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In an 8K released last night, SKX made the long awaited announcement that they have finally secured land to develop their new distribution center.  While much of the attention on the stock has shifted towards the success of its Shape-Ups shoes, supply-chain inefficiencies and its related drag on profitability has seemingly faded into the background of late.

With land secured, the company can now move forward in developing its new DC, which management has maintained will be accretive day 1. One thing to keep in mind here is that while this is indeed a positive from a longer-term sustainability perspective, the company will incur duplicative costs near-term. Once the new DC becomes operational, however, the costs eliminated and efficiencies gained from the transition will be a material positive (see notes below for details). The question now appears to be one of duration and whether the tailwind from Shape-Ups sales will persist as the company spends to build its business. If sales from Shape-Ups start to fade as SKX undergoes this transition later in the year or early in 2011, the upward trajectory in SKX’s margins could come to a end – abruptly.

Here are a few highlights from the 8K filing along with notes on the topic from our meeting with management a few months ago:

  • “The purpose of the JV is to acquire and to develop real property consisting of approximately 110 acres situated in Moreno Valley, California (the "Property"), and to construct approximately 1,820,000 square feet of buildings…” 
    • HE: at this size, capacity will be ~30% larger than the 5 building capacity currently in place.
  • “The Company, through Skechers RB, LLC, will make an initial cash capital contribution of $30 million
    • HE: This is within (below) the range of $35-$40mm mgmt expected to spend in add’n to what they’ve already spent on equipment for development –
  • “In the event that either the construction loan is not finalized or construction does not begin by June 1, 2010, the JV is null and void and the parties are entitled to receive return of their initial capital contributions in the form contributed.
    • HE: Management mentioned only 3-weeks ago out at ICR that they expect to break ground in March –
  • The base rent shall be $933,894.44 per month during the Lease.

Notes from recent meetings with management:

DC Transition Update:

  • Latest timing expected to be 3Q of F10 or 1Q of F11
  • Already spent $40mm in equipment (currently sitting in storage)
  • Will have to spend another $35-$40 in 2H F10 towards installation of equip, software, & programming (CapEx)
  • Will be located in southern California
  • Will be accretive day 1
    • Due to the savings from consolidating 5 buildings to 1 = $5-$7mm in transportation savings
    • Massive reduction in head count ~900 @ $50k/head = ~$45mm in payroll savings
      • 1 employees currently in 5 buildings
    • New equipment will be able to move 60-70mm pair of shoes /yr
    • ~$75-$80mm to depreciate over a 12-year period = incremental $6-$7mm in D&A
    • Currently have 1.4mm sq ft. in capacity in 5 buildings currently could hold 13-14mm pair
    • 30 containers a day delivered with 6k pair each