California Apparel News

Recently, 4-year-old contemporary streetwear brand RVCA made news when it secured its first-ever factoring deal with Wells Fargo Century. Strong word-of-mouth marketing helped fuel the growth of the Newport Beach, Calif.–based company, even as its founders struggled to keep up with the demand.

There are lessons to be learned from Rvca’s experience, which has been echoed by many Southern California start-up apparel companies trying to overcome financial hurdles as their businesses grow. Likewise, there are lessons to be learned from the experiences of apparel companies at their mid-range, as well as from mature companies with a long history of reacting to economic and fashion cycles. California Apparel News Executive Editor Alison A. Nieder recently asked several local finance companies to consider three fictitious apparel companies: a small start-up, a growing contemporary label and an established misses company looking to launch a new line. She asked the factors to discuss the risks involved in factoring each company and what each could do to minimize or counteract that risk and be more attractive to a potential factor.

The first part of this three-part series, which ran in the Aug. 5 issue, focused on a small start-up company in the streetwear category. In the second part, several finance executives discuss the challenges of factoring a growing contemporary label.

Contemporary label heading overseas

This 5-year-old women’s contemporary brand has a steady account base of upscale boutiques and department stores domestically and in Europe and Japan. The stores typically buy the line consistently but not deeply. The company has sales in the $30 million range and a full-time staff of 30. It produces primarily locally, but has placed a few test production orders overseas and is interested in shifting more production offshore.

Selling overseasKen Wengrod, FTC Commercial Corp.

U.S. contemporary manufacturers today have a tremendous value in Europe and Japan in particular, so they must understand and have a proper knowledge of who they are selling to and how they are going to get paid back. How do they mitigate their losses if a foreign receivable doesn’t get paid? What are their alternatives? They need to truly understand their foreign distribution network. Who are they doing business with? Because now they have to consider the fact that they are moving these goods thousands of miles away. If they don’t sell, how are they going to get them back? What is their recourse?

You also need to look at inventory control. When you’re doing domestic production, you’re able to produce very quickly. When you get orders, you’re able to turn them in two or three weeks. However, when you’re starting to place orders offshore, your lead times increase and also your foreign suppliers are probably not going to produce small units for a short run. So that would mean that the U.S. entity would have to take certain inventory risks; they’re going to have to do some projections. But projections lead to more risk. Do they understand that risk? How do they mitigate that risk, especially if the stores cancel the orders and/or the sell-through is poor?

To me, that’s the biggest danger and also the cost of doing business offshore in terms of paying things sooner than you would on open credit. You know, you can get open credit in the states for piece goods and with the contractors. There’s open credit on a limited basis with foreign suppliers, but there’s a learning factor; they might not do it in the beginning. You have to build those relationships.

Distribution Paul Herold, First Capital Western Region LLC

As they broaden their base of customers, the first concern is the customer list. As they move into the boutiques, they’re going to be perhaps opening doors that maybe they haven’t opened before—so it leaves them open to some nasty credit surprises if the invoices start aging out a little too far. That increases our value as a financial partner to them, given that we have files on a lot of these boutiques. Credit exposure is a concern of this mid-sized company. It’s a concern that the factor may be able to help them mitigate. As they begin to move into higher-margin sales, [there] comes the temptation to let overhead go a little bit or let expenses run a little. [They will say:] “We’re making 50 percent margins now. We can hire another person to make coffee, or we can increase our factory space by 700.” The industry has seen companies begin to grow but [then have their] administrative and market costs begin to spiral to the point where it’s harder for them to make a profit than it was when their sales volume was lower and they were working in smaller margins.

Prudence suggests that [you ask], “If the sales aren’t always going to be on the rise, how do you cover your overhead?” We look at a number that shows how much sales they need to make each month to cover their overhead. That number is going to keep increasing as the costs increase. How easy is it going to be to meet your break-even point if sales start coming down? When things are rosy, when skies are blue, it’s hard to think about putting sandbags out for the next rainstorm.

Dilution David M. Reza, Milberg Factors Inc.

Generally, the more expensive the product, the higher the percentage of dilution of the sales. [There is] a bit more allowance built in and a bit more expectation and a little more of a liberal policy to accept returns to satisfy the customer because of the pricing involved. For the client, they need to mitigate that dilution wherever they can.

Inventory

D.R.: The other thing, inherent to all [three] examples is the amount of SKUs. A design-driven company is typically a little higher-end. They’ve got more margins, [and] they can support a little more R&D. Design-driven companies have a tendency to spend their time designing. They are pulling swatches and samples and production samples. It can be very costly. With lots of SKUs, that can build up excess inventory.

In my almost 30 years in the business, I [have looked] at companies that failed and often [have seen] the same things: too many SKUs, too much inventory, high dilution and [no watching of] expenses. You need to make money. You need to try not to say, “We’re a seasonal business; we’ll make money in the season.” That’s probably the reality, but if you adjust your business [mantra] to “I want to make a lot of money in the months where I’m shipping, and in my off-season months, I want to break even,” then you’ll probably do okay.

I have clients who will go out and speculate 60 to 70 percent on goods. [They will say:] “I like the design. I’ve got orders for 20,000. I’ll open a [letter of credit] for 100,000 because I’ll bring in extra goods.” I think it’s good to be 80 percent pre-sold. Yes, it’s good to bring in some extras for resale, but to speculate 70 to 80 percent on goods when you open a letter of credit or place an order overseas I think is dangerous. It leads to inventory buildup.

P.H.: The big risk a company of any size runs into is inventory. A lot of times people in the apparel industry become enamored of their own designs and are so convinced that the market will fall in love with their product. They will stock up on it without any regard for the financial downside. The downside is they invest all this money in goods that the market doesn’t embrace [and that] will ultimately have to be discounted, and there will be costs and write-offs and losses.

We always look at the inventory levels when we’re reviewing a deal. Is inventory new? Is it stale? Are they building on speculation, or are they building against booked orders? When they are buying on spec, it would have to be a reasonable number for restocking and replenishment. That’s something companies of all sizes fall victim to, from the small streetwear company to the women’s contemporary brand to the biggies. They all get stuck with inventory.

Know your timeline

D.R.: The world has changed a lot. A few years ago, I would have said, “[If a company is investigating sourcing offshore,] they need to understand the L/C [letter of credit] cycle, [and] they need to get a facility that allows L/Cs.” To some extent that’s still true, but we’re finding many suppliers offshore, particularly in Asia, are giving companies open credit much [sooner] than ever before.

Still, I think clients need to sit down and look at their delivery timeframe and understand where the production cycle is at all times. If I’m buying from a supplier in China or India or Sri Lanka, what do they have to do? Once I place the order, what happens over there? Do they have to go out and get goods? Do they have to make it somewhere else? Then how do they deal with subcontractors? You may not be able to get detailed information, but I always advise my clients, “If you’re going to start importing, go put together a timeline.” Your greatest fear is not having the goods here when it’s time to deliver, and then you create a billing issue with your customer. It’s very important to understand how long it’s going to take to get the goods in and where they’re going to be in the major timeline, from fabric to product to shipping to customs to the warehouse. A lot of people, I find, underestimate the timeline.

How does that affect the factor? There would be more dilution if they’re shipping late, so there’s going to be an allowance, so the goods are cancelled. The factor may have opened a letter of credit, [and] we have to pay the letter of credit. So the goods come in and the order is cancelled, you only have an inventory loan, and there’s no imminent sale to convert that from inventory to a receivables loan.

Maintaining momentum Kevin Sullivan, Wells Fargo Century

In terms of a medium-sized company, the company, by virtue of having grown to a certain size, has probably been around long enough that they’ve managed to fill in a lot of the gaps that a smaller company would still have. But the challenge for them tends to be how [to] either maintain that level of dollar sales volume or really take it to the next level. In the apparel industry, what you’re faced with is a retail marketplace that has obviously consolidated quite a bit over the last few years, and there seems to be very much a desire to focus on a smaller number of suppliers. What that means is a lot of what we would call medium-sized companies feel they have to make that jump into being bigger companies so they can command enough shelf space among the major retailers. And that can be a very difficult stage of growth for a lot of companies. In the apparel industry, what that means is a lot of companies have had to search continually for that cheaper sourcing, and that’s why you’ve seen as many of the formerly domestic manufacturers look to the Pacific Rim or to any number of different places throughout the world for sourcing their production. They realize, in order for them to become as big as they need to be to continue to do business with the major retailers, it necessitates that they have to be a low-cost producer. That, to me, is the most challenging stage to be at because that medium-level company has gotten past the start-up stage, but they are always struggling with how to maintain that sales volume or become important enough to the retailers where they matter. Both of those segments represent a pretty good segment of our customer base.

Contacts: Ken WengrodPresidentFTC Commercial Corp.1525 S. BroadwayLos Angeles, CA 90015-3030(213) 745-8888www.ftccc.netPaul HeroldSenior Vice President of MarketingFirst Capital Western Region LLC 700 S. Flower St., suite 2325Los Angeles, CA 90017(213) 996-2610www.firstcapital.comDavid M. RezaSenior Vice PresidentMilberg Factors Inc.655 North Central Ave.17th floorGlendale, CA 91203(818) 649-8662www.milbergfactors.comKevin SullivanExecutive Vice PresidentWells Fargo Century333 South Grand Ave., suite 4150Los Angeles, CA 90071(213) 443-6003www.wfcentury.com