North Face Essay Example
North Face Essay Example

North Face Essay Example

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  • Pages: 17 (4430 words)
  • Published: May 13, 2017
  • Type: Case Study
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Company Analysis:

  1. Company Overview (3)
  2. Financial Performance (3)
  3. SWOT Analysis (4)

Company Analysis:

  1. Background Strategy-SWOT Analysis (6)
  2. Strategy-Porter’s Five Forces (9)

III. Accounting Analysis:

  1. Cash Flow Analysis (10)
  2. Quality of Earnings (10)
  3. Earnings Manipulation(11)

    Note:The above and their contents areand unified below while preserving the original structure:

    Sally Chin Monique Harper Marmeline Petion Eric Yaker Advanced Financial Analysis Final Group Project The North Face, Inc.December 5, 1999 Table of Content

    I. Industry Analysis:

    Overview(3)< / li > Industry Trends(3)< / li > Competitive Landscape(4)< / li >

II. Company Analysis:

  1. Background Strategy-SWOT Analysis (6)
  2. Strategy-Porter’s Five Forces (9)

ting-analysis">

III. Accounting Analysis:

  1. Cash Flow Analysis (10)
  2. Quality of Earnings (10)
  3. Earnings Manipulation(11)

Company Analysis:

  1. Background Strategy-SWOT Analysis (6)
  2. Strategy-Porter’s Five Forces (9)

III. Accounting Analysis:

  1. Cash Flow Analysis(10)
  2. Quality of Earnings(10)
  3. Earnings Manipulation(11)

Company Analysis: Background (6)

Strategy-SWOT Analysis (6)

Strategy-Porter’s Five Forces (7)

III. Accounting Analysis:
  • Cash Flow Analysis (10)
  • Quality of Earnings (10)
  • Earnings Manipulation (10 11)
  • IV.Financial Analysis:

      < li  class = " list - item" > Dupont Decomposition(12)
      < li  class = " list - item" > DCF Assumptions(12)
      < li  class = " list - item" > WACC Calculation(12)
      < li  class = " list - item" > DCF Results(13)
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    View entire sample
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    " list - item" > Multiples EBO Valuation(13)
    < li  class = " list - item" > Dupont Decomposition(14)   

    SECTION V Conclusion 14

    Appendix A Appendix B Appendix C Appendix D Appendix E Appendix F Appendix G

    Accounting Analysis

    Beneish Model

    DCF Model

    DCF Sensitivity

    Multiple Valuation

    EBO Valuation

    EBO Sensitivity

    2 Industry Analysis Overview

    The US apparel industry is a sizable and fragmented market influenced by economic conditions, demographic trends, and pricing. The average American spends about $800 per year on clothing, resulting in a market worth approximately $215 billion for a population of nearly 270 million.

    The apparel market is categorized into two tiers: national brands and other apparel. National brands, produced by about 20 major companies, currently account for approximately 30% of total US wholesale apparel sales. The remaining 70% of the market comprises small brands and private label products. Due to the industry's maturity, growth opportunities are limited, leading companies to constantly pursue cost reductions. Hence, manufacturing is outsourced to Asia and the Caribbean.

    The industry has experienced advantages such as offshore manufacturing and cost-effective raw materials, leading to reduced operating expenses. Among the various segments of the apparel industry, the technical outdoor apparel segment has established its own distinctive market. The primary customers of this segment are professional climbers and outdoor enthusiasts. Nevertheless, there has been a rising trend of wider consumer base interested in these products. This expansion can be attributed to the growing popularity of outdoor recreational activities

    and adventure travel among the general population.

    Consumer preferences have changed, leading to a higher demand for functional products. Furthermore, outdoor apparel is now accepted as casual wear, which is beneficial for the industry. Additionally, the U.S. economy's positive state with modest inflation, low unemployment, and a thriving stock market has resulted in increased spending in the apparel industry. Despite these positives, the industry remains highly competitive and fragmented.

    The industry possesses uncomplicated technologies, low fixed assets per employee, and effortless expansion capability, thereby rendering barriers to entry insignificant. Nevertheless, sustaining competitiveness proves challenging due to narrow profit margins in the competitive setting. Consumers wield considerable power and display no allegiance towards any particular brand. Consequently, the three companies within the industry consistently incur expenses on advertising to establish brand recognition, thus augmenting their costs.

    Demographic changes, including an increase in teenagers and an aging population, will impact the apparel industry. Over the next decade, there will be a rise in households with both younger and older members, while middle households will decline. Companies that typically target the middle group must devise new strategies to adjust to these shifting demographics. Nevertheless, this change also presents opportunities for profitability in the teenager and young adult markets.

    On the other hand, companies can also target the aging population who have more disposable income. Additionally, older individuals will have more leisure time and engage in outdoor activities, increasing their demand for casual clothing.

    1998 Number (Thous.) 19,117 39,396 19,426 17,451 18,568 20,189 22,579 21,811 18,813 15,707 22,662 34,823

    270,542 U.S. Population Projections
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    2005 % of Number % of Total (Thous.) Total
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    100.

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    2015 Number (Thous.)
    21,

    174

    40,

    795

    21,

    194

    21,

    876

    20,

    836

    20,

    248

    18,

    872

    18,

    726

    19,

    594

    21,

    602

    39,

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    45,

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    399

    2015 % of Total

    6.

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    Rising Income Baby boomers are experiencing a rise in income associated with the bull market. Increased gain in personal income has led to an increase in personal consumption expenditures with individuals in higher income brackets spending more money.

    Consumers are currently spending more money overall, but they are cautious when it comes to making big purchases on individual items. The pricing factor is of utmost importance for these selective consumers, which means companies need to create sophisticated advertising tactics in order to justify higher costs. Moreover, consumer lifestyles are evolving as demonstrated by their increasing participation in outdoor pursuits such as camping, hiking, and backpacking. A survey carried out by the Travel Industry Association of America in 1997 revealed that half of U.S. consumers partake in these activities.

    S adults, or 74 million people, have taken an adventure travel trip in the past five years. ! Dressing Differences The US has seen a rise in casual attire both at home and in the workplace, resulting in increased spending on such items. More employers now have casual dress days, benefiting the apparel industry. ! Globalization Faced with intense competition, businesses have looked to foreign companies to improve sales, reduce expenses,

    and enhance operational effectiveness. As a result, offshore manufacturing has expanded, greatly influenced by trade regulations.

    Many companies have chosen to expand their sales operations internationally to increase revenues, despite one negative aspect in the industry. Despite seeing revenue growth and favorable demographic trends, companies are facing increased pressure on profit margins due to intense competition and price-conscious consumers. However, it is predicted that branded products will perform better in the market and generate healthier profits by expanding sales overseas.

    North Face's main competitors are LL Bean, K2, Lost Arrow, and Columbia Sportswear. Both LL Bean and Lost Arrow are privately held companies. Columbia Sportswear is a leading seller of skiwear in the US and one of the largest outerwear companies globally. They also manufacture footwear, sportswear, gloves, and caps. In 1997, Columbia went public and has since achieved success with sales reaching $427.3 million in 1998 and a net income of $32.7 million. The company's return on equity (ROE) was 17%, return on assets (ROA) was 8.4%, and revenue growth was 20.9%. Their low long-term debt/equity ratio of 0.15 indicates low leverage. During the Asian crisis, Columbia benefited from its manufacturing operations in Asia which helped reduce costs while maintaining their revenue stream. Additionally, they have established a strong international market presence with a presence in over 30 countries but are perceived as highly risky by the market with a beta of 2/3As of November 30th, 1999.

    K2 is headquartered in Los Angeles and offers various products including fishing rods, mountain bikes, sports apparel, outdoor gear, surf apparel, and skis.They also have an industrial business segment that sells plastic- and fiberglass-based products.Their strategic approach involves acquiring well-known

    sports equipment manufacturers with significant shares in specialized markets.
    In 1998, K2 achieved sales of $574/5 million and a net income of $3/9 million. However, due to industry pressures, one of the acquired companies, K2, saw its profit margin decline from 6% in 1997 to 2.9% in 1998. Despite being financially more stable than North Face, K2 still faces challenges in maintaining competitiveness. K2 has a return on assets (ROA) of 4.1% and return on equity (ROE) of 8%. Additionally, despite having a long-term debt/equity ratio of .47, the company demonstrates low risk with a beta of only 0.1. As of November 30th, 1999, the stock price for K2 was $7.38.

    The North Face Inc., established by Doug Tompkins as a retail store in 1965, specializes in providing mountaineering equipment and supplies. The name "North Face" is derived from the treacherous side of a mountain located in the Northern Hemisphere where their equipment is frequently utilized.

    During the 70s and the 80s, North Face was highly successful due to its superior product innovation in the industry. Its geodesic dome tents and synthetic bags became the industry benchmarks in design. However, in the late 1980s, the company faced a downfall when it ventured into manufacturing. As a result, North Face suffered a significant decline and was eventually acquired by Odyssey Holdings International (OHI). Regrettably, OHI declared bankruptcy in 1993, leading to North Face being sold at an auction to J. H. Whitney & Company.

    Three years later, in the late 1990s, the company went public and encountered persistent problems. The company faced accounting issues that resulted in consecutive financial restatements, including a 62% reduction in earnings for 1998. Despite being

    in severe financial difficulties, the company's customers appear to be somewhat unaware of its misfortune. Sales saw a 19% increase for the six months ending June 1999 and grew by 18.6% in 1998. North Face specializes in high-end outerwear, skiwear, and mountaineering equipment.

    The company produces Tekware, a synthetic sportswear line designed for active men and women who enjoy outdoor activities. Additionally, the company manufactures durable footwear and holds the exclusive rights to La Sportiva rock climbing and mountaineering shoes in the United States. The company's objective is to enhance brand recognition by projecting a premium, technologically advanced, and genuine image that attracts professionals and dedicated outdoor enthusiasts. In order to effectively market its products, the company employs a group of renowned athletes in its advertising campaigns. North Face primarily sells its products through specialty outdoor and high-end sporting goods stores.

    In 1996, the company introduced the Summit Shop concept, which is a store within a retail store dedicated to selling North Face products. Sales by Segments Sales Breakdown Other 22% Tekware 13% Equipment 15% Outerwear 50% Strategy Insight-SWOT Analysis Strengths To truly value and analyze the future prospects of North Face, we felt it necessary to gain an insight into the company’s strategy, its future plans, its position vis-a-vis its competitors, and the industry dynamics that affect the long-term performance. We started by performing a SWOT analysis.

    North Face has a strong brand equity and is highly regarded and recognized. The brand's products are popular among various consumer groups, including adventurers who tackle extreme challenges such as climbing Mt. Everest and college students who wear their jackets and backpacks. North Face offers a diverse selection of products,

    including casual apparel, equipment, outerwear, rugged footwear, and snowsports gear. This encompasses different categories like T-shirts, thermal underwear, anoraks, jackets, parkas, sleeping bags, pullovers, vests,sweatshirts,and full body suits.

    The company aims to provide advanced technological products and set the standard for quality and performance in the industry. Despite challenges in selling consumer durables, the company has succeeded by consistently evaluating its product lines and seeking input from elite athletes, retailers, consumers, and suppliers. Additionally, a strong product development team composed of textile and design engineering experts contributes to the company's success.

    The reputation of North Face's products is further enhanced by including climbers, explorers, and extreme skiers in its research and development team. This strategy allows the company to sell its products at premium prices, emphasizing their status. However, North Face's success is limited to its premium brand. One major weakness lies in its internal management, which has consistently shown poor financial management. Consequently, shareholders have experienced minimal returns, and the stock price has continued to decline.

    In 1998, the company's earnings decreased by 62%, leading to unfavorable financial figures. The return on equity, return on assets, and return on investment for that year were -22.60%, -11.59%, and -19.75% respectively. These figures have made it difficult to obtain equity funding, resulting in reliance on debt financing with a debt-to-equity ratio of 73%. Analysts predict negative diluted earnings per share ranging from -$1.18 to -$0.65 for the year ending 1999. However, there is optimism for improvement by 2000 as analysts anticipate a potential increase of up to $0.35 per share.

    The market standing and ability of North Face to capitalize on industry opportunities have been adversely affected by its weak

    financial performance. Nevertheless, the company has the potential to enhance its brand equity and draw customers to its stores through effective positioning and advertising strategies. Currently, North Face has a total of nine retail stores, with three in California, three in Illinois, two in Colorado, and one in Washington.

    To expand its customer base, North Face can consider two options: opening more retail stores in the United States and enhancing its e-commerce outlet. However, both of these expansions necessitate significant financial investments that are currently unavailable to the company. Moreover, North Face is encountering competition from competitors who are successfully building their own brand reputation within the market.

    Three prominent companies in the industry are Columbia Sportswear Company, LL Bean, and K2. These businesses have strong finances that enable them to increase their brand value and take advantage of growth opportunities. After evaluating their products and market position, it is evident that North Face has great potential for success. However, poor management decisions have led to a decrease in value for the company's shareholders. Currently, North Face is considered an underperforming player in the market with negative return on assets (ROA), return on equity (ROE), and return on investment (ROI).

    To make significant strategic decisions in the market, the company must undergo financial reconstruction - reducing debt to equity ratio and enhancing profitability. Porter's five forces analysis highlights North Face's main challenge as its financial capacity. The consumer apparel industry is constantly at risk from potential new entrants, posing a continuous threat.

    While barriers to entry may not be significant enough to deter new entrants, the fashion industry's volatility and consumers' fickleness make failure a high risk. Additionally, these

    companies have minimal ability to effectively compete against established brands such as North Face, LL Bean, and Colombia Sportswear. Porter's five forces analysis has revealed the increasing bargaining power of customers who are now more knowledgeable and demanding.

    Consumer loyalty, especially in the fashion industry, is decreasing. Consumers are becoming more demanding and will switch to a competitor if a product does not meet their expectations. This applies to both regular customers and high-status customers who are quick to abandon a brand when it loses its prestige. With North Face facing financial difficulties, it is only a matter of time before investors start choosing more stable competitors. The Bargaining Power of Suppliers is another issue for North Face. The company relies on around 50 external manufacturers, with ten of them producing the majority of its products in 1998. As there are no long-term contracts, any disruption in obtaining manufacturing services could severely impact the company's operations. There is also a risk that suppliers may stop providing goods due to non-payment or unfavorable credit terms.

    As the company's financial difficulty worsens, it will be unable to manage its suppliers, who in turn will cease supplying the company, causing a domino effect. Furthermore, the threat of substitutes is insignificant. Apparel is generally similar across brands, with the exception of the brand itself. As long as North Face maintains production and continues delivering high-quality products, substitutes will not impact the company's growth potential. Finally, the industry itself poses a potential threat.

    The apparel industry is highly volatile and influenced by shifts in consumer fashion preferences. Some companies have consolidated to achieve cost efficiencies and build a strong brand presence across different

    product offerings. Despite facing bankruptcies, the industry has become more stable with modest growth. It is particularly vulnerable to economic changes, but the current bullish market has increased consumers' buying power, benefiting the industry. Additionally, e-commerce has revolutionized the industry by providing an extra sales channel.

    Adapting swiftly to technology has been crucial for companies in the industry to maintain competitiveness. The industry's overall prospects are optimistic, with established firms projected to gain from future profits. In evaluating North Face as an investment option, analyzing their financial statements and assessing management's involvement in earnings manipulation is essential.

    The analysis began by examining the company's cash flow health (Appendix A). In the past three years, the operating cash flow has been significantly negative, indicating a failure in managing working capital by the management. Additionally, cash flow from financing has been assisting both the company's growth and operations. North Face should be concerned about this trend, as it cannot indefinitely finance its operations using debt or equity. It is worth noting that the negative cash flow from operations is primarily due to the funds being held up in receivables and inventory.

    An increase in accounts receivable could indicate management's decision to offer more credit to boost sales or a strategy of loading wholesalers near year-end to improve sales. The substantial rise in inventory is even more concerning as it suggests the company is struggling to sell its products despite high consumer spending. One more cause for concern in North Face's cash flow is the difference between Net Income and cash flow from operations. Typically, these figures should move in sync to demonstrate efficient operations.

    The cash flow from operations of North

    Face is significantly lower than the net income, indicating a lack of earnings quality. It was also observed that the free cash flow was negative in both 1997 and 1998. Unfortunately, the projected 10-year free cash flows are also negative, which is concerning for current investors. Therefore, North Face's liquidity performance is not meeting expectations. To evaluate the quality of the balance sheet and income statement, we utilized the Lev & Thiagarajan model, using financial figures from 1997 to 1998.

    Only six out of the 12 items from the original model were found to have statistical significance. These six variables are detailed in Appendix A. Among these significant items, two were found to be irrelevant for the analysis. Firstly, the company does not possess an order backlog. Secondly, there is evidence suggesting that fluctuations in capital expenditures can be interpreted as either positive or negative news, making it difficult to determine their impact on quality. The remaining four items indicate a deterioration in the quality of both the balance sheet and income statements.

    Between 1997 and 1998, the inventory increased at a slightly faster rate than sales, indicating a difficulty in selling the merchandise. The change in account receivables exceeded the change in sales, reinforcing the analysis of cash flow. In 1998, there was a slight deterioration in gross margin, while SG&A as a percentage of sales increased slightly. These trends align with industry predictions of lower margins.

    To ensure that earnings were not being manipulated, we thoroughly examined the footnotes to detect any unusual changes in accounting policy. However, no such changes were found.

    The company has not made any significant changes in its accounting policy that could

    have led to higher earnings. We used the Beneish model to detect potential earnings manipulation by inputting financial numbers into the Model and calculating an overall M-score for North Face. According to the 8-variable model, the reported M-score is –1.81, which exceeds the threshold of –2.22, indicating that North Face is likely manipulating earnings. Among the eight variables, only three were above one: Days Sales in Receivable index at 1.0, Sales growth index at 1.21, and leverage at 1.19. These findings support our analysis of the cash flow statement which reveals a liquidity problem as receivables increase and additional financing becomes necessary to sustain operations. Another concerning result was observed with TATA, yielding a score of 0.078 above the threshold of 0.05. Hence, according to the Beneish model, it is plausible that North Face manipulates earnings by relaxing credit terms and boosting sales resulting in an accumulation of account receivable.

    The company is facing financial difficulties, as indicated by negative cash flows, leading to manipulation of accruals to delay payment. The financial analysis revealed that the company's return on equity (ROE) is -0.00684, with a negative return on sales (ROS) of approximately -3%, an asset turnover of around 20%, and a financial leverage of 1.12. These factors contribute to an overall ROE of -0.6%, meaning investors are losing their investment gradually. The discounted cash flow model assumes a sales growth rate of 25% for the first five years, based on the 5-year average trend for North Face retrieved from Market Guide.

    The company's growth rate is projected to decline from 25% to 15% in the next five years, attributed to competition and globalization. Despite a favorable bull

    market that encourages consumer spending, customers are reluctant to allocate additional funds towards apparel purchases. Sales growth will primarily be driven by outerwear, equipment, and Tekware. Historically, outerwear has accounted for roughly half of total sales and is expected to maintain its position as the largest segment going forward. Cost estimates encompass a cost of goods sold (COGS) representing 54.6% of sales and selling, general, and administrative (SG&A) expenses comprising 37.8% of sales.

    The figures in this text were acquired using average values from the past two years for these line items. Taxes were also calculated based on the average figures from the previous two years. The cost of goods sold has remained steady over recent years, and we anticipate it to continue in that manner. In fact, because of the Asian crisis, manufacturing costs may even decrease, resulting in a lower cost of goods sold. The expenses for Selling, General, and Administrative have slightly increased which may indicate poor operational performance. The assumptions made for the balance sheet are similar to those made for the income statement forecast, taking into account the average ratios from the previous two years.

    At present, North Face lacks a specific strategy to boost sales or reduce costs, resulting in our forecast being based on historical trends. No growth rate was assumed when calculating the terminal value. To determine the discount rate or Weighted Average Cost of Capital (WACC), we employed two different approaches. The first approach utilized the traditional CAPM model, while the second approach employed the implied cost-of-capital model.

    Under the CAPM, industry data provided a risk-free rate of 6.3% and a market premium of 3%. After adjusting the beta

    from 1.93 to 1.62, we obtained a discount rate of 11.6%. For the implied cost-of-capital model, we added a retail sector risk premium of 2.48% to the risk-free rate of 6.3%, yielding a discount rate of 8.78%.

    Using discounted cash flow analysis by discounting free cash flows and subtracting debt market value, our evaluation resulted in a share price of $0.0 However, employing the CAPM discount rate produced a negative stock price at -52 cents per share whereas utilizing the implied cost-of-capital model yielded a price of $9.16.

    The substantial discrepancy in prices is due to significant differences in discount rates which greatly impact both discounted cash flow and terminal value assessments.

    We conducted sensitivity analysis considering income and balance sheet factors such as COGS/SG&A, cash/accounts receivable, and discount rates.

    If accounts receivable decreases by 1% of sales, using the CAPM discount rate would lead to an increase in stock price by $0.1On the flip side, if SG&A decreases by 1%, the stock price will increase by $4.92. It is difficult to find similar companies for a multiple valuation analysis on North Face due to their private ownership, as seen with REI, LL Bean, and Eastern Mountain Sports. However, within consumer cyclical companies, we consider Columbia Sportswear, K2, Nike, Nautica, and Tommy Hilfiger as reputable and comparable entities to North Face.

    The analysis performed involved three multiples: Price/Earnings (P/E), Price/Book (P/B), and Price/Sales (P/Sales). By using industry average P/E of 16.91, the implied stock price for North Face is $4.91, which is close to its current trading price. If the average P/B of 1.59 is used, North Face's implied price becomes $16.28. Alternatively, considering the average P/Sales of 0.878, the

    stock price is calculated to be $17.02. Taking these three multiples into account, the stock price for North Face can vary from $4.91 to $17.02.

    The North Face, Inc. has a market capitalization of $62.2 million, which is much smaller compared to its competitors. For example, K2 has a market capitalization of $133.2 million. The company's valuation using the EBO method resulted in an implied price of $8.82. This calculation was based on ESPs for FY1 and FY2, with a long-term growth rate of 17.10%. The book value used for the valuation was 12.83 and a discount rate of 11.6% was applied using the CAPM model due to zero dividend yield from the company.

    Using estimated EPS for 1999E as zero for FY1 and $0.05 for FY2 in 2000E would give an implied price of $4.35 - which matches the current stock price.

    Conducting sensitivity analysis showed that increasing the long-term growth rate to 19% slightly increased the implied price to $4.37.
    Similarly, raising the target ROE to match industry standards at 0.1704 would result in an implied price of $7.3.
    Decreasing or increasing the discount rate by one percent gives an implied price of $9.33 or $6.63 respectively.

    In summary, we are starting our coverage on The North Face, IncThe text is unified andas follows, while preserving the :

    Hold rating is assigned to this company due to its potential for growth under new leadership and strong brand reputation.

    The new management faces a significant challenge in improving various aspects of the company's operations, including accounts receivable and inventory management.

    This task is crucial because the management has already obtained funding from both debt and equity markets.

    THE NORTH FACE, Inc Analysts' Recommendation: HOLD

    NASD: TNFI $4.75 $16.69 $3.94 $60.52mil $187,409 $8.20 $0.59 1.11 1998 (TTM) EPS 1999E EPS 2000E EPS P/E Year-End P/E (1999 Earnings) P/E (2000 Earnings) 60-Month Beta Price Target $0.29 ($0.91) $0.05 45.14 NA 95.00 1.90 5.00-9.00 Current Price 52 Week High 52 Week Low Market Capitalization 30-Day Average Volume Book Value (MRQ) Price/Book(MRQ) Debt/Equity(MRQ)

    The North Face, Inc - The Challenge Ahead

    The North Face, Inc is a Carbondale, Colorado-based company specializing in high-end outerwear, skiwear, and equipment for serious mountaineers.

    North Face primarily sells its products through around 4,000 retail outlets in the US, Canada, and Europe. These resellers must have advanced technical knowledge. The company was founded in 1965 and went public in 1996. Recommendation Highlights
    The technical outerwear industry is experiencing growth due to positive trends in casual wear, changes in demographics, and an increase in outdoor activity participation. The strong market is also leading to higher personal income levels and consequent personal spending. With new management leading the way, the company seems well-prepared to revive its operations.

    The company is currently facing financial and accounting difficulties, but there is a reasonable chance that operations will improve with new management and a new strategy. Additionally, the company can leverage their strong brand equity to improve sales and promote growth. At present, th

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