Surf Expo; The Report of the Death of Trade Shows is Greatly Exaggerated

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Apparently, if you get a whole bunch of retailers who need to buy stuff together with the brands they want to buy from there’s still every reason to have a big old trade show.   Maybe, in fact, the bigger the better. The more brands and retailers, assuming they are the right brands and retailers, the more can be learned and the more business done in the most efficient manner.

Surf Expo struck just the right balance between a positive, upbeat environment and a focus on business.   Noisy, but not loud. You could talk. Active, but not frantic. Fun, but professional.  

Not that trade shows and the ways they provide value haven’t changed. Technology, the economy, and the way the retail environment is evolving have seen to that.  You don’t compete against other brands for the biggest booth prize any more (though that was sure fun!). Retailers tend to bring fewer people. Shows don’t need to be quite as long. More buying is done outside of the show environment. And brands from one industry don’t fret any more about having other industries at “their” show. We’re all in this together.  In our industry, we think of Surf Expo as surf, skate, and now, SUP.  But the resort and gift people are there too and that, I think, gives Surf Expo the size and resources to do some of the things they do. 
 
Internet at the show was free, which I really appreciated. I’m used to doing without given the simply unbelievable prices that have been charged at other shows. “Unbelievable” is a much kinder word than I first thought about using.
 
In terms of which brands exhibited, the surprise was the absence of Volcom. Still, I’m not certain that Volcom, as what I’ll characterize as an urban/youth culture brand, really fits at Surf Expo, though it’s certainly convenient for their East coast retailers to see them there. I didn’t talk to any brand that was sorry they weren’t next to Volcom’s booth. Maybe that’s a good decision by Volcom.
 
I thought one of the most consistently busy booth was Sanuk, though John Vance is a friend of mine and I probably spent too much time standing around his booth bullshitting with him. I’ve frequently written that the biggest risk for a business is to not take any risks. Sanuk is doing some management things that are not traditional for our industry. Some people might call them risky, but I think they’re responsible for a lot of the brand’s success.       
 
Traffic Thursday was deemed by most people I talked to as a little light, but it picked up nicely on Friday and I’d characterize the show as busy. I have to confess I left on Saturday. Show management tells me that Saturday was stronger than they expected, and that retail attendance exceeded last January’s show by 9.2%. Don’t quite know if that’s 9.2% more stores, more retailers, more days stayed, or more beer consumed.
 
The skate park was very well done. I’m not qualified to discuss its technical attributes but it was big enough to keep things moving, and located where it wasn’t in the way but was still part of the show. There was plenty of room to stand around and watch and you could move past it without getting trapped in the crowd.
 
But the undisputable highlight of the show had to be the Quiksilver sponsored All 80s All Day Vert Challenge with skating by Tony Hawk, Andy MacDonald, Christian Hosoi, and about 15 other skaters. It happened Friday evening after the show closed. They set up the huge ramp in a part of the convention center the size of the trade show, but where the trade show wasn’t. Basically, nothing in it but the concrete floor, ramp, the Quik van, and some crowd control barriers. The industry came in from one side and the public was allowed in from the other. No clue how many thousands of people were there. It felt a little like Quiksilver’s coming out party announcing that their problems were behind them.
 
In the past, there has been talk and some attempts to integrate the public with the trade at a show and it either hasn’t happened or hasn’t worked out. This worked spectacularly well. I managed to get in a little early (thanks Doog!) and could stand right next to the ramp and watch them warm up. If Einstein were alive, I’d let him know that a bunch of people were violating his laws of physics on a skate ramp. I look forward to Surf Expo thinking up new ways to involve our customers in the future.
 
My next challenge at the Vert Challenge, in the best industry tradition, was to figure out a way to get into the Quik VIP area where they had the free beer and food. I was stopped at the entrance for lack of a wrist band but some guy I didn’t know said, “Here Jeff, I’ve got an extra one.” Turned out to be Kevin from the Quik marketing department and am I ever glad I put my picture on my web site. Thanks Kevin.
 
I didn’t know much about the standup paddle market before this show, but I learned a bunch. There were, well, a lot of SUP companies and Surf Expo had installed a shallow pool where you could take a lesson. But the real eye opener was the SUP industry discussion group I went to Friday evening after the show closed.
 
The meeting was past standing room only. Those of you who have been around a while know that in the mid 90s I rained on the snowboarding parade by suggesting that it was possible all 300 or so hard goods companies might not make it and that the industry would go through the usual growth, maturity, consolidation cycle every industry goes through. Around 2004 I told the skate industry that Chinese product was coming, there wasn’t anything they could do about it, that distribution issues weren’t going to go away, and that shop decks and blanks were here to stay.
 
It seems that every eight years or so I piss off some segment of our industry and it must be time again.
 
What the SUP industry has going for it is that it’s a sport for the whole family with an easy learning curve. But that doesn’t make it immune to the usual industry cycle that snow, skate, and surf all went through. When somebody stood up to announce how “the industry” had to keep margins up and various heads nodded in agreement, I had a flashback to the IASC/BRA sponsored breakfast round tables at ASR. Those of you who have been to one of those don’t need me to say any more.
 
Here’s what I’d like to tell the SUP industry. First, the consumer is going to get what they want. If you won’t sell it to them, somebody else will. Ask the skate industry. Second, “the industry” is not going to keep margins up. It’s probably illegal. But more importantly, I guarantee you that every company in the business is going to do what they perceive to be in their own best interest. If there’s no meaningful product differentiation, margins will head to the point where marginal revenue equals marginal cost. There’s only so much advertising and promotion can do to prevent that. Ask the snowboard guys.
 
Like Boardworks’ Bob Rief put it during the meeting, “If you are in a low volume, low margin situation, you really don’t want to be because it’s a lethal combination.”
 
Please don’t kid yourselves SUP people. Make sure that many of the people you talk to aren’t your industry peers so you get some perspective. Run your businesses well and realistically knowing that you can succeed in spite of an inevitable business cycle if you do.
 
Strangely enough, I don’t think anybody complained to me about the show. Oh wait- one complaint about booth location, but they confessed they were late booking. The general attitude of the retailers and brands I talked with was:
 
·         Good show.
·         Things are better than last year but not good.
·         I’m still cautious and running my business that way.
·         We’re not going back to 2007 any time soon.
 
Except for the “Good show!” part we really can’t hold Surf Expo responsible for those sentiments. They’re doing everything they can to make their show easy to attend, functional, and valuable. Wonder what they’ll do next.

 

 

Gross Profit Margins; How to Think About Them for Brands with a Big Retail Presence

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A friend of mine who wants to remain anonymous (I get quite a few of those) sent me an email the other day and had an interesting point to make about gross margin for brands who owned retail stores.

When a brand opens retail stores they do it at least in part because they expect to capture the margin that previously went to the retailers they sold product to. We all understand that. Just to pick some numbers, let’s say that brand earns a 35% gross margin when they sell their product to retailers they don’t own. And let’s say it’s 65% when they are selling the product in their own retail stores.

Of course, they incur all sorts of additional expenses by virtue of having to run and staff stores and some of those may be accounted for as part of the cost of goods sold, reducing gross margin. But let’s just go with my “accounting light” numbers for purposes of my example. The point is just that they get a much better product cost margin at retail then they do at wholesale.
 
Here’s what my friend said. I’ve paraphrased it a bit.
 
“When you see a sales decline with the margin rising, it could be that most of that decline is taking place in the wholesale rather than the owned retail sales. So the increase you see in gross margin would be, to a greater or lesser extent, just the mathematical result of selling a higher percentage of the higher margin retail product. It wouldn’t represent better inventory management, reduced product cost, or price increases or any kind of positive management action.”
 
Let’s say a brand is selling $1,000 of product (it’s a really small company). 30% of those sales are through their retail stores and 70% to other retailers. On the 30% they sell through their owned retail, they earn a gross profit of $195 (using the gross margin percentages I chose above). On the 70% they sell through other retailers, gross profit is $245. That’s a total gross profit of $440 on that $1,000 of sales, or 44%.
 
Let’s assume their total sales fall by $100. Let us further assume that the entire decline is in their wholesale sales. Now they are selling $600 at a gross profit margin of 35%, earning $210 in gross margin dollars. On the sales in their owned retail, they continue to earn $195 in gross margin. That means they earn a gross profit of $405 on sales of $900. Their gross margin percentage has risen from 44% to 45%, but not, as far as I can see, for any reason we should feel good about.
 
An independent retailer can reduce or eliminate the presence of a brand that isn’t selling pretty quickly. If you’re brand X, you’re probably going to be pretty reluctant to stop carrying brand X at your owned stores. This begins to get us into all sorts of interesting discussions about merchandising when you’re both a brand and a retailer. Will weakness in your wholesale accounts eventually translate to weakness in your owned stores? Or can your ability to merchandise your entire line the way you think it should be make a difference?     
Declining sales would typically go hand in hand with declining inventory levels. There are reasons you might not see that- like building inventory for a new brand launch- but overall if you see declining sales, higher margins and no fall in inventory from a brand with significant owned retail, it’s worth exploring.

 

 

Quiksilver’s Focus Goes From Balance Sheet to Income Statement; Their Quarterly and Annual Results

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Quiksilver continued to improve its balance sheet over the year and quarter, and this conference call is the first in a while where I’ve gotten a sense of where some growth might really come from. We’ll talk about that. 

But first, I thought some of you might actually want to know how much Quiksilver earned for the quarter and year ended October 31, 2010. Amazingly enough, if all you did was read the three pages of text in the press release and listen to the conference call, you wouldn’t know. You could finally see the actual, bottom line number on the financial statement on page four of the release.

For the quarter, Quik lost $22.1 million on revenues of $495.1 million. In the same quarter the previous year, they reported a loss of $1.78 million on revenues of $538.7 million. For the fiscal year, they lost $9.68 million on revenue of $1.837 billion. For the previous year, they had a loss of $192 million on revenue of $1.978 billion.
 
There. That wasn’t so hard. It’s not operating income. It’s not EBITDA. It’s not proforma. It’s not in constant currency. It’s just the bottom line results according to good old fashioned Generally Accepted Accounting Principles. A lot of really smart people worked really hard to give us GAAP. Couldn’t we just start with that and then provide the explanations and adjustments?
 
And we do need some of those explanations. We want to know that $119 million of last year’s loss was due to the Rossignol debacle and there’s value in being able to compare the company’s results without that impact by looking at continuing operations. But I wouldn’t want to act like that didn’t happen or that it somehow wasn’t a real loss.
 
Our industry’s popular press essentially reproduced the press release. The exception was Boardistan, who actually showed the quarterly loss in their headline.
 
On To the Numbers
 
With my rant now completed, let’s look a little harder at some of the numbers. Gross margin percentage in the quarter rose nicely from 47.6% to 53.5% compared to the same quarter last year on the decline in revenue noted above. With some help from a 3.6% reduction in selling, general and administrative expenses, this allowed them to increase their operating income from $15.1 to $34.3 million. But interest expense, not unexpectedly, jumped from $20.9 to $50.6 million. All but $16 million of that was the write down of debt issuance costs that had been capitalized and that went away when they paid off debt. The loss from continuing operations grew from $13.8 to $22 million.
 
The year ended October 31 looked a lot like the quarter. The gross profit percentage rose from 47.8% to 52.6% on the sales decline shown above. Selling, general and administrative expense fell 2.3%. Operating income was up 80% to $123.5 million. As in the quarter, interest expense rose as expected from $63.9 to $114 million, more than offsetting a reduction in income taxes from $66.7 to $23.4 million. The continuing operations result improved from a loss of $70.3 million to a loss of $8.1 million.
 
Quik’s reported business segments are the Americas, Europe, and Asia/Pacific. In the quarter, sales fell in all three, but the gross margin percentage was up in all, though gross profit dollars rose only in the Americas. All the gross profit increase, obviously, came from the Americas though it has the lowest gross margin percentage of the three segments at 48.1%. Gross profit percentage was 60.2% in Europe and 54.8% for Asia/Pacific. 
 
The big turnaround in operating income for the quarter was in the Americas, where it went from a loss of $9.3 million to a profit of $12.7 million. Europe’s operating income was up about $4 million to $20.9 million. Asia’s actually fell from $14.5 million to $8.6 million. I imagine Quik’s management would get positively giddy if they could get their Americas gross margins up to those of the other segments.
 
For the year, sales fell in the Americas and Europe and rose slightly in Asia/Pacific. Gross margin percentages were also up in all three segments, reaching 46.3% in the Americas, 59.8% in Europe, and 54.2% in Asia/Pacific. The Americas represented 46% of total revenue. Europe is 40% and Asia/Pacific 14%.
 
The trend in operating income for the year was much the same as in the quarter. The Americas went from a $25.3 million loss to a $56.9 million profit. Europe fell a bit from $104 to $94 million and Asia/Pacific was down from a profit of $23.2 million to a profit of $11.8 million.
 
The Quiksilver brand’s revenues were about $770 million during the year. Roxy and DC were each about $500 million in revenue for the year. DC is the brand where they see the most growth potential; especially outside of the Americas. They note that the juniors market is still impacted by fast fashion price point driven goods. As they put it, “Declines in the Roxy business are moderating, and it appears they will reach the bottom in fiscal 2011.”
 
The balance sheet, well, there is no balance sheet and I feel more ranting coming on. There are some balance sheet numbers (and to be fair, it’s most of the important ones) but we won’t see the complete balance sheet until the annual report. I’m actually writing this now rather than when that report comes out because at the end of the year, the SEC gives companies a lot longer to file.
 
Receivables, compared to a year ago, have fallen 14.5% to $368.4 million. They note in the conference call that days sales outstanding fell 5 days to 63 days. Inventories are essentially the same at $268 million, and they note in the conference call that it’s about where they expected inventories to be. I guess I would have expected some reduction with sales down, but given the increase in gross margin it’s hard to argue that inventories aren’t under control. Lines of credit and long term debt are down from $1.04 billion a year ago to $729 million. The debt reduction reduces their annual interest expense by $26 million. 
 
Sorry to disappoint those of you were looking forward to my scintillating discussion of the “GAAP to Pro-Forma Reconciliation” or the “Adjusted EBITDA and Pro-Forma Adjusted EBITDA Reconciliation” or even the ever popular “Supplemental Exchange Rate Information,” but I think I’ll move on to the conference call. You can view the complete press release here.     
 
Strategies for Growth
 
 CEO Bob McKnight said, “Our overriding strategic objective is to retain and remain the world’s number one action sports lifestyle company centered on boardriding. And boardriding for us has a broader connotation than just surfing, skating and snowboarding. It also includes the closely related interest of our growing global demographic. BMX, rally, moto, bike, hike, climb, paddle, mix martial arts, and many other growing action sports and activities.”
 
He identified four “primary initiatives” they would use to implement this objective. The first was to “…focus our energy and resources primarily on our three major brands.” Second is to “…focus on strategic core marketing initiatives and core athletes.”
 
The third is to “…expand through product line extensions, geographical reach, and further channel development.” This includes the Quiksilver Girls line, launching in spring. They also plan to expand DC into “…surf, snow, BMX, rally and moto.” They “… also believe we have a huge opportunity in mountain resorts and colder weather markets within the Americas and Asia-Pacific to replicate the success of our European winter outerwear business.” The geographic expansion will be where they already have a presence, but have underinvested in the past.
 
The fourth primary initiative “…is the development of incubator brand concepts that can potentially represent opportunities consistent with our culture and areas of expertise.” I don’t know quite what that means but he mentions Lib Tech and Gnu as examples, and that must have Mike and Pete reaching for their favorite adult beverage.
 
As is the case for every company of any size that wants to grow, the devil’s in the details. How do you focus on your three major brands and remain centered on boardriding but grow moto, bike, climb, paddle, mixed martial arts and others? How big a part of your business can those become before you’re no longer centered on boardriding? If you want to grow Lib Tech and Gnu “…consistent with our culture and areas of expertise,” that might be interpreted as putting some serious limits on their growth.
 
Quik’s ecommerce business is about $25 million, and they think it has the potential to be 10% of their business. They closed the year with 540 stores. They believe DC has the potential to be a billion dollar brand.
 
For 2011, they are looking for “…modest sort of growth” overall for the company. They’ve got cost pressures they estimate at five to ten percent, and expect to implement some selective price increases. They expect an overall gross margin for the year consistent with 2010. The price increase and some cost initiatives, along with favorable currency rates in some countries outside of the U.S., should allow them to achieve this in spite of costs going up.
 
What do they expect in terms of sales for 2011? “Quiksilver kind of low-single digit expectations for fiscal ’11; Roxy, down mid-singles, and DC, up somewhere in the high-single to low-double digit range. In terms of what we are expecting in regionally, much of the growth is focused on the Americas region in 2011. We are launching the Quiksilver Girls collection beginning on 2/25. Our first delivery is coming out.”   
 
It’s nice to see Quik more or less out from under their liquidity and debt problems and focused on brand building and the future. I can see that they have some possibilities for growth, but none of them feel easy and it sounds like real impact will be felt after 2011. I guess that’s just business for all of us these days. 

 

 

A True Christmas Retail Tale

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My youngest son and I went out to get our Christmas a week or so ago. I headed towards our usual lot, expecting to pay something like $60 for a tree when we spotted a sign that read, “Christmas Trees: $29.95.” Never one to turn down a deal, I followed the signs to the lot where, indeed, all the perfectly good looking trees were $29.95.

After picking out a tree (the needles did not all fall off when I shook it), I struck up a conversation with the guy manning the lot. “How come you’re selling trees this cheap?” I asked.

“Well, it’s our first year in this business and we bought too many,” he explained. I asked how many too many and he told me, “Four times too many.”
I suggested that somebody at the company must have been sentenced to life in front of the firing squad for that one and he said it was so. Intrigued, I asked how, exactly, the buying decision had been made.
Now clearly this guy wasn’t an owner of the company that was losing its ass on all these trees because he was already starting to laugh as he told me, “The guy who sold them to us told us how many we needed.”
It got better. I asked him how they were moving and he said, “Okay, but we didn’t get the right size assortment.” I asked why not and he told me- you guessed- it, “The guy who sold them to us told us which sizes to get.”
By this point even my son, who’s only retail experience is as a customer but who has hung around me long enough to pick up a few things, was laughing hysterically.
Trying not to lose it completely, in case this guy actually cared I said, between chortles and guffaws, “So the guy selling you the trees not only told you how many to buy, but managed to sell you the ones that nobody else wanted? Is that about it?”
“Yup,” he said with a smile.
Christmas trees are even worse than snowboards from a retail perspective. The selling season is shorter and the damned things die.
Anyway, happy holidays and, be you a brand or a retailer, may you never buy four times too much of a wrong product who’s only residual value is as mulch or firewood, and have only two weeks to sell it all.

 

 

Billabong’s Announcement and the Industry Strategic Issues Underlying It.

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On December 15th, Billabong revised its projected results for the six months ending December 31, 2010. Here’s what they said:

“The Company’s previous guidance….indicated net profit after tax (NPAT) for the first half year ended December 31 2010 would be slightly lower than the prior year in constant currency terms. The Company now anticipates that first half NPAT will be 8% to 13% lower than the prior year in constant currency terms.”

You can read the press release and the transcript of the conference call they held here. It’s the “trading update” and “trading update transcript.”
 
In Australia, they pointed to cool wet weather, lower than expected wholesale repeat business, and weaker than expected consumer retail spending. In the US it was a shift in seasonal orders pushing delivery into the second half of the year, partially offset by strong retail performance in their owned stores. In both Australia and Canada, slower sell through of existing product in newly acquired retail has meant a delay in getting their owned product into this retail. To a lesser extent, Europe and Japan were also just a little soft.
 
Well, every year shit happens. To all of us. It can be weather, or product delays or a soft economy somewhere (or everywhere) or a container I put on a train from the East coast because it would be faster than a ship and then a blizzard stops the train and they “lose” the railroad car (true story) or lots of other things. They will always happen.
 
What I would like to do is get out from under the tactical issues and the uncontrollable stuff for a minute and talk about market evolution and strategy. If it sounds like I’m saying, “I told you so,” and am being a bit insufferable well, I probably am. But I’m going to enjoy it. You can trash me on my web site if it gets too bad.
 
This isn’t by the way, just about Billabong, though I’m using them as an example and their announcement was motivation to write this.
 
As attractive as all that extra margin is to brands, successfully integrating retail with your existing owned brands isn’t easy or straightforward. How much of which brand to put where, what brands to cut, whether you require a retailer to carry your owned brands even if they aren’t selling, etc. are not trivial issues. About 40% of Billabong’s revenue is from retail now.
 
Oh wait- I already wrote about that like just last week. See it here.
 
West 49 is the biggest retail acquisition (maybe the biggest acquisition?) Billabong has made. And, as far as I know, it’s the first one they made that had some elements of a turnaround to it, requiring more management time and attention I suspect.
 
Oh wait- I already wrote about that when Billabong bought West 49. See it here. Look towards the bottom of the article in the section called Nuts and Bolts.
 
Though the short term issues Billabong is facing are certainly real, I think there’s more to it than that. At the end of the day, both retailers and brands have to expect that sales increases will be harder to come by for a while. Anybody expecting a strong economic recovery in the short term is fooling themselves. Retailers and brands are (correctly in my judgment) focusing on expense and inventory control, and generating gross margin dollars. It’s not that they don’t want to grow, but they aren’t expecting it like they use to.
 
Oh wait- I already wrote about that. See it here back in 2009. And here. Okay, I guess I’ve been insufferable enough.
 
Of course if you’re a public company, you’re kind of reluctant to tell the analysts, “We don’t think we can grow much for a while!” Just wouldn’t be well received, though I doubt I’m saying anything here the analysts aren’t thinking. They are smart people.
 
Look at Billabong’s announcement as representative of issues we all face.

 

 

PacSun’s October 30 Quarter; Big Changes Take Time

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PacSun released their earnings and had a conference call on November 22nd. So why am I just getting around to writing about it? It’s because they didn’t file their 10Q until December 9th. I’m funny like that- I like to have the most complete information I can before doing much analysis.

What I was hoping for, but not expecting, was some detailed discussion of the company’s strategy. I didn’t really get it. The quarterly numbers are important, and I’m interested in hearing about cost pressures, and how various segments are doing. But what I really want to know is how Pacific Sunwear is going to make itself relevant to its target market again. We have the broad outlines of that strategy, but it’s too soon to know how it’s going to work out. Let’s take a short detour into the company’s recent history to understand what ‘s going on.

Recent History
 
Gary Schoenfeld took over as PacSun’s President and CEO on June 29, 2009, replacing Sally Frames Kasaks. Ms. Kasaks had a stellar background in retail, but it was never clear she quite “got it” in the action sports/youth culture space. Mr. Schoenfeld (former President and CEO of Vans) clearly does “get it” and is taking a different approach.
 
She had taken PacSun out of shoes, and he reversed that decision. Her merchandising strategy had the same assortment at all the stores. He’s moving to make it specific to location. He mentions in the conference call that he’s been cautious about rolling the localization strategy out and that the “…actual execution didn’t begin to materialize until towards back to school.” This is a critical strategy that should impact margins and sales. To some extent, the strategy had been delayed because they didn’t have somebody who could lead the execution, a problem now resolved. I talk below about their management transition and its impact.
 
Gary Schoenfeld talked about the need to reconnect with the customer and the culture in a way Sally Kasaks never did and he has rolled out some marketing initiatives to do that. As he put it in the conference call, “I talked [when he first took the job] about the importance of reestablishing our relationships with brands, improving our merchandising and selling culture within our stores, connecting with our customers, and reigniting a culture of passion and creativity within Pac Sun.” Zumiez could have written that.
 
He’s cut the number of stores from over 900 when he started to 877 at the end of October and expects to be at about 850 by the end of January 2011. Depending on how accommodating landlords are, we may see a further cut of over 100 stores in the next couple of years.
 
To me, the most telling thing he’s done is to hire eight new vice presidents and promote a ninth in the last 11 month. The most recent hires were in September and October. There were, obviously, some vice presidents who left the company as well. They’ve also changed their whole regional director team in the last 12 months.
 
The list of management on their web site only has 12 people, including Mr. Schoenfeld. So these changes represent a nearly complete turnover. My experience is it takes a minimum of at least a couple of months for a new senior manager to become fully effective.
So we’ve got a big management transition going on along with an attempt to change and reinvigorate the culture. That ought to keep them off the streets. And, like every other company, they are doing it in a difficult economy. Like other companies, they are concerned about sourcing and product costs hurting their margins. Also like other companies, they don’t expect to be able to pass these costs along to consumers. CEO Schoenfeld notes they “…are committed to working aggressively to try to maintain our gross margins next year through better product assortments, localization initiatives, detailed review of product specs, and refined pricing strategies.” I expect there will be some price increases as well.  
 
I have neither a crystal ball nor a level of arrogance that allows me to think I can predict whether they will succeed or not. With the level of change they’ve undertaken, it’s just too soon to tell. But I do know this; if PacSun had continued along the same path it was on, it would be in a world of hurt. Like I keep saying, the biggest risk is to take no risk at all.
 
And Now, the Numbers
 
I’ve got the balance sheet from a year ago to compare the October 30, 2010 one to. I feel more like I’m comparing apples to apples that way.
 
Current assets have actually grown a bit, but that’s mostly because they’ve got some more cash and that’s almost never a bad thing. In August, PacSun borrowed $28 million in term money secured by some of their facilities.
 
I was a bit surprised to see that their inventory was down only $2 million to $166 million. With lower sales, fewer stores, and the kind of tight inventory management we’re seeing from other companies, I expected more of a decline. CEO Schoenfeld said they “…were down modestly, and consistent with our expectations in terms of how were planning the quarter.” They don’t say this, but I wonder if it might have something to do with their decision to localize assortments. Maybe until they get that dialed in, it requires a little extra product.
 
Net property and equipment is down about $60 million.
 
Accounts payable rose from $63 million to $77 million. Long term liabilities were up due to the mortgage debt they took on in August. The current ratio is essentially the same, riding from 1.93 to 2.02 over the year. Total liabilities to equity is up from 0.57 to 0.89. This is mostly explained by the loss the company has incurred. At the end of the quarter, they had no direct borrowings under their line of credit and $95 million in availability.
 
Sales for the quarter fell 3.9% to $257.9 million. Comparable store sales were down 3%. That’s the smallest quarterly drop this fiscal year.  Gross profit fell from $73.4 million to $64.4 million. Gross profit margin was down from 27.4% to 25%. Most of that decline was due to a “Decrease in merchandise margin as a percentage of sales primarily due to a decrease in initial markups and increase in markdowns, particularly within denim and wovens.”
 
They cut their selling, general and administrative expenses by 20.5% to $71.1 million. As a percentage of sales, that’s down from 33.4% to 27.6%. 1.6% came from a decline in payroll expense. 2.8% was because their $2 million noncash charge in this category for underperforming stores was so much lower than the $9 million charge in the same quarter last year.
 
The reduction in expenses was what allowed them to cut their operating loss from $15.9 million in the third quarter last year to $7.1 million this year. Their net loss was about $7 million for the quarter compared to a loss of $10.9 million in the same quarter last year. Their income tax provision this quarter was only $173,000 compared to $5.04 million in the same quarter last year, so maybe we’re better off looking the pretax loss, which fell from $15.9 million to $7.1 million.
 
For nine months, the pretax loss was $53.2.0 million last year and rose to $61.1 million for the nine months ended October 30, 2010.
 
We need to give Pacific Sunwear some more time. The extent of the change they are undertaking requires it. I wish they didn’t have to climb the mountain of a lousy economy while they did it.           

 

 

What’s Up with Quiksilver? The Stock Was up Huge Today

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Quiksilver’s stock jumped 22.7% today (December 9th) from 4.75 to 5.68 on the biggest volume since last March. These kinds of moves don’t happen in a vacuum, so I thought I’d check around a bit. An investment banker I know was kind enough to alert me, and I found the following reported on Bloomberg:

“PPR SA has agreed the sale of its Conforama chain to Steinhoff International Holdings Ltd. for 1.625 billion euros, La Tribune reported, without saying where it got the information.”
“PPR Chief Executive Officer Francois-Henri Pinault is interested in buying Quiksilver Inc., La Tribune said. He has reestablished contact with the company, as well as with Rhone Capital, which holds a 19 percent stake in the California-based maker of clothing for skateboarders and surfers, according to the newspaper.”
The link is here, though I’m quoting the whole thing.
Who’s PPR SA? I didn’t know either, but here’s a blurb on them from Yahoo Finance.
PPR SA Company Profile
PPR has transformed itself from a conglomerate to the world’s third-largest luxury group (behind LVMH and Richemont). PPR’s stable of global luxury brands includes a 99% stake in Italian luxury goods company Gucci Group, and luxury brands Alexander McQueen, Balenciaga, Boucheron, Bottega Veneta, Stella McCartney, and Yves Saint Laurent, among others. The group’s other activities include the multichannel merchant Redcats, Fnac music and book stores, the Conforama chain of household furniture and appliance stores, and the German athletic shoemaker PUMA. More than half of PPR’s sales are generated outside of its home country. PPR is run by Fran�ois-Henri Pinault, the son of its founder Fran�ois Pinault.
Is this actually going to happen? Somebody thinks something is going to happen given the way the stock jumped.   I don’t know what the price might actually turn out to be, but Rhone Capital would sure make a nice return quickly.
Love to do more analysis of this, but the unfortunate fact is I don’t have any information.  Maybe soon!  Or maybe not.

 

 

“Independent” Retailers; Are They Still Independent? And What if They Aren’t?

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Sometimes I do my best work with a glass of wine. The secret is to never post what you’ve written until the next day, after you’ve read it again. I put “independent” in quotes (there, I’ve done it twice) because as I think about retailers and their relationships with brands I kind of wonder what independent means.

Independents have always relied on brands for terms to make their cash flow work. But now we’re into brands investing in or, to some extent controlling what were independent retailers. When that happens, that retailer ain’t independent no more.

But that independence is always what has made the best core (core, independent, specialty- pick your term) retailer successful. They were typically a destination in that community and they carried the brands that community wanted and the brands the store believed in. When people stopped buying, or a brand got over distributed or just when it started putting out ugly stuff that didn’t work, the store dumped it. I mean, they had to. It was their only chance.
 
Glenn Brumage, then of Tum Yeto , and now Director of Business Development for Wabsono International and Vice President of IASC, spewed forth some wisdom at one of those IASC/retailer morning meetings at ASR (guess we won’t be doing that any more) a couple of years ago. As usual, the group was bitching and moaning about distribution. Glenn said something like, “Hey guys, most successful brands grow up and out of specialty store distribution eventually and the store replaces them with new, smaller brands. Get over it- it’s just what happens.”
 
Okay, arguably those aren’t his exact words. But we all know he’s right. Not every brand, and not all the time. But I’d say that no core retailer can differentiate itself if most of what it carries is available at better prices in chains, department stores, and on the internet.
I’ve even said from time to time that not bringing in new, smaller brands is less of a risk than not bringing them in. Especially in current economic circumstances.
 
The action sports industry is really pretty small. It’s composed of those retailers and brands that cater to the participants in the sport and the first level of nonparticipants who are into the lifestyle and watching the sports. We (at least I) used to think we were a whole lot bigger than that. But we were confusing youth culture and fashion with action sports.
 
Selling to the action sports consumer, as I define it, means you better have the product they want. What happens when Large Brand X has a deal with you that requires you to carry their product which, not surprisingly, they’d rather you sell than Brand Y? But you, the independent retailer, are part of a community, which is why you are successful. And the community wants Brand Y. Not brand X.
In times past, the retailer might have ordered less, send some back, exchange it for what was selling, or said, “Shit, we screwed up ordering this crap” and put it on closeout. Now, I wonder if they have quite the flexibility to do that.
 
I did hear a story of a retailer this past summer that could have sold the hell out of hoodies given the cool weather but was stuck with racks of board shorts. How does that retailer keep its credibility with its customers, much less make up for the lost sales?
 
Recently, there was an interview in Transworld Business where Jake Burton outlined his company’s plans to support local snowboarding shops. I think I’ve got a whole other article to write on the questions I would have asked.
 
I’m for Burton’s efforts and am really glad Burton has seen the light. But to the extent that any of these brands (snow, skate, or surf) have a relationship with core retailers that create additional limits on the retailer’s ability to respond to their customer base, they may damage that retailer. At some point, I worry that core retailers begin to look (and act?) too much like the stores big brands are opening in malls.
 
For a long time, there’s been a consensus that core retailers were critical to spotting trends, creating new participants, and building new brands. If we still think that’s true, we need to be a bit cautious about how the retail environment is evolving.

 

 

Zumiez’s October 30 Quarter and Its Position in the Market

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This shouldn’t take long. The balance sheet has more cash than a year ago, no long term debt, and is solid. The inventory increase of 8.8% since a year ago is a lot less than the 20% sales increase for the quarter (but remember that inventory is at cost and revenue at retail price). Zumiez indicated in the conference call that efficiencies provided by the new Southern California warehouse had a lot to do with their ability to better control inventory. They expect to continue to increase inventory by less than sales.  You can see the complete filing here.

Sales grew from $113 million to $136 million. Gross profit margin rose from 35.4% to 39%. If that looks low, remember they include occupancy and certain other costs in their cost of goods sold calculations. Other companies don’t do that. They indicated the increase was about half product margin improvement and half a decrease in store occupancy costs. In 2007 it cost them around $440,000 to open a new store. Now those costs are down to about $340,000 due to better deals with landlords and their improved operations.

Ecommerce sales for the quarter were about 4.4% net sales for the quarter, or a bit less than $6 million. In the same quarter the previous year, they were 2% of net sales, or about $2.3 million. They expect that ecommerce will be “…substantially larger for us over the next five years,” but they weren’t specific.
 
Management indicated they were learning a lot from the ecommerce business. They can read trends faster and allocate inventory better. They noted that operating margins in stores and on the web were not very different. Those of you who have actually invested in the systems and people it takes to run a really responsive ecommerce site won’t be surprised at that.
 
Selling, general and administrative expenses were up 7.3% but fell as a percentage of sales from 28% to 25.1%. Of the 300 basis points decline, 140 came from “store operating expense efficiencies and the rest from accounting changes I won’t bore you with the details of. Net income rose 143% to $12.3 million. That’s 9.1% of net sales compared to 4.5% in the same quarter last year.
Now for some fun facts about Zumiez.
  • 400 stores in 37 states. They opened 27 in 2010. They expect to open “a handful” in Canada in 2011, but not enough to have a meaningful impact on revenue. You know, I wonder if they ever really thought they were going to buy West 49 or if they just hoped to get a peek at their numbers.
  • They’ve still got this 14.3% interest in a manufacturer of apparel and hard goods I reported last quarter. They still won’t tell me who it is or how they got it. Rats.
  • Unredeemed gift cards at October 30 were $1.83 million. They don’t count them as income until they are used, but after 24 months they take unused card balances as revenue because their experience is that they won’t ever be used after that. Got to love that free money.
  • Pages 29-38 of their 10Q are all risk factors. It’s the longest section of the report. I just find it interesting that a company that seems to be doing so well could feel the need to talk about so many things that might go wrong. Must be the lawyers.
  •  Private label represented 15.7% of net sales last year. That number will be higher for 2010, but they didn’t say what it will be.
  • Their long term goal is to have 600 to 700 stores. I imagine that’s based on their analysis of how many malls there are that can support their concept. But I wouldn’t be surprised if they’ve looked at what happened to PacSun and said to themselves, “Nobody need 900 Zumiez stores.”
  • They bought snow product cautiously and might be a little tight on inventory if the snow conditions are good. Good for them. Leftover snowboard inventory is a dagger in the heart. Okay, maybe I’m overdramatizing, but you know what I mean.
  • Back in 2006, their sales per square foot were about $500. They think they could reach their operating goals now with square foot sales of maybe $440 or $460 due to operating leverage, the web, and their new warehouse. 
CEO Brooks say they want to “Stay true to who we are and focus on things that distinguish Zumiez from the competition.” That means carrying hard to find brands, providing a unique shopping experience, and having the best in class customer service. My guess is that their growth will be constrained by their ability to staff stores with the kind of action sports enthusiasts they want, but I’d characterize that as happening in a good cause. They’d be crazy to grow faster than they are able to perpetuate their culture in new stores.
 
Zumiez, like everybody else, is concerned about the strength of the economic recovery, issues with certain product supply, and increasing product cost due to cotton costs, labor, shipping, and other factors. Yet they seem uniquely positioned as the only hard goods carrying mall shop with at least a feel of independent core shops. And the days of it being evil to be in mall are long gone based on the other brands that are there.   

 

 

Making Changes in a Difficult Market; Orange 21’s Sept. 30 Quarter and Nine Months

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Orange 21 (Spy Optic) is one of my favorite brands for a couple of reasons. First, over the last couple of years they’ve worked themselves through some really tough issues, making difficult decisions when required. And they’ve had to do it during the recession. Second, for better or worse they’re public. We get to see the numbers, actions, and management strategies of a smaller company in this industry. 

 Finally, they are representative of the issues that most smaller companies are facing right now, and we can learn a lot from how they are responding. Let’s get learning. I should make it clear that the following analysis is mine based strictly on their public documents. Nobody at Orange 21 has talked to me about it.   
 
Key Strategic Decision
 
Orange 21’s sales fell 6.3% for the quarter to $8.2 million compared to the same quarter the prior year. For nine months, they increased 2.8% to $26 million. Like almost every other company, they know that sales increases are harder to come by than they use to be and that there are some pressures on margins. I’d say the latter is especially true in the sun glass business and would be (though to a lesser extent) even if there was no recession. Sun glasses are (were?) a high margin product that inevitably attracted competition from many sources and put pressure on those margins.
 
Orange 21 is at that awkward stage of its life- too big to be small and too small to be big. There are margin pressures and fewer core retailers to sell product to. They’ve been disciplined in controlling expenses, but a brand needs advertising and promotional support, and you can only reduce expenses by so much for so long. Essentially, they need to grow but I don’t think they thought they could grow as much as they need to with their core product lines.
 
The last article I wrote was about Volcom. In that, I talked about how brands, and maybe our whole industry, was transitioning from action sports, to youth culture, to the fashion market. The markets are of course not as distinct as I make it sound, and moving from one to the other is in no sense linear or inevitable for all companies. But Orange 21 has decided they need to move towards the fashion market in order to find the growth they need.   
 
Enter their licensing agreements. In September of 2009, they signed a licensing agreement to develop and sell O’Neill branded eyewear. Along with Spy and Spy Optic, the O’Neill brand is targeted at the action sports market. In February 2010, they signed a licensing agreement with Jimmy Buffett and his Margaritaville brand for eyewear. They did the same with Mary J. Blige in May. Blige is pretty clearly the fashion business.  I don’t quite know if you’d characterize Buffett as fashion, but it’s sure not action sports or youth culture. Is “parrot head” a market segment?  
 
A few years ago, Orange 21 bought the factory that was making some of its product in Italy. At the time I thought maybe that was mistake. But since the purchase, they’ve worked hard to restructure, revamp and generally rejigger that factory so that it’s an asset. I’m guessing it will never compete on price with Chinese made glasses. But for the market Orange 21 is aiming at with the newly licensed brands, the factory may be just what they need. In fact, I’d bet that a desire to increase its throughput was a factor in the licensing decisions.
 
So Orange 21’s key strategic decision was to recognize their need for growth and that the amount they needed couldn’t come from their traditional sales channels. Hence the licensing agreements.
 
The downside is that the licensing agreements come with certain design, development and marketing expenses before they generate the first dollar of revenue. They spent about $400,000 in license related operating expenses during the quarter. There are also various minimum payments under the licensing agreements that total $479,000 for the year ending December 31, 2010. For the next three years, those minimums are $1.4 million, $1.1 million, and $0.8 million.    The Blige product started to sell in September. The Buffett product was to have hit markets in November. It better sell well.
 
The company’s decision to seek its growth outside of its traditional channels had a financial impact that we’ll now examine.
 
The Balance Sheet- Inventory is What I’ll Be Watching
 
Back in March, Orange 21 borrowed $3 million from Costa Brava Partnership. Costa Brava and its general partner own 46% of the company’s stock. $2.6 million of the $3 million was used to pay down its asset based line of credit from BFI. We can tell from the current balance sheet that they later drew down part of that line of credit again. At September 30, their line of credit outstanding was at $2.6 million. Subsequent to the September 30 balance sheet date, the company borrowed an additional $2 million from Costa Brava in two loans for $1 million each dated October 5 and November 1. What are they doing with this $5 million?
 
The first thing we notice is that in the nine months ending Sept. 30 2010, inventory has increased 41% from $7.76 million to $10.9 million, so there’s over $3 million in additional cash  tied up there. As noted above, sales over the same period were up only 2.8%. I expect part of this increase is for the holiday season. But some, I assume, is also to meet expected sales from the newly licensed brands that have launched or are launching now. They’ve are also funding, as noted, significant royalty payments and expenses for the new brands that are not yet generating income.
 
Income Statement- Improved Gross Margin and Expenses in a Good Cause
 
The gross margin for nine months rose from 42% to 50%. For the quarter, it was up from 33% to 47%. I’m glad to see those increases. Orange 21 had some problem inventory and if the problem isn’t solved, the increasing gross margin at least suggests they are getting it under control. They’ve got gross accounts receivable of $6.885 million. Their allowance for doubtful accounts is $720,000 (10.5%) and a further allowance for returns of $1.114 million. Subtracting those two gets us down to the balance sheet reported receivables number of $5.051 million. So some of the slow moving inventory may still be around, but it’s been written down or off and when they do sell it, the margin in big.
 
In spite of the small sales decline for the quarter, total operating expenses were up 17.8%. From what they said in their 10Q, I expect most of this is for the newly licensed brands. They’ve been too good at controlling their expenses to let them increase like that without a very strong justification.
 
I would note that in spite of these increased expenses and a decline in sales, their loss for the quarter fell from $1.136 to $932,000. Witness the power of an improved gross profit margin! What Orange 21 is really doing right now is investing in their new product lines. If we weren’t seeing those investments, they’d have no chance these new brands could succeed.
 
We can see that Orange 21 is getting hit by most of the problems that afflict other brands in this industry. A tough economy, a decline in the number of specialty retailers, smaller orders from the ones that are still standing, and some difficulty getting paid. The sunglass and goggle market is also very competitive and, as I’ve written before, brands with their own retail have a bias towards replacing other brands with their owned brands. Lousy West Coast summer weather also hit reorders during the sunglass season, and they had some vendor delays on snow goggle product.
 
All about par for the course. What seems to me to be different at Orange 21 is that they didn’t limit their response to struggling with those issues on a day to day basis, though they have certainly had to do some struggling. They said, “Hey! Doing more of the same isn’t going to cut it. What can we do differently?” They came up with the licensing.
 

These licensing deals are a risk.   But business is a risk and my personal opinion is that if they hadn’t tried something new, their longer term future might be problematic. I wrote years ago that when things change, the biggest risk is to do nothing. I wish I could take credit for Orange 21’s decisions, but I think they figured it out all by themselves.