Action Sports Market Evolution as Reflected in VF’s Quarterly Results

VF released its earnings and held the quarterly conference call yesterday at 8:30 Eastern time. I’m not quite dedicated enough to listen to it at 5:30 AM on the West coast, but I did listen to the replay later in the morning. You can see the press release here. Remember, we don’t have the SEC filing on the quarter yet, so though the numbers are the same as what you’ll see in the 10Q, we do get management’s spin on things- their “happy dance,” as I like to call it.

The Numbers 

There’s no doubt VF had a good quarter.  For the quarter ended September 30, revenues were up 7% to a record $2.2 billion and gross margin at 46.5% was the highest ever. Net income for the quarter was up 11.4% to $243 million. For nine months, sales have risen 5.1% to $5.576 billion and net income is up 31% to $517 million. They accomplished this while increasing marketing, administrative and general expenses in both the quarter and the nine months compared to the same periods the prior year. The balance sheet is very strong with $403 million at the end of the quarter. They’ve got no real financial limitations in carrying out their strategy.
 
You may recall that VF divides their business into six segments they call coalitions; outdoor and action sports, jeanswear, imagewear, sportswear, contemporary brands, and other. The table below, taken from the press release, shows sales and  what I think are operating profits for each segment, though they just call it profit. As you can imagine, they were almost giddy with the
 
 
results and opportunities they see in outdoor and action sports.   They said that revenues for the North Face and Vans rose in the quarter by 17% and 19% respectively. The whole coalition rose 14%. The coalition’s growth for nine months was 12%. For the quarter, the outdoor and action sports coalition generated 59.3% of total coalition profits and 46.9% of sales. For nine months, the numbers are 50.5% of profits and 41.4% of sales.
 
You can understand the focus on outdoor and action sports. The other coalitions didn’t perform as well and aren’t as large. Jeanswear is actually down for nine months and up only slightly in the quarter. That was impacted by VF exiting the jeans mass market segment in Europe. Imagewear revenues are up 10% for the quarter but just 5% for the year. Its profit, however, increased pretty dramatically as you can see.
 
Sportswear revenues were down for both periods and profits fell rather precipitously, especially in the quarter. This is explained partly by some Nautica shipments being moved from the third to fourth quarter.   Contemporary brand revenues were up 11% for nine months, but pretty much level for the quarter. But profits in that segment fell hard in both time frames.
 
You can see why they spent so much time on outdoor and action sports. It’s the biggest chunk of their business, it’s performing well, they see lots of opportunity, and the news in some of their other segments isn’t as good.
 
Implications for the Action Sports Market
 
What I really found interesting- more than the financial statements- were a handful of observations made about their business. Those included:
 
  • They have 779 retail stores (retail comps were up about 3% for the quarter) and are on track to open 85 stores for the year. Direct to consumer revenue was up 10% for the quarter (18% in outdoor and action sports).
  • Marketing spending is up 35% for the quarter. Year to date they’ve spend an additional $50 million and expect to spend an incremental $45 million in the fourth quarter. Half of this will go to the North Face and Vans.
  • They are “…adding top freeride and slopestyle skiers, and halfpipe snowboarders to our athlete team to extend the reach of The North Face(R) as a snowsports brand during the upcoming winter X Games.”
  • In the fourth quarter and going forward into next year, they expect gross margins to be “stable.” That is, not up though in another context they note it is improving in retail.
  • They expect that their average wholesale price will be up next year. There was a lot of discussion about the cost of cotton.
I slept on this to see if an eloquent way to tie all this together would explode fully formed into my brain. It didn’t, so I guess I’ll just start writing. The North Face as a snowsports brand just sort of stopped me in my tracks. Can any brand that makes anything to be in cold weather become a snowsports brand if they have enough resources to establish the marketing position? If you’re a snowsports brand, are you an action sports brand?
 
Just what is the action sports market these days anyway? I don’t think the action sports market grows just because VF (or Nike, or Billabong, or Burton, or Quiksilver, etc.) sells one more piece of stuff to one more person who’s never been near a skateboard, snowboard, or surfboard. I know that there’s still a meaningful connection between some people who don’t participate and the “core” market of those who do, but as you get further and further from that connection and deeper and deeper into the distribution can you still talk about being an action sports brand in a meaningful way?  That is, in a way that helps you run your business.
 
Growth in the action sports market is related to growth in participation, and I don’t think we’re seeing much of that right now. As a brand, it’s dangerous to believe yourself an action sports brand once you move beyond the participants and its relatively immediate environment because you just won’t have the customer connection you think you have. 
 
VF, of course, doesn’t see itself as an action sports brand, but as a portfolio of brands some of which are in action sports. Maybe they’ve got the resources and management to make The North Face into a snowsports brand (Please, no North Face snowboards).   That won’t make it an action sports brand, but it will contribute to the confusion (at least to my confusion) about what this market is and is becoming.
 
Meanwhile, they’ve got 779 retail stores and counting. And speaking of confusion, which brands will they carry in their stores? Just their own or brands they don’t own as well? Will the brands they carry but don’t own want to be in those stores? Can they afford the possible sales decline that will occur if they aren’t in those VF (or Billabong, or Nike, or Quik) owned stores? Do more brands have to open more retail stores as a strictly defensive move to preserve their sales volume? 
 
And this is all going on while cotton costs are going to lead to some inevitable price increases and no growth in gross margins while consumers are cautious about their spending. This is happening to VF (and others, we already know) even with their sophisticated systems, supply network, and negotiating power. How will it impact smaller companies?
 
Those of you who have been around a while remember when it was clear what was and was not the action sports business. You knew who your customers and potential customers were. My suggestion, if you really are and want to be in the action sports business, is that you go back to that.   I’m not saying don’t grow. But don’t delude yourself into believing that the real action sports market and your target market is $10 billion or $20 billion or whatever the apparel/fashion/lifestyle market is. That is not the action sports market no matter how many big companies with their very own retail chains say it is.

 Dance around the 800 pound gorillas. Not with them.  

 

6 replies
    • jeff
      jeff says:

      Daniel,
      That’s why you can dance around them. Though they are getting more nimble than they use to be. Maybe another accurate way to put it is that they aren’t prone to risk taking.

      Thanks for the comment.

      Jeff

  1. George Powell
    George Powell says:

    I enjoy your commentary Jeff. Truthfully, however, when you dwell on the quarterly reports of public companies I have to really focus to stay interested… but you know I am a product guy, not a financial guy. It definitely does matter how they are doing though, and we need to know how big their inroads into our industries are, so good on ya mate’ for taking the time and effort to do this for our industry.

    It is clear to me that all the larger players who can, are going vertical these days, from Billabong, VF, Quiksilver and Nike to Zumies, Wallmart, and Target, and the handwriting is on the wall for smaller entities who are specialized in either product manufacturing or distribution. There is tremendous pressure on small individual retailers and manufacturers from large chains and Public Multi-Nationals (PMN). I am always amazed that those retailers and manufacturers who are threatened, either do not see the threat (because it has not come to their town yet), or they do not feel the resistance stopping their growth because they are too small to be “restricted” or in the radar of the major PMNs yet.

    Speaking of myopia, the consumer is especially guilty of short term thinking when it comes to voting with their dollars. I believe they too often choose the warehouse shopping experience over the mom and pop full service experience in order to save a few bucks. I don’t know, did this start with gas stations and spread? Regardless of its genesis though, it has spawned Wall Mart, Target, Home Depot, CostCo, and Sport Authority, stores where service is virtually nonexistent and adequate product knowledge IS nonexistent. In these stores, you have three levels of choice, cheap, medium and sort of expensive, but not the best. There is no one to tell you the real difference between the products, and “green cards” abound, telling customers how environmentally conscious each manufacturer is, to mask their real goals. These stores with seemingly large inventories, offer shoppers false alternative choices (would you like to choose this junky product or this slightly less junky product, or our rip off of this well known brand’s decent product?), and in the long term, by reducing competition, will be able to choose what the consumer will be able to find in a local store. OOps what happened to my cheap prices and better choices when there is no competition? Has anyone ever heard of “the company store”? Think about where this trend is going.

    Are we all sheep, just being lead by our desire for cheaper products into the trap of having to shop at the company store? I guess you could read that Multi-National Public Corporation. It is a very clever strategy…use greed to attract investors to buy stock in your Public Corporation, use this money to out compete/out market the competition, use greed to attract customers by offering them better prices, then you end up with a virtual monopoly or economic oligarchy, ensuring outrageous profits and control of the markets indefinitely into the future. Once you control the market, you own “the company store”.

    From the consumer’s viewpoint, I guess it is all about convenience and perceived value, not quality, selection or real value. In the beginning, the chain store and the locally owned retailer competed side by side, and consumers chose chain stores because they offered the same bulk products for less money and sometimes had a better selection (in key economically important product lines). When they went to the sore to take advantage of the loss leaders, then they also purchased lots of other stuff because of the broad category selection, while they were there. It seemed like a better deal to consumers, and so they have largely chosen MPC over most of the local based stores. Only the specialty store with a large enough customer base to support their offerings of stuff the MPCs don’t find profitable enough to carry yet survive today. Chain stores can buy their products for less than single entities, and either enjoy greater profits or use the lower costs to gain customers through lower prices. If they are smart, they usually lower prices until their competitor is gone, then they can raise prices with no resistance.

    I am a big believer in diversity, competition, and fairness, but this is seemingly an antiquated view with little chance of success in the short term, and perhaps not in the long term either, if I am forced out of business by competitors who are so big, they can literally price me out of the market, or cut me off from meaningful distribution outlets in my major markets.

    This is where skateboarding and indeed, our entire world’s economy is going. All the means of production, distribution, finance, transportation, and even our government are going to be controlled by an ever shrinking number of very rich, powerful, people who can live anywhere in the world they choose and buy anonymity to prevent the frustration of their serfs and peons from ever reaching them personally. Yea, big conspiracy theory… not really, just “human nature” manifesting in greed, lust for power, and self-protection, all blending into a new Medieval Age of “The Global Economy,” where secret Kings control governments, markets, and the lifestyle of the world’s people they live off for their own personal good.

    Why don’t more people see “what is going to happen next?” Perhaps because they are being moved backwards economically by these Public Multi-Nationals, and don’t have any choice but to shop at the cheapest place they can find to feed their families and pursue the “American Dream”. Well, I could go on for a while on this very complicated, complex topic, but I’m sure you get my drift. What can we do about it at a global level? I don’t know. What can we do about the current take over of the skateboard industry by large multi-nationals like Nike, Quiksilver, Billabong, and the like? We can fight back against them instead of bickering amongst ourselves as we put our heads underground to avoid seeing or recognizing what is going on.

    It seems to me as though many of the skate-centric marketing companies who have wielded control of the industry for the past 15 years, more often seek personal advantage by cooperating with or trading economic favors from multi-nationals by offering legitimacy or lack of resistance to the large multi-national take overs, in payment for the leg up they get for their cooperation or non-resistance. Can you see a parallel here between those who cooperate with an invader to protect themselves, instead of joining a resistance movement? History abounds with examples of this, and we only have to look at what happened in some of our European neighbors during WWII, as the Nazi machine goose-stepped into their villages, towns and cities.

    What has our country done to try to keep manufacturing here in the US? Essentially nothing. It is now too late to stop the initial tidal wave of destruction, and we must now try to rebuild a new economy based on the minds of our brightest, instead of the backs of our labor. Will this create a broad based middle class? No. Will this result in large Multi-nationals attracting all the brightest and most able to do their bidding by offering a little higher salary? Yes. Will these mega corporations, who are based on greed, not better products, in spite of their BS propaganda to the contrary, ultimately create a Medieval Global Economy where they control the “technical nobility” and keep “the people” at a subsistence level lifestyle, where they have no choice but to shop at the company store? What do you think?

    • jeff
      jeff says:

      George,
      Thanks for the post and interesting ideas. I know my financial stuff can sometimes be the cure for insomnia but, as you say, somebody has to do it. In my defense, you should try reading one of the SEC filings I get the data out of. That makes what I write seem practically light and airy.

      George, I want to lay out a little background here, so bear with me and I’ll get back to the issues you’ve raised.

      For about five centuries the Western economic model was successful and dominant. As a country, the U.S. extended this dominance for a couple of additional decades by coming out of the Second World War with its manufacturing plant strong and intact. Its potential competitors were largely flat on their backs. Bombs do that.

      Now, we’re in a probably inevitable period of relative decline, and it’s uncomfortable and unpleasant. I’m afraid it’s going to last a while. A traditional recession occurs when supply gets ahead of demand and the manufacturers realize it. They cut back production and some people lose their jobs. Eventually, demand catches back up with the reduced supply, employees are hired back, and growth resumes. That has been our experience with most post war recessions.

      But financially caused recessions, of which the Great Recession is one, are different. They involve high asset prices, what turns out to be excessive debt and leverage, slowing growth, a large current account deficit and an apparent suspension of the realization that there’s a relationship between risk and return. There’s a lot of cognitive dissonance involved- the tendency we all have to focus on information that supports our point of view and, conversely, to rationalize away what doesn’t.

      As it did in this case, the end begins with a liquidity crisis which may seem localized (remember how the subprime crisis was going to be contained?), but turns out not to be. The aftermath of a systemic banking crisis is, historically, a severe and protracted decline. It really just makes sense. Deleveraging takes time. Money that is being used to fix balance sheets and pay down debt isn’t available to purchase goods.
      I did a book report on This Time Different; Eight Centuries of Financial Folly and you can read it here. The
      point of the book, of course, is that it hasn’t really been different for 800 years.

      I know this is all kind of depressing, but in the longer term I’m optimistic for four basic reasons. First, this country has geopolitical advantages that most people aren’t really aware of. They revolve around our borders, the attitudes of our people, our river system, ports, and resources. They are simply immense.

      Second, I remember the example of Canada. Around 1995 they were in what was measurably a bigger financial mess than we are in. Somehow, they managed to make the hard decisions that were required to make and turned things around in a manner of three or so years. I haven’t studied it enough to know what triggered their sudden burst of resolve, but I’m hoping it will happen here eventually.

      Third, the trends you raise are valid and of concern and seem particularly troubling under current economic conditions. But when we extrapolate into the future based on what’s happening now, we’re mostly wrong. We can’t imagine what’s going to happen in the future. But just because something seems highly improbable to us doesn’t mean it’s unlikely. Think about that- think about all the things that could happen tomorrow that we can’t even imagine today. Remember in the 1980s when “everybody” knew that Japan was going to take over the world? Didn’t quite work out that way. Now it’s China. We’ll see.

      That gets me to point four. I don’t know what they all are, but I know that new industries and jobs are going to be created. I imagine some jobs are going to be in energy, water management, biotechnology, materials, and agriculture. Then there’s all the stuff I can’t even imagine yet.

      I worry about two national trends in this area of job creation. The first is the environment for small businesses. By small I don’t just mean a single core store. I mean a company those employs hundreds of people as well. They are the engine in this country for jobs and innovation and I’d really like to see them nurtured. The second is our education system. If we don’t turn out people who can do the jobs in the industries where we have a way to compete well, then we won’t compete. Our education system is a significant strategic advantage I’m afraid we’re pissing away.

      To carry the issue of doing what you can do better than anybody else a step further, I wonder why we’re still making cars in this country. I understand the economic and social reasons for the GM bailout, but it seems to me the best we can do is make cars as good as other countries- not better. I am not recommending blowing up the automobile business, but when we had all those manufacturing jobs that supplied middle class life styles to millions, it was because we made products people wanted to buy and were willing to pay a good price for. Okay, granted they wanted to buy some of them from us because their factories were bombed into dust, but I guess you get your competitive advantage where you can.

      And that might actually bring us to the skate board business. You seem to be suggesting, George, that the skate companies could have done something of a cooperative nature that might have prevented them from being in the difficult situation they find themselves in today. I would be for that, but I’ve never seen it happen in an industry. Companies just don’t seem to be able to cooperate on competitive issues. Each company will do what they perceive as being in their own best interest.

      The best chance for them to avoid the circumstances of today probably happened at the peak of the skate hard goods boom around- what- 2003? At that point, with strong balance sheets, high demand, and before the competitive conditions deteriorated so badly, they might have been able, as individual companies, to expand their brand presence into related products. But honestly, I just don’t know if any of them had the resources to succeed even then.

      As I think about it George, I’d also note that one of the things that got skate industry companies in trouble was too much cooperation. Without being too specific, let’s just say that too much cooperation can stifle creativity and risk taking. It leads to fat and happy syndrome which the market always punishes.
      I know the analysis I’ve provided above doesn’t directly address some of the issues you raise that we’re both concerned about. But if the economic crisis didn’t create those issues it certainly made them more urgent. I suspect neither of us would be as concerned if things hadn’t gone to hell. So I thought the perspective I tried to give above was worthwhile.

      But to your specific points. Going vertical by public companies was inevitable as they sought the growth Wall Street required in markets that weren’t growing very fast. They are not going to get it from core stores. I’m right with you being amazed at companies who see what’s happening but don’t seem to want to do anything about it. But the market takes no prisoners. For better or worse, they just won’t be around.

      I am not as worried as you are about consumer behavior in a general sense. Right now, they are all especially price sensitive, but you are completely correct to point out that product quality is being leveraged down and down and down in the overall economy to try and make a few more cents. My Sears microwave broke after about a year and a half. The warranty was only a year. You and I are both old enough to remember when if you bought a microwave it would still be working 20 years later, though it would be really, really ugly. I didn’t respond by buying another one Sears. I bought it at Ikea where they offer a five year warranty.

      Competitive pressures do take things to extreme, but they ultimately bring them back the other way. Regression to the mean. I believe there will always be competition unless we screw things up beyond what I believe is likely.

      Have a little faith George. Consumers will figure it out, but it takes time. Remember that concerns about mass produced food have been around for years, but it’s only recently that the “small food” movement has really started to take hold. The first TV was demonstrated in, I think, 1939 but it was the mid to late 50s before it took off (for better or worse). The cycles are longer than we like to admit. Have you noticed how we all took for granted an unprecedented period of growth from 1980 to 2000? But we seem to have a hard time believing that a period of decline might last a while as well, but not be indicative of our fate.

      Consumers will pay for quality when they perceive it exists. You and I, however, are in an industry where there’s quality all over the place. Is there any bad product in our industry anymore? I was in a Sports Authority the other day and looked at their snowboards. They had some last year’s models for $159. Anything wrong with those snowboards? Nope. If you can buy it everywhere and it’s all good stuff, give me a reason not to buy on price. I don’t think that’s the consumer being stupid. I think that’s the consumer being smart.

      I don’t think it’s a problem that manufacturing jobs have left the United States. I think the problem is that they haven’t been replaced by anything that pays a similar wage. Jobs come and go. Industries come and go. If they didn’t, we’d be really screwed. The process isn’t pleasant, but it’s necessary.

      Look again at my concerns about education and small businesses above. Can we recreate the middle class in the way it was 30 years ago? Probably not- the competitive environment has changed too much and the change was inevitable. But we can recreate it in a new way, and probably a way neither of us can imagine.

      Okay, George, I think I’ve now written more than you wrote and I didn’t mean to. Thanks again for taking the time to do this. Hope we can continue the conversation in person.
      Jeff

  2. Benjamin Zlachevsky
    Benjamin Zlachevsky says:

    Did VF mentioned Reef at all in the report and I was not paying attention??? ………RIP?
    Jeff, your “Gorilla” insight is superb.
    George, even that i am not from the US, I do understand how this Multi-National companies are killing the little and not so little guy, aided by consumers that do not care for the industry, and will not care at all, as they are NOT ACTION SPORTS enthusiast at all (and that is fine), they are consumers looking for a good deal.
    Unless they realize how dangerous this is for the average Joe, for themselves, they need to find out that they are shooting at their own feet…
    Being way away from the USA and this even affects me….

    Cheers,
    BENJUCA

    • jeff
      jeff says:

      “Benjuca,
      Not a word on Reef. There was even an analyst who wanted to talk about their brands they don’t usually talk about on the conference call and Reef didn’t come up then. I suspect it’s too small and not doing that well. You can bet we’d hear something if it was growing madly.

      You are right, I think, that many of the consumers that buy what some call action sports product are not action sports enthusiasts. Part of our problem as an industry, perhaps, is that we’ve never recognized that they weren’t. As I’ve written, back in 2007 and before, we thought that any shop that carried hard goods was an action sports core shop. It wasn’t. In the same way, we thought that the action sports business was a lot bigger than it ever was. With everything you and George and I describe going on in the market, maybe it’s time to realize that the action sports market is the market of participants and the first layer (maybe) of non participants who are truly interested in the market and the sports themselves. That’s what it’s always been. If that’s true, it has big implications for how companies think about their markets and their opportunity.

      Thanks for the comment.

      Jeff

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