Tilly’s IPO Moving Forward; Another S1 Amendment is Filed

Not much is different in this filing, but we do get a few additional pieces of information. You can review what I wrote about their initial filing last July here. I updated that analysis in March of 2012 when they released their numbers for the year. My opinion hasn’t changed and I think the analysis is still valid.

What we learn from the newly amended S1 is that the share price of the offering is expected to be between $11.50 and $13.50. They expect to raise about $86.4 million (assuming a $12.50 a share price). Of that amount $84 million will go to the existing shareholders and only $2.4 million will be available to be utilized in the business. Here’s how the filing puts it:

“The principal purposes of this offering are to obtain capital to pay all undistributed cumulative earnings to date to the current shareholders of World of Jeans & Tops [the former corporate name of Tilly’s], obtain additional capital, create a public market for our common stock and facilitate our future access to the public equity markets….We expect to use $84.0 million of the net proceeds from this offering to pay in full the principal amount of the notes, as well as any accrued interest. Therefore, our stockholders immediately following this offering, who were also the shareholders of World of Jeans & Tops prior to termination of its “S” Corporation status, will receive most of the net proceeds from the sale of shares offered by us.”
When the offering is done, there will be Class A and Class B common stock. Purchasers of the offering will get the Class A, which has one vote per share. The Class B common stock has ten votes per share.
As a result, “The Shaked and Levine family entities [current owners of Tilly’s and the only ones who can own the Class B shares] will control approximately 96% of the total voting power of our outstanding common stock following the completion of this offering. As a result, the Shaked and Levine family entities will be able to control the outcome of all matters submitted to a vote of our stockholders…”
Tilly’s numbers for last year, as I discussed in my March article, were strong. It will be interesting to watch how the offering is received. 



Do Retailers Really Need to Carry All That Inventory?

I suppose that seems like a stupid question. But having just been through another Christmas shopping (and return) season, I’m not so sure it is. I’ve shopped on line. I’ve been to too many malls too often (I confess it- I hate shopping). In those malls I saw way too much product on sale at way larger discounts than I like to see before Christmas.

As an aside, I’m wondering if the increased holiday sales being trumpeted by the media were at prices which will generate bottom line profit which, I take as a matter of faith, is still the idea.

I’ve made an effort this week, as I usually do this time of year, to catch up on my reading. Some of that reading included retail trends, pop up stores, inventory management, Sears closing 100 plus stores, and various other mostly business and action sports related topics. It all got me thinking about the retail environment.
Inventory is where retailers tie up most of their working capital. Retailers (and brands) have made heroic efforts to control inventory in recent years, but I think there might be still an opportunity for improvement by following the ongoing process of integration between brick and mortar and online retailing. I want to talk about that and ask what you think.
The Online Experience
I’m not going to tell you anything here you don’t know, but I want to build a (hopefully) logical argument. Consumers like online shopping because it’s efficient, it allows ease of comparison, it may be cheaper, and you don’t have to leave the comfort of your desk chair.
They dislike it because they can’t physically interact with the product (which is more or less important depending on the product), and they don’t get it the moment they buy it. They may also miss the personal interaction with a sales person. Or not.
The improved functionality of web sites and the development of logistics to get products to the customer (and back from them if necessary) faster and easier has accentuated the reasons for the consumer to shop on line, and reduced the reasons not to. You need look no further than the growth in online sales in a soft economy to know that’s true.
Brands and retailers (remember it’s getting harder and harder to differentiate between the two) see a role for web sites and social media in brand building. The competitive environment requires them to be on line and sell there either independently or in coordination with retailers.
Building, maintaining and keeping fresh a quality web site with ecommerce capabilities cost a bunch of money. The expense is not just in designing and creating it, but in keeping it up. Servicing online customers generates additional expense.
See- I told you I wasn’t going to tell you anything you didn’t already know. Let’s continue.
Is the brand building from being online worth it? That is, does it generate enough new customers, or increased sales to existing customers, to pay for all the incremental expense? Being the way I am, I guess I’d ask if it generated enough gross profit dollars.
Maybe you sell to new customers who are too far away to get to your store. Maybe your online communications program increases traffic and/or the average sale. Maybe, as a brand, you sell products in your line that retailers didn’t typically have room to carry and consumers didn’t previously know much about. Maybe a lot of things. Or maybe not.
So, competitive pressures require you to be online. Being online in a competitive way is expensive. You have to earn enough incremental gross profit to at least pay for the cost of being online. Cannibalizing brick and mortar sales for online won’t do it. If you accept those points, then you have to agree that total sales, including online, have to rise enough to pay for the online expense or overall industry profit will fall.
Let’s say that again in a slightly different way. With the existence of online retail, in the absence of any change in the brick and mortal expense structure, sales have to rise just to break even because of the additional expense of being online. And not, I’d estimate, by a trivial amount.
But consumers don’t automatically and graciously just spend more just because we’ve boosted our expense structure. What might we do about that structure?  
A Lesson from the Airport
Last time I was at the airport (not over the holidays happily), I was struck by how the airlines have learned to use online to manage their business “in their store” so to speak. Pretty much everything happens at the monitor unless you’re changing your flight, checking baggage, or have some other variety of crises. You can do most of it at home, or you can wait and do it at the airport. At the airport or at home is pretty much the same for the airline and its passengers. They’ve gone a long way towards integrating brick and mortar, if I can call it that, and online. And they’ve done it in a way that the passengers seem to like. Although now, instead of standing in line at the airline counter, we stand in line to get through security. Oh well.
How does this translate to our retail business?
Taking Trends the Next Step
Retailers are already giving consumers the online or in store choice. They are dealing with the brands they carry (when the brand and the retailer are not one and the same) through not only the traditional model of purchasing inventory but of taking it on consignment or even having the brand run its own store in their existing store. My point (and once again, you already know this) is that the traditional model of see it, order it, receive it, sell it, pay for it is evolving. 
In general terms, what I’m seeing is independent retailers take less and less inventory risk. The brands may not like this but have been dragged towards supporting it. Bluntly, they can’t afford to sell product to retailers who can be hard pressed to pay them, may dispose of the merchandise at prices and through channels the brand would prefer they didn’t use, and can’t really merchandise the complete line the way the brand wants. 
We’ve got retailers becoming brands and brands becoming retailers. Zumiez, to use one example, thinks of itself as a brand. And go look at a Buckles someday. I’ve got to write about that.
We’ve got the merging of online with brick and mortar and the rapid growth of online sales. Through pop up stores, renting space in existing retailers, consignment and other gyrations we’ve got inventory risk migrating to brands. The relationship between brands and retailers is more codependent than it used to be. Brands want to capture the higher retail margins, and have the ability to better control and accelerate the process of creating and getting product into stores. Retailers are selling their own brands.
We tend to look at these developments as independent events. I don’t think they are. How might they be addressed in a positive, structured way?
Here’s a Wild Idea   
What if a brick and mortar retailer cut the inventory it kept in half? Maybe by two thirds. Like the airlines, they let their customer decide whether they want to “check in” at home or at the airport (the store) and handle various purchases or changes at either place. The customer can come into the store, see the product and decide what they want to buy, but it gets shipped that day to their home (or they can come back to the store and pick it up).
Yeah, yeah, I know, I’m crazy. And the world is flat and real estate prices only go up. Maybe I am crazy. That’s why I’m asking you.  
Maybe for the first time a retailer, due to the much lower inventory I’m proposing, is able (and can afford) to display most of a brand’s line rather than just the pieces they bought because they thought that was what would sell and it was all they had room for. The quality of the presentation, and the customer experience, might increase significantly. Part of the reason brands want to get into the retail business is so their brands can be controlled and presented the way they want.
The customer would come to the store either because they want help and like the in store experience (which I’m suggesting would improve), or because it’s a product they don’t want to buy without seeing and touching it. But they wouldn’t necessarily walk out with it. The very broad but not deep inventory would mean that the product would not necessarily be available for the customer to take home. The customer, after having had the opportunity to look at the biggest selection of a particular product they’ve ever seen, would make a selection and have the clerk swipe their card and tell them, “It will ship to your home tonight.”
The biggest objection, I suppose, is that customers who come into stores want to take the product with them. But we know that more and more customers are making the decision to wait a few days for their product. We also know that they are coming into stores to evaluate products then going home and ordering on line. And there is some benefit to not having to carry the product around with you.
Another interesting problem would be for the retailer to determine (in consultation with the brands it carries) exactly what to carry in inventory and how to price it. Do you charge some percentage more for product people walk out with? Which products will people be most determined to take with them? How do inventories get replenished under this situation of in store scarcity? Will you need to replace the product on the floor because people are playing with it so much? The gross margin return on inventory investment approach I’ve discussed before might be a tool that could add some value in figuring some of this out.
What I’m proposing is an approach to brick and mortar retailing where the role of online and the melding of brands with retailers is recognized. The retailer would tie up a bunch less working capital in inventory. The quality of their merchandising could improve and I think the customer would have a better experience. Thinking globally for a minute, this might also play to the U.S.’s competitive strengths in logistics and distribution.
Brands would take less collection risk and would be better presented at retail. They’d have more inventory risk but, as I said, that seems to be where we’re heading anyway.
I don’t want to trivialize what I’m suggesting. There would have to be some interesting negotiations between brands and retailers to sort out a lot of details. Retailers would have to invest in some new fixtures and other merchandising expense. In addition, I imagine there’d be some in store technology costs. Hopefully this is more than made up for by a massively lower inventory investment.
I’m suggesting this brick and mortar low inventory internet fulfillment approach because that’s where I see the trends taking us anyway. I figure you might as well ride the wave rather than have it break on your head and drive you into the sand. If the trends I’ve highlighted are valid, I’m not sure there’s much of a choice.



What Will You Do When Your Greek Receivables are in Devalued Drachmas?

There are lots of public company quarterly reports I should be writing about, but I am going to step off that track and think, for a bit, the unthinkable.

Or at least it was the unthinkable. But at this point the Eurozone seems to be moving towards two choices, either of which has huge implications for managing any international business.

Let’s review for a minute. What are the three things you can do to get rid of debt? You can pay it off. You can default (a “restructuring” is basically an agreed on default). And finally, at least if you’re a government, you can inflate it away by printing money.
The third approach has always been the favorite among governments, because it’s kind of sneaky and doesn’t require politicians to directly take anything away from anybody. It’s happened many times. But don’t take my word for it. Go and read This Time is Different; Eight Centuries of Financial Follies. The point, of the book, of course, is that it’s never different. It won’t be this time. I reviewed the book on my site and you can buy it here.
Next, let’s talk about Iceland. Iceland thought it had turned itself into a financial capital, and its banks borrowed lots and lots of money from various British and other European banks. They were, of course, heavily leveraged. So when the cash stopped flowing and they couldn’t renew any of those loans, everything went to hell in the proverbial hand basket. The British and other Europeans howled that Iceland’s government had to make good on their banks debt. Unlike the Irish government, Iceland said, “Uh, actually we don’t.” And they didn’t.
Their economy went south and their currency devalued dramatically. It was ugly. But with the competitive boost of a devalued currency, they’ve started growing again.
That’s how it’s supposed to work. But Greece, and Ireland, Italy, and Spain, can’t devalue their currencies because they are part of the Euro.
Next, let’s talk about the bond market. The bond market is the biggest, meanest, son of a bitch on the continent. It has decided that there’s more risk in these country’s debt, and has pushed their interest rates way up. Italy is up over 7% even with the European Central Bank buying Italian debt (increasing demand and theoretically driving the cost down). Inevitably, higher interest rates make the debt burden even higher and paying off the debt harder. Spain is around 7% as well.
So what is Greece, or Ireland or Italy, to do? Austerity! Fiscal Responsibility! Which might work if they could devalue their currency as it is working in Iceland. It’s painful, but it can work. But with this much debt, and no devaluation possible, austerity in the form of spending cuts and tax increases just reduces the economy’s growth, which reduces tax collections, requiring more austerity. It’s a pretty vicious cycle.
Here’s the bottom line. There’s too much debt to be paid off. Somebody is going to lose money. They’re just fighting over how much and who.
If you’re a debtor nation like the Southern Europeans, you like the inflation solution, because it effectively reduces your debt. If you’re a creditor national like Northern Europe and Germany, you aren’t so enthusiastic because you know inflation also reduces the value of assets. And the Germans, of course have an institutionalized fear of inflation from the hyperinflation of the Weimar Republic. There’s the story of the cup of coffee that cost more when you had to pay the bill then it cost when you ordered it.
Remember when Fed Chairman Ben Bernanke told us the subprime crisis would be contained? Then Lehman Brothers collapsed and it wasn’t. I don’t know what will happen in Europe, but it can happen just as dramatically and just as suddenly. Most people seem to think the European banks are a bigger mess than ours ever were. There are simply not two to six trillion Euros (estimates vary) available to bail everybody out (unless they just start printing those Euros) and if there were, it wouldn’t solve any of the competitive issues that lead to this mess.
Long term Greek government debt is priced to yield about 30% right now. I’m sure it’s obvious that they can’t pay that, or anywhere near it, and actually service their debt. Something is going to happen. I think it’s either going to be inflation, or one or more countries leaving the Eurozone and defaulting on their debt on the way.
In not one quarterly report or conference call I’ve read so far have I seen any discussion of the management of this possible risk. It feels like it’s too uncomfortable to consider. Maybe it’s just concern that talking about it might make it happen. Perception does matter.
I doubt any of our major industry players’ sales to Greece are make or break for it. Still, if you’re selling and holding receivables in Euros and have assets denominated in Euros there and Greece suddenly goes back to the Drachma, what exactly happens? Nobody knows. Well, we know the lawyers would make a lot of money.
I assume companies are trying to hedge their exposures (not just in Greece) but I’ll bet that’s getting really expensive. I might consider offering discounts for prepayments. I guess you could try and denominate your contracts in dollars, but that might not help. There’s no mechanism for a country to exit the Euro, so they’d be making it up as they go along.
I’m not projecting a breakup of the Eurozone, but the possibility of some countries leaving it is certainly higher than it used to be. Frankly, I think they’ll resort to the good old printing press. That’s what’s happened historically, and the powers that be are all issuing coordinated statements about how they will “manage” it; that is, not let inflation get out of control.
What am I asking you to do? As always, just to consider the possibility, it’s impact on your company, and your strategy to manage it.



Peak Resort’s Initial Public Offering. What’s Going On?

Back on April 18th, Peak Resorts filed an S-1 with the Securities and Exchange Commission (SEC) to take the company public. There have been four amendments since then, with the latest filed September 19thHere’s the link to that most current version of the S-1. The company is not yet public but, based on that filing, is still working on the process.

It is, by any measure, not an easy time to take a company public. Skullcandy, you’ll recall, had to delay their offering a while due to market conditions. I don’t think Peak Resorts is facing any better conditions.

Peak Resorts operates 12 ski areas in the Midwest, Northeast, and Southeast U.S. They had about 1.8 million skier/boarder visits in the 2010/2011 season. Total revenues for the fiscal year ended April 30, 2011 were $98 million. Mount Snow generated 40% of Peak’s revenue and Attitash, 12%. None of the other areas generated more than 8%. Lift tickets were 52.2% of total revenue and food and beverage, 15.5%. Hotel/lodging represents only 6.5% of total revenue because Peak’s areas are overnight drive ski areas and day ski areas. They don’t have any of the areas characterized as fly destination areas.
That’s part of their strategy as all their areas “…are located in or near metropolitan areas and target a regional market.” They think their experience in acquiring, integrating and managing areas is one of their competitive strengths, and they expect to look for more acquisitions.  
The S-1 still has a lot of the usual holes in it. They expect to raise about $75 million, but we don’t have a proforma balance sheet yet showing what it will look like after the offering. Neither do we have an estimate of the share selling price, or specifics as to how the proceeds will be used, though they note that a chunk will be used to pay down debt. We’ll get back to that.
We do, however, have historical financials. Revenues for the three years ended April 2009, 2010, and 2011 were $84.3 million, $89.8 million, and $97.6 million respectively. Earnings from operations for the same three years were $9.9 million, $13.8 million, and $16.8 million. As a percentage of revenue, earnings from operations have grown from 11.7% to 15.3% to 17.2% over those three years.
Note that their latest acquisition, Wildcat Mountain, was completed October of 2010, so its results are included in the April 30, 2011 numbers.
Interest expense, at $10.8 million, was 12.8% of revenue in 2009. In 2010, it was $11.4 million or 12.7% of revenue. The numbers for 2011 are $11.3 million or 11.6% of revenue. Those numbers exclude, for 2009-2011, $2.1 million, $2.2 million, and $2.6 million of interest that was capitalized rather than expensed.
Taxable income was a loss of $492,000 in 2009. There were profits in 2010 and 2011 of $2.8 million and $6.4 million respectively. In 2009 and 2010, Peak Resorts was a subchapter S corporation, so there’s no corporate income tax on the income statement. Those earnings, or the loss, flowed through to shareholders who are responsible for paying the taxes in 2009 and 2010. Net income is therefore the same as taxable income for the company. For the 2011 fiscal year, as part of doing this stock offering, they converted to a C corporation and had to book a $10.4 million income tax provision. That resulted in a loss of $4 million for the year. But there’s some funky deferred tax stuff going on, so if you can’t ignore the number, you can’t take it as typical of their tax rate going forward either. That is, their tax rate will not be 163% of income in future years.   That would be discouraging.
Ok. Balance sheet. There was a time when I wrote a lot more about winter resorts for SAM. Back then, I used to tear my hair out trying to decipher balance sheets with negative current ratios and other interesting stuff. Finally, I reconciled myself to the inevitable gyrations of winter resort balance sheets and focused more on cash flow.
Peak Resorts has $107.6 million in long term debt as of April 30, 2011. As part of current liabilities, they have an additional $34.8 million representing the current portion of long-term debt and capitalized lease obligations. That is, they’ve got to pay or refinance $34.8 million of debt before April 30, 2012. Basically, it’s one big payment due April 1, 2012.
Also at April 30 2011, they had $27.7 million of cash on their balance sheet. If a winter resort was ever going to be flush with cash, it would be at April 30. $11.3 million of that cash is restricted. That restricted cash is the “…interest due on our outstanding debt with EPT, our primary lender, and rent under the lease for the Mad River resort for the 10 months following April 30.” So that $11.3 million is not available for paying down the debt due this fiscal year. 
A little footnote diving tells us that this is the only year through the 2016 fiscal year where Peak Resorts has to pay off a big chunk of debt. In none of the other years through 2016 does the amount of principal due even get to $1 million. In the S-1, Peak Resorts says they “…have $28.3 million under various loan agreements to fund expansion and capital expenditures at our ski areas. We expect that our liquidity needs for the near term and the next fiscal year will be met by continued use of operating cash flows (primarily those generated in our third and fourth fiscal quarters) and additional borrowings under our loan arrangements, as needed.”
Peak Resorts is telling us they can pay off the $34 million in long term debt due this year from resources created or available to them from the normal operation of their business. Good, but I’ve got questions.
We know the $11 million in restricted cash isn’t available for debt repayment. The $28 million available under existing lines seems to be for expansion and capital expenditures and that would be borrowings from basically the same people they already owe the $34 million to (EPT- see below). The Consolidated Statement of Cash Flow for 2011 shows net cash provided by operating activities of $12.2 million. But they used $13 million in investing activities, most of which was additions to property and equipment and land held for development. Capital expenditures in the current fiscal year are projected to be $11-$13 million. We also know (because they tell us) that “…the repayment of this debt will not result in additional borrowing capacity under these credit facilities but may create available collateral for future borrowing if necessary.”
Overall interest rate on the debt is around 10%, and some of it is escalating. Given that interest rate, and the amount of interest they are paying (as described above) you can see why they are planning to use some part of the offering proceeds to pay down debt. It will do wonders for their cash flow and bottom line.
Who’s EPT?
Entertainment Properties Trust is Peak Resort’s only lender. It describes itself as“…a specialty real estate investment trust (REIT) that invests in properties in select categories which require unique industry knowledge, and offer stable and attractive returns.” It’s traded on the New York Stock Exchange under the symbol EPR. If you go to the link above and click on “Portfolio” along the top, you’ll come to a map that shows all their properties. If you then click, on the left side, on “Metropolitan Ski Parks” the map will show nine ski areas that are all part of Peak Resorts.
I’m told by people wiser than I that what’s happened REIT wise in the winter resort business is that there was a trend for REIT operators to buy areas and then lease them back to the operator. These resorts are shown as part of EPT’s portfolio, but they aren’t all owned by EPT. If they were, then Peak Resorts wouldn’t have on its balance sheet the debt from buying them. It would just be making lease payments and be responsible for running them.
The debt that Peak Resorts has to repay to EPT this fiscal year is the “Mount Snow Development Debt.” It’s due April 1, 2012. It “…represents obligations incurred to provide financing for the acquisition of land at Mount Snow that is in development stages.” Under an agreement dated April 4, 2007, EPT lent Peak Resorts $25 million which I assume was used to buy that land. An April 1, 2010 modification to the agreement increased the amount to $41 million. That increase included $8.7 million in accrued interest to the date of the modification. $25 million plus $8.7 million is more or less the amount that’s due next April.
You may have noticed that the economy hasn’t exactly improved since April 4, 2007. I would guess that any land Peak Resorts bought is worth a bit less than it was. I suppose it’s unclear if it would make economic sense to develop it. Peak Resorts balance sheet shows $28 million in land held for development. I wonder if that’s the Mount Snow land. If so, then none has been developed and sold. If it had been, the proceeds are required to be used to pay down the debt.
On October 30, 2007 Peak Resorts entered into an option agreement with EPT Ski Properties, Inc. (a subsidiary of EPT) giving EPT Ski Properties an option to purchase Hidden Valley, Snow Creek, Brandywine, Boston Mills and the part of Paoli Peaks owned by Peak Resorts at prices specified in the agreement. The same agreement would allow them to assume Peak’s leases at Big Boulder, Jack Frost, and Paoli Peaks. It could exercise any or all of these options on or after April 11, 2011. If EPT did exercise any of those options, it would, under the agreement, immediately lease the areas it bought back to Peak Resorts.
One wonders if the prices in that agreement under which EPT could exercise its options are as attractive to EPT now as they were when the agreement was signed in 2007.
So What’s Going On?
All I know is what I read. Nobody at Peak Resorts can talk to me because they are in the middle of the offering process. Down to the earnings from operations line, Peak Resorts results look good and improving, and the Peak Resorts managers are known as good operators.   But the interest burden is substantial and they’ve got $35 million in principal to pay off by next April 1st. It looks to me like the deal made with EPT in 2007 doesn’t seem quite so good in 2011’s economic reality and hasn’t worked out the way both sides hoped it would.
I heard on CNBC yesterday that the first IPO in two months had just been completed; a testament to how tough this market is. I would expect you wouldn’t try to do one now if you didn’t need to. I hope the next amendment gives us not only a proforma balance sheet showing some debt repaid from the offering proceeds, but a proforma income statement that shows what will be significant improvement of their bottom line from a lot less interest expense and a normalized tax rate.  



Tilly’s is Going Public- A First Look at Their Registration Statement (S-1)

Tilly’s started in 1982 with a single store in Orange County, California. The company name is World of Jeans & Tops, but it does business as Tilly’s. It was founded by Hezy Shaked and Tilly Levine. As of April 30 2011, they had 126 stores in 11 states averaging 7,800 square feet each. They filed last week for their initial public offering.

As is normal, the initial filing  has some important blanks not filled in yet. They will be completed as the process moves forward. In the meantime, we can look at the historical financial statements. I also want to talk about the impact of changing from an “S” corporation to a “C” corporation, the ownership structure post offering, and their competitive strengths and brand strategy. Let’s get started.

Sales have grown from $199 million in the year ended February 3, 2007 to $333 million in the year ended January 29, 2011.   During the same period, they went from 51 to 125 stores. Comparable store sales rose 17.3% in the first year of that period. They then rose 8.7% before falling 12.5% and 3.1% in the next two fiscal years and rising 6.7% in the year ended January 20, 2011. E-commerce revenues have grown from $15.4 million to $32.8 million in the last three complete years.
One has to wonder these days, in evaluating any consumer based IPO, whether the company can hope to return to its pre Great Recession growth any time in the next few years. It’s not the company’s fault; it’s just the economy.
The gross profit margin was 37.1% in the year ended February 3, 2007. The following year, it was 37.2%. For the January 31, 2009 year, it fell to 32.5% and for the most recent two years it was 30.9%. Selling, general and administrative expenses have of course grown in absolute dollars with sales, but as a percentage of sales has been more or less constant around 23.3% in the last three complete years.
Of the 126 stores Tilly’s has as of April 30, 72 are in California and 16 in Florida. There are also 17 in Arizona. The other 21 are distributed in 8 states with New Jersey, at 7, having the most. I would be particularly interested in learning something about the performance of the stores by location (which isn’t included). As we’ll discuss, part of their growth strategy is to increase their number of stores, and I wonder if performance has been similar in all geographies.
“C” and “S” Corporations 
Tilly’s has always operated as an S corporation. What this means is that the earnings were distributed to the owners who reported the income on their personal income tax returns. It also means that “No provision or liability for federal or state income tax has been provided in our financial statements except for those states where the “S” Corporation status is not recognized and for the 1.5% California franchise tax to which we are also subject as a California “S” Corporation.”
The chart below shows Tilly’s Operating Income and Net Income as reported on their financial statements. The Pro Forma Net Income line shows what their net income would have been over the last five years had they been a C corporation accruing tax at typical rates. Big difference. They will transition to a C corporation before the company goes public. This is disclosed in the registration statement of course. But the point is that you would not want to purchase the stock expecting Tilly’s to report net income going forward at the levels of the past.     

FISCAL YEAR ENDED (millions of $):

Feb. 3

Feb. 2

Jan. 31

Jan. 30

Jan. 29






Operating Income






Net Income (as reported)






Pro Forma Net Income





Post Offering Ownership and Control and Use of Proceeds
Buyers of this common stock will receive Class A shares and will be entitled to one vote per share. There will also be Class B shares that will be entitled to ten votes per share “on all matters to be voted on by our common shareholders.” The Class B shares will be owned by the founders and their family. When the offering is completed Mr. Shaked, who is Chairman of the Board, will control more than 50% of the total voting power of Tilly’s common stock. We don’t know from this first draft of the registration statement exactly how much he’ll control, but it says more than 50%.
As a result, Mr. Shaked is in a position to dictate the outcome of any corporate actions requiring stockholder approval, including the election of directors and mergers, acquisitions and other significant corporate transactions. Mr. Shaked may delay or prevent a change of control from occurring, even if the change of control could appear to benefit the stockholders.”
Tilly’s will be considered to be a controlled company according to the rules of the New York Stock Exchange. As a result a majority of the board of directors don’t have to be independent. And the corporate governance and nominating committee and compensation committee do not have to be composed entirely of independent directors, as would otherwise be required.
Tilly’s says they will comply with these listing requirements anyway, but they don’t have to.
The company leases its 172,000 square foot corporate headquarters and distribution center from a company owned by its co-founders. It leases another 24,000 square feet of office and warehouse from one of the co-founders.
As usual, there are a lot of blank spaces in this early version of the Use of Proceeds section. We’ve seen from other sources that the goal is to raise $100 million. What’s going to be done with that money? The registration statement tells us the following:
“Therefore, our stockholders immediately following this offering, who were also the shareholders of World of Jeans & Tops prior to termination of its “S” Corporation status, will receive most of the net proceeds from the sale of shares offered by us.”
We don’t know what “most” is at this point.
After spending 30 years building a successful business, the owners deserve the benefits. But if they are getting “most” of the proceeds of the offering, where’s the money for growing the business to the 500 stores they are planning going to come from? At least that would be my perspective if I were a potential investor.
Competitive Strengths and Growth Strategy
Tilly’s lists six competitive strengths:
  • Destination retailer with a broad, relevant assortment.
  • Dynamic merchandise model.
  • Flexible real estate strategy across real estate venues and geographies.
  • Multi-pronged marketing approach.
  • Sophisticated systems and distribution infrastructure to support growth.
  • Experienced management team.
Their growth strategies are:
  • Expand our store base.
  • Drive comparable store sales.
  • Grow our e-commerce platform.
  •  Increase our operating margins.
If you read the discussions of their competitive strengths, you’ll note a great deal of similarity to other retailers in our space. Maybe that’s why they call them strengths and not advantages. Their growth strategies are exactly the same as every other multi store retailer.
It seems to me that an investor in this stock is basically betting on Tilly’s ability to operate better than its competitors. Of course they do have a successful operating history, but I don’t see an obvious competitive advantage here. I don’t think their plan to grow to 500 stores is necessarily unrealistic, but that most of the offering proceeds are being paid out to the owners makes me wonder how they’ll finance the growth.
We’ll get some more information as the amended S-1s show up.



The Lesson to be Learned from SIA’s Sales Report

SIA recently reported that the snow sports market in February exceeded $3 billion. You probably get the same emails I get, but if not, you can see the announcement and analysis here. SIA expects the industry to set a record by the time the season ends. Through February, sales are up 13% in dollars and 8% in units. In February unit sales were down 2% and dollars sales 1.5% compared to February last year. But gross margins rose 8%.

With the usual cautionary note that we always do well when the snow gods favor us, let’s look briefly at the opportunities these results present us with.

I’m thrilled to see February sales down and margins up 8%. That happened because inventories were tight. For the whole season, sales are up more than units, also reflecting rising margins.
If dollar sales fell 1.5% in February but margins were up 8%, how did you do? I’d say you had more gross margin dollars than if sales had been a bit higher but margins lower. Those gross margin dollars, I may have argued a time or two, are what you use to pay your bills. But wait! There’s more!
You have less working capital tied up in inventory. You could have spent less money on advertising and promotion. Your customer is learning not to wait for a deal. Tons of closeout product isn’t showing up in places we really don’t want it (unless you’re one of those close out people, in which case you may not be too happy). There’s not a pile of left over product in your warehouse waiting to be cleared out before the start of the season next year.
Won’t it be fun when customers start coming in looking for cheap stuff and you can tell them that not only isn’t there any, but if they don’t get what they want now, they may not get it? You’ve already improved your gross margin by next year just by not having a bunch of inventory left and we’ve collectively improved our brands’ images.
As an industry, we go to conferences, hold trade shows, create learn to ski/ride programs, run all sorts of programs, do studies advertise and promote, and spend overall millions of dollars trying to get people to try riding/skiing and stick with it.
But I’d hypothesize that we could forgo a bunch of that if we just didn’t get so damned greedy and continued to control our inventories. Oh, and we- you, that is- could make more money with less risk.
Now, I’m the guy who’s always said every business is going to (and should) make the decisions that they perceive to be in their own best interest. That’s true. But it looks to me right now that what’s good for your business is probably good for the industry in at least this one instance. Everybody left standing in the ski/board industry has figured out, finally, that there’s no way to make money in winter sports if you’ve got a pile of left over inventory. And also you won’t be able to pay your bills.
I know we’re left with the not so simple issue of trying to match production and purchases with how much it’s going to snow and where. And I know that somebody, somewhere (probably more than one) is going to see the inventory shortage as an opportunity and crank up their factory and/or purchasing. But if most of us perceive that it’s in our interest to buy and sell a little less at higher margins, we can sleep better over the summer, have stronger balance sheets, make more money with less investment and help get more people on the mountain.
At least think about that before you say, “Shit, I could have sold more last year” and up your orders.                           



A Perspective on Zumiez Accounting Treatments as Reported by Forbes

An article in Forbes called “Great Speculations” had the subtitle “Accounting Smells a Little Fishy Down at the Zumiez Surf Shop.” It calls into question Zumiez’s reported earnings and balance sheet strength due to a couple of their accounting practices. Boardistan called our attention to it and concluded, “Apparently, Zumiez is shifting over to the “whatever it takes” program.” I had a couple of people email it to me, though nobody expressed an opinion. Maybe they thought I’d jump on Zumiez or something or were just pointing out to me that I hadn’t covered either of the issues mentioned by Forbes in my recent analysis. We didn’t hear anything about this in either Transworld Business or Shop- Eat-Surf.

Forbes analysis and explanation was fine as far as it went, though I’d have trouble reaching the same conclusion they reached. I thought it might be useful if I looked in a bit more detail at the two issues they raise. My goal is not just to give you some perspective on the accounting issues, but to show you that the issues are not quite as clear cut as Forbes explained them and to make you leery of short, pithy, articles you read in the popular media. Hopefully, nobody thinks my stuff is pithy. Well, maybe from time to time I’m a little pithy.

I’m going to assume you clicked on the link above and read the article. Let’s start with a little perspective on accounting.
Over many, many years, many people have struggled to figure out what the “right” accounting procedure for certain transactions is. It’s typically obvious what’s just not acceptable. It’s sometimes not so easy to choose from a number of reasonable approaches. Eventually a consensus is reached by the accounting powers that be and they choose a way to do it. The goals are consistency, comparability, and accuracy. Reasonable people can reasonable believe that different approaches are correct.  If you think of accounting as being exact, get over it.
The first thing the Forbes article points out is that Zumiez increased the useful life of its leasehold improvements. That’s the cost of the stuff you do to stores after you lease the space to make them ready to open or to improve how they look. When you increase useful life, you decrease the annual depreciation and so have less reported expense. So your income goes up. Zumiez changed its useful life from the lesser of 7 years or the term of the least to the lesser of 10 years or the term of the lease.
“For the fiscal year ended January 29, 2011, the effect of this change in estimate was to reduce depreciation expense by $4.2 million, increase net income by $2.7 million and increase basic and diluted earnings per share by $0.09,” Zumiez states.
Forbes notes that “…ZUMZ is the only retail com­pany, and 1 of only 9 in the 3000+ com­pa­nies we cover, to increase the esti­mated use­ful life of any of its assets accord­ing to all 10-Ks filed since Jan­u­ary 2010.” There’s a kind of “Aha! We caught you!” sense to the article. But what we don’t know, either from the article or from Zumiez’s 10K is why this is, or is not, a reasonable thing to do.
The other thing that the Forbes article points to is that Zumiez “…car­ries over $310 million (nearly 50% of its mar­ket cap and over 120% of reported net assets) in off-balance sheet debt.” It’s all in footnote 9 in Zumiez 10K; Commitments and Contingencies. The number I see is actually $347 million which is more than Forbes reported. The number for Pacsun, by comparison, is $506 million (they have a lot more stores) and is disclosed in a similar footnote. And you’d find the same thing for other larger, multi-store retailers. In this case, then, we have good comparability.
Should that amount be on the balance sheet? Maybe. The Financial Accounting Standards Board came out with FAS 13 in 1976 to tell companies how to account for leases. It’s been amended quite a few times since then. A link in the Forbes article describes how they are considering requiring that these leases be included on the balance sheet as a liability starting in 2012. 
I should make it clear that the idea of a public company managing (some would say manipulating) their earnings to put their best foot forward is hardly new. There are lots and lots of ways to do that. You change your reserve for bad debts. You can decide to ship and invoice on the last day of the quarter or early in the new quarter to determine what quarter the sales go in. The list goes on. Did Zumiez do something wrong? All we can say, taking the Forbes article at face value, is that increasing the useful life of leasehold improvements is unusual. Is it justified? We don’t know. Does it meet generally accepted accounted principles? Yes.
Not including the lease liabilities on the balance sheet is normal practice. Is it the “best” way to do it?   Damned if I know. Let’s leave that to the Financial Accounting Standards Board.
And if they do change (again) the way leases are accounted for, it will be hard to compare the first year they do that with the previous year’s results. We’ll probably need a footnote to take care of that.  It will be hidden in the back of the report, and you’ll have to go find it and read it. And then there will be some other change, and some other accounting issue will rear its early head. But we still won’t know the “right” way to do the accounting.”
The moral of the story is that there’s a certain inevitable amount of complexity and ambiguity when it comes to evaluating the “quality” of a company’s earnings. We can and will move towards doing it better, but we’ll never get to end of that road. Evaluating a company’s financial statements and their reasonableness probably means you have to get a little dirty back in the footnotes to get a clear perspective. You shouldn’t rely on what Forbes says. Or on what I say for that matter.
But don’t get too dirty. Knowing that Zumiez increased their earnings per share by $0.09 for the year by increasing the useful life of its leasehold improvements doesn’t, by itself, change my evaluation of their market position and strategy. But I’m glad that Forbes highlighted the issues for us to think about.



Inventory Management and Customer Conversion/Retention in the Snow Sliding Business

SIA was kind enough to feed me a nice breakfast this (Friday) morning before the show opened. While I ate and drank coffee, people from the various industry organizations that are and have been involved in the industry’s programs to convert first time snow sliders talked to us about what they’ve accomplished and what more needs to happen.

I guess the headline number was that conversion of first timers has increased 2% over ten years to 18%. There was a sense of “that’s not so good and we can do better” in how it was presented. I am sure we can do better, but I’m not quite sure that’s such a bad result. When you talk about trying to change people’s fundamental behavior, ten years isn’t very long and I’m not quite sure that 2% is so bad. We’ve learned a lot over the last ten years (both about what to do and what not to do) and I expect more progress over the next ten.

One thing that didn’t come up was how our inventory management can contribute to conversion. One of the stories in the Snow Show Daily for Friday is called Sold Out and Stoked. It’s about how hard goods inventories have reached equilibrium.
If there’s one thing every retailer, resort, and brand has learned over the last couple of years it’s that having leftover snowsliding inventory at the end of the season sucks. When you’ve got to carry over or close out a bunch of inventory, it can easily mean you make no money on your snow business for the year. Not to mention the impact on your cash flow and balance sheet.
I’ve been arguing for years that you might be better off focusing on your inventory management and gross margin dollar generation than on getting every last sale you could. Now, in the midst of our little ongoing economic inconvenience, I feel even more strongly about that and I want to discuss how it ties into the conversion issue.
Every brand I talked to yesterday told me they were managing their inventories tightly and had next to nothing left. I’ve heard a couple of stories about retailers exchanging product with each other to meet customer requests because they couldn’t get any product from suppliers. This morning at breakfast one long time industry participant I chatted with bemoaned not being able to get a pair of boots he needed for himself.
I’m in favor of tight inventory management, but I sure hope it doesn’t come to us all having to pay retail for product.
So what does this have to do with conversion and retention? Suddenly, the harder to find product looks special to the consumer and finding whatever they need at a discount isn’t something they can take for granted. Under conditions of uncertain supply, price can’t always be the driving factor in a purchase. Retailers are making a good margin, which means they are better positioned to service their customers. Price increases are more likely to stick. The money the retailer would like to have to pay his suppliers isn’t tied up in inventory. There won’t be excess inventory that will keep him from ordering for next season and he won’t go out of business.
Brands will have happy, solvent retailers. I’d even suggest they might be in a position to spend a bit less on advertising and promotion because there’s no better marketing than customers and retailers who want more of a product and can’t always get it.
Want more people to go snowsliding? Or to do almost anything for that matter? Make the product just a bit hard to find and require that the consumer make a conscious, active decision to seek it out because if they don’t, it won’t be there. I think that’s an important step in creating commitment.
And now what’s happened? We go and have all this great snow (unless you’re from the Northwest like me where we have floods instead of powder) and I know that somewhere out there some management team at some brand is planning for next year. And they’re going, “Wow! We had a great year! We’re great managers [We always are when it snows]. We could have sold more if we’d had it!”
And some retailer is thinking, “Damn! I have got to make sure I don’t run out of product next year! I’m boosting the hell out of my preseason orders.”
Well, you can see where this is going. Not for a minute am I suggesting that “the industry” should control inventory levels. It won’t happen and isn’t legal. Every business will and should do what they perceive to be in their own best interest.
I know.   If you’re a retailer that it just felt awful when you didn’t have the product your customer wanted, though hopefully you sold them something else. But forget that bad feeling. Think of the good feeling when you had great margins and less discounting and closing out to manage. And look at your bottom line and balance sheet. What I’m suggesting is that it’s not in your best interest to boost those orders too much. Clean inventory and high margins may well give you a better bottom line result than a boost in sales. I talked about that a while ago in an article you can see here.
As a brand, when that wild eyed retailer comes to you with a greedy look in their eye and wants to books their order for next season 58%, try and calm them down. And you calm down too. Talk about how much it sucked when they couldn’t pay their bill, and you had to either take product back or they had to sell it for cost or through some ugly distribution channels you’d rather have stayed away from.
Both of you try to remember how nice it feels when inventory is clean, margins are high, and customers are clamoring for product they see as special. You just don’t want to return to the days of overbuilding and overstocking for hoped for incremental sales.
 If we can maintain the mentality that has led to just a bit of product scarcity we just might contribute to getting more people snowsliding. And we could make some more money besides.



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

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.



The End of an Era (In a Good Way!) at Quiksilver

I don’t think anybody else noticed this (or at least I didn’t see anybody else mention it) but on October 27th, Quik got a $20 million term loan from Bank of America. Along with some cash on hand, they used it to pay off the last $24.5 million (including accrued interest) of their original term loan from the Rhone Group.

The new term loan’s interest rate is 5.3%. You may remember that the interest rate on the Rhone money was 15%. The rest of the Rhone loan (it was originally a $150 million five year term loan made in August of 2009) has either been paid off or converted into equity.

Instead of paying $22.5 million a year in interest on the $150 million (some of it was non cash), they are now either paying nothing (to the extent it was converted to equity) or paying at a much lower rate.
Financially, of course, paying off $24.5 million in debt doesn’t fundamentally change anything for Quik. But it makes me feel good to see it happen, so I can only imagine how everybody at Quik must feel. I hope they had a Rhone Credit Agreement Termination Party and burned the note. And I wish I’d been invited.
Nice work!