Volcom’s Numbers and Opportunities for Growth

What I’ve admired about Volcom is its consistent approach to the market over most of the life of the company. You get rewarded for that consistent approach with a strong market position and brand awareness among your target customer group. Reef did the same thing with a similar result over many years.

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’ll get to Volcom’s numbers. But the numbers tend to work out if the strategy and positioning is correct. Let’s take a close look at some of the comments in Volcom’s annual 10K and recent conference call to see how they’re managing it.
Brand Positioning and Growth
Volcom characterizes itself as, “…an innovative designer, marketer and distributor of premium quality young mens and young womens clothing, footwear, accessories and related products under the Volcom brand name.” They say they have, “…one of the world’s leading brands in the action sports industry, built upon our history in the boardsports of skateboarding, snowboarding and surfing. Our position as a premier brand in these three boardsports differentiates us from many of our competitors within the broader action sports industry…”
As an apparel/soft goods brand, it’s easier to build your franchise across sports in the action sports market than it is if you’re a hard goods brand based on an individual sport. It’s also easier to grow beyond action sports into the broader market. Everybody needs pants, shirts, and shoes, but not everybody needs snowboards, skateboards and surf boards. I think that’s non-controversial, so I’m not going to spend time on it.
Volcom characterizes its brand as “…athlete-driven, innovative and creative. We have consistently followed our motto of “youth against establishment,” and our brand is inspired by the energy of youth culture.” They go on to say that, “We seek to enhance our brand image by controlling the distribution of our products. We sell to retailers that we believe merchandise our products in an environment that supports and reinforces our brand and that provide a superior in-store experience.”
From what I can tell, that works just fine in “core” shops and in certain chains, like Zumiez. But once you get to Macy’s and Nordstrom, and your motto is “youth against establishment,” are you controlling your distribution and can these retailers “support and reinforce” the brand?
Well, this is hardly an issue that’s unique to Volcom. Every successful brand in our industry thinks about issues of distribution (where to sell and how fast) every day. And of course you have to be successful enough for Macy’s and Nordstrom to want you in the first place before it becomes an issue so it’s kind of under the heading of “good problem.”
Volcom indicated in the conference call that they are presently in 150 Macy stores. But I want to return to what they said, and what I wrote, after their last conference call on their Sept. 30, 2010 quarter.
“In the conference call, Nordstrom’s is mentioned as having stopped carrying action sports last year. In their previous conference call [for the June 30, 2010 quarter], Volcom was describing the opportunity they had at Macy’s. In this call, we’re told, “Macy’s has been more difficult for us right now in terms of our door count has been reduced over the course of, I think, this year, kind of quarter to quarter.” Quite a change for one quarter. Now Volcom is saying that “…Bloomingdales is our bright spot for our department store business.” But they’re only in eleven stores.”
“Those of you who read my last article on Volcom know that I visited a handful of Macy’s stores to look for Volcom and other action sports brands. What I found was that Volcom and other brands were either miserably merchandised or not present at all. It seems kind of clear that there’s some work to be done before Volcom moves much of its inventory in those channels.”
Over three quarters, then, Volcom’s description of its success in department stores has been pretty volatile. Last quarter, Nordstrom was noted as having stopped carrying action sports, but this quarter’s 10K lists them as a customer of Volcom.
I’m confused. At least in the U.S. Volcom’s growth prospects are closely tied to their performance in some broader distribution channels including department stores, but from public data, I have no clear idea how they are doing there.
If Volcom’s management asked me (I won’t hold my breathe) I’d probably suggest that rather than department stores, which are apparently having some difficulties understanding and merchandising action sports brands, they might look for growth in the U.S. through  fashion boutique kind of stores. 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.
But then there’s the public company thing. The department stores offer the possibility of larger purchases which is obviously attractive to any public company that wants quarterly growth.
When I wrote about Quiksilver last week, I noted that margins and growth opportunities seemed higher outside of the U.S. The same may be true for Volcom, as we see when we review their numbers. Boy, life was sure easier for a strong action sports brand in this country before the economy went to hell.
The Numbers
Sales for the quarter ended December 31 rose 22% to $78.6 million. The U.S. segment (which includes Canada and Japan and most other international territories outside of Europe and Australia, but not Electric) increased 18% to $54.3 million. Their five largest full price accounts grew 19% to $15.4 million and represented 29% of the segment’s revenues. It was the same percentage in Q4, 2009. PacSun was $7.9 million for the quarter, up 31% and represented 15% of the U. S. segment revenues.
Gross margin for the quarter fell from 49.2% to 45% overall. In the U.S. segment (remember that’s not just the U.S.) It was 42% down from 48.1% in the same quarter in 2009. The reason is that they were too optimistic in their sales projections and inventory had to be liquidated in the fourth quarter. Probably has something to do with the rise in PacSun revenues.
Net income for the quarter was $1.6 million, down from $3.4 million in the 4th quarter of 2009.
For the year, revenues rose 15.2% to $321 million. That’s still below 2008’s $334.3 million.
Gross profit margin fell from 50.2% to 49.2%, but that’s an improvement over the 48.8% of 2008.
U.S. segment sales rose 15.3% to $218 million and represented 67% of revenues. Europe, at $70.3 million, was essentially constant and was 22% of the total. Electric grew 30.3% to $27.5 million and was 9% of the total. Australian segment revenue was only $7.7 million, but remember Volcom just acquired it’s licensee in that country last August 1, so the numbers will be much higher this year.
Sales in the U.S. (the country- not the segment) totaled $161.4 million. Canada was $37.4 million and Asia/Pacific $32.1 million. 18% of 2010 revenue came from Volcom’s five largest customers. That’s down from 20% the previous year, and 28% the year before that. PacSun was 10% of total product revenue in 2010. 10% of total product revenue is $32.1 million. PacSun operates only in the U.S. and Puerto Rico. Knowing Volcom’s U.S. sales, we can calculate that 20% of those sales were to PacSun. 
Volcom sells product that it categorizes as men’s, girls, snow, boys, footwear, girls swim, Electric, or other. Of these nine categories, men’s was $168 million, or 52.4% of product revenue. Girls, at $55 million or 17% is the next largest.   
The gross profit margin in the U.S. segment was 46.1% for the year. It was 55.6% in Europe, 58.9% for Electric, and 43.8% in Australia. Management tells us that the Australian gross margin will be around 50% once it’s fully integrated.
We don’t have a gross margin number broken out for just the U.S. If I were a betting man, I bet that the gross profit margin in just the U.S. is lower than that 46.1% for the U.S. segment. As with Quiksilver, you can see that Volcom’s bias would be to increase sales outside of the U.S., where margins are significantly better.
Volcom notes that one of its strategies is to take control of its international operations in countries where they have licensees when the license agreement expires. The one in South Africa expires at the end of this year. Brazil is at the end of 2013. So is Argentina, but it can be extended for five years. Indonesia’s expires at the end of 2014.   
 Selling, general and administrative expenses rose 16% from $111 million to $129 million. As a percentage of sales, they rose a bit from 39.5% to 39.8%. Of that total advertising and promotion accounted for $26.8 million in 2010 and $21.9 million in 2009. In 2011, estimated minimum payments for professional athlete sponsorships are projected to be $8.7 million.
Net income rose slightly from $21.7 million to $22.3 million. In 2008 it was $21.7 million. As percent of sales, it fell from 7.7% to 6.9%.
The balance sheet continues to be solid with no long term debt even after they paid out $24 million as a special dividend to shareholders.
Other Information
Retail’s always interesting to talk about.  Volcom owns 13 full-price retail stores and licenses 11 more around the world. They own the two multi-brand Laguna Surf and Sport stores and have 10 outlet stores. As you’ve probably heard, they are purchasing those 10 stores from the operator. Volcom seems focused on retail locations that “present our brand message directly to our target market.” I think that’s a good reason for a brand to have a limited number of retail outlets.
Volcom has basically the same cost pressures that other companies are feeling, and expects input costs to be up between 15% and 20% in the second half of the year. What was a bit different was their apparent confidence that, “As far as the cost increases go, generally, those are going to be passed through as price increases.”
Maybe that says something about the strength of the brand. Other companies are not quite so certain they will be able to pass through all the costs increases, recognizing that the consumer will have something to say about that. CEO Woolcott acknowledges later in the conference that consumer acceptance of price increases is an open issue.
Volcom has as strong a brand as any significant player in our industry. Maybe, within its target segment, stronger. But, as was discussed above, the price of that kind of strength can be difficulty growing outside of that segment. Like a lot of brands, I think we’ll see a strong international focus from Volcom. That’s where the margins and growth opportunities seem to be. In the U.S., it will be interesting to watch where growth happens. I imagine Volcom would like to sell less to PacSun, core stores can be hard to get enough consistent growth out of and, as I indicated, some of the department stores just don’t seem to get it.