Retailer Risks Cutting Off Nose to Spite Its North Face

Short-sellers say the company's sacrificing its name for short-term sales gains.
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The North Face

(TNFI)

will show its latest mountaineering gear at the

Outdoor Retailer Trade Show

in Salt Lake City this weekend. At the same time, Gary Neptune, owner of

Neptune Mountaineering

, a Boulder, Colo., specialty shop that sells $2 million worth of outdoor products annually, will urge retailers to boycott North Face.

Neptune, who will hold an informal meeting at the show to discuss industry problems, says North Face, among other suppliers, is glutting the market and cheapening its brand by allowing discount stores to sell its products. In a letter to fellow retailers, Neptune urges them to stop doing business with the company.

Concerns that North Face is producing more products than its distributors and retailers can sell have plagued North Face since last spring, just after its stock hit a 52-week-high of 29 in February. Since then North Face shares have declined more than 50% to 13 15/16. But one person who is short the stock says it could fall to about half its current value.

Even though the stock may now look cheap trading at just 13 times next year's earnings, the company is wrestling with inventory and receivables that are growing faster than sales. In the third quarter, inventories grew 26% and accounts receivable jumped 51%, far outpacing the 19% sales increase. (Inventories and receivables, measures of a company's health, typically rise in line with sales.)

North Face is scheduled to report fourth-quarter results Friday. A

First Call

consensus has the company earning 22 cents per share, a 22% increase over the year-ago period, when North Face earned 18 cents per share.

But longer term, concerns persist.

North Face products are finding their way to discount stores.

Wal-Mart

(WMT) - Get Report

's

Sam's Clubs

in Boulder and Ft. Collins, Colo., and Seattle, all carry North Face jackets, store managers say. A manager at a Portland, Ore.,

Costco

(COST) - Get Report

says his store recently sold out of them.

Specialty retailers find it hard to compete with the steep discounts those chains offer. The problem became especially frustrating last spring for one retailer, who asked not to be named. The Sam's Club in his town was selling merchandise for $19.99. His cost for the same product: $20. As a result, he says, he's cut back the amount of North Face merchandise he carries.

North Face says it doesn't sell to discount stores, but some of its distributors, in violation of North Face's policy, "divert" merchandise to these outlets through middlemen. "Once we find that happens, we try and shut that dealer down," says Ashley Devery, a spokeswoman for the company, which recently relocated its headquarters to Carbondale, Colo. "Other

merchandise is coming from overseas and is counterfeit."

Guarding against counterfeiters and middlemen who sell products to unauthorized locations is a common battle for apparel makers.

Tommy Hilfiger

(TOM)

has been battling Wal-Mart, trying to keep its products -- both real and counterfeit -- out of the discount chain's stores. It even won an injunction in 1996 prohibiting Wal-Mart from selling counterfeit Tommy merchandise.

Devery says North Face isn't involved in litigation over these matters, but in the past has taken legal action against counterfeiters.

But some specialty retailers and short-sellers insist that North Face, which operates nine retail stores and five outlet shops, is more concerned with boosting short-term sales than in preserving the brand's longevity. They argue that the company has turned a blind eye to the flood of products to discount stores because North Face has more inventory than it can sell through traditional channels. For instance, Stephen Choate, who manages the Fort Collins Sam's Club, says his store has been selling North Face jackets for two years.

From its origins more than 30 years ago as a maker of technical apparel for serious outdoor enthusiasts to a company whose jackets are now worn by inner-city kids, North Face is navigating a path that has proven treacherous for other apparel companies. Typically, niche status lends cachet to a brand. Its exclusivity fuels demand. But to keep growing, a company must sell to more people. Often that wider reach can do more damage than good if not properly controlled.

Take the case of

Calvin Klein

jeans. Its former licensee,

Designer Holdings

, grew exponentially by indiscriminately pumping the product everywhere. The "designer" image soon tarnished. It wasn't until

Warnaco

(WAC)

, which assumed the license through its purchase of Designer Holdings, drastically cut back distribution and cracked down on distributors who sold to discounters that the brand regained some of its clout.

Some industry observers say they see a similar pattern developing with North Face.

"The worst offender is the North Face without question," says Bob Woodword, publisher of

SNEWS

, an outdoor industry newsletter. "It was a company that had a good name. Now they're selling willy-nilly to everyone."

Says Devery, the North Face spokeswoman, "Anytime a company grows, there's always people who aren't content."

With the sports utility vehicle replacing the station wagon as the car of choice in the suburbs, North Face is tapping into a renewed penchant for the rugged outdoors among regular folks. To reach city slickers, North Face has begun selling its jackets and

La Sportiva

hiking boots to

Nordstrom

(NOBE)

,

Dillard's

(DDS) - Get Report

,

Just For Feet

(FEET)

,

The Sports Authority

(TSA)

and

Foot Locker

, owned by

Venator

(Z) - Get Report

.

"We used to get knocked because people loved the North Face and couldn't always find us," Devery says. The company protects its arrangements with specialty retailers by offering them more technical products, she says. (Some specialty retailers say there actually is little differentiation.)

Of course, not all retailers are revolting. "North Face is a good vendor of ours," says Michael Collins, spokesman for Seattle-based

Recreation Equipment

, which operates 49 stores. "As long as it's something customers expect us to carry, we'll find a way to work with them."

But the cluster of retailers who are voicing their concerns say North Face, in selling the outdoors to suburbia, may ultimately sell out itself.