly seems like what Footlocker (and other retailers) is trying to do.

People will still want to come to brick and mortar stores, though perhaps not so many, not so often, and for different reasons.  Customer service does not mean what it used to mean unless you have a product that’s distinctive and somewhat scarce.  As I talk with executives and read what they say, I find them very specific about the problems, but often speaking in generalities about the solutions.  Like I said, we’re all still trying to figure it out and, if we think we have, don’t want to tell our competitors.

Do two things for me.  First recognize the difficult economic process we’re going through and prepare for it.  Some people I talk with don’t precisely want a recession, but some part of them wants to get on with it to perhaps come out the other side and complete this consolidation.  I’m generally in that boat.

Second, think hard about customer service.  You can’t afford to do all the things you used to do in the same way and do all the new things the consumer wants you to do.  If only financially a transition is necessary.

On a personal note, I’m just back from two weeks in Tuscany with my wife.  Good food, good wine, nice people, beautiful country.  Recommend not driving in hill towns.

I started this article in Tuscany when the jet lag started to wear off.  I’m finishing it at home where the jet lag has not worn off.  Moan.  Maybe I need to proof read this after my nap.  Thank you for reading.  I really feel lucky you’re willing to spend a few minutes on my ideas and always look forward to your comments.

Some New (or Not) Retails Ideas

In my travels, I’ve come across a few articles describing some new retail ideas.  I don’t know which might turn out to be “right” or “wrong,” but it seems incumbent on us to be aware and consider whether any of the ideas might apply to our businesses.  I guess this is my way to help you whack yourselves on the side of your heads.

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Light at the End of the Tunnel – But it’s Not a Short Tunnel; Billabong’s Annual Report

What we have here is progress, but still a long way to go. That’s how Billabong’s management characterizes their results, and I agree. I’ll take a look at the financials as reported and with the impact of divestures and certain “significant items” removed. Regular readers know I’m not quite comfortable with some of the stuff that Billabong management characterizes as “significant” and removes from their operating results. Happily, the number has declined dramatically for the June 30 fiscal year.

Next, I want to touch on exchange rates and how they affect the results. It’s way more complicated than is the Australian dollar “strong” or “weak,” though that’s often how the issue is characterized.

Finally, I want to talk about how extensive and complex Billabong’s makeover is. Basically, they are rebuilding the company while running it. It’s kind of like highway construction, where you have to keep the road open while you redo it. It adds cost and slows down the process, but you’ve got no choice.

I want to point you to Billabong’s investor web site, where you’ll find the documents I discuss. Under “Featured Report,” I particularly suggest you take a look at the full year report presentation which they refer to in the conference call. The transcript of the conference call is also there.

Financial Results

All the numbers are in Australian dollars unless I say otherwise. At June 30, it costs you about $0.75 US to buy one Australian dollar.

For the year ended June 30, 2015, what they call “Revenue from continuing operations” was reported on the official financial statement as $1.056 billion (US$792 million based on the June 30 exchange rate). That’s up 2.82% from the prior calendar period (pcp) result of $1.027 billion. That does not include $10.6 million of other income this year and $6.3 million of other income in the pcp. It does include the revenue from brands that were divested at some point during the two years.

Gross margin rose from 52.2% to 53.1%. Selling, general and administrative expenses rose 1.6% from $423 to $429.6 million. Other expenses fell 23.1% from $165.9 to $127.7 million. Finance costs declined from $82.2 to $34.3 million, or by 58.3%. As you’ll see, much of those two declines were the result of the restructuring and refinancing expenses in the pcp.

Below is the rest of the income statement. Seems easier to show you than to describe it. The first column is for the year ended June 30, 2015 and the second for the pcp.

Billabong 6-30-15 annual report 1








As you can see, as reported Billabong earned $4.15 million compared to a loss of $233.7 million in the prior calendar period. Mostly, the change from a big loss to a small profit is due to a reduction in all the costly tax, restructuring, and financial expenses they had last year.

Okay, now let’s take out the businesses they sold and their significant items. They do that for us in the presentation they used at the conference call. Page 22. Billabong sold it’s 51% stake in SurfStitch and it’s 100% ownership in Swell on September 5, 2014, which is in the most recently ended fiscal year.  West 49 was sold in February of 2014. Dakine was out the door in July of 2013. Discontinued operations generated $196 million of revenue in fiscal 2014, but only $15.4 million in fiscal 2015.

Billabong 6-30-15 annual report 2









The first thing I’ll point out before somebody points it out for me is that the Sales Revenue number of $1,063.7 million is not the same as in the numbers from the official financial statement I just quoted. I’m not saying it’s wrong. I just can’t figure out why it’s different.

Taking out those items leaves us with a slightly reduced net income (from $4.2 to $3.0 million) for the June 30, 2015 fiscal year. More importantly, comparing the last two columns in the chart, you see an increase in EBIT from $25.9 million in the pcp to $32.8 million for the June 30, 2015 year.

Okay, significant items. For you data geeks, go to the Billabong investor web site. Under “Featured Reports” click on “Full Year Reports to 30 June 2015.” Go to page 69. Look at note (dd) “Significant Items.” I won’t blame you if you don’t read every word, but you might just peruse the list and note the discretion management seems to have in terms of what is or is not classified as a significant item.

If you want to suffer even more, go to page 86 of the same document where Note 8 starts. It lists all the significant items for the recently ended fiscal year and the pcp. A more detailed description of just what those items are appears on the next two pages.

What!?! You didn’t hang on each word?! Yeah, me neither.

The good news is that the significant items from continuing operations totaled $24.7 million this year compared to $120 million in the pcp. After discontinued operations, the total fell from $146 to $11 million.

You can’t just ignore numbers of this size, and certainly some of these are one time numbers. But if I were an investor, or potential investor, in Billabong, I’d be digging into these to satisfy myself as to the improvement of the continuing business from last year to this year.

Now let’s move on to the results by segment. First, as reported.

Billabong 6-30-15 annual report 3





You can observe revenue drops for Asia Pacific, the Americas, and Europe of 10.8%, 15.3%, and 9.7% respectively. EBITDAI fell by 28.3% in Asia Pacific, but improved dramatically in the other two segments. The result is a $107 million turnaround is EBITDA as reported.

Taking out the discontinued operations and significant items gives a different segment and total EBITDAI result. The change in EBITDAI is not nearly as dramatic but, then again, it shows as positive in the pcp.

Billabong 6-30-15 annual report 4







The next chart in the report is EBITDAI in constant currency. I’m not even going to show you that and I guess this is a good place to explain why.

Foreign Exchange

In the first place, if you’re an Australian investor in Billabong, I expect you mostly care about results in Australian dollars. But perhaps more importantly, there is a complexity here that goes way beyond whether the Australian dollar is “strong” or “weak” against the US dollar.

Billabong management does a great job trying to highlight and explain this. They provide a chart on page 71 of the document I point you to above that shows their exposure in Australian dollars, US dollars, Euros, and “other” currencies. There are both assets and liabilities involved and, if most of the exposure is in the first three currencies the “other” is not insignificant. Billabong “…receives revenue in more than ten currencies…”

In the conference call CFO Peter Myers spends way more time on this issue than I would have expected. Just to give you a way to think about all the moving parts, here are a few things he says. This would be a place where you can skim a few paragraphs if you want to, but I think it’s important.

“As an Australian listed entity with US operations, it is logical for us to have a significant part of our debt denominated in US dollars to match our foreign currency assets with foreign currency debt. So whilst it is true that the Aussie dollar equivalent of our debt is higher, so is the Aussie dollar value of our businesses and our US dollar earnings…”

“…the Aussie dollar value of businesses that are predominantly US-based, like RVKA and BZ, and the value of our US dollar earnings from our more global businesses like Billabong are also growing in Australian dollar terms. We also have US dollar cash flows to match our US dollar interest obligations.”

“So before that allocation of central costs, the Australian dollar value of the earnings from the Americas was AUD42 million, or about $35 million. So you see we have the Americas give us US dollar EBITDA of $35 million to match our US dollar interest obligations of $25 million, but — and it’s a significant but — it does serve to reinforce how important it is to us that we build the earnings base in North America, as it’s obvious the FX changes do impact on all of our financial ratios, et cetera.”

“The other big impact of the currency is in our input prices, the product purchases. In APAC alone, and bear in mind there is a European effect here as well, we have cost of goods sold of over AUD150 million, the vast majority of which is bought in the US dollar-exposed market.”

Sorry to let Pete go on for quite so long there, but I thought it important you appreciate the complexity and all the moving parts. While currency movements in the recently ended year may have been more dramatic than usual, the issue isn’t going away. At the end of the day, however, it’s how many Australian dollars of net income Billabong generates that will be the barometer of the company’s success or failure.

Reducing Complexity

Billabong’s brands include Billabong, Element, RVCA, Kustom, Palmers, Honolua, Xcel, Tigerlily, Sector 9 and Von Zipper.

“The Group operates 404 retail stores as at 30 June 2015 in regions/countries around the world including but not limited to: North America (60 stores), Europe (102 stores), Australia (123 stores), New Zealand (30 stores), Japan (46 stores) and South Africa (27 stores). Stores trade under a variety of banners including but not limited to: Billabong, Element, Surf Dive ‘n’ Ski (SDS), Jetty Surf, Rush, Amazon, Honolua, Two Seasons and Quiet Flight. The Group also operates online retail ecommerce for each of its key brands.”

Some of those stores carry multiple brands. Others don’t. About 55% of revenues are from wholesale. No single customer is 10% or more of their revenues. They expect to close around 40 stores this year, but have a new store model they believe gives them the opportunity to open new ones, so the net number of stores may not change much.

That’s a lot of moving parts in a lot of countries for a company that did just over a billion dollars Australian during the recently ended year. You probably also recall that Billabong’s brands operated pretty independently for a long time. The company is moving to change that in the name of efficiency and brand building. To me, Billabong really couldn’t support the implicit inefficiencies in the structure it had with the revenues it’s generating.

Let’s see what they’re doing.

CEO Neil Fiske has a seven part strategy the company has been implementing since shortly after he came on board in September, 2013. From their filed report, here are the strategies and descriptions of what they involve.

Billabong 6-30-15 annual report 5


















I want to make a few general comments on this. First, you should note that pretty much no part of the business is untouched. Second, while this will ultimately save them a lot of money (they have for example cut the numbers of suppliers they work with by 50%) it’s going to cost a bunch of money to implement.

Third, there is a certain urgency to doing all this, and an imperative to interconnect these functions that wasn’t so important or at least so necessary 10 years ago. And I will point out that doing much of this doesn’t create a long term competitive advantage. It’s just what Billabong, as well as other larger companies in our space, have to do to have the chance to compete. Certainly when you looked at the chart above you noted that many of the actions they are taking seem obvious and necessary.

You may even have asked, “How the hell can they not have done this stuff before now!” I have no idea what went on inside Billabong, but trying being the CEO of a publicly traded corporation and explaining to your board of directors that you’re going to rip the place apart, it’s going to take a couple of years to reconfigure, it will cost a lot of money, it may not work out, and in the meantime, your earnings are going to suck. Good luck with that.

Typically, the pressure has to come from an outside change agent.

Neil also talks about their “…fewer, bigger, better…” approach. This means that they are focusing on their three big brands; Billabong, RVCA and Element. That was a financial imperative for a money losing company, and it’s certainly the place where they can see the most immediate return. Think of it in percentage terms. A 5% increase in Billabong branded sales is way more dollars than a 5% increase in Von Zipper, and larger brands will benefit more from the various restructurings going on.

The other brands aren’t insignificant, though we don’t know how much revenue they are doing. We are told the big three represent something like two-thirds of the wholesale business worldwide.

CEO Fiske tells us that “…Tigerlily has shown standout performance once again. Sales are up over 40% and comp store sales grew 7.8% for the year. Collectively, the rest of the emerging brand portfolio was down in sales and EBITDA. With the progress of the big three brands well underway, we can now focus on the strategy and the performance of the emerging brands.”

This is the first time they’ve said much about the other brands. I still won’t be surprised if more get sold, but it’s hopeful that they think they have the breathing room to give them some attention.

Here’s a series of comment Neil made about Europe. “Gross margins [He’s talking in constant currency] lifted 650 basis points for the year as we focused on quality revenue, quality accounts, quality distribution…Revenue for the year declined 1.7% as a result of our decision to narrow our account base, tighten trading terms and build margin… In retail, comp store sales for the region were up 2.9%. Store level profitability improved 160 basis points before the effect of provisions, driven by the improvement in retail gross margins. Total store count at year end was down from 111 to 102 as we rationalized our network of outlet stores from 24 to 17 and country presence from nine to five.”

 I added the emphasis. Note the focus on quality, simplification, margin, branding and efficiency over sales growth. Or rather, the confidence that those things will lead to sales growth. This is a theme not just for their European operations, but across the other segments and found in their strategy as well.

I haven’t focused as much on brand and segment specifics as in previous Billabong reports. I really don’t want us to get lost in the weeds right now.

I’m kind of going “Billabong blind” from shuffling through all these documents and trying to create a coherent whole, but I think it was CFO Myers who said, somewhere, that he was surprised to be calling such a small profit a turning point for the company.

I know what he means. Currency, significant items (I know, I just can’t leave that alone) and divestitures make it something of a challenge to compare results over years, but there is the sense that the elements of the strategic makeover are starting to have an impact. Maybe a better way to put it is that it really feels for the first time like rebuilding the road while they drive on it is something that has a reasonable chance of succeeding.

The balance sheet is at least stable. Operating results seem to be improving and even where they aren’t improving, there’s some sense of progress in doing the things that will improve them.

The problem is most definitely not solved. There are currency issues, work remains on their retail operations, the overall economic environment isn’t too great, and completion of the systems and structural transition will take a couple of years. But things are better than a year ago and the path seems a bit clearer.

Lululemon Appoints Laurent Potdevin as New CEO; Founder Chip Wilson Steps Down.

Okay, so really short article. I don’t have much to say. One could say I’m speechless. Anyway, here’s the link to the press release announcing the appointment. If you want more info, here’s another link where you can find additional information and listen to this morning’s conference call. Laurent, as you know, spent a lot of years at Burton Snowboards (as the press release calls it) and was President and CEO from 2005 to 2010. More recently, Laurent was President of Toms Shoes. 

Lululemon founder Chip Wilson is stepping down as CEO but will remain as a member of the board of directors. I imagine most of you are aware of Chip’s roots in action sports with Westbeach, which he found around 1980. You are probably also aware that some of his recent comments about some women’s bodies just not working for Lululemon clothing have pissed off a bunch of people. Strangely enough, that issue didn’t get mentioned in the conference call or press release. 
Michael Casey, Lead Director of the Lululemon Board of Directors, will be their next Chairman of the Board. In introducing the new CEO, he described Laurent’s experience at Burton this way:   
“During his time at the company, he helped the company grow far beyond its roots in snowboarding to become a truly global brand synonymous with the sport and lifestyle.”
There was time for just three or four questions from analysts. They generally focused on Laurent’s background and experience as it related to Lululemon.
That’s it. I look forward to the comments and discussion on my web site.



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.



Skullcandy has a Strong Quarter

Skull’s sales for the quarter ended June 30 rose 46.4% to $52.4 million over the same quarter last year. Net income more than doubled from $2.1 to $4.3 million. This was helped by an income tax rate that fell from 56.6% to 41.6%. Gross margin essentially stayed the same, falling just one tenth of a percent to 51.1%. You can see the 10Q here.

Selling, general and administrative expenses rose $7.9 million or 84% to $17.2 million. There was a $3.7 million increase in payroll and $2.9 in marketing expenses. There were, obviously, also higher commission expenses on higher sales. As a percentage of sales, these expenses increased 6.8% to 32.9%.

Income from operations rose, but as a percentage of revenue it fell from 25% to 18.3%.
Skull is dependent on two Chinese manufacturers for their product. Like everybody else, they are experiencing higher costs from China and note that their gross margin might decline if they can’t pass these costs on to consumers.     
Remember that this quarter closed before they went public. As a result, we have $1.9 million in related party interest expense that wouldn’t be there if the offering had closed during the quarter. Also, I’m not going to spend any time on the balance sheet as it improved dramatically after the IPO. A bunch of cash has that impact on a balance sheet.
Just one balance sheet comment. Inventories grew 86% from $22.6 to $41.9 million. They discuss this in the conference call. Part of the growth was due to inventory levels being too low last year, and part is because of the acquisition of Astro Gaming. They also decided to increase their stock levels in 2011 to better service their retailers.
In discussing their outstanding orders, Skull says, “We typically receive the bulk of our orders from retailers about three weeks prior to the date the products are to be shipped and from distributors approximately six weeks prior to the date the products are to be shipped….As of June 30, 2011, our order backlog was $10.1 million, compared to $10.0 million as June 30, 2010. Retailers regularly request reduced order lead-time, which puts pressure on our supply chain.”
Obviously, they can’t wait for orders from retailers before placing orders with their factories. They say in the conference call inventory growth was roughly in line with sales if you ignore those three factors. But it looks to me like some of the inventory increase results, as Skull puts it, from “…pressure on our supply chain” that’s requiring some inventory growth in excess of sales growth.
Okay, one more balance sheet comment. There was a statement on the call about how, because they carried their inventory under FIFO, product margins had benefitted so far this year. In the second half of the year, as they start to sell the higher cost product, that benefit will go away. This inventory accounting stuff is going to start to matter with costs rising. I wrote about it in a bit more detail when I took my last look at VF Corporation.
The company’s net proceeds from the public offering in July were $77.5 million. Of that amount, $43.5 million, or 56.1% of the net proceeds, went right back out the door to pay accrued interest on convertible notes, unsecured subordinated promissory notes to existing shareholders, notes in connection with already accrued management incentive bonuses, and a bunch of other moneys due to existing stockholders. They used an additional $8.6 million to pay down their asset based line of credit in early August, and they may use a portion of the proceeds to buy back their European distribution rights. If that happened, that would leave them with $10.4 million of the offering proceeds, but they continue to have availability under their line of credit. 
If I had all the time in the world I’d like to go review and understand in detail how Skull financed its growth. It’s always hard to finance fast growth and it got harder when the economy went south. It must have been an interesting experience. Ah well, what doesn’t kill you makes you stronger.
In the conference call Skull management laid out its five major strategies. The first was to further penetrate the domestic retail channel. Skull is currently in Best Buy, Target, Dick’s and AT&T wireless. Domestic sales were about 80% of the total. During the quarter net sales to three customers totaled 27.4% of total sales and represented 44.4% of receivables at the end of the quarter.   That’s down from 33.2% of total sales and 46.9% of receivables at the end of the same quarter the previous year.
The second was to accelerate its international business, which is largely in Canada and Europe. It grew by 47.1% in the quarter and represented about 20% of total sales. A dispute with their European distributor had reduced 2010 sales, so part of the growth is catching up.
They sell in 70 countries and have 26 independent distributors. They want to distribute directly in key markets. This is a strategy most other companies in our industry have utilized.
57 North, their European distributor, represented more than 10% of their sales during the first half of 2011. In June, Skull entered into a non-binding letter of intent to buy those distribution rights back from 57 North for $15 million. As noted above, Skull has had a previous dispute with 57 North, and from the way they describe it in the 10Q, it sounds like there’s some uncertainty the deal will close. Maybe that’s just what they have to say because it’s a non-binding letter and negotiations are still ongoing. 
The third strategy is to expand their premium priced product category. The “vast majority” of their products are priced in the $20 to $70 range. They said they had premium products in the pipeline that could be released in the next 24 months. I’m pretty sure they said “could,” so unless they just used the wrong word, there seems to be some doubt as to the timing.
One of their existing premium products is the Aviator. They launched it in Apple stores and it was exclusively available there for six month. I like that distribution strategy but of course it may cost you some sales early on.
A fourth strategy is to expand complimentary product categories. This includes Astro Gaming’s head phones. They bought the company in April for $10.8 million. Astro sales are obviously included in the June 30 quarter. I don’t know exactly how much those sales were.
The fifth strategy is to increase online sales. Those sales were $4.3 million in the quarter, or 8.4% of net sales. In the quarter last year, online sales were 3.9% of total sales. $2.5 million was organic growth, which tells us that $1.8 million in online sales came from the Astro Gaming product. Organic online growth was 117% over the same quarter last year.
These are all fine strategies. In fact, they are so good that most companies are trying to implement them. What Skull says they have done is, “…revolutionized the headphone market by stylizing a previously-commoditized product and capitalizing on the increasing pervasiveness, portability and personalization of music.” I think they are right, but we’ll have to keep watching to see if they can continue to do it better than anybody else.   



PPR Buys Volcom, Probably

You know, I should have seen this coming and been sitting on 10,000 shares. But no such luck and anyway, I don’t own shares in companies I write about. Still, the deal’s not a complete surprise. Vans, DC, Reef, Sector 9 and Hurley are a partial list of industry companies that have been acquired by larger companies that wanted to get into or expand their action sports offering and grow their credibility with that customer group. Consolidation is not new, and most successful companies in our industry seem to reach a point (usually as they start to grow into the larger fashion market) where they perceive they need some help to continue growing and succeed in that broader market.

Volcom has been showing some symptoms of needing that help. Last time I wrote about them, in March, I said,

“But there comes a time, especially as a public company, when that strong brand positioning with a targeted consumer can make growing more of a challenge as the new customers you need don’t feel a strong connection with the brand and the customer you have may feel alienated if and as you do what you have to do to build a connection with the new one.”
“It’s not like this is a surprise to anybody who’s been around our industry for a while. Large or small, public or not, every company deals with this when they grow. I wrote last week about how Quiksilver is pushing its DC brand and my concern that they might push it too hard. Burton, when it changed its name from Burton Snowboards to just Burton, was dealing with this issue.”
I noted in the article that Volcom was counting on some broader distribution including the department store channel for growth, but that I wasn’t quite sure a company with the motto “Youth Against Establishment” fit in the department stores.
I went on to say, “Volcom says they make premium product that typically sells at premium prices and they’ve got a very distinctive image they’ve worked hard and successfully to build over 20 years. That sounds boutique like to me- not department store. Just saying.”
They’ve also had some issues with dependence on PacSun and too much inventory. In 2010 revenues were up 15.2% over the prior year, but net income increased hardly at all, from $21.7 million to $22.3 million. A decline in gross margin from 50.2% to 49.2% explains most of that.
During PPR’s conference call announcing the acquisition, one analyst ask why, if Volcom actually believes it can earn $2.20 to $2.40 a share in 2014 it was selling now for this price. The PPR CEO answer was something along the lines of “Uh, oh, well, I guess they think it’s a fair price.” Great question I thought and maybe Volcom’s answer has something to do with the issues I raised.
By the way, the reason I put “probably” in the article title is because no deal is done until it’s closed. Also, from time to time an offer from one company will result in a higher offer from another company. The board of directors of a public company has a fiduciary responsibility to do what’s in the best interest of their shareholders. They couldn’t just ignore a better offer they think has an equal chance of closing. Of course, what’s “better” can be open to interpretation. I don’t actually expect there to be another offer. PPR, as we’ll get to next, is an 800 pound gorilla and I consider the deal fully priced.
PPR had 2010 revenues of 14.6 billion Euros (2.3 billion of which was sold online). That’s north of $21 billion at the current exchange rate. Western Europe is about 59% of their revenues.  North America is 16%. They have 60,000 employees and their products are distributed in 120 countries. Volcom, at $321 million in revenues in 2010 is a tad smaller, but much, much cooler. It’s around 1.5% of PPR’s revenues. I’d like to tell you all about them, but their web site is in French. I guess I can at least say they are a French company.
 Oh- wait- here’s the English version. Their luxury group of brands includes Gucci, Bottega Veneta, Yves Saint Laurent, Balenciaga, Alexander McQueen, Boucheron, Sergio Rossi, and Stella McCartney. I’m pretty sure none of these brands are hanging in my closet even though I’m such a fashion forward guy. The Stella McCartney stuff just doesn’t accentuate my bust.
They also own PUMA, FNAC and Redcats. Okay, I know what PUMA does. FNAC is apparently in the process of being sold. In 2010, the luxury group was 27% of sales and PUMA was 18%. PPR has over 800 stores globally. Here’s a link to the English version of their 356 page reference document which I am not reading. It has some easy to absorb graphics you might be interested in. It’s a big file and a bit slow to download.
This is PPR’s first adventure into the action sports market. It should be interesting to watch. On an operational level it seems obvious that Volcom should benefit from PPR’s size in terms of systems, manufacturing, access to capital and operations. Those synergies are usually real, but also usually harder to achieve than people expect. I guess Volcom will report through PUMA. It was interesting to hear PPR management say that Volcom was complimentary to PUMA and then note that PUMA was not involved in action sports. Maybe they just meant complimentary in terms of getting Volcom into shoes in a much bigger way, which apparently we can expect.
PPR, of course, is particularly well situated to increase Volcom’s presence in Europe, where both Volcom and PPR think they have a lot of room to grow. It sounds like we can expect to see quite a few more Volcom stores worldwide (no numbers given). I wonder if Volcom product would fit into any existing PPR owned stores. Many PPR brands can reasonably be characterized as boutique brands and, as I suggested before, if Volcom’s description of their brand and its positioning is accurate, maybe that’s where they belong. But I have a hard time seeing Volcom in a Gucci store at the moment. Maybe Europe is different.
Volcom may be strategically important to PPR, but it’s an awfully small piece of the whole. As I listened to the PPR executives describe Volcom, it felt like they were reading Volcom’s description of itself and its market position right out of Volcom’s 10K. Even though they’ve been talking for a year, I was left unsure if PPR “got it” or not. Over the years, I’ve watched European companies try to break into the U.S. action sports market and just do it wrong. I’ve watched U.S. companies have the same problem going to Europe, if only because we start out thinking of Europe as one market.
One European analyst called Volcom a “sports” company and inquired of management if they were thinking of launching a PUMA action sports brand. Happily, PPR made it clear that was a bad idea. There was also a question about whether Volcom and PUMA could be distributed together.
PPR talked about “…building the Volcom business globally while maintaining its authenticity” and keeping it positioned as it is today without changing the target customer. Of course that’s what they want to do, or they wouldn’t be buying Volcom. But as I’ve written, it’s also the challenge. Every action sports brand comes up against this. At some level growing and maintaining authenticity becomes as challenge. PPR has, of course, dealt with all forms of distribution and growth issues, but I am not aware that PPR management has experience with this in the youth culture market. Growth, after some point, requires changing, or at least expanding, the target customer.
They will be relying on the Volcom team to continue managing the brand. The deal, however, is an all cash one at $24.50 per share (22.6 P/E ratio according to one investment banker) with no earn out component we learned in the conference call. I sure hope Richard Woolcott and his team are happy working with PPR.
Given the challenges Volcom faces, they’ve made themselves a good deal at the right time. PPR can certainly make them more efficient operationally, in manufacturing, and financially. They will help Volcom grow especially in Europe, and there will be an expanded retail presence. In the longer term, if PPR and Volcom managements have some patience with each other, we might see Volcom make a transition into the fashion market in a way no other action sports brand has done.
Youth Against Establishment indeed.