An Interesting Advertising Observation; What Does it Mean?

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I was recently paging through a couple of Transworld consumer mags (Surf and Skate I think) and something caught my attention. I don’t know what made me notice it, but I suddenly realized there was not one non-endemic advertisement in either mag. Okay, maybe I missed one, but there was no Ford Trucks, Mountain Dew, AT&T or any other of the major brands that had previously graced their pages. There was Nike. I’ll get back to that.

Talking about coming full cycle. I remember when there use to be none of these big advertisers in Transworld’s magazines at all and we thought that was a good thing. I had conversations with various Transworld people years ago about their efforts to work with these major brands. The brand, having exactly no understanding of the industry or the demographic they wanted to reach, would submit ads that were, well, not specifically too good. Transworld would try to work with the company to get it to change its ad, but that meant working through the advertising agency who could hardly go back to their client and say, “Actually, our ad sucked and we didn’t know what we were doing.”

And Transworld, no matter how much they wanted the money (and they charged these companies more than they charged industry brands) wouldn’t take the ads that sucked. Those ads made Transworld’s magazines look bad and inevitably generated irate phone calls from industry advertisers who found their ads next to the sucky ads of the companies that didn’t know what they were doing.
The economy has led brands in all industries to cut back on their advertising. But I can guarantee that Ford, Mountain Dew and AT&T have not stopped advertising everywhere. They have stopped advertising, however, in what I still consider the leading action sports consumer publications and have decided their dollars are better allocated somewhere else. Why?
I should note that if I had other action sports publications in front of me, I bet I’d find the same trend so this is not about Transworld.
You advertise through a particular channel because you believe that channel is the best way to reach and influence customers and potential customers. I can guarantee that action sports publications do not take up a big chunk of Ford’s advertising budget. Even though it’s a relatively small number, they found it expendable. Aside from the economy, there are a couple of possible reasons for that decision.
First are the changes in distribution that have occurred in the industry. Recent attempts to control certain distribution channels not withstanding, our products are all over the place. I suppose we could be critical of that (Hell- we are! All the time!), but it’s pretty much inevitable industry evolution.  In general (some brands are exceptions), we have sent the message that we’re not as exclusive as we use to be. And more and more of our customers are non participants so I’m guessing that the big non endemic companies no longer think it’s quite as necessary to be in the core publications to reach most of the action sports customers.
There’s also a certain decline in the panic that big non endemic companies felt when surf/skate/snow were growing like weeds and generating all kinds of publicity and excitement. Big brands were worried they were missing something, even if they weren’t exactly sure what it was.
Finally, there’s the recognition that the disposable income of the core magazine consumer has declined. Obviously, this has been made worse by the recession, but the decline in middle class real income is a long term trend that started before 2007.
Then there’s Nike, still advertising away in Transworld. The difference is that Ford, whoever they want to sell them to, still wants to sell pickup trucks. Nike wants to sell skate/surf/snow products and, in the process, build brand credibility across our demographic to sell the other related products they make.
So you can see why Nike is still in action sports magazines, but other big companies aren’t. The same analysis applies to Quik, Billabong, Volcom and other large action sports brands (if we can call them large in the same breath with Nike). They’ll be advertising in action sports magazines, but will spread their dollars to other advertising platforms as well. Because just like Nike, they want credibility in action sports to translate into sales in a broader market.
Only it’s not quite like Nike. Nike already has credibility and consumer recognition in the broader market and now wants to build that credibility in a small subset of that market. If they should fail (and it doesn’t look like they are going to), Nike will be just fine. Action sports industry brands are trying to go the other way- from a smaller, defined market to a much larger one. They focus every day on how to gain credibility in the larger market while keeping it in the smaller. They believe that without the later they can’t develop the former. And yet, ultimately, if they want to keep growing, they have to be able to keep larger market credibility even if they lose it in the market where they have their roots.
I think that, as much as anything, explains why our industry has evolved the way it has.

 

 

Zumiez’s 10K for Year Ended Jan. 30, 2010; The Strategy’s the Thing

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In my analysis of Billabong and Genesco, I have spent some time talking about their retail strategies and the possible impact on the action sports retail market, especially on the core retailers.  Zumiez’s 10K has me thinking about this again.

I would first like to thank Zumiez for keeping their 10K to only 75 pages, simplifying my task and reducing my work load.  I have a theory that the best companies have the shortest 10Ks; business models that are simple to describe and fewer problems to explain.  Maybe that’s a new investment strategy.

Zumiez’s financial results, like with every other publically traded company in any industry, reflect the recession and their efforts to manage through it.  There was inventory control, expense management, a reduction in capital expenditures, and focus on continuing to follow their basic strategy (which can be done, as usual, when you have a strong balance sheet like Zumiez’s).

Zumiez ended their fiscal year with 377 stores in 35 states averaging 2,900 square feet each.  As they note, their size seems to leave them room to grow given the number of stores that other similar retail chains have.  New store openings have declined from 58 stores in fiscal 2008 to 36 in 2009 and a projected 25 in 2010.

Their customers are “…young men and women between the ages of 12 and 24 who seek popular brands representing a lifestyle centered on activities that include skateboarding, surfing, snowboarding, BMX and motocross.”

They go on to say:

 “Our stores bring the look and feel of an independent specialty shop to the mall by emphasizing the action sports lifestyle through a distinctive store environment and high-energy sales personnel. We seek to staff our stores with store associates who are knowledgeable users of our products, which we believe provides our customers with enhanced customer service and supplements our ability to identify and react quickly to emerging trends and fashions. We design our stores to appeal to teenagers and young adults and to serve as a destination for our customers.  Most of our stores, which average approximately 2,900 square feet, feature couches and action sports oriented video game stations that are intended to encourage our customers to shop for longer periods of time and to interact with each other and our store associates. To increase customer traffic, we generally locate our stores near busy areas of the mall such as food courts, movie theaters, music or game stores and other popular teen retailers. We believe that our distinctive store concept and compelling store economics will provide continued opportunities for growth in both new and existing markets.”

 They talk about this strategy in more detail in the 10K and you can see the whole thing at http://www.sec.gov/Archives/edgar/data/1318008/000119312510064532/d10k.htm.  Focus on pages one through nine.

Ignoring whether or not you think this strategy is valid (their history tells us it has been), you’ll notice that this description of their stores and how they position themselves could essentially be the same description that any independent core retailer would use.  Except of course the core retailer wouldn’t be in the mall (I guess by definition?) and doesn’t, therefore, have the ability to locate in high traffic areas in the mall.  So your typical independent core retailer might to be more dependent on destination traffic than a Zumiez.   Zumiez pursues, on a national scale, the same branding strategy the best independent retailers pursue.  “We seek to build relationships with our customers through a multi-faceted marketing approach that is designed to integrate our brand image with the action sports lifestyle.” They spent $822,000 on advertising in fiscal 2009.

In other words, as I’ve said a few dozen times before, the best retailers, chain or independent, give credibility to the brands they carry and do not rely on those brands to define them.  Zumiez is clearly not dependent on a handful of brands.  No single brand accounted for more than six percent of net sales in 2009.  Their private labels in total accounted for 15.7% of net sales, up only slightly over the last two years.  Ecommerce sales represented 2.3% of the total, up from 1.1% two years ago.

 And Zumiez has undeniable advantages in terms of negotiations with vendors and landlords, systems, and overall efficiencies associated with size.  Like they say, “compelling store economics.”  Genesco, by the way, pretty much said the same thing.  So would any multi hundred store retailer.  Here’s another kind of long quote that described part of that advantage.

“We have developed a disciplined approach to buying and a dynamic inventory planning and allocation process to support our merchandise strategy. We utilize a broad vendor base that allows us to shift our merchandise purchases as required to react quickly to changing market conditions. We manage the purchasing and allocation process by reviewing branded merchandise lines from new and existing vendors, identifying emerging fashion trends and selecting branded merchandise styles in quantities, colors and sizes to meet inventory levels established by management. We also coordinate inventory levels in connection with our promotions and seasonality. Our management information systems provide us with current inventory levels at each store and for our Company as a whole, as well as current selling history within each store by merchandise classification and by style.”

Pretty powerful stuff.  Then I noticed that in 2008, Zumiez’s net investment to open a new store (net of inventory and landlord contribution) was $311,000.  In 2009 it was down to $221,000.  In part that’s because of economic conditions, but it’s also indicative of the advantages of scale.

Let’s talk about the numbers while all this strategic stuff sinks in.  I’ll come back to it in my conclusions.

Net sales for the year were about even, falling $1 million to $407.6 million.  Comparable store sales were down 10% after having been down 6.5% the previous year.  Net sales per store were down 12.8% from $1.24 million to $1.08 million. Comparable store sales had grown an average of 12.6% a year in fiscal 2005 to 2007.  Gross profit as a percent of sales actually grew from 32.9% to 33.1%, an indication of good inventory management and control of the need to discount.  This gross profit percentage may look a bit low, but you have to consider how the company calculates it.

“Cost of sales consists of branded merchandise costs, and our private label merchandise including design, sourcing, importing and inbound freight costs. Our cost of sales also includes shrinkage, certain promotional costs and buying, occupancy and distribution and warehousing costs. This may not be comparable to the way in which our competitors or other retailers compute their cost of goods sold.”

I agree.  There’s no right or wrong way to do this but, though detail is lacking, I think Zumiez includes some costs that other don’t. 

Selling, general and administrative expense rose from $109 to $122 million both due to store openings and, I assume, because Zumiez had the balance sheet to let it continue to pursue its strategy.  As a percentage of sales, it rose 3% to 29.9%.

Operating profit fell by half from $24.6 to $12.7 million.  Though cash and cash equivalents grew from $78 to $108 million, interest income fell from $2.059 to $1.176 million, reflecting not only the difficulty in finding yield under current conditions but, I suspect, an unwillingness to take risk.  Net income fell from $17.2 to $9.1 million for the year.

Comparing fourth quarters you can see what looks like the beginning of some level of economic recovery (this is not unique to Zumiez).  Sales rose 5.5% from $125.5 to $132.4 million.  Same store sales had fallen 13.4% in the quarter ended Jan. 31, 2009.  They only fell 1.7% in the quarter ended Jan. 30, 2010.  Okay, so maybe that isn’t good news but it’s sure less bad.  Gross profit as a percent of sales was up from 32.4% to 36.3%.  Net income rose from $6.3 to $8.8 million in the quarter ended January 30, 2010 compared to the same quarter the previous year.

The balance sheet has actually strengthened slightly from last year by the measures I use and is in good shape.  I won’t bore you with a detailed analysis of nothing interesting.

Now we’re back to those pesky strategic issues and you know what?  I don’t think I’m going to write a new conclusion.  I’m just going to go see if I can’t use the same one I used when I wrote about Genesco (the owner of Journey’s) a few days ago.  Here it is.  I’m quoting myself, which is a little strange.

“I wrote not too long ago about Billabong’s retail strategy.  They might agree with Genesco executives about how the retail environment is evolving.”

“My own expectation is that due to some of the pressures on core store described above, their numbers will tend to decline until we have just the right number to service the enthusiasts who are truly prepared to pay extra for expert advice and service in a community based environment.  I don’t know how many stores that is or how long it takes, but when it happens, we will have come full circle in the action sports core store business; because that’s how it use to be.”

Zumiez thinks they can be a core store in a mall.  They are the only one who puts it quite so directly, but others are thinking that way too.  If they’re right, and they have other business advantages (as described above) what does the model of a successful independent core retailer look like?

I’m going to the IASC sponsored skateboarding conference this month and am going to moderate a panel discussion on retailing.  As you can see, I’ll have some interesting questions to ask.

 

Genesco’s Take on The Retail Business

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Genesco, the owner of Journey’s, reported its results for the quarter and year ended January 10th in early March. A couple of days later they made an investor presentation that discussed these results. I’ll talk briefly about their numbers, but what really caught my attention was their discussion of the retail environment and their retail strategy.

Genesco operates 2,270 retail stores in the United States and Canada. 90% of their revenues are retail and 10% wholesale. Revenues for the year were $1.57 billion, up only slightly from the previous year’s $1.55 billion. Earnings for the year were $28.8 million compared to $150.8 million the prior year, but there was a huge legal settlement that accounted for $124 million of the difference. The company says that adjusting for that settlement and some other non operating items, earnings from continuing operations grew from $40.8 to $43.1 million. Net earnings per share declined from $1.87 to $1.81.

Comparable store sales were flat in the 4th quarter compared to the same quarter the previous year. The Hat World group increased by 6% and Journey’s declined by 3% in the quarter.
 
The Journey’s group represents 48% of the year’s sales. Hat World group is 30%. However, they each generated about the same level of operating income during the year. The Journeys group, which includes Journeys, Journeys Kidz, and Shi by Journeys includes 1,025 stores of which 819 are Journeys. The Hat World group had 921 stores at fiscal year end.
 
Genesco is looking at “very modest” store growth in Journeys. They say they don’t want to have happen to them what has happened to other retailers who have over extended themselves on their store count. They mention Footlocker, The Gap, and Starbucks as retailers who are closing stores because they got a bit overextended. They might have mentioned PacSun as being over extended as well. They plan to open only 50 net new stores over the next five years across the whole company. The majority will be in the Hat World group.
If you can’t grow stores, you’d better improve your comparable store sales and control costs. One of the trends they think may be favorable to them is “a shift out of athletic shoes into brown.” They say they are only seeing hints of it now, but should know in the spring. That should get our attention don’t you think? Would it be completely a surprise given the number of athletic shoes and shoe brands out there? Yes, there can be too much of a good thing and markets can become saturated.
 
They also note that they have another wave of store leases coming up for renewal. They expect to get lower costs and more favorable terms when those leases are renegotiated. Overall, they expect that with very modest store growth and comparable store sales growing by only two to three percent, they can expand operating margins from the current five to eight percent and grow earnings per share by 15% to 20% annually. Obviously, they see a lot of opportunity in reducing costs and operating efficiently.
 
The other thing that’s happening, as they describe in discussing their hat, uniform and sport apparel business, is that they “…are consolidating the industry. The mom and pops are going out of business or they are credit constrained and can’t stay fresh.” That sounds the slightest bit familiar.
 
The hat business, by the way does include stores that just sell hats. But it also includes stores, under the Lids name, where you can buy branded sports apparel of all kinds and the uniforms that you need, for example, for school sports. They go very deep in their hats, apparel and uniform stores, and the merchandise mix favors the local teams.
 
President and CEO Robert Dennis talked about how the economics of their hat and hat related business has changed as they have gone from 150 to 800 stores since he got there. The difference, he says, “is enormous.” There is tremendous leverage with landlords, the leagues from whom you license product, vendors, and infrastructure.
 
He notes that the team sports business is highly fragmented with perhaps 5,000 dealers, and Genesco’s business in this area is already the second largest even though it’s small. He doesn’t quite know whether to characterize their strategy in this space as a rollup or displacement. But he notes that when, for example, a five store chain has a lease coming up for renewal, it will find Genesco on their landlord’s doorstep taking over that space. Wonder who the landlord would rather have as a tenant? He also characterizes most of these small players’ systems as being “from the dark ages.” That, I’m afraid has the ring of familiarity as well.
 
Action sports is kind of in the hat business, but we’re sure not interested in selling uniforms and team jerseys. But Genesco’s description of this retail environment and how they take advantage of it has to sound at least a little familiar as well. Larger retailers in our space are certainly taking advantage of the same pressure points Genesco is, and we can’t expect it to stop.
 
I wrote not too long ago about Billabong’s retail strategy. They might agree with Genesco executives about how the retail environment is evolving.
 
My own expectation is that due to some of the pressures on core store described above, their numbers will tend to decline until we have just the right number to service the enthusiasts who are truly prepared to pay extra for expert advice and service in a community based environment. I don’t know how many stores that is or how long it takes, but when it happens, we will have come full circle in the action sports core store business; because that’s how it use to be.