Zumiez’s Strong Quarter; Stores, Stash, Expansion, Strategies, Shrinkage, Wayward, the Numbers

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That’s a lot to cover.  I had some hope this would be short.  Let’s start with strategy and quote CEO Rick Brooks from the conference call.

“Our top and bottom line results…are a direct result of our relentless commitment to winning with today’s empowered consumer. Our success continues to be driven by the strength of our diverse and differentiated assortments that are presented through a seamless shopping experience across all consumer touch points, accompanied by the world class customer service that our teams continue to deliver globally.”

“With the increasingly blurred lines between retail channels, we’ve moved toward a channel-less world in which the empowered consumer isn’t focused on going into a store or buying online but rather transacting with a trusted retailer. With the barriers between the physical and digital worlds coming down and the increased speed at which individuals communicate, trend cycles are rotating faster than ever before. The same holds true for the pace at which demand for emerging brands can go from local to global in nature. In this type of environment where consumers can access so much information, a new level of transparency in retail is being created that is driving out inefficiencies within the market and forcing consolidation in the industry.”

It’s conceptually that simple, but really complicated to do, requiring a long-term perspective, flexibility in thinking and structure, a different attitude towards risk, and a strong balance sheet.  What, exactly, is the formula for management structure and discipline on the one hand, but raging flexibility on the other?

The bottom line, as you see in the quote, is that Rick thinks many of Zumiez’s competitors can’t do it.  Is just operating at the level required by the new environment now a long term strategic advantage?

Rick also commented about trends rotating faster than ever.  A couple of years ago, Rick was expressing the belief that longer trends would return.  It looks like he’s changed his thinking as the competitive environment required.

Okay, on to Wayward.  There’s no mention of the Wayward stores Zumiez has opened.  There are only two, they haven’t been open long, and the numbers are obviously not significant.  But I liked the concept and am kind of curious.

At the end of the quarter on August 4, Zumiez had 611 stores in the U.S., 50 in Canada (Room for more growth there? I’d guess not much), 35 in Europe- Blue Tomato, and 7 in Australia- Fast Times.  They expect to open 13 stores this fiscal year including five in the U.S., seven in Europe, and one in Australia.  I want to put that in context of their comment on expansion in the 10Q.

“We plan to continue to open new stores in the Canadian, European, and Australian markets. We may continue to expand internationally in other markets, either organically, or through additional acquisitions.”

That’s part of a risk factor telling us that theirs plans for international factors could be, well, risky.  Zumiez has acknowledged that they were running out of room for new stores in the U.S.  However, their concept of “trade areas” and a channel-less world coupled with ongoing industry consolidation makes me wonder if they can’t grow revenues in the U.S. without more stores.  I am certain they are wondering too.  There’s no reason that concept would only apply to the U.S.

CFO Chris Work reminds us in the conference call that Zumiez is doing almost 100% of their ecommerce fulfillment in their stores.  It sounds like they are doing it without much added expense.  In a previous call (but only one I think) Rick told us how in store fulfillment was allowing Zumiez to spread the cost of these sales over the existing expense structure.  That is very powerful.  I’m surprised nobody is pushing for more details.

In recent quarters, Zumiez has noted an issue they are having with shrinkage.  Chris says it cost them about $5.4 million in 2017, and they are continuing to work on it.  I wanted to raise it in conjunction with in store fulfillment because I have the sense the two happened around the same time.  I know correlation doesn’t prove causality, but I’m intrigued.  I almost hope it’s somehow related to that.  Zumiez decades long process of hiring, supporting, training, and advancing people who are part of Zumiez’s customer base has been key to their success.  I would think/hope it would mitigate against shrinkage.  If suddenly it’s not, I’d be concerned.  Shrinkage in the quarter was 0.3% lower than in last year’s quarter.

Last, but not least, their loyalty program called Stash.  What I wanted you to think about is that loyalty programs become more valuable as the quality of your algorithms and customer data rises.

Finally, we get to the numbers.  Revenues in the quarter rose 13.9% to $219 million, up from $192 million in the same quarter last year.  U.S. revenues rose 14.2% from $165 to $189 million.  In Canada, the increase was from $11.3 to $12.5 million.  Europe rose 14.8% from $11.3 to $16.1 million.  Australia rose from $1.687 million to $1.787 million, or by 5.5%.  Overall, U.S. revenue represented 86.15% of the total, up from 85.94 in last year’s quarter.  I imagine the U.S. percentage might be lower if not for the strong U.S. dollar.

“The [revenue] increase primarily reflected an increase in comparable sales of $12.8 million, an increase of $9.9 million due to the calendar shift to include an additional week of back-to-school season, and the net addition of 11 stores (made up of 10 new stores in North America, 5 new stores in Europe and 1 new store in Australia partially offset by 5 store closures in North America) subsequent to July 29, 2017.”

Comparable store sales rose 6.3%.

The gross margin rose from 31.1% to 33.1%.  “The increase was primarily driven by 160 basis point leveraging of our store occupancy costs, 30 basis point increase in product margin and 30 basis points in lower shrinkage of inventory partially offset by 30 basis points in higher shipping costs.”  Note the impact of leveraging occupancy costs and refer to the discussion of in store ecommerce fulfillment.

SG&A expenses as a percent of net sales decreased 150 basis points for the three months ended August 4, 2018 to 30.0%.  “The decrease was primarily driven by 140 basis points from the leveraging of our store costs and 40 basis points decrease due to the timing of annual training events partially offset by a 40 basis point increase related to the accrual of annual incentive compensation.”

There’s that improvement due to leveraging store costs again.  I’m growing very fond of in store ecommerce fulfillment.

Net income rose from a loss of $608,000 to a profit of $4.38 million.  That’s usually what happens when you increase revenue and gross margin while reducing expense as a percent of revenue.

The balance sheet remains strong with more cash and no long-term debt.  Cash provided by operating activities was $15.5 million for six months, up from $3.77 million in the same six months last year.  I’m wondering why they’ve got $5.6 million in short term debt on the balance sheet given all the cash they’ve got.  Maybe it’s a non-U.S. thing.

Good quarter.  As usual, there are interesting things to think about in the 10Q and conference call if you read carefully.  I look forward to their next quarter.

MooseMart- the Moosejaw Store on Walmart

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Moosejaw, Wikipedia tells us, “…is an online and brick and mortar retailer specializing in outdoor recreation apparel and gear for snowboarding, rock climbing, hiking, and camping. The company was founded in 1992 by Robert Wolfe and David Jaffe, two longtime friends who chose to sell camping equipment instead of becoming wilderness guides. [3] Moosejaw is known for its nonsensical marketing called “Moosejaw Madness”.”

It’s got ten retail stores, most of which are in Michigan.  It was acquired by Walmart for $51 million in February 2017.  Previous investments had been made by some private equity firms.

Things got interesting about two weeks ago when Walmart opened a Moosejaw premium outdoor store on its website.  When I first went to Walmart.com to check it out, it was prominently featured on the home page.  Now, it’s gone though the Moosejaw web site can still be accessed from the bottom of Walmart’s home page along with the other brands it owns.

That’s not a complete surprise given the brouhaha that was stirred up when outdoor industry specialty brands that were being comfortably sold through Moosejaw found themselves featured on a Walmart related site and some of their specialty retail customers went through the roof and told Walmart and Moosejaw in no uncertain term that they didn’t want to carry brands that were part of it.  That happened even though the products on the Walmart/Moosejaw site weren’t discounted.

Gee whiz, it turns out that some people think that distribution matters even when the profit margin remains the same.  I think they’re right.  That’s particularly true when your product can be easily replaced by a bunch of other branded product with generally equivalent features and pricing.

The perceived quality of your brand matters and some of the perception comes from scarcity, which is not exactly how you think about something that can bought through Walmart.

Moosejaw CEO Eoin Comerford published an open letter to the outdoor industry defending the decision to open the store on Walmart.  You can read it here.

He said he had been surprised at the vehemence of the attack from certain retailers and said that, “…the industry remains predominantly male and remarkably white. If we’re going to grow this industry beyond its exclusionary, historical norms, we need to reach new audiences … younger, more female, more diverse.”

I think we may be into the third decade where I’ve pointed out that, “Every company will do what it perceives to be in its own best interest.”  CEO Comerford probably won’t get a lot of push back from suggesting that we’d like/need a more diverse customer base.  But I think he’s wrong to suggest that, as a result, “the industry” should support the Moosejaw store on Walmart.

“The industry” doesn’t make those kinds of decisions.  Brands do.

Perhaps some brands can do well there.  But others-not so much.  It’s up to each brand to decide which side of that divide they fall on based on their competitive positioning and customer characteristics.

It sounds like brands were caught by surprise.  I called up a friend after I saw his brand on the Moosejaw site on Walmart and he didn’t know anything about it.  I’m wondering if Mr. Comerford, or at least somebody in his organization, didn’t reach out to at least some of the brands to find out what they thought about it before the site went live.  I suspect they would have gotten an earful.

But Moosejaw, remember, is owned by Walmart.  And for all the fatuous blather we get in press releases when one company buys another one about how the acquired company is going to be left alone to do what it does so well, etc., etc., etc., when you’re bought, you’re bought.  I’m not completely sure Mr. Comerford had a lot of choice.

I see a number of pages of Moosejaw branded products on the Walmart web site.  I wonder if that’s good for the brand.  I’d also love to know just how much of which purchased brand was sold at the store on Walmart while it was open.

Moosejaw is barely a flea on the Walmart brontosaurus.  But I hope Mr. Comerford drags some senior Walmart executives to some meetings with some of the retailers/brands who objected to the store.  Everybody might learn some good stuff.

Uh, can I come to the meetings?

“A Destination Retailer.” Tilly’s August 4 Quarter

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In its 10-Q Tilly’s describes itself as “…a leading destination specialty retailer of casual apparel, footwear and accessories for young men, young women, boys and girls with an extensive assortment of iconic global, emerging, and proprietary brands rooted in an active and social lifestyle.”

We all know what a destination retailer is; a store that customers go out of their way to shop in.  I think Tilly’s has to be a destination retailer because of where they locate their stores; “…in malls, lifestyle centers, ‘power’ centers, community centers, outlet centers and street-front locations.”  If you are a destination retailer, you can be a bit more agnostic about locations.  You can put them where it makes  sense from a cost of operation perspective.  As they put it in a recent 8-K filing, “We have a flexible real estate strategy across real estate venues and geographies.”

Tilly’s “…operated 226 stores, including three RSQ-branded pop-up stores, in 31 states as of August 4, 2018 …Customers may also shop online, where we feature the same assortment of products as carried in our brick-and-mortar stores, supplemented by additional online-only styles. Our goal is to serve as a destination for the latest, most relevant merchandise and brands important to our customers.”

I want to note the use of pop-up stores.  These are not just tents which are there for a day or a week.  They average 2,600 square feet.  Tilly’s standard stores average 7.600 square feet.

I expect these are short term (months?) leases from owners happy to have somebody paying them some money.  I expect to see more of this- not just from Tilly’s.

The question is how you become a destination retailer if you carry many to most of the same brands your competitors carry.  Look at the brands they carry here.

From the same 8-K mentioned above, here’s how Tilly’s describes their efforts to differentiate their stores and be a destination retailer.

“We believe our experiential marketing efforts in our stores foster an environment that is vibrant, stimulating and authentic, serving as an extension to our customers’ individuality and passion for an active, connected lifestyle. We accomplish this by blending the most relevant brands and styles with music videos, product-related visuals and a dedicated team of passionate store associates. We continuously think of fun, creative ways to drive consumers to our stores, including augmented and virtual reality experiences, various social events, and partnerships with some of our vendors, all of which are posted on various social media platforms, further driving brand awareness. Additionally, in order to improve the look and feel of our stores, we have remodeled or refreshed nearly 90% of our stores in the last three years.”

Decide for yourself whether Tilly’s is a destination retailer.  The point I want to make is that being a destination retailer combined with skill and agility in managing your store portfolio is a very positive combination, as each of those characteristics enables the other.

Tilly’s had some problems during its fiscal 2012 through 2015 years.  Things started to improve after they brought in Ed Thomas as CEO in October of 2015.  If you read in that 8-K what they believe their strength are, you won’t find much different from what other successful brands and retailers are doing.  The question, as usual, is whether you have the balance sheet and management team to do these “things of importance” better than the competition.

Tilly’s has a solid balance sheet, allowing them to think long term, react to bumps in the road, and deal, or even prosper, in an economic downturn which, I guess, will eventually happen.  In the first six months of their fiscal year, cash generated from operations was $22.0 million, up from $2.87 million in the first six months of last fiscal year.

Revenues for the quarter ended August 4, 2018 were $157.4 million, up 13.4% from $138.8 million in the same quarter last year.  E-commerce revenues rose from $16.6 to $19.7 million, or by 18.7% and represented 12.5% of total revenues, up from 12.1% in last year’s quarter.  Comparable store sales, including e-commerce, were up 4.4% compared to an increase of 2.1% in last year’s quarter.

Of the $18.6 million increase in revenue, $12.3 million was the result of the quarter having a 53rd week.  It happens every few years.

The gross profit margin rose from 29.5% to 31.8%.  Product margins were flat.

SG&A expense as a percent of revenue fell from 30.4% to 23.9%.  In dollars it declined from $42.2 to $37.6 million.  This was the result of a reduction in legal expense of $7.6 million compared to last year’s quarter.

Operating income improved dramatically from a loss of $1.2 million to a profit of $12.5 million.  However, “Of this $15.4 million improvement in year-over-year operating income, approximately $7.6 million was attributable to the aggregate year-over-year impact of the legal matter noted above, approximately $5.2 million was attributable to the retail calendar shift impact noted earlier, and approximately $2.6 million was attributable to increased comparable store net sales results.”

Net income improved from a loss of $596,000 to a profit of $9.7 million, but don’t forget the impact of the factors mentioned in the paragraph above.

Tilly’s is doing a lot of what I think are the right things. We’ll see if they can continue to do them better than some of their competition.

Globe Had a Good Year- But It’s Hard to Tell How They Did It

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I like Globe.  They’ve always had a good attitude, have been able to spot opportunities, and have acknowledged and moved to correct mistakes when they happened.  They are, as a result, a company I want to write about because I think we might all learn something.

Unfortunately, their required statutory report for the year ended June 30, 2018 is somewhere between not much and no help.  How can a 60-page report not even list the brands they own and tell us at least a bit about how they are doing?

The answer is that Globe is closely held by the Hills, has few shareholders, isn’t closely followed by the analysts and, last but certainly not least, is operating under Australian accounting rules.  I may not like the paucity of information, but in their place, I’d do the same thing.  Let’s see if I can glean a bit of useful data from what they do tell us.  Remember, all numbers are in Australian dollars.  One Australian dollar will cost you around 72 U.S. cents.

Revenue rose $7.2 million (5.16%) from $140.5 to $147.7 million.  All the growth happened in the second half of the year.

Revenues in Australasia rose 1.75% from $77.1 to $78.4 million.  EBITDA grew from $12.2 to $14.6 million, or by 19.7%.  The rise in EBITDA, we are told, was mostly driven by “…sales and profit growth in the workwear division.”

North American revenues were up 10.5% from $42.0 to $46.4 million.  EBITDA in that segment went from a loss of $1.25 million to a profit of $1.56 million.  “This turn-around was a result of the restructuring that was completed during the 2017 financial year, as well as an 11% increase in revenues driven by new apparel initiatives.”

Europe revenues rose from $21.4 to $22.9 million, or by 7.0%.  It’s EBITDA was $636,000, up 0.8% from $631,000.  All they tell us is that “The European business reported modest growth in sales and profitability.”  Well, that’s helpful.

What I hear is that workwear and apparel are responsible for most of the revenue growth.  Does that imply some stagnation in some of the hard goods driven brands?  How are shoes doing?

The gross margin rose 1.4% “…driven by sales mix and favorable foreign exchange impacts.”  Using Globe’s “Revenue from operations” number and what they call “Cost of sales” in Note 4, I calculate a gross margin as having risen from 45.8% to 47.8%.

I am sure they are right and that I don’t understand what “Cost of sales” includes.  But the calculation I did gives a better result than what they report.  Obviously, cost of sales can include more costs than the expenses included in gross margin, but if that was true then wouldn’t my calculated “gross margin” be less than what they reported?

Moan.  I need a footnote to the footnote.

Selling and administrative expenses rose 7.9% from $36.6 million last year to $39.5 in the most recent year.  Employee benefits expense was down very slightly to $21.4 million.  Net income rose 66.1% from $5.08 to $8.4 million.  There’s no discussion of the changes. The balance sheet is solid.

I want to thank Globe for providing a report that made it impossible for me to spend much time analyzing it.  I confess I don’t entirely miss having Billabong’s public filings to try to figure out every six months.

Globe seems to be a company changing its focus to apparel and workwear.  Not a surprise given the current state of growth opportunities in hard goods. They are managing the transition while keeping the balance sheet strong and earning more money.  There is something about their culture that makes them early recognizers of market changes and willing to act on that knowledge.

Deckers Has Strong Quarter- Sanuk Feels Like an Afterthought

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With its restructuring expenses largely behind it ($55.3 million since February 2016) and net sales up 19.5% for the quarter ended June 30 compared to the same quarter last year, Deckers reported a good result.  Sanuk continues to be the laggard, and I still won’t be surprised to see Deckers management sell the brand, though for orders of magnitude less than they paid for it.

Revenue rose to $251 million from $210 million in last year’s quarter.  The chart below compares revenues for both quarters and shows the percentage change for each brand.  Also included is the breakdown between international and U.S. revenues.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Note the continued dominance of the UGG brand and the revenue growth of all the brands except Sanuk, which was down 6.6%.  They report in the 10-Q that “Wholesale net sales of our Sanuk brand decreased due to a lower volume of pairs sold primarily driven by lower performance in the US surf specialty channel and lower international sales in connection with our strategic focus on US markets for this brand.”

The gross profit margin rose from 43.2% to 45.9%.  The increase “…primarily driven by favorable foreign currency exchange rate fluctuations, improved full-price selling compared to the prior period, and lower input costs as we execute our supply chain initiatives as part of our operating profit improvement plan.”

SG&A expenses fell from 70% to 61.6% of revenue while growing in dollars from $147 to $154 million.  The pretax loss declined 30.9% from $56.6 to $39.1 million.  The net loss fell from $42.1 to $30.4 million, or by 27.8%.  Note that about $10 million of revenue was shipped early and had been expected to be part of the current quarter.  The question is whether that means the current quarter’s revenue will be $10 million below what it would otherwise have been.  There were also “certain operating expenses” shifted to the current quarter.  They don’t say how much.

Remember that corporate tax rates are lower this year.  As with other companies, this is Deckers’ weakest quarter.

Below is a table showing the operating income by brand and the change from last year’s quarter.  Note that all the brands are up except poor Sanuk.  Deckers also has some work to do on its direct to consumer business and has been busily rationalizing its brick and mortar footprint, and this may lead to some further charges.

“At June 30, 2018, we had a total of 160 retail stores worldwide, which includes 93 concept stores and 67 outlet stores. During the three months ended June 30, 2018, we opened one and closed six concept stores… Management continues to target an overall reduction in our worldwide retail store count.”

 

 

 

 

 

 

 

 

They make a comment that Sanuk’s lower operating profit was the result of lower sales offset by higher gross margins.  Hopefully, that’s in indication of distribution getting cleaner.

The balance sheet is solid, and I’d note a small inventory decrease from $442 to $436 million even with the sales increase.  I love the turnaround in cash from operations.  It was a negative $7.35 million in last year’s quarter.  It’s a positive $8.07 million in this year’s.

Deckers has improved their spending efficiency, and the benefits will continue to grow into fiscal 2020.  They’ve improved their distribution.  CEO Dave Powers says, “We have closed a few hundred doors over the last 18 months, and are really focusing on the top 15 strategic accounts that are driving the majority of the volume.  We’ll continue to do that.  And I think naturally there’ll be some accounts that will close on their own, just continuing through the marketplace disruption that’s happening out there…”

There’s a lot of that kind of distribution consolidation going on.  Advantage, big players.

Deckers is continuing to rationalize its brick and mortar business.  I’d feel better if I heard them talk more about how they are tying it to ecommerce.

Higher sales with a higher gross margin, improved distribution, and lower SG&A as a percent of revenues is a good thing.  Sanuk is a bit of a fly in the ointment and I wonder if its potential justifies it being part of a public company.

Strategy, Housekeeping and the Numbers: VF’s June 30 quarter.

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It’s interesting to review this recently released 10-Q, as it discusses VF before the recent announcement that they will spin off the jeans business as a separate public company.  With hindsight, you can see how their strategy would lead to that decision.  I’ll also outline the company’s change in their business segments and, of course, review the numbers.  Let’s get started.

Strategy

Here’s what CEO Steve Rendle says in the conference call.

“…we all see that the U.S consumer continues to be open to and motivated to interact with powerful brands, brands that they connect with, brands that provide products and experiences that are relevant to who they are. I don’t think we’re sitting here saying that this is easy…but we — what we’re seeing is that we have a clarity of focus on what our brands stand for, that we’re bringing the best product. And more importantly, big learnings over the last couple of years is really elevating the brand experience in connecting more emotionally with our consumers. We are able to stay at the forefront of the decisions that they have and where they choose to spend their time and money. We see the same to be true in Europe, and we see the same being very true in Asia and I think as we really focus our attention against those key drivers and platforms within our portfolio, we will continue to see our opportunity to connect and maintain those long-term loyal relationships.”

I’d say that’s not the jeans business he’s describing.  Like I said, hind sight is wonderful.

Steve is the second industry CEO I know of who’s trying to help the analysts focus on asking the important questions.  I was hoping for follow up questions about systems and the different quality of information, changes in how and how fast they make decisions, their view of risk taking and how better/different customer information is leading to changes in logistics and inventory management.  Oh well.

Later, talking specifically about Vans, CEO Rendle makes some related comments.

“The strength and understanding of the consumer, that the team has gained through our consumer insights and brand building focus, they just have gotten stronger and stronger, more focused on who they are and more importantly who they are not. We are in exceptional moment where we’re seeing distorted growth. Some of that could very much be some trend, level of trend. But honestly, the way we look at it, we are resetting the rightful level of penetration that this brand has with the consumer and within the wholesale channel and as you — as we do our channel checks, you can see the brand has just taken a larger footprint both on the footwear wall, the tables in the footwear section, but we’re also now starting to place really relevant assortments of apparel. So that the better this brand begins to understand…its consumer, the more thoughtful we can be on placing the right products at the right time. The disciplined franchise management, channel management segmentation just gets stronger and stronger and it really is disciplined of how that team operates… This isn’t an exceptional moment of time that likely has a downward cycle in the back and this is just a reset of its rightful position as one of the top footwear brands in that active lifestyle component of the consumer’s choice.”

You can see Steve alluding to using the same tools/approach for Vans he discussed in the first quote.  No surprise there.  He also talks about Van’s current growth as “exceptional” and “distorted.”  They’re using that as an opportunity for “resetting” the brands penetration and positioning.  They are being thoughtful and purposeful in how they distribute the brand.  Good.

They see a particular opportunity in Vans’ apparel.  It sounds like some cautious management of the brand even as it grows is creating, as they see it, the opportunity for apparel.  What I think I hear, and what I imagine they’d like Wall Street to pick up on, is that even if (when?) revenue growth does slow, they could continue to grow the bottom line.

But he doesn’t see that this time of “exceptional” growth as one that will have a “downward cycle in the back.”

Well, that’s walking a fine line.  I have endless respect for what VF has accomplished with Vans.  If he means the brand isn’t in danger of the kind of blowup we’ve seen in other industry brands, I can buy that giving their management process for the brand as they describe it.  But there’s an implication that any kind of turn down isn’t going to happen.  That would be somewhere between unusual and unprecedented.  Even Nike had its hard times.  I continue to believe there’s a limit to one brand’s market share.

If they are saying that by careful distribution, positioning of the brand, and paying attention to the consumer, they can manage and minimize a downturn when it comes, I’d think that right.  They may be well positioned to benefit from the inevitable recession.

Vans is taking advantage of its exceptional revenue growth to position the brand for success even when that revenue growth is not quite so exceptional.  Good plan.

Housekeeping

VF has changed its reportable segments, joining other companies who have stopped referring specifically to action sports.  The new segments are:

  • Outdoor, which includes The North Face, Timberland, Smartwool, Icebreaker and Altra.
  • Active, which includes Vans, Kipling, Napapijri, JanSport, Reef, Eastpak and Eagle Creek.
  • Work, which includes Dickies, Bulwark, Red Kap, Timberland PRO, Wrangler RIGGS, Walls, Terra, Kodiak and Horace Small.
  • Jeans, which includes Wrangler, Lee and Rock and Republic.

As we know, those four segments will become three after the spinoff of the jeans business.

CFO Scott Roe tells us why they made the change.  “Our Outdoor Action Sports business has become so large that we felt it was good for you the readers to have one click down one more level of visibility rather than having one giant segment, especially given some of the different financial characteristics of the two as you can see, right. And really that’s the driver in the guidance is companies with like characteristics are grouped together and it’s really no more or less than that.”

Makes sense to me.

The Numbers

Net revenues rose 22.9% from $2.269 billion in last year’s June 30 quarter to $2.278 billion in this year’s.  The table below shows revenue and operating profit by segment.  You can see that the active segment, where Vans lives, is still the largest segment, though not as large as before the change described above.  Vans was up 35% for the quarter, speaking of unsustainable trends.  The big jump in work came from the Dickie’s acquisition.  The North Face revenues rose by 8% and Timberland was down 1% despite a 4% boost from foreign currency.

 

 

 

 

 

 

 

 

 

11% of the 22.9% revenue growth came from acquisitions, and 3% from favorable foreign exchange trends.  Direct to consumer revenues rose 22% and were 31% of total revenues.  Acquisitions accounted for 6% of that growth and foreign exchange 2%.  Ecommerce rose 54% including 4% from foreign currency and 21% from acquisitions.

International revenues represented 38% of quarterly revenues and rose 27%.  5% of the increase was from foreign currency and 13% from acquisitions.

56.6% of revenue growth in the quarter came from acquisitions and foreign currency.  The table below shows the sources of revenue and operating for both quarters by segment.  This is worth spending a minute on.

 

 

 

 

 

 

 

 

The gross margin rose from 49.6% in last year’s quarter to 50.3% in this year’s.  “Gross margin was favorably impacted by a mix shift to higher margin businesses, increases in pricing and foreign currency changes, partially offset by lower margins attributable to acquired businesses, acquisition and integration costs and certain increases in product costs.”

SG&A expenses as a percentage of revenue declined from 42.6% to 42% due to spreading these expenses over a bigger revenue base.

Net income rose 45.6% from $109.9 to $160.4 million.

One other financial comment that may be of interest to some of you.  VF has a defined benefit pension plan, which is becoming something of a rarity in this country.  Looking at Note 10 in the 10-Q on that plan, I saw that the discount rate they are using to determine pension obligations was about 4.25%.  “So What?  How else are you going to bore us today, Jeff?”

I just wanted to congratulate VF on having a reasonable discount rate.  The lower the rate, the more it costs them to fund the plan.  In the public sector, discount rates of 7 or 7.5% are more common, because, I guess, the politicians know they won’t be around to deal with the blow back when the impact of the underfunding hits (as is starting to happen now).  Unless “This time is different,” the business cycle suggests that the markets are not going to support those higher returns over the next decade or so.  Honestly, I’m afraid 4.5% may prove to be too high.

Anyway, it’s good to see VF in touch with reality on this one.

CEO Rendle had this comment about how VF was becoming more “retail centric.”

“…you’re seeing greater attention to thinking and acting like a retailer, focusing on sell-through and getting our very best products on the floor at the beginning of the season, working dynamically to make sure those products are selling through and just keep the offer fresh, balanced with better and better marketing.”

I circled the term when I read the conference call and wrote “inevitable!” above it.  It struck me that the need to become retail centric had started to appear perhaps 20 years ago, even if we didn’t identify it as such then.  Basically, the requirement to address a customer who shopped a new way and had different priorities and sources of information made it necessary for brands to move in that direction and, finally, to become retailers.  The ones who manage that well will be successful.

VF to Spin Off Denim Business as Separate Public Company

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Yesterday, VF Corporation, owner of Vans, Reef, The North Face and a lot of other brands announced that it was spinning off its jean business (it owns Lee and Wranglers) into a separate public company with 100% of shares to be distributed to existing VF shareholders.  It also announced that VF would be moving its headquarters to Denver.

The stock market, which never likes surprises it doesn’t understand, took the stock down 3.3%.  It’s back up 1.55% so far this morning (Tuesday).

To give you perspective, VF’s total revenues for the year ended December 31, 2017 were $11.8 billion.  Of that total, the jeans wear segment contributed $2.65 billion, or 14.0% of the total.  The company’s total operating profit during the year was $1.91 billion and jeans contributed $421.9 million, down from $491.1 million the previous year and $535.4 million the year before that.  Revenues in jeans have been down as well.

Why Are They Doing This?

If I were to sum up the press release, presentation and conference call, I’d say that the jeans business is great at generating cash flow, but not so great at generating growth.  So, it holds back the overall results of VF.  They didn’t exactly put it that way.  They said that:

  • Jean and the rest of VF now have “diverging path to long term value creation.”
  • “The separation will provide greater strategic focus, operating model alignment, and greater management capacity to invest in new growth vectors and capabilities to accelerate growth.”
  • “The separation creates an opportunity to unlock long term value creation through streamlined operations, scale and cost efficiencies and the flexibility to pursue and invest in strategic priorities and growth initiatives not easily accessible inside the VF portfolio today.”
  • They will be separate companies with “…a separate management team focused actively on its own unique opportunities.”

VF, as you know, has always trumpeted the synergies and efficiencies between its businesses, but we learn in the conference call that the synergies between jeans and the other business are less clear than they used to be and that the jeans business is more independent than the rest of the portfolio.

This, then, as they describe it is good for shareholders, good for the jeans business and good for VF.  Everybody should be happy.

Why Not Just Sell the Jeans Business?

Good question.  They’ve sold, as well as bought, businesses before after all.  It’s kind of what they do.  The answer they gave is that they’ve held the jeans business so long that it’s fully depreciated.  A sale would result in a big reported profit and tax hit.

Fair enough, but the devil is in the details and it’s a long-term capital gain (I assume- I’m not a tax guy).  Whatever the tax hit would be, let’s phrase the decision to spin it off, instead of selling it, differently.  Would it be unreasonable to say, ‘It’s a declining business and we didn’t think we could sell it for enough to justify the tax hit.’

From the language they used in the conference call, it sounds like they didn’t shop it before deciding to spin it off.  That suggests that they were quite certain that it couldn’t possibly be worth the price they needed to get.  They did acknowledge that if a potential buyer came along they were obligated to consider an offer.

A Complicated Deal

This deal is going to take one to two years to get completely done.  There are a lot of moving parts.  Assets to be allocated between VF and the new company (which doesn’t have a name yet), people to be moved, supply contracts to be managed, debtholders to be satisfied, real estate to be bought and sold or leased.  If the presentation and conference call were a little short on specifics, I’m giving VF a break on that one.  They have a responsibility to announce the deal, but the early stage, given the scale and timeline, makes it reasonable that specifics were largely unavailable.

There’s not yet a proforma balance sheet for either company after the transaction is done.  We did learn that, “There’s no change to VF’s capital structure or capital allocation priorities as a result of this separation.”  They also told us that the new company, whatever its name is, would have around $1 billion of new debt and leverage at the time of separation of around three times debt to EBITDA.  They assured us the new company would pay that down to close to two times within “a couple of years.”  Some or all of that new debt comes back to VF as cash and will replace the lost EBITDA from the jeans business.

They were not specific about how that will work.  You can understand why I’d really, really, really, like to be looking at a proforma balance sheet to figure this out.  They also noted that the costs of doing the deal weren’t quantified yet.

I’m cautious in my conclusions because of the lack of solid information.  Certainly the jeans business qualifies as the kind of business VF has divested before.  Strategically, I understand why they’d want to move on from jeans.  Perhaps they waited this long because of the size of the business and the fact that it was a foundational and critical piece of VF back when it was known as Vanity Fair.  As they acknowledge, they used to need it for its cash flow.  Now they don’t.

Some of the advertised benefits of the spin off are a bit too touchy feely for me.  That doesn’t mean they aren’t real, but it’s very hard to evaluate them.  I guess I’ve always thought of VF as a company where businesses could realize those benefits from inside the company anyway.

We’ll all know more in the months to come as the process moves forward and solid information is released.  This is a public offering and there will be a prospectus and a road show.  In the meantime, whatever the benefits of the spinoff are or are not, VF is getting rid of a business that’s declining and doesn’t meet its growth/specialty criteria.

Big 5 Sporting Goods July 1 Quarter; Are They Addressing the Retailer’s Challenge?

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Regular readers know I’ve had a pretty strong and, I hope, consistent opinion about how retail is evolving and what retailers/brands in our industry need to do.  Most recently, I wrote about it here.  It’s occurred to me that I should look at some new industry related companies to see how they are doing and if my thesis is holding up.  Big 5 is my first try.

Big 5 describes itself as “…a leading sporting goods retailer in the western United States, operating 435 stores and an ecommerce platform as of July 1, 2018. The Company provides a full-line product offering in a traditional sporting goods store format that averages approximately 11,000 square feet. The Company’s 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.”

I imagine many of you have been in a Big 5 store.  Here’s a link to their web site.  From my perspective, there’s not enough distinctiveness in their stores or web site.  But with the demise of The Sports Authority, they’ve got less brick and mortar competition.

When I say there’s a lack of distinctiveness, I mean the focus is completely on selling stuff.  Now, we all need to sell stuff.  But if your total focus is on selling things that lots of other places sell, then you are competing mostly on price.  In our industry, successful brands and retailers have to/are creating a customer connection through new brands and products, experiences, some amount of exclusivity, good data mining and communications, and applying new found knowledge of who their customers are and why they buy; all the stuff we tend to group under “omnichannel.”  When you start to see brick and mortar and eCommerce supporting each other and being thought of as one revenue stream, you’re moving in the right direction.

Let’s look at Big 5’s 10-Q and conference call transcript and see if we can get some insight into how they are addressing these issues.

Sales for the quarter ended July 1 were down 1.57% or $3.7 million from $243.7 to $240 million in the same quarter last year.  Same store sales declined by 2.1%.  Most of the decline was in hard goods sales which, at $129 million, represented 53.8% of revenue for the quarter.

“Revenue associated with e-commerce sales is not material,” they tell us in the 10-Q.

The gross profit margin fell from 32.5% to 31.4%.  I’m wondering how doing more than half of your business in hard goods impacts gross profit margin.  Selling and administrative expenses were $74.7 million, or 31.1% of sales.  In last year’s quarter, they were $74.2 million or 30.4% of sales.

Interest expense rose from $380,000 to $793,000.  “Interest expense reflects an increase in average debt levels of $42.9 million to $83.0 million in the second quarter of fiscal 2018 from $40.1 million in the second quarter of fiscal 2017, as well as an increase in average interest rates of approximately 80 basis points to 3.3%…”

This is not the only company where interest expense will go up due to higher interest rates.

On the balance sheet, the current ratio improved from 1.99 to 2.20, but total debt to equity deteriorated, rising from 1.25 to 1.63 due to the increase in long term debt.  Stockholders’ equity fell from $207.0 to $180.1 million.  Inventory rose 5.1% to $345.6 million while sales declined.

CFO Barry Emerson made this comment on the inventory increase during the conference call.  “On a per store basis, merchandise inventory was up 3.3% versus the prior year. The increase primarily reflected the carryover of winter related products following the unfavorable warm and dry winter selling season…As we have done successfully in prior years with unfavorable winter weather, we plan to reintroduce this winter product carryover next season and we see little markdown risk associated with it.”

Cashed used in operations was $21.8 million in the six months ended July 1.  For the same period the prior year, it was $19.4 million.  “The decreased cash flow from operating activities for the first half of fiscal 2018 compared to the same period last year primarily reflects the decrease in net income, partially offset by smaller reductions in accrued expense largely related to income taxes.”

So that’s the rundown on the quarterly results.  Hardly going in the direction they want.  What might be the solution?

It’s not opening new stores.  They ended the quarter with 435 stores.  That’s up from 433 a year ago.  “Our current plans for 2018 full year have us opening approximately five stores and closing approximately three stores,” says President and CEO Steve Miller in the conference call.  It’s the correct time to be cautious about opening new stores and most are taking that approach.

But it doesn’t sound like improvement will come from ecommerce either.  Here’s Barry Emerson’s take on their efforts in ecommerce.  “We’re pleased with the growth of e-commerce.  Again our goal is to grow our – e-commerce business profitably. We still think that the key for us is the convenience of our brick-and-mortar stores. We continue to invest in the e-commerce business. We’re adding and more products and more functionality at the website.”

“And again as I mentioned it’s growing, it’s growing well but of a relatively small base. So we don’t – our e-commerce business wasn’t material to our overall operating results for 2017 and we don’t see it being material to our results for 2018. We hope that we’ll be able to again just continue to provide a reasonable sales count to our customers.”

To me, it’s a rather remarkable statement to say that the key for Big 5 is the convenience of their brick and mortar. More convenient than online if you’re selling the same product everybody else is selling with no customer centric strategies?

What does, “…just continue to provide a reasonable sales count to our customers” mean exactly with regards to ecommerce?

It’s like he was struggling a bit to know what to say about ecommerce.  And there’s no discussion of the kind of actions I mentioned above that leading brands and retailers are taking to compete in a customer centric, always connected environment.

It was only in 2018 that Big 5 started consolidating their ecommerce and brick and more revenue streams.  I come away with the sense that they are behind the curve in melding their stores and ecommerce business to serve their customers.  Perhaps being a big box retailer somehow makes it different, but I don’t think so.

How Brick and Mortar Retail Has to Change

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I don’t think brick and mortar is going away.  I doubt many of you think it is either.  I do believe that consolidation and transformation of the space has a way to go and I further believe it will reach its climax when (not if) the next recession hits.  I know this sounds kind of unfeeling, but I’d sort of like to get that recession going and out of the way.  The longer it’s delayed the worse it will be.

It won’t be just a recession that leads to this continuing transformation and consolidation.  The continued growth of ecommerce, retailers resisting change, and slower long-term GDP growth will also play their parts.

But you, as a retailer, don’t want to be consolidated (well, maybe at the right price) and you don’t want to go out of business.  Knowing that, I’ve been evaluating the role of a brick and mortar store these days compared to what it used to be.

What Stores Are Not Doing as Much Of

Let’s remind ourselves of the traditional functions stores helped customers perform.

  1. Finding the product
  2. Discovering the price
  3. Understanding the features
  4. Learning how it performs
  5. Figuring out if others like it and why
  6. Buying the product

That’s quite a list.  Some of your customers will continue to need (or want) your store(s) to perform some of these six functions some of the time.  But not most of your customers all of the time as used to be the case.

If that isn’t a kick in the pants alerting you to the need to change your business (and financial!) model, I don’t know what is.  What changes?

What You Have to Do More Of

In the last few months, I’ve developed in my head a model of what I think retail is evolving to.  I’m certain it’s incomplete and wrong in some way given the continuous change.  I’m laying it out here anyway because (1) Even though some of it is known, I want to draw it together, (2) writing about it helps me think deeper, (3) I’d like you to tell me where you think I’m wrong and (4) there is urgency for every retailer to have a vision and act on it regardless of the uncertainty.

I think most of this applies to brands as well, as retailers are brands and brands are retailers.  Anyway, here’s my shot at it.  There is a certain advantage to being a large retailer right now, but this all generally applies to one store or one thousand.

First, your brick and mortar and online has to be completed integrated.  You have to see your business as having one customer, no matter how they buy, and one revenue stream.  The customer has to be able to view and buy the same product at the same price in the store or online on any device.  You should be agnostic in terms of where and how a product is sold and delivered.

You do that by making your stores as responsible as they can be for handling the online, as well as the in store, customer relationship.  Which, and I hope I don’t have to point this out, is really one relationship.  Don’t argue with me about that- argue with your customer.

If you’re one store, that’s not as much of an issue.  As the number of stores grow, the opportunity to move ecommerce expenses into the stores can result in saving a bunch of money.  The more stores, the more money you can save.

The savings happen for two reasons.  First, you’re going to cut some expenses.  Maybe in labor or facilities.  You are going to use the assets you have more efficiently.  The public retailers call this “leveraging” their fixed costs- spreading the same costs over a larger revenue base.

Second, you’re going to cut off any dysfunctional competition between ecommerce and brick and mortar.  Why might that competition exist in the first place? What, for example, if you have people who receive a bonus based, in one case, on brick and mortar sales and, on the other, on ecommerce sales?  I can pretty much guarantee they won’t be focused on maximizing companywide revenue.

The next thing you have to do more of, based on the integration of brick and mortar and ecommerce, is evolve your stores.  This is an example of where we find ourselves in the uncomfortable place of needing to change, not quite knowing how, but having to start anyway.  The integration of brick and mortar and ecommerce I’m describing means the role, functionality, and layout of stores will change.  As you work to minimize your inventory (I’ll get to that) and give store personnel the overall customer relationship, how big do stores have to be?  What inventory will they carry (as you can seamlessly draw on inventory across your whole system and probably on what your non-owned brands have in inventory as well)?

If you have a lot of stores, how might the role of your district managers change?  Will the growth of ecommerce mean you can get by with fewer stores in a given region?  What will a store’s layout and space requirements look like if it’s carrying some of the inventory that was previously held in some distribution center?  Will you need less square feet as customers order t-shirts online and they are automatically printed in the back room?

Would that t-shirt sale be a store or an ecommerce sale?  Doesn’t matter does it.  That’s why you have to see your stores as having just one revenue stream.

Okay, I said something about minimizing inventory.  The quality and immediacy of your data has to get better.  There are so many reasons that’s important, but right now I want to focus on its inventory impact.

Snowboarding used to be the industry poster child for inventory disasters.  One season and snow dependent.  It used to be common to end a season with enough close out product to wipe out the profit for the whole season.  Most of you have figured that out and adjusted your buys accordingly.  Better to mourn lost sales than product you have to slash the price on.

My suggestion is that you treat all your inventory like it was snowboarding product.

You’re in (and will continue to be) a market where product life cycles and trends don’t seem to last long.  We’re an industry where product is differentiated mostly by marketing and community judgment rather than features and new brands come (and go) with the speed of light.  Time to embrace that- since your customers are.

It’s been years since I started advocating for retailers to take risks with new brands.  It’s not now just urgent- it’s unavoidable.  It’s also been years-more than 10-since I suggested being prepared to give up some revenue, or at least some revenue growth, in favor of higher margins and lower operating expenses for a better bottom line.

Both are related to the quality of data and inventory.  Your plan for identifying new brands/product may be disciplined and rigorous or, for smaller retailers and brand, just a matter of keeping your ear to the ground and developing a culture where employees are aware of products and trends.

If new brands are important (both bringing them in and knowing when to dump them), if product differentiation is tough and based to some extent on scarcity/distribution, if trends are short and dynamic,  if you think getting stuck with merchandise you have to mark down sucks, if something not selling in one place might sell in another, and if you have another use for cash besides sitting in inventory then knowing exactly what is selling where, to whom and  how quickly matters a lot.

Yeah, I know- you already have inventory reports and gross margin reports and various other reports.  How often do you get them?  Do they provide the data you need to address the issues I’ve raised in the paragraph directly above?  Is the level of detail adequate?  Set goals you can measure that improve on the issues listed above.  Some retailers are installing systems with algorithms that are parsing customer as well as inventory and sales data to gain new insights.  What new insights? They don’t quite know yet.

Over the next couple of years this software will become available to everybody at a reasonable cost.

Let’s take a short break while I point you to a couple of related articles.  I haven’t used the term “social media” yet but obviously it’s impact on the changes in retail is important.  Here’s a link to an article from my research department on a social media influencer with 1.2 million followers.  “She” is a bot.  I have no idea where to go with that.  It’s just another example of the complexity we’re dealing with.

On the subject of distribution and brand building, read this about specialty brands doing limited edition, lower priced collaborations with Target.  Is this the way to expand your sales and build your brand, or destroy it? I tend towards the later.  What do you think?

Okay, breaks over.

What Retailers are Doing More Of

  1. Customer service
  2. Community building

Neither of those sound particularly new.  But if you’ve read this far, you know I’m suggesting you have to do what you did before in the way of customer service (though less of it for some customers) plus satisfy with new brands, experiences, surprises, and engagement.  And all this for a customer who wants endless newness.  No wonder I’m trying to get you to increase efficiency, improve inventory management, and cut costs.  One issue I need to give some more thought to is how, specifically, the role of a brick and mortar sales person changes given the integration with ecommerce.

Most industry retailers would say they’ve always been community builders.  I think that’s true.  Especially for smaller retailers, that community’s reach was defined by a limited geographic space around stores.  Now your community isn’t so easily defined. Your reach, through the internet, is “everybody.”  One thing hasn’t changed- if you think everybody is your customer, probably nobody is.

The word that’s popping up a lot more in defining your target customer is “culture.” Culture, in the context we’re talking about it, refers to commonalities among your customers.  It’s easy to say, for example, “We’re a skate retailer/brand.”  That’s a fine thing to do as long as you recognize that positioning yourself that way limits your growth because you’ve defined your target market.  I don’t have to remind you of all the companies that started with their roots in an activity, tried to expand outside their solid franchise in that activity, and did themselves a lot of damage.

Trying to figure out the culture of your target customers is a lot harder than saying “We’re a skate company” and defining your universe of potential customers that way.    Fortunately, you’ve got a lot more data on customers than you used to have, and they are busily telling the world what they like and don’t like and why.  That brings us right back to the importance of systems that allow you to parse all this data to provide insights on the culture of your customers.  You can always be a “skate” retailer/brand and perhaps draw comfort with that solid, if maybe over simplified, characterization of your customer and target market.  If you’re culture focused, you have to be plugged in enough to change as that culture changes.

I wish I had the space to be more specific, but this has already run longer than I like and, in any event, generalities are inevitable when I’m discussing industry wide issues.  I’m not asking for much am I?  I just want you to change most aspects of your business, integrate the pieces in a way that didn’t used to be necessary, and do it fast and continually-as your customer is requiring-while what you need to do is changing and isn’t completely obvious in the first place.

It’s not me asking.  It’s your customer requiring.

Quality Information on the Internet and Ecommerce

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Mary Meeker is a venture capitalist focusing on the internet and new technologies.  She’s a partner at the VC firm of Kleiner Perkins Caufield & Byers.

Every year, Mary offers up her Internet Trends report in the form of slides.  This year, it’s 294 slides long, but I’m asking you not to be put off by the length.

Some of the slides have very little on them.  Some you may not care about.  Speaking for myself, some you may not quite understand.  “Hyperconverged Infrastructure” sent me scurrying to Wikipedia.

Okay, so maybe you don’t want to look at all the slides, though I think you’d find it well worthwhile.  But the sections on e-commerce, advertising, and consumer spending might get your attention.  Those sections start on slide 44.  Look, just go to slide 71 on the extent to which social media is driving product discovery and purchasing.  If that doesn’t get your attention, I give up.

Personally, I hope you choose to spend some time on the last section (starting at slide 278) on where your tax dollars go and the debt we’ve built up.

Here’s the link to Mary’s presentation where you can view and, if you want, download the report.  No charge.