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Here's an update for anyone that might be lurking on this board.

They just released Q4 results yesterday so I thought it might be interesting to go over how things have evolved here, for anyone interested in the story.

In a nutshell, the turnaround is taking place much faster than I originally anticipated. This is largely due to management executing on their strategy to turn comps around, which is something that I wasn't factoring into my model.

I originally had suggested there were 4 principal factors that would drive the turnaround.

1) The company is not planning any major skatepark decisions for at least the next six months. After this time, however, I expect to see them plan the gradual closure of 3 or 4 additional parks. As I explained earlier, closing these parks should yield $1 million in pre-tax earnings a piece.

First, the company didn't both waiting 6 months. Their plan was to simplify the pricing structure, wait 6 months, and re-evaluate.

I think (it) is a waste of time, but hey, I'll let them give it a shot. Changing the pricing structure would be an effort to appeal to the more value-conscious customers. The problem with this is that their main competition is FREE. If anyone is leaving a Vans park because of the price, a drop from $11 to $9 isn't going to tear them away from a free park. When you are competing against free you have to differentiate based on service and customer experience; trying to offer a better 'value' is a waste.

Turns out that the revised pricing structure was a total failure, and that's why the company accelerated their skatepark closure plan. The company operated 13 parks. Six of them have already been terminated, with 2 more on the way in Q1. Of the remaining 5, the company plans to close 3 of them. The final 1 or 2 will be kept for marketing/brand-building purposes, and run at roughly breakeven.

The good news comes with the lease termination costs. Last CC the company said the firm they retained to help them with the skateparks came up with an NPV of $45 million for the leases. Consequently, I was expecting around $20-25 million to get out of the 11 leases, or around $2 million a park. The first 6 leases were cancelled for $10.1 million or $1.7 million / park. Moreover, the company anticipates that the remaining leases will have lower termination costs than the first six (there is significant variability in the leases). So altogether that's around $5 million cheaper than I was expecting.

2) Retail sales comped down -9.3% in the second quarter, and they were even worse prior to this. The weak comps for the past few quarters are being caused partially by general weak consumer spending, and partially by Vans' having underinventoried stores (they were 17% lower y-o-y in Q2, and 12% lower in Q1 – on a per store basis the decline is even more significant). The inventory situation is a management gaff that is clearly fixable. Retail spending will pick up again eventually, and when this happens I don't see any reason why Vans won't benefit. The company spends a lot of money promoting and building its brand. If Vans didn't do this I might be a little concerned about the ability of sales to rebound with consumer spending, but this isn't the case. The company also has several initiatives in place to improve comps, but I don't place particular faith in any of them driving comps.

After the -9.3% comp, they went from -6% in Q3 to +9% in Q4. One of the main drivers that company cited was the inventory situation. The company is actually a little overinventoried at this point, having purchased some BTS stuff earlier than they usually do.

As for not placing any particular faith in management's initiatives, well I probably should have.

As for turning around the rest of the retail business, the company has a few other ideas:

1) Getting Vans product into stores where their key customer shops, whether that is skate/surf speciality stores or PacSun or wherever.
2) Increase targeting of 10-20 year old female customer.

PacSun sales have been doing really well as of late, so it looks like they're doing a good job focusing on their key shops.

#2 is what has really made the biggest difference I think. The women's side has been doing incredibly well. Management plans to continue their increased marketing to the 10-20 year old female customer.

3) Marketing and promotion will return to regular levels, which will save 2-3 margin points over last FY from this alone.

From the few years before 2002, marketing and promotion was typically 7% of sales. After reaching over 10% last year, the first two quarters are already running around 1-1.5% lower at 8.9% of sales. In the past few quarters the company has been actively decreasing marketing and promotional expenses as part of their restructuring plan. While marketing came in around $34 million last year, I think it is reasonable to expect $25-$30 million annually going forward. The company has been taking the steps necessary to make this happen. Also, any pick up in retail comps will provide some additional leverage to make the 7% a more realistic goal.

After running around 10% of sales for the past 1.5 years, marketing is finally being brought down as expected. The past two quarters have seen marketing represent 7.7% and 8% of sales.

4) General and administrative expenses have been inflated recently by several one-time charges that will eventually disappear. They are still digesting the Mosa acquisition. They also have some ongoing litigation costs. For the first half of this FY these have resulted in around $2 million in G&A charges that are one-time in nature, IMO.

There are no significant changes here, but there should be a bit of a decline once the company has finally disposed of the remaining skateparks.

As a result of the turnaround, the company is now guiding $0.35-0.40 EPS for FY04. I like their plan of holding back store expansion for FY04 to focus on continuing the store cleanup; this will hold their capex down and allow for decent free cash flow. As a result, even with the lease termination costs, the company expects to have $40-45 million in cash by FY04 year end.

One factor which I totally missed was tax rate. I knew that the company was shifting their business more internationally and that their tax rate internationally is lower, but I didn't put two and two together to realize that their blended tax rate was likely to be on the decline. The company now expects their tax rate, which has been around 30%, to decline to around 20-22%.

Thankfully the market has appreciated the turnaround too, with the stock up 2.6x, from around $3.60 to over $9. I've already sold some of my holdings, but have decided to retain a smaller position at these prices as I have been very impressed by management's execution.
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