Some Perspective on GDP Growth

Here I go again- telling you stuff I think you need to know but that’s kind of unpleasant to hear.  I’d love to help you ignore it (come to think of it, I’d love to ignore it too), but it’s just not in my DNA.

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Deckers’ June 30 Quarter; Continuing Problems with Sanuk

This is the first earnings release and conference call since Dave Powers, who was previously President, took over as CEO from Angel Martinez at the end of May.  He steps into the position at a time when Deckers, as well as other brands and retailers, are suffering from general economic conditions and the continuing growth of online.

Deckers’ sales for the quarter fell 18.4% from $214 million in last year’s quarter to $174 million in this years.

“The decrease in overall net sales was due to decreases in sales in each segment, largely driven by UGG, Teva and Sanuk brand wholesale sales. We experienced a decrease in the number of pairs sold in each segment. This resulted in a decrease in the overall volume of footwear sold for all brands of 22.4% to approximately 4,500 pairs sold for the three months ended June 30, 2016 from approximately 5,800 pairs for the three months ended June 30, 2015. Overall net sales were primarily impacted by a difference in the timing of shipments as we shifted shipments in advance of our Business Transformation Project implementation, which benefited the fourth quarter of fiscal year 2016 and negatively impacted the first quarter of fiscal year 2017.”

The good news is that the gross profit margin rose from 40.5% to 43.7%, though total gross profit fell by 11.9% to $76.3 million.

“The overall improvement in gross margin was driven by the sales variances noted above primarily reflecting a lower proportion of closeout sales to total net sales, improved wholesale margins and improved international margins.”

SG&A expenses rose 2.8% from $150.3 to $154.6 million.

The operating loss increased from $63.7 million in last year’s quarter to $78.3 in this years.  The net loss rose 24.5% from $47.3 to $58.9 million.

Sanuk saw its total revenue fall 20.2% from $33.4 to $26.7 million.  Wholesale revenues fell 21.8$ to $22.3 million and direct to consumer was down 10.9% to $4.4 million.

The numbers in the quote below are in thousands.  WASPP stands for weighted average selling price per pair.

“Wholesale net sales of our Sanuk brand decreased primarily due to a decrease in the volume of pairs sold reflecting the difference in the timing of shipments noted above, partially offset by an increase in WASPP. The decrease in the volume of pairs sold had an impact of approximately $7,000, offset in part by an increase in WASPP of 24 approximately $1,000. The increase in WASPP was attributable to the higher margins on closeout sales compared to the prior period and a shift in product mix.”

The operating profit from Sanuk’s wholesale business fell 21.8% from $5.35 million to $4.18 million.

“The decrease in income from operations of Sanuk brand wholesale was primarily due to a decrease in sales reflecting the timing of shipments noted above, partially offset by a decrease in operating expenses of approximately $1,000. The decrease in operating expenses was primarily attributable to changes in the current period for the Sanuk brand contingent consideration compared to the prior period.”

Given the continuing poor performance of Sanuk since it’s purchase by Deckers, it’s amazing we haven’t heard at least an occasional question from the analysts about what went wrong.  I was concerned from the first conference call after the acquisition, when it began to seem that they didn’t understand what they’d bought.  You may recall that Deckers paid $120 million in cash plus a hefty earn out for a company with $43 million in revenues.  As I said at the time, “Not in the middle of snowboard industry lunacy in the mid 90s did a company go for three times sales.”  As of June 30, 2016, Deckers carries $128 million on goodwill on its balance sheet and $114 million of that (89%) is for the Sanuk brand which generated 15.3% of the company’s revenues in the quarter.

Dave Powers tells us in the conference call that they’ve finished moving Sanuk to their corporate headquarters and that they’ve brought in a gentlemen named Magnus Wedhammar as General Manager of the brand.  He has experience at Sperry, Converse and Nike.  Dave Powers says, “We look forward to Magnus’s impact on repositioning the brand and developing new product and marketing to ignite sale.”  Me too.

Deckers bought Sanuk in May 2011.  In all that time, I don’t recall a single comment about what went wrong or how they are going to fix it.

The balance sheet is in pretty good shape.  I would note the increase in inventory from $374 million at the end of last year’s quarter to $469 million at the end of this year’s while sales are down 18.4%.  Part of that is apparently due to the installation of new systems that delayed some shipments.  In addition, Deckers has made a decision we’ve seen at other companies to carry over some perfectly good inventory to next season rather than close it out.  They tell us that’s most of the inventory increase actually.

I want to briefly focus on Deckers’ four strategic priorities as laid out last quarter and described again this quarter by new CEO Dave Powers.

“Our first priority is on product, with a focus on elevating product design, fueling innovation and increasing our speed to market.”  He indicated later that their product lead time was 15 to 16 months and, as a start, they’ve reduced 25% of their line to 9 months.

“Second, connecting with consumers digitally through targeted marketing and robust eCommerce. A strong digital presence is key to creating brand heat and driving sales.”

“Third, we must drive growth by optimizing our Omni-Channel distribution globally.  We need to ensure that we are reaching new consumers through the right channels and distribution and existing consumers in the channels where they shop the most. To do this, we are segmenting our product line and wholesale accounts and working with wholesalers to develop product that appeals to the taste of their consumers.”

My point of view is that segmentation is way more important and way harder to do than in the past.  More than ever, it’s a moving target.

“Fourth and finally, driving efficiencies to streamline the organization and improve operations. We have completed our major investments in Omni-Channel, new talent and upgraded systems and are now fine tuning our business.”

You know what I’m going to say right?  That’s all good, necessary stuff but no different from what everybody else is doing.  Advantage larger companies with strong balance sheets.

The trends impacting their business seem a lot like those impacting everybody else.  I’d particularly highlight two.  They won’t surprise anybody

“We believe there has been a meaningful shift in the way customers shop for products and make purchasing decisions. In particular, brick-and-mortar retail platforms appear to be experiencing a significant and prolonged decrease in consumer traffic, while Ecommerce businesses continue to evolve and experience growth.”

They are reviewing their brick and mortar stores and have plans to close 24 stores.

“Continuing uncertainty surrounding US and global economic conditions has adversely impacted businesses worldwide.”  There’s a shocker.

We’ll continue to watch to see what happens to Sanuk.  In the meantime, I’d point out that this conference call seemed a bit more upbeat and action oriented than some of the previous ones.  I don’t know if I’m imagining that or if it means anything.  We’ll find out.

Skullcandy Files It’s 10-Q in the Middle of Going Private

Skull filed its 10-Q for the June 30 quarter on August 9th.   As you are probably aware, there are a couple of dueling offers to take the company private out there.  At this point, I’d be surprised if they didn’t end up private- I’m just not sure of the price or who the owner will be.

Because, I assume, of that pending and probable transaction, there was no conference call.  So my comments here are based on the 10-Q and press release.

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VF’s June 30 Quarter: It’s Not Easy Out There for Anybody

After the results we’ve seen from VF in previous quarters and years, this quarter’s can only be characterized as disappointing.  Just goes to show you how difficult the market is right now.  They’ve got lots of company.

Total revenue rose just 0.75% to $2.445 billion.  VF ended the quarter with 1,461 brick and mortar stores worldwide. Direct to consumer business was up 6% in the quarter and accounted for 27% of total revenues.  “The increase in direct to consumer revenues…were due to new store openings and an expanding e-commerce business.”  The increase was not, apparently, due to higher comparable store sales or I assume we would have been told about it.  International revenue was 35% of total revenue.

The most interesting thing they said about revenue was that department stores represent only 3% of their total revenue and that they are “…much more weighted towards specialty and sporting goods…” I guess I was surprised that this large a company doesn’t do more business in the department store channel, but I’d say good for them.

The gross profit margin went from 48.0% in last year’s quarter to 48.1%.  It would have been up around 0.7% in the quarter if not for foreign exchange issues.

SG & A expense kicked up slightly to $965 million from $947 million last year.  Operating income fell 3.5% from $219 to $211.4 million.

Interest expense of $23.6 million was up from $22.9 million last year due mostly to higher interest rates.  Net income fell from $170.8 to $51 million.

VF would like you to know that on June 29, they agreed to sell their contemporary brands segment (The 7 For All Mankind, Splendid and Ella Moss brands) for $120 million subject to the usual working capital adjustments.  They took a loss of $100.6 million on the sale and show, on their income statement, a net loss from discontinued operations of $97.3 million for the quarter.  They had a $3 million gain from discontinued operations in last year’s quarter.  If we ignore both those numbers, net income in last year’s quarter would have been $167.8 million.  This quarter’s net income would come in at $148.3 million, down 11.6%.

The balance sheet hasn’t changed much.  The current ratio fell from 1.66 to 1.53, inventories rose 5.8% to $1.776 billion, equity fell 6.4% to $4.65 billion, and total liabilities to equity rose slightly from 0.97 to 1.08.

I do want to touch on the inventory number.  What we learn (they’ve said this before actually) is that VF carried over some first quality winter inventory.  They didn’t write it down, they didn’t blow it out, and they expect to sell it for full retail this winter.  They aren’t the only ones taking this approach, and I think it’s a good one, though not as good as buying closer to requirements in the first place of course.  That’s easier to say than to do.

I don’t know how much inventory we’re talking about, and I don’t know if they have or will do the same with other seasonal inventory.  I guess the result, in general, will be reduced quarterly inventory volatility.  Doing this, of course, requires having a balance sheet that allows you to carry inventory longer than you otherwise would.  VF has that.

In the first six months of 2015, VF’s cash flow showed cash used by operating activities of $253 million.  In 2016, operating activities generated $11.4 million.  They tell us that, “The increase in cash flows in the first six months of 2016 is primarily due to a $250 million discretionary contribution to the domestic qualified pension plan in the first quarter of 2015 that did not recur in 2016.”

Why would you make a discretionary contribution to a pension plan?  One possible reason is because your plan assumes a return on the pension fund assets of something like 7%, but you aren’t confident the assets are actually going to be able to earn that without taking a lot more risk.  If that’s the case here, those of you who are relying on a pension from VF should be thanking your lucky stars you work or worked for a company both able and responsible enough to do this.

You might take a moment to consider the situation of pension plans, insurance companies and, by the way, savers (like maybe some of you?) who used to rely on a 6% or so basically risk free return as a major source of funding.  Thanks all you central banks around the world for basically screwing up the market under which there was a meaningful relationship between risk and returns.  Yeah, that kind of was a political comment.

Outdoor and Action Sports revenue grew just under 1% during the quarter to $1.42 billion.  That represented 58% of total revenue, up from 57.5% in last year’s quarter.  Its operating profit was $123.2 million, down from $134.9 million in last year’s quarter.

Vans’ revenue rose 6%.  Kudos to Doug Palladini for what he and the VF team have done with the brand.  I’m still not entirely sure how they seem to be able to make it appeal to pretty much everybody.

The North Face was up 2% and Timberland was down 7%.  You probably noticed some recent management changes at Timberland.  They are expecting Timberland to face a “…challenging sales environment…” in the second half of the year.

“Global revenues for Outdoor & Action Sports increased 2% in the first six months of 2016 compared with 2015, reflecting 3% operational growth partially offset by a negative 1% impact from foreign currency. Revenues in the Americas region increased 2% in the first half of 2016, net of a negative 1% impact from foreign currency. Revenues in the Asia-Pacific region increased 3% despite a 2% negative impact from foreign currency. European revenues increased 2% in the first half of 2016 compared with the 2015 period, reflecting a positive 1% impact from foreign currency.”

“Wholesale revenues [for Outdoor and Action Sports] were down 3% in both the second quarter and first six months of 2016, primarily due to elevated inventory levels at customers in our key channels of distribution in North America and Europe.”  That’s a pretty common problem around the industry.  Bankruptcies have put a lot of inventory in the market.

It’s tough out there, and it’s the big players with solid balance sheets that are in the best position to take advantage of it in the long term. A lot of the blocking and tackling that goes into managing in this environment isn’t very exciting to write about, but it’s critically important.

VF management didn’t say anything about new store opening plans, but they were clearly excited about growing their ecommerce business which they characterized as high margin and their most profitable format.  They described a “…new digital and ecommerce technology engine…” they are rolling out.

I will be very interested to see how they manage their brick and mortar footprint going forward.

Vail Buys Whistler; A Good Deal For Everybody?

You know, I always try to write things that identify a valuable business lesson.  The valuable business lesson here I guess is do what Vail did.  While I think there are a couple of interesting industry considerations, I can’t strategically fault this deal.  Vail by no means got a great deal with a price of a little over US$1 billion, but paying a fair price for a good property is the kind of combination that’s most likely to work out in my experience.

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GoPro’s Quarter: Tactics VS Strategy

Just what kind of company is GoPro exactly?  Well, obviously, in spite of its recent difficulties, it’s a huge success.  How else can you characterize a founder and a company that recognized and created a new market, took the lead in it and built a billion-dollar business?  But having accomplished that, it now has to wrestle with being a consumer electronics/device company or an active outdoor, content/media company.

There’s really not much wrestling to do.  As I’ve been pointing out since they went public, they are in trouble if they can’t evolve from the first towards the second.  Right now, their capture devices (cameras) and the associated accessories generate all their revenue.  I’ve never seen a mention of any proprietary technology they own, and certainly their resources are not as great as some of their competitors.

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The Potential Downside of Successful Brand Building in an Online World?

Branding, they tell me, is all about building a relationship between a customer and a brand.  That customer, theoretically, will have a bias towards your brand that encourages less consideration of alternatives, more purchases and, hopefully, less price sensitivity.  That’s the theory anyway.

It was, most of us would probably agree, a pretty good theory.  It was true for most brands to a greater or lesser extent at least some of the time.  Still is.

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Is Claire’s Stores Our Next Bankruptcy Candidate?

Teen focused jewelry and fashion accessory retailer Claire’s Stores has more than 2,800 stores in Europe and the U.S.  It was the “beneficiary” of a leveraged buyout (LBO) back in the giddy days of 2007.  The debt it acquired in that process, along with the over retailed, soft economy, online selling environment has pushed it to the edge.

The article I link you to below talks a little about the LBO process and how Claire’s private equity (PE) owners are now using the threat of a bankruptcy filing to try and negotiate itself out from under its debt.  Below that discussion is a list of retail chain bankruptcies in the last 12 months, and a brief explanation of their PE connections where they exist.  You’ll recognize most of the names on the list.

Ultimately, the decline in brick and mortar location is a necessary and appropriate reaction to market conditions.  In the short term, it’s hard if only because of the discounted inventory that’s thrown on the market.  It’s also hard on the poor shareholders who bought shares in some of these companies.

Here’s a text message I got a couple of days ago:

“My name is ************.  I am from Kazakhstan.  In ***********, 20**, I have invested all my savings into ********** at the average price of $*.**.  I was an owner of 73,500 ******** common stocks when in ********, 20**they claimed CH11 without any reimbursement for shareholders and until the stocks were finally delisted in *******, 20**, so I have lost all my money.  So, my question is: is there any chance to get any reimbursement from them?”

I had to tell him “no” and explain a little about U.S. bankruptcy laws.  His result gives some of you something in common with somebody in Kazakhstan, which you probably didn’t expect.  It’s also a reminder of investment rule number one:  Never put all your eggs in one basket.

It’s worth reading this article to understand how LBOs work for some of the PE community and why things go to hell if the cash doesn’t keep flowing.  It’s all about the balance sheet.  The list of bankruptcies also reminds you of the breadth of our consolidation.

Here’s the link.

Good Things Happening at Spy.

You may remember that until a few months ago Spy, as a public company, was releasing the usual filings and I was analyzing them.  But they stopped releasing them and, though still public, its shares are now traded on the OTC pink sheets under the symbol XSPY.

As I wrote every quarter, I always liked the brand and thought they were doing most things right.  But I couldn’t quite see how they could be successful.  It’s beginning to look like they might have figured it out.

On July 15, they let fly with a couple of press releases.  One of them announced that they had converted $22.8 million of debt into convertible preferred stock.  As I’d write every quarter, that debt was effectively equity any way.  Now, they’ve acknowledged that and cleaned up the balance sheet.  I don’t recall all the terms and conditions of that debt, but certainly it stood in the way of any deals the company might make.  So on the one hand, the change is kind of window dressing, but on the other hand, it gives the Spy some flexibility going forward.

More impressive were the summary financial results they released for the six months ended June 30 2015 and 2016.

Revenues fell 14.9% from $17.25 million last year to $14.68 million this year.  Okay, so that doesn’t sound very impressive, but it is.  Here’s why.

Spy increased its gross profit margin from 53.4% to 54.1%.  Of course total gross profit declined with the fall in sales, but hold on.

Operating expenses fell from $8.88 to $7.27 million, or by 18.1%.  As a percentage of revenues, they dropped from 51.4% to 49.5% even with the decline in revenue.

The result, according to the press release, was that operating income rose from $150,000 to $671,000 and net income went from a loss of $927,000 to a profit of $443,000 for the six month periods.

What!?  On a 15% revenue decline they had a monster turnaround on the bottom line!?  What the hell is going on here?

Seth Hamos, who is the Chairman of the Board and Acting Chief Executive Officer, is the guy who owned most of the debt in the company.  He stepped in after Michael Marckx resigned.  Seth had at least two things going for him.  First, he wasn’t from our industry and apparently didn’t suffer from all the preconceptions we all have about THE WAY THINGS ARE.  Second, he looked and said, “Well, I’m not going to get my money back if the company keeps losing money, so I guess I better try something different.”

That’s not an actual quote, but it’s how I always feel when I walk into a turnaround situation- nothing is sacred.

I’m guessing a few sacred cows were slaughtered for the barbecue.  Probably stopped selling to a few people who weren’t paying, didn’t merchandise the product right, or where they weren’t earning a good enough margin.  Wouldn’t be surprised if the number of SKUs declined.  I’m guessing there was some panic among the marketing staff when Seth asked, “What the hell are we spending money on this for?”

Again, not an actual quote.

The wailing and gnashing of teeth no doubt continued as he sliced some of those expenses.  But let’s remember the premise here.  Continuing to fund losses was a non-starter.

I’ve been in that position myself.  There’s always another way to spend marketing money to support retailers.  It’s always considered critical.  But, with some limits, most of the time when you cut a chunk of it, you find that nothing bad happens- at least immediately.  An open question is whether any of those cuts might impact the brand’s results down the road.

As always, if your product is checking at retail at a good margin, the retailer will want it.  If it isn’t, they won’t.  Spy believes itself to be a specialty brand.  It looks, with the actions it’s taking, that the company is confirming that and is positioning itself accordingly.

Three other brief financial comments; First, Spy’s net operating losses means no income tax is payable.  Second, I’m guessing Seth isn’t taking a salary.  Not paying whatever they were paying Michael Marckx and not paying income taxes didn’t hurt the bottom line.  Finally, there was interest expense being incurred on the debt before it was converted to preferred stock.  The press release doesn’t mention a dividend payment on the preferred stock.  In the future, a decline in interest expense could result in another boost in Spy’s bottom line from an accounting perspective.

What Spy seems to be doing is pretty much what I’ve been recommending since around 2007; sales growth is harder to come by so focus on your distribution, gross margin and controlling operating expenses with the goal of improving the bottom line.  That’s consistent with building and protecting your brand in an industry where actual product differentiation is hard to come by.

I’m sure Spy figured all this out without my help, but it’s nice to have a poster child to point to.

Billabong Sells Sector 9 and Lets Fly with a Press Release

Well, the press release was back on June 3rd.  And the sale of Sector 9 was, I guess, a week ago.  Happily, it’s not my job to be timely, but to give you things to think about with the goal of maybe helping you do better business.

So let’s think about Billabong.  Back when CEO Neil Fiske took over, there was a decision early on to focus on their big three brands- Billabong, Element and RVCA.  Good decision, I thought.  Most recently, they’ve sold Sector 9 for US $12 million.  As I’ve written previously, I expect the sale of additional brands.  Some of them may be small enough that a formal announcement of the sale won’t be required.  Maybe they are already gone.

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