Over the past several quarters, we have observed an increasingly common trend of large big box and specialty retailers working on a Direct Import (DI) basis with branded product vendors. Historically, name brand manufacturers and license holders have managed the entire supply chain, from factories overseas to the retailers' doors. In this model, financing on the part of the manufacturer or distributor has been carried through the entire supply chain, and has typically reflected higher gross margins on the part of the supplier.

Retailers, in an effort to reduce cost and improve IMU and ultimately retained margin, have increasingly begun to split their businesses into two parts: The first operating through the previously described traditional sale and purchase arrangement where product is delivered to them by way of their suppliers' DC systems; the second being the Direct Import model.

In the Direct Import channel to market, the retailer leverages its own balance sheet and takes possession of the product at the factory door, most commonly in Asia. The gross margin realized by the manufacturer on such sales is often lower than what is experienced under the historical model; however, since the product never truly enters into the supplier's ABL borrowing base, and the risks of late delivery and chargebacks for noncompliance are somewhat mitigated, the sale and resulting margins to the borrower appear to be within normal standards.

We recommend that ABL Lenders continue to monitor this activity under close review, as their clients' sales concentration with retailers operating in this "split account" fashion may be somewhat understated. Furthermore, with the additional level of transparency that results from these first cost programs, eventually the gross margins on the part of their wholesale borrowers may be subject to closer scrutiny by retailers, who will increasingly be in a better position to monitor actual cost of goods throughout the value chain to the consumer market.