California Apparel News

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 the companies 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, concerned a small start-up company in the streetwear category. In the Aug. 12 issue, several finance executives discussed the challenges of factoring a growing contemporary label. The final part of the series focuses on an established company considering new avenues of growth.

Established company looking for new opportunity

This 10-year-old misses brand built its name on career separates, but now would like to grow its sister division, a 2-year-old casual sportswear label. The company is on track to reach $50 million in annual sales for both lines, primarily to department stores and catalogs. The primary career brand is a back-of-the-department basics line, but the company wants the sportswear line to be more fashion-focused and has allotted for a marketing budget to help grow the brand. Five years ago, the company shifted most of its production offshore for its primary label. About 70 percent of production for the new sportswear label is done offshore, and about 30 is completed domestically. The company employs about 100 full-time employees.

Shifting from basics to brands

Ken Wengrod, FTC Commercial Corp.What percentage of the $50 million is the career separates brand versus the casual sportswear brand? It’s only a 2-year-old operation, but I would want to understand a couple of things. Do they have enough capital to go into this? People always see that there’s opportunity in other areas. Are they going to be selling [to] the same departments, or are they going to be selling [to] different departments within a department store? Would this be going to the same buyer or to a different buyer? You want to make sure they are not competing with themselves for the same open-to-buy because there’s only so much space on the floor within the department store.

Monitoring the risk

Paul Herold, First Capital Western Region LLC The risks involved in this type of company are probably a lot less than for the other two. It’s not really as much of a risk to us as factors as it is a risk for them as prudent operators.

As we monitor the company, as we take the pulse, we do quarterly factor audits, we ask them to have their CPAs do at least semiannual audits, and we’re looking at their sales all the time. So we know how the machine is running. If we see that the machine is slowing down, that inventory is starting to bloat, that something is happening with collections, that the dilution is skyrocketing, we can cut back on the amount we’re lending to them. If we’re lending them an 80 percent advance and we start sensing that something doesn’t make sense, we can go back to 50 percent, to 40 percent. We can cut them off completely and say, “No more advances until you straighten this out.”

Get the right people

David M. Reza, Milberg Factors You hope [the company has] good internal discipline, good controls, good reporting, a good CPA—particularly the start-ups need someone with apparel specialization. There’s a number of firms here in town [that are] well-known, well-respected, [and] have specialized in this industry for a long time and understand it. As [manufacturers] get bigger, we think internal controls become a more and more important factor in being successful. There used to be a number of companies at $100 million in sales in L.A. They’re gone now because they didn’t have good internal controls; they didn’t have a good CFO. They had one guy who did sales and one guy who did production, [but] they didn’t have good reporting telling them what was on back order, what inventory was, how it matched up with sales. It’s important to have good internal controls when you get to that kind of scale.

[This company is] shifting into a new product line; this may require a new sales force. You may be able to use your existing sales force; it would be great from an expense standpoint. But if you can’t, you may have to go out and get sales people that can sell to these new buyers. Does it require new designers? Is there somebody at the design level or the merchandiser level that can look over the design and merchandise on both divisions? Can they share things in common on some level?

K.W.: They are trying to do a brand instead of a basic item. So, they are trying to power-brand the label. Well, it’s a whole different mentality. Forget the marketing budget—that’s way after the fact. You have to have a significant design budget. How are you going to differentiate your product and truly understand what the consumer wants? How do you convince the retailer that this is better? You have to put capital up to do that. Does the company have the ability from prior years of profit to take money out and build this new operation? What you need to do is set up a separate structure with a separate design team. You want to take advantage of economies of scale on the back end, in accounting. But your creative side has to be separate between the two lines. And the sales people probably have to be separate so they don’t compete for the same dollars.

Taking fashion offshore

K.W.: They’re talking about doing 70/30 offshore [for the new label]. In the contemporary market and the upscale market, quick turn is the name of the game. We see it in the premium denim business. That’s why domestic manufacturing in the contemporary market is doing so well. There’s different ordering of piece goods. They have to realign who their suppliers are, even for that 30 percent. The question is why do you want to go offshore? What can offshore offer you versus domestic?

Is the casual sportswear line also separates, or is it a related line? If it’s separates, you can get away with certain things for doing production. But if it’s related separates, and your production doesn’t go as planned and the tops don’t go with the bottoms, you can’t just ship the bottoms without the tops. Those are some of the things you need to understand.

The most important thing is to try to understand what niche you’re going to try to exploit, why you’re going to do something better and whether there’s need for your product. What can you do differently? You don’t want to do the same thing that your non-brand is doing because they’re a non-brand.

Managing inventory

D.R.: Managing inventory is so key. So many companies hold inventory. It doesn’t get shipped, for whatever reason, then they hold on to it, thinking it’s going to be desirable next season. Well, it’s not. Nobody likes to accept a lower price or a missed expectation or even a loss versus their cost, but it is better to be liquid than to have the inventory. When you have too much inventory and you’re not liquid, then you make mistakes where you feel compelled to make a sale just to get the goods out and you’re selling to a company that might be a marginal risk.

Markdowns and charge-backs

P.H.: One big risk in the large scenario is potential for increases in dilution and markdowns. It’s probably no surprise that the larger the store you sell to, the more they demand in markdowns and allowances. That presents a risk to us because if we’re advancing 85 or 90 cents to the dollar and suddenly 30 percent of June’s invoices are in dispute or they get bounced back for deductions and allowances, our collateral base is suddenly less than it was.

Financing growth

Kevin Sullivan, Wells Fargo CenturyThe biggest challenge I’ve seen [going public] creates for apparel companies is you have this continued need to grow. Sometimes it causes management teams to get into businesses that might not make sense for them. But it [comes from] an effort to grow when management comes to the realization that the apparel side of the business in and of itself might not have that much room to grow but [there’s] an effort to grow the brand. Management decides to get into other businesses that might not make sense for that company. It can be retail, it can be home furnishings, it can be shoes. It really varies from company to company. I’ve seen companies where the retail side of the business has become extremely profitable. I would say that is by far the exception. I would say that more often than not, what ends up happening is the wholesale customer base views a company’s retail channel as an effort to almost compete against itself.

P.H.: Generally, when an owner has survived the last 10 years, they’ve made some money, their company’s got some net worth, they’ve got some equity to play around with or they’re going to be bringing in more money to support the new line. For us, if they are working under the scenario where they are bringing in more capital to fund it, then it tends not to be that big of a deal for us. On the other hand, if they’ve been operating on a shoestring budget and they have been taking as much money out of the company as they could each year, then suddenly they are coming to us and saying, “Now we want an over-advance, an inventory combination and we want [letters of credit] because we’re doing this [new line],” that’s when our risk profile increases. It doesn’t mean we’re not going to do it. If we’ve got a good track record with them and we’ve been factoring for the past 10 years and we haven’t had any trouble with their audits and their statements are on time, they’ve run their business well. Who are we to say you don’t know how to make tops, or you don’t know how to make bottoms. But the numbers they present to us in terms of the cash-flow statement have to make sense. If we see realistic projections and numbers that make sense, we’ll stand behind them. It’s obviously risky for anyone to move into a business they don’t know. You do what you’re good at, and if you want to try something else, you’ve got to start cautiously. I think we look at it the same way. It opens up a little more risk, especially if the new venture is taxing the capital base in an untoward level.

Considering the public route

K.S.: The bigger companies tend to be faced with an entirely different set of challenges. The challenge tends to be being able to support the level of sales growth that they’ve experienced that’s now taken them to this larger size. I think the dilemma that most of those management teams face is whether to access the public markets for capital, whether they can continue to do it at the current sales level with the equities that they currently have. That always becomes a very difficult internal discussion for the management teams because what they tend to find is that they end up needing to give up a bigger percentage of the business than most founders would like to give up. And then it becomes a question of private equity versus public equity. A company that has traditionally been a very creative entity that has been able to focus on design and production now has to answer to Wall Street; it becomes a different dynamic. Not every apparel company is necessarily happy with that switch when they have to answer to the public market. Because now instead of focusing on just building a brand, they have to focus on producing quarterly results that meet what Wall Street expects of them. I find that tends to be a very interesting stage for a company that has been founded by the very creative entrepreneur.

I think the reality is for some brands there is an optimum level of growth which they really don’t want to go above—because it almost forces them to get into different businesses that they might not normally have decided to go into.

I sometimes see apparel companies, founded by very creative individuals, [that] get to the point where they are public, it wasn’t what they expected it to be and they long for the days when they weren’t public. Certainly, there is the payoff that management can see, but there is a whole host of other issues that I think management didn’t anticipate taking place.

It’s an important decision that the entrepreneur has to make, and there isn’t any one good answer to it; it’s different for everybody. I think to the extent that a larger company can access private equity, perhaps that’s the better way to go. Sometimes the public markets make sense. A lot of that depends upon the management team and how prepared they are to go public.

It seems like we’re again seeing some pretty high valuations on apparel companies, whether it’s in the public marketplace or as it relates to private investment. We’re seeing money come into companies that have some pretty high valuations. So it wouldn’t surprise me if you started again seeing people looking to go public. But I would say, in general, more people are probably more wary of the process of going public today than they were a few years ago.

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