Big 5 Sporting Goods. What Should We Think About Their Solid Quarter?

At its September 29 quarter end, Big 5 had 433 stores down from 436 a year ago.  Big 5 “…provide a full-line product offering in a traditional sporting goods store format that averages approximately 11,000 square feet. Our product mix includes athletic shoes, apparel and accessories, as well as a broad selection of outdoor and athletic equipment for team sports, fitness, camping, hunting, fishing, tennis, golf, winter and summer recreation and roller sports.”

Almost 55% of their revenue for the quarter came from hard goods.  27.5% was from footwear and 17.1% from apparel. 

I’ve been in maybe a half dozen of their stores, most recently within a couple of weeks.  As you can see from their product description above, they carry a very diversified product mix.  I wouldn’t say it’s well merchandised and I certainly think of them as competing on price.

As I’ve said in prior reviews of their results, that’s not a compelling source of competitive advantage in our current environment.

Revenue for the quarter was essentially constant at $266 million.  But they grew the gross margin from 31.0% in last year’s quarter to 32.3% in this year’s.  They reduced SG&A expense from 29.2% of revenue to 28.9%.  The result was operating income that rose 89% from $4.8 to $9.1 million.  Net income more than doubled from $3.1 to $6.4 million in spite of a tax bill that rose from $0.84 to $2.0 million.

The stock market of course loved that, but I want to dig a little deeper into how they did it.

While total revenues didn’t rise significantly, same store sales were up 0.3% compared to a 2.0% decline in last year’s quarter.  They note that “Sales from e-commerce in the third quarter of fiscal 2019 and 2018 were not material.”  That’s kind of a concerning statement. 

The improvement in the gross margin had three main components.  First was a 0.98% increase in merchandise margins.  “The increase primarily reflects a shift in sales mix towards higher-margin products and a decrease in promotional activities.”

Second was a reduction of 0.78%, or $2.1 million, in distribution expense.  “The decrease primarily reflected a reduced provision for costs capitalized into inventory compared with the third quarter of last year.”  Sounds like a one-time thing.

Third was a $0.6 million increase in store occupancy expense.

From the conference call: “Multiple factors contributed to the margin gains, including the benefit of a product mix shift, reflecting reduced sales of lower margin firearms and ammunition products and increased sales of higher margin opportunistic buys. Additionally, and quite significantly, our margins benefited from a favorable response to our strategic efforts to optimize our pricing and promotion.”

I wonder if those “high margin opportunistic buys” are a repeatable, intentional part of their strategy and would love to hear more about how, exactly, they are optimizing their pricing and promotion.

The $0.8 million reduction in SG&A expense resulted from three factors.  First was a $0.9 million reduction “…due mainly to lower newspaper advertising.”  Most of us are familiar with those ubiquitous Big 5 advertising inserts.  If they are reducing them, I wonder what they are replacing them with.  There’s no mention of a social media strategy.

Second, store related expenses were down $0.7 million “…due primarily to reductions in certain employee benefit-related expenses such as health and welfare expense, partially offset by increased employee labor expense.”  The increased labor costs were the result of minimum wage increases.

Finally, administrative expenses increased by $0.7 million. 

The balance sheet hasn’t changed much since last year, except that the current balance sheet reflects the new accounting standards for reporting operating leases.  Cash provided by operations improved from a negative $8.1 million in the nine months ending last September 30, 2018 to a positive $13.7 million for the nine months ended September 29, 2019.  I also want to highlight the nine months capital spending decline from $8.4 million to $6.1 million. 

So here we are with a solid quarter from Big 5 as measured by the bottom line.  I’ve been encouraging a bottom line rather than top line focus for years now.  This strong bottom line improvement, however, seems caused by one-time events and expense cuts that can’t be continually duplicated.  I am not as optimistic as the people who drove up the stock when the earnings were announced.

We still seem to have a brick and mortar retailer that’s competing based on abroad product offering and price, and its online performance isn’t significant they say.  There was no discussion of strategy in the 10Q or on the conference call- at least partly because no analysts took part in the call to ask questions.

Based on the information Big 5 is providing in its public documents, I don’t understand their strategy for success.

“More of the Same” is Not the Way to Prosper When Change in Retail is Rampant: Big 5 Sporting Goods.

I don’t cover Big 5 every quarter.  However, their 10K for the year ended December 30, 2018 requires some discussion.  They seem to be flailing in the emerging retail environment and seem reluctant to respond to all the changes.  They are betting that their old strategy will continue to work.

It appears I’m not the only one who thinks that’s not the right approach.  Go take a look at a chart of their stock (symbol BGFV) since the start of 2017.  Let’s take a look at the numbers before discussing the strategy.

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In Touch with Reality? Big 5 Sporting Goods Quarter

For its September 30 quarter, 436 store Big 5 reported a small decline in revenue and a larger decline in net income.  More significant to me are comments in the conference call that suggest a very traditional retail focus, rather than one acknowledging the massive changes required to succeed at retail.

Revenue in the quarter fell 1.5% from $270.5 million in last year’s quarter to $266.4 million in this year’s.  54.8% of the quarter’s revenue was from hard goods.  Apparel was 16.9% and footwear 27.8%.  A 2% decline in comparable store sales was the major reason for the revenue decline.  I want to highlight the following comment from the 10-Q as part of the revenue discussion:

“Sales from e-commerce in the third quarter of fiscal 2018 and 2017 were not material and had an insignificant effect on the percentage change in same store sales for the periods reported.”  You might also want to look at their web site.

It’s 2018 and a 436-store retailer has e-commerce revenues that are “not material?”  Hmmmm.  Wonder how much e-commerce related expense it takes to produce “not material” revenues.

The gross margin fell from 32.4% to $31.0%.  Revenue reduction was the biggest cause of the decline.  Second was higher distribution expense of 0.73% including increases freight costs.  Lot of that going on.  Store occupancy costs accounted for 0.42% “…due primarily to lease renewals for existing stores.”

Finally, there was 0.10 decline in merchandise margins.

SG&A expense rose a couple of hundred thousand to $77.7 million.  As a percent of revenue, they rose from 28.6% in last year’s quarter to 29.2% in this year’s.  Minimum wage increases, especially in California where more than half of their stores are located, caused a $400,000 increase with more coming.

Operating income was down 52.7% from $10.2 to $4.8 million.

Interest expense rose from $447,000 to $860,000 reflecting both higher debt levels and an interest rate that rose 1%.  That’s happening to many companies.

Income taxes fell from $3.79 million to $844,000 “…primarily reflecting a reduction in the federal corporate income tax rate…”  The decline in net income was 47.7% from $5.95 million in last year’s quarter to $3.12 million in this year.  Consider how much more net income would have fallen if not for the reduced income taxes.

Net cash used in operations for the six months ended September 30 was $8.06 million, up from $5.55 million in the same six months last year.  You’d rather see cash generated by operations rather than used.

On the balance sheet cash, at $5 million is down about $300,000 from a year ago.  Inventory has risen from $309.3 to $314.8 million.  They note they are carrying over some inventory to next year- a common practice these days (but also indicative of a lack of product differentiation in the industry).  The current ratio has improved from 2.07 to 2.36 times.  Long term debt is up from $46.4 million a year ago to $83.5 million at the end of this year’s quarter.  Equity has fallen by 11.3% from $203 to $181 million.

The quarterly dividend has been reduced from $0.15 to $0.05, reflecting the weaker financial position and operating results.

Let’s move to the conference call.  On the positive side, Chairman, President and CEO Steve Miller says, “With our new POS system now in place, we are expanding our customer relationship management capabilities, which should provide enhanced customer analytics and improve the effectiveness of our marketing efforts.”

Collecting, slicing and dicing, and making better use of customer data is something every retailer has to be figuring out how to do better.  They also are increasing their digital advertising spend at the expense of newspaper advertising.

But other comments seem traditional.  There’s a generic statement about the change happening in retail, but what I hear in their comments is a tactical urgency to deal with the current financial situation (not inappropriate) rather than a strategic acknowledgement that a lot has to change- quickly.

“We are testing pricing strategies to be more responsive to an increasingly promotional competitive retail environment.” He mentions that again in part of his response to an analyst’s question.

Well, okay, but if you’re planning to compete on price with brands lots of others carry with your current real estate model in an environment of over supply and limited product differentiation, you might have a hard time.  No brick and mortar pricing strategy is likely to win in an online world unless the product offerings are distinctive in ways that probably have to go beyond the actual product attributes.

“From a product standpoint, we are accelerating the pace of change within our assortment. This includes downsizing certain product categories to position us to be more aggressive in pursuing product opportunities that we believe have higher growth potential.”

Again, fine, but tactical.  Have you acknowledged the fact that brands are going to turn over faster?  How are you identifying and bringing in new brands and what’s the process for getting them in the right stores?  How’s the micro sorting going?

There are a couple of mentions of finding new ways to reduce expenses.  That’s great, but of course there’s a limit to it and as they describe it, it sounds tactical.  Successful retailers won’t be the ones that reduce expenses; they will be the ones that increase expenses in a way that improves margins, provides a better customer experience, and ties brick and mortar and online together in a way that ultimately reduces costs.

It’s hard to know too much about what’s going on from what they say in a conference call, but I work with what they give me.  I suggest you visit a Big 5 store then perhaps a Dicks and see what you think.  I’d like to see more sense of urgency from Big 5.  An acknowledgement of the interdependence of brick and mortar and online as a means of providing customers with the flexibility and connection they require would make me feel a whole lot better too.