Fewer Brands Simplifies Management but Means Bigger Bet on Each Brand: VF Corporation’s Quarter

VF continues to manage its brand portfolio consistent with its strategic imperatives.  Before moving onto the financials, we’ll take a look at their decision to divest their occupational work brands.  It’s consistent with other brand decisions they’ve made.

The Deal

Once they sell, as they’ve announced they will, the occupational portion of its work segment (Red Kap, FV Solutions, Bulwark, Workrite, Walls, Terra, Kodiak, Work Authority and Horace Small), their brand count will be reduced further.  In the conference call, CFO Scott Roe notes that “…at the end of this transaction, our portfolio at 12 brands will be roughly half of what it was just a couple of years ago.”

The work brands they are selling represent B to B business where higher levels of inventory are required.  Understandably, it’s not exciting to VF.  This isn’t their word, but it feels to me like more of a commodity business than what VF wants to own.

“Our decision,” says CEO Steve Rendle, “reflects management’s continued focus on transforming VF into a more consumer-minded retail-centric enterprise with a portfolio of more growth oriented, outdoor active and work brands.”  The sale won’t include Dickies and the Timberland PRO brands.  “There are,” he says, “fundamental differences between the Occupational Work brands and the Dickies and Timberland PRO brands, including the ability to connect directly with consumers, distribution footprint, supply chain infrastructure and financial profile.” 

The brands they are selling “…contributed about $865 million of revenue and $130 million of adjusted operating income in fiscal 2019.”  But they have, we’re told, “only minimal exposure to VF’s international and D2C [direct to consumer] growth platforms.”

The last thing I want to say about this deal is that most of VF’s factories apparently go with it, and they’ll end up out of the apparel manufacturing business.  As supply chains have evolved, becoming more sophisticated, and as consumers have demanded more newness and shorter timelines, I thought of VF’s manufacturing capabilities as offering flexibility and perhaps some competitive advantage.  I guess getting out of a business that doesn’t fit their strategy trumps that.

The Financials

Here’s the summary for the quarter ended December 31st.  Details follow.  Revenue grew 4.9% from $3.228 billion in last year’s quarter to $3.385 billion in this year’s.  The gross margin rose 1.1% to 55.7% “…primarily driven by a mix-shift to higher margin businesses and a favorable net foreign currency transaction impact.”

SG&A rose 5.1% from $1.242 to $1.305 billion, “The increase… primarily due to costs related to the relocation of our global headquarters and certain brands to Denver, Colorado and specified strategic business decisions in South America. The increase…was also due to continued investments in our key strategic growth initiatives.”

Net interest expense was down 33% from $25.2 to $16.8 million.  They received a bunch of cash when the spun off the jeans brands as Kontoor and used that to repay debt.

Net income was up hardly at all from $463.5 to $465.0 million.  They’d probably rather you looked at income from continuing operations, which rose 10.7% from $409 to $453 million.  The difference is that last year’s quarter included after tax income from discontinued operations of $54.4 million from $712 million in revenue.  For this year’s quarter, the number was $12.3 million just from an income tax benefit. 

VF has a lot of brands coming and going, and for that reason I like to focus on plain old net income after taxes.  Now for those details.

Organic revenue, as opposed to from acquisitions, contributed $183.8 million in revenue growth for the quarter.  That’s more than 100% because it was offset by losses of $4.4 million from dispositions and $22.4 million from foreign exchange.

The charts below show the source of revenue and operating income for each of VF’s segments during the quarter with last year’s quarterly results being the starting point.

The outdoor and active segments, you can see, provided most of the revenue and operating profit for the quarter.  Outdoor revenue rose 2.88% from last year’s quarter.  Active was up 8.48%.  Those two segments operating profit rose 3.25% and 4.99% respectively.  The numbers for the work segment will decline after the sale of the brands.

The outdoor segment includes The North Face, Timberland (but not the PRO part of Timberland), Icebreaker, Smartwool and Altra.  Active includes Vans, Kipling, Napapiiri, EastPak, JanSport Reef (until the sale date) and Eagle Creek.

VF’s four biggest brands by revenue are Vans, The North Face, Timberland and Dickies.  Their respective growth rates for the quarter were 12%, 8%, (5%), and 13%.  For nine months, the growth numbers were 15%, 8%, (3%) and 3%.  “…Vans and The North Face, account for over 80% of our growth in the long-range plan.”

This next chart shows where the revenue came from by channel and location for the quarter.

If you exclude work, which remember will decline with the brand sales, you see revenues well balanced between wholesale/direct-to-consumer and U.S./international.  Revenue growth during the quarter was 3% in the U.S., 4% in EMEA (Europe, Middle East, Africa), and 14% in APAC (Asia/Pacific).  China by itself grew 30% and the non-U.S. Americas business was up 9%.  Overall international revenue was up 8%.  Wholesale was up 3%, direct-to-consumer 7% and digital (part of direct-to-consumer) 16%.

VF ended the quarter with 1,438 stores, up from 1,420 a year ago.

What’s it all mean?  Let’s start with China.  This is before the viral scare and VF isn’t finding a big impact from tariffs over the whole year.  But ignoring the headlines, China has some longer-term financial issues associated with high levels of debt that are probably worse than in the U.S.  CFO Roe said the following in the conference call: “The good news for us is that China and the region has really been strong and you saw 30%. That’s somewhat artificial. And we said there’s about 5 points due to the timing of Chinese New Year. So there’s a little quarter-to-quarter noise in that. But still if you look, we’ve been in that 25-plus kind of growth rate consistently in China. And that’s really driven the strength of Asia.  And really why we’re at the top end of our long-range estimates overall.”

Not sure the 5 points due to the timing of Chinese New Year will have worked out.  Longer term I’m wondering how long they can expect a 25% growth rate.  I’m sure VF management wonders the same.

There seems to be only good news from Vans.  “Vans® brand global revenues increased 12% and 15% in the three and nine months ended December 2019, respectively, compared to the 2018 periods…The increase in both periods was due to strong operational growth across all channels and regions, including strong wholesale performance and direct-to-consumer growth driven by an expanding e-commerce business, comparable store growth and new store openings.”

I’m sure we all miss the good old days of 25% quarterly growth for Vans.  But neither you, me, or VF management expected that to continue and they told us so.  So far, they seem to be managing the inevitable decline of the growth rate really well, if you want to somehow call a gain of 15% for the year a decline.  What a remarkable brand and management job.

Dickies had a quarter over quarter increase of 13%.  “Growth was strong across all key strategic growth drivers, highlighted by 68% growth in China and 16% growth in digital with category momentum across icons and new seasonal product. After a flat first half, we had high expectations for the Dickies brand heading into the back half of this fiscal year and the global teams delivered.”

In the same vein that I mentioned Van’s China growth, I wonder about Dickies.  I assume it’s from a small base.

The North Face was up 8%.  “…led by our international business. Growth was balanced across both our D2C and wholesale channels globally and we saw solid performance in our urban exploration and mountain lifestyle product territories as the brand continues to attract new consumers and capitalize on growth opportunities beyond the core mountain sports.”

Now we come to Timberland.  VF bought it in 2011 and has been trying to get it to perform up to their standards since then.  “Global revenues for the Timberland® brand (excluding Timberland PRO®) decreased 6% and 4% in the three and nine months ended December 2019, respectively, compared to the 2018 periods. The decrease in the three months ended December 2019 reflects overall declines in the wholesale and direct-to-consumer channels and an overall 1% unfavorable impact from foreign currency, which were partially offset by e-commerce growth and increases in China. The decrease in the nine months ended December 2019 was primarily due to an overall decline in the wholesale channel and an overall 2% unfavorable impact from foreign currency, which were partially offset by e-commerce growth and increases in China.”

Again, we see some amount of reliance on China.

In 2020, VF expects Timberland revenue to fall by between 1% and 2%.  Previous guidance had been for 1% to 2% growth. 

Some of their frustration with the brand comes out in the conference call.  CEO Rendle, talking about Timberland, says, “…it absolutely aligns with the consumer, the position in the marketplace, and the ability to connect with consumers. My earlier points that we’re disappointed in our ability to execute and our conviction around the strategy that we have been working on, really, over the last 18 to 24 months that Martino articulated in Beaver Creek, we don’t have endless patience. We certainly have a very focused approach and clear sets of KPIs that we will look for our brand teams – all brand teams to deliver on a year-over-year basis. But I really want you all to leave this call knowing that we are still deeply committed to the Timberland brand. “

So deeply committed, but without endless patience.  So, not too deeply, I guess? 

Nobody challenges VF’s ability to manage brands.  What’s going on here?  Is there some fundamental problem with the brand as it relates to the market that VF’s tactics can’t fix?  We’ll all keep watching.

VF has chosen to put itself through a lot of change.  Not that it’s bad change, but it’s disruptive and costs a few bucks.  The most important thing they can do is get Timberland functioning as well as their other big brands, but after eight plus years of ownership, they aren’t there. 

Meanwhile, unless frustration with Timberland goes through the roof, I expect the work businesses will be the last divestiture by VF for a while.  They are always on the prowl for acquisitions that fit their criteria and they think they can bring value to.  But I won’t be surprised, given current economic conditions and prices, if they don’t keep their powder dry until conditions become more favorable for buyers.

VF can improve it’s bottom line without significant acquisitions right now, but with fewer brands in its portfolio the performance of each becomes more important.     

Thoughts from Outdoor Retailer/Snow Show

The first thing you think when you walk into the show is what an incredibly great idea it was to consolidate The Snow Show with Outdoor Retailer.  The second thing you think is, “What took them so long?”  I imagine the answer to that is quite a soap opera.

The next thing I thought was whether I’d gone to the dog show by mistake.  I like dogs, but the sheer number was rather remarkable this year.

For the two days I was there, it was a vibrant and active show.  Not so sure about the third day, given the number of attendees who were on the Friday morning flight back to Seattle with me, but that’s what happens at trade show; the last day is typically slower.

What the hell did we do when the show was even longer?   Oh, that’s right- we were younger and it was a lot more fun.  It was amusing when the people who were supposed to show up first thing in the morning didn’t make it till noon because they’d been out “networking” all night.  Somehow, it made you credible.

Before the world (inconveniently) changed on us, shows focused on retailers writing orders and brands “getting paper,” whatever that is, from them.  Now, as a show veteran pointed out to me, buyers want to get on their computers, put orders from all their brands into their systems, and see how things look over all before finalizing orders given their sell through and new brands they may have discovered. 

Which is how it should and has to be in a digitized world where, if you aren’t using big data to figure out what to buy and who to sell it to, and how the brands you carry relate to each other, you may not be around after the next recession, whenever that is.

But even if orders aren’t written like they used to be, the show validates the importance of having face time with customers and other industry folk.  That’s especially critical for what used to be The Snow Show, where we gather once a year.  It will be interesting to watch how the trend towards shows that include consumer involvement play out.  Is it just a way to sell some product, does it bring consumers to the sport and the brands, or is it a way for show producers to solidify their financial positions?  I don’t have the answer to that one. 

And then, in quick order, I noticed two things that kind of book ended the show for me.  I looked down and saw (besides my size 14s which are hard to miss) concrete- not carpet.  First time I remember seeing that.

My take is that Outdoor Retailer, owned by struggling public company Emerald Expositions, is trying to save some money.  Well, why shouldn’t they?  We’re all a bit tighter on our spending than we used to be.

The second thing I saw, like the first moment I got to the section where the snowboard companies congregated, was the announcement in front of Volcom’s booth telling us, “Volcom is the official outerwear partner of the U. S. Snowboard team through the 2022 Beijing Winter Olympic Games.”  Not saying that this is a good or a bad thing for the brand.  It just struck me how much the industry has changed.  This is definitely not “Youth Against Establishment.”

To nobody’s surprise and not for the first time, Burton wasn’t exhibiting.  But neither was Mervyn Manufacturing (Gnu, Lib Tech, Bent Metal).  Mostly, I was just disappointed not to see those guys and their booth concept.  It was years ago I suggested them as a brand that may be could find something better to do with their dollars than go to trade shows.  Kind of disappointed they decided to agree with me.

Sims had a small booth off in the corner with five or six boards in it.  I don’t have a point here- I just have some history with Sims and waxed a bit nostalgic when I saw it.  Always wanted that brand to succeed.

DC characterized some of their footwear as “winterized.”  I don’t know what functional differences there might be, but I thought that an intriguing attempt at differentiation.

Tracey Canaday at Never Summer showed me their new towable camper.  For those of you who think that’s a weird thing for them to produce, look at it this way.

First, it sounds like they’re really having fun doing it, and that might be a good enough reason.  Second, they own their factory and have all those CNC machines that aren’t doing anything at night.  Those machines cut out all the parts and they’ve got a place to put it together.  The only out of pocket cost is for materials.

I didn’t find it incongruous.  Felt like it worked with the brand.  The one they were displaying is only the 3rd they’ve made. Each gets better based on the pictures I saw.  Will they sell a lot of them?  Will snowboarders buy them? No idea.  Is there a market for them outside of the brands traditional customer base?  Haven’t a clue.

But it’s low risk/cost, something they are enthusiast about, and certainly won’t damage the brand.  I highly recommend that way of thinking about product extensions to all brands as they consider new ideas.

Finally, if I can wax macroeconomic for a minute, I was struck by the functional sea of sameness I saw at the show.  This is hardly new.  Everybody makes good product now and there’s a whole lot of it not differentiable by anything but marketing.  Apparently, there can be too much of a good thing, though I suppose not if you’re a consumer. 

Worldwide and certainly not limited to the active outdoor industry, there is too much production capacity and too much product.  As I see it, that’s the fault of low to negative interest rates kept low for way too long.

There are companies in business that would simply not be around if their interest rate doubled for example.  There are companies that would never have been financed in the first place.  These low interest rate dependent companies are called “zombies” in financial parlance.

Go look at your balance sheet and, if you’ve got debt, ask how your cash flow would look if the interest rate was twice what it is.

We’ve adjusted to the quantity and sameness of product at least partly by controlling our distribution- something I’ve always been a fan of. 

At your next trade show, you might look around and ask, “If this show was smaller and the zombies had all gone away, would I be able to sell more product in more places at better prices without damaging my brand?” 

Just something for you to consider as you walk the show.

Ski INC. 2020; My Second Ever Book Review

It took two guys like author Chris Diamond and his editor Andy Bigford to make this book as valuable as it is.  Their combined 88 or so years in the industry means they have the knowledge, perspective and access to write this book, and the book takes full advantage.  When Chris says “ski” he means ski, snowboard, etc. through the whole book. 

It’s both a strategic evaluation and a history of the ski/snowboard/mountain resort business.  Like most of you, I was aware of the events and transactions Chris describes.  But having them laid out chronologically and the competitive impact and interrelationships evaluated was great.  It caused useful thinking. 

What does Chris conclude?  The subtitle of the book is a good place to start.

“Alterra counters Vail Resorts; mega-passes transform the landscape; the industry responds and flourishes.  For skiing? A North American Renaissance.”

“My premise in this book,” he says, “is that the Epic revolution, as others have followed Vail Resorts’ lead has initiated a renaissance in skiing.  For decades, the media focused on the high cost of skiing, but now the standard refrain is “what a deal” the new passes are.  Total skier visits can be expected to grow coast-to-coast, and not just at the mega resorts.  This energy will eventually expand the number of total participants, if that hasn’t happened already.”

“It is my view that these recent changes have rescued skiing from the trend of becoming, in effect, a rich person’s sport.”

Isn’t it interesting how consolidation has, so far, turned out to be a good thing?  Or at least a necessary thing.  In doing turnaround work I quickly learned that doing “more of the same” isn’t the path to success.  I’d come around to the idea that some consolidation was necessary and appropriate for the industry, but that it would lead to a “renaissance?”  Not sure I’m that far along in my thinking, though I can see how I might have to get there in the not too distant future.

What’s Chris’s business proposition?  He states it pretty clearly using Holiday Valley’s strategy as an example.

  • Make great snow [technology continues to make that easier].
  • Take care of your guests.
  • Know your markets.
  • Maximize summer opportunities [So you’re not a one season business].

That’s from his chapter on small to midsized areas but, you know, all pretty good business advice for any resort. Early on in this chapter I considered skimming it.  Glad I didn’t.  Aside from turning out to be really interesting, it highlighted some consistent themes over the history of the industry

1.            How important commitment, passion and optimism have been (are, I’d say).

2.            The role, for better or worse, of real estate.

3.            The bad things that happen when commitment, passion and optimism obscure the importance of good financial management and a solid balance sheet.   

When you think about it, what’s going on is that the survivors of the consolidation are doing better business.  Well, that’s what happens in a consolidation.  Like, for example, retail.  Adapt or die.  Know your market and take care of your guests (customers).  What an original idea!

It’s true that many small hills have gone away and, as Chris acknowledges, they were great places to learn.  But they only existed when times were easier and the industry was growing madly and they floundered (Chris describes plenty of this) when times got hard and the environment changed, but they wouldn’t or couldn’t change with it. 

Now, as Chris also describes, some of these places are being resurrected by communities, local governments, and investors/skiers who have resources (including for the significant capital improvements required) and are prepared to run the places with best industry practices.

The story for the industry is not fundamentally different from other consolidating industries.  A revolution?  Nah.  Too fraught a term for me.  Let’s say that the pressures of a changing competitive environment have finally, after many years, reached a tipping point where it was, for the individual players, adapt or die.

Chris’ hypothesis is that the mega passes, along with cheaper lodging (VRBO, etc.) are bringing affordable skiing to more people as long as you’re willing to plan in advance.  The mega passes have become the brand, and customers are planning and plotting to get the best deal.  The resorts, meanwhile, are using dynamic pricing, buddy passes, and other permutations of pass terms to give their customers choices and control – what customers want in most industries these days- and influence their behaviors.  Chris and I agree that this process is just beginning and that the ultimate result will be that few people will be walking up to the window and buying day passes.

But what, you say, about all those hills that have closed, mostly to never reopen again?  Where will we get new participants?  Yeah- problem even with all the positive changes Chris outlines.

He reports that retention has increased from 15% to 19% over the many years during which we’ve been trying to move the needle.  He also reminds us of all the improvements in equipment, process and teaching technique for teaching beginners that have evolved.

Perhaps most importantly, he makes it clear that the larger, consolidating, remaining resorts know that developing new, committed skiers is imperative.  Their acquisition of and relations with other resorts as well as the structure of their pricing and pass products are focused on the issue. 

And perhaps, since we’re trying to change human behavior and tried to do it through the Great Recession, we shouldn’t be too hard on ourselves.  I’m not sure 15% to 19% over a decade or more is so bad.  With the changes going on now, I can even imagine it accelerating. 

So, everything is fine, right?  It’s conceivable that Chris as a consummate industry insider might be on the optimistic side, but he does point out some issues.

To paraphrase, he says the industry will be fine if we don’t have a recession.  I’d change that to “until we have.”  The business cycle has not been rescinded and we won’t have any more fun in a recession than other industries. 

He also notes our inability to crack the diversity puzzle.  I’ll just include myself on the list of people who don’t have a solution.

Climate change.  Yes of course, though it’s amazing that this industry still has people resisting the idea.  Tactically, we are relying on improved and increased snowmaking and warm weather activities to deal with this.  The big players are counting on geographical diversification.  Strategically, the industry is active in sustainability and confronting climate change.

He also discusses issues with demographics; an aging base and drop off in snowboarding.  He spends just a paragraph on issues of income, and I think more time might have been warranted.  Skiing may be getting less expensive, but it’s never going to get cheap.  What I know about the stagnation or even decline in real middle class and below incomes over several decades gives me pause.  Skiing may be “cheaper” but if taking advantage of that requires a $500 or higher outlay months before you hit the slopes (plus equipment, lodging, transportation, food, apparel even if they are all cheaper), does it matter?  Economics limits our customer base.

The answer?  Snowmaking, good management, and summer activities generating year around cash flow.  It doesn’t hurt if some of your competitors have gone out of business.  You need to read this book.  The integrated strategic perspective is very important as you consider what your industry business should be doing.

I’ve never met Chris.  I think I might have met Andy.  If you guys are going to be wandering around Denver in a couple of weeks, I’d love to talk with you.  Among the things I’d like to ask is if the numbers exist yet to evaluate the extent of the decline in cost to go skiing. 

Tilly’s: A Solid Quarter. What Did They Do Right?

In its 10Q and conference call, Tilly’s is kind of tentative in explaining what they are doing right.  Let’s go through the numbers and review a few conference call comments to see if we can tease out an explanation.

Revenue for the quarter ended November 2 rose 5.4% from $146.8 million in the prior year’s quarter (PYQ) to $154.8 million in this year’s.  E-commerce revenues were 16.9% of the PYQ’s revenues ($21.2 million) and 17.2% ($22.7 million) in this year’s quarter.  Revenue from proprietary brands were 25% of total revenues in the current quarter, the same percent as in the PYQ.  Below is a table showing revenue by category for 13 and 39 weeks.

Comparable store sales rose 3.1% compared to 4.3% in the PYQ.  That includes e-commerce sales, which means we don’t have an important metric of how their brick and mortar is performing. 

The gross margin rose from 29.7% to 30.5%.  They had a 0.8% improvement in the merchandise margin.

SG&A expense rose 6.9% to $39.5 million.  The most significant increase was $1.0 million for e-commerce marketing and fulfillment. 

Pretax income was up 17.7% from $7.32 million in the PYQ to $8.62 In this year’s quarter.  Just to give you some perspective, pretax income for the first nine months of the fiscal year went from $22.0 to $22.3 million, an increase of 1.4%.

The balance sheet remains solid with lots of cash and no long-term debt.  Equity declined from $183 million a year ago to $181 million, but this has to do with accounting for operating leases- something they didn’t have to do a year ago.  They note that the $5.2 million increase in cash provided by operating activities was “…primarily due to lower inventory.”  That’s a good thing.

Tilly’s starts its narrative by describing 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. Tillys is headquartered in Irvine, California and operated 232 stores, including one RSQ-branded pop-up store, in 33 states as of November 2, 2019. Our stores are located in malls, lifestyle centers, ‘power’ centers, community centers, outlet centers and street-front locations. 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.”

Really nothing insightful or distinctive there.  They seem to put stores almost anywhere, and I’ve always thought them as being particularly focused on their real estate- perhaps a source of competitive advantage.  You can see that in the way they talk about the retail market and their brick and mortar strategy.

In describing the industry they say, “The retail industry has experienced a general downward trend in customer traffic to physical stores for an extended period of time. Conversely, online shopping has generally increased and resulted in sustained online sales growth. We believe these market trends will continue.”

Then they go on, “We continue to believe we have a meaningful number of opportunities to open profitable, new stores in the future. We believe we are under-represented nationally in terms of the number of stores in key population centers relative to many of our larger teen specialty apparel competitors who have a much greater number of stores than we do. We expect to finish fiscal 2019 ending February 1, 2020 with 14 new store openings. In fiscal 2020 ending January 30, 2021, we anticipate opening up to 15 additional new stores. We will continue to focus new store openings within existing markets and certain new markets where we believe our brand recognition can be enhanced with new stores that are planned to drive additional improvement to our operating income.”

They tell us they aren’t committed to closing any stores in in 2020.  “Yet some may likely occur as we work our way through our continuous lease renewal negotiations.”  Once again, there’s that real estate focus, though all retailers are looking for better lease deals these days.

They acknowledge the e-commerce trend, then, but are focused on new brick and mortar.  Perhaps it’s because Tilly’s is so good at picking real estate.  Partly, it’s because they only have 232 stores.  They think new stores can enhance their brand recognition.  There are hints of an undescribed strategy here, though I can’t figure out what they are doing that might give them better brand recognition than their competitors.

Towards the end of the conference call CFO Michael Henry talk about the relationship between brick and mortar and e-commerce in a way that gives some insight into their strategic thinking.  “SG&A leverage,” he says, “is going to have a lot to do with how sales are balanced between stores and e-commerce.” He explains that growing e-commerce sales generates a lot of costs (they mentioned $1 million in the quarter we’re discussing here) while improving comparable brick and mortar sales generate a real opportunity to leverage SG&A expense.  That is, higher sales in a store don’t mean you have to pay more rent and other expenses.  Remember brick and mortar is still around 85% of their business.

They’ve got to have improvement in both e-commerce and brick and mortar, CFO Henry explains, “Because as you’ve seen in recent quarters when it’s only e-comm those are more expensive sales for us because of the shipping fulfillment and all the marketing affiliate costs that go along with the e-comm business.”  Did you hear that?  E-commerce sales are more expensive than brick and mortar I think he said.

So, what is Tilly’s doing right?  First, they seem to be pretty good at managing their real estate and picking locations.  Second, they believe they have some room to expand brick and mortar because they don’t have that many stores yet.  Third they recognize, hopefully like all other retailers, the interaction between online and brick and mortar.  E-commerce is critical for brand positioning and customer interaction- omnichannel and all that stuff.  But it’s especially valuable if helps to improve brick and mortar comparable store sales and you can spread some of both e-commerce and brick and mortar SG&A across the store base, improving the bottom line.

Tilly’s isn’t the only big retailer in our space that understands this.  We’ll figure out which ones don’t when they go away.

What We Can Learn from New Paint Companies?

I imagine it’s happened to all of us.  You need to paint (or if you’re lucky, have painted) a wall/room/house.  You go into the store to pick “the right” paint color and are confronted with literally an infinite number of choices- because they can match any color you want.  As if the paint chips by themselves weren’t more than you could possibly parse.

Home you go with a big bunch of small chips.  After some agonization, you come back and maybe (at a paint specialty store) get some large chips.  Then on the next visit, you get some small sample paint jars and slap them on the wall.  By this time, any thoughts you may have had about being daring and, for example, having a bright accent wall has been bludgeoned out of you.  You just want to get “the right” color.

I spend way too much time choosing and about 14 nano seconds after the project is complete, it’s fine and I never think about it again.  I may not have gotten “the right” color but I sure spent a lot of time doing it.

Some new paint companies are trying to help me.  They offer curated palettes of between 50 and 150 colors.  One of the company names is actually Curator.

It was a decade or two ago when I suggested that snowboard companies should stop picking their SKUs based on what their competitors were doing.  What mattered was what your customer wanted.  More SKUs wasn’t automatically better. 

True- following your competitors’ lead was easy, but it was lazy.  It didn’t answer the question, who are my customers and what do they want?  Mostly, I think we’ve figured that out.  Many of you, I know, have cut your SKU count.  It’s good for inventory management, cost of goods sold, branding and holding margins.  May not help your top line, but it will sure help the bottom line.

Have you cut it enough?

If a paint company believes they can compete with just fifty colors against Benjamin Moore’s 3,500, well, maybe they are on to something.  When you read this article think about how they’ve tried to have colors with a common theme that fit together.  Looks to me like a lot of their colors work with each other.  These companies are betting that the customer will have a better shopping experience with fewer choices with a product I’d have previously characterized as a commodity. 

Can you make your brand special by offering fewer choices?  Perhaps a lot fewer.  You can if you improve their shopping experience.

How’s the Trade Show Business? Emerald Exposition’s Quarterly Results

Emerald didn’t report a great September 30 quarter.  However, there are some mitigating factors.  I’ll discuss those results and the factors below. 

 Before digging into the numbers, let’s focus on issues of strategy and tactics.  Emerald’s previous CEO was resigned about a year ago.  It happened suddenly and, to the outside world at least, unexpectedly.  I wondered why but never was able to find out.

Now, I might have a glimmer.  Sally Shankland has been President and CEO since June 2019.  She used a presentation during the conference call to describe her actions since becoming CEO and the company’s new strategy.  If you go to this link, scroll down a bit, and on the right, under “Third Quarter 2019 Earnings Call” click on “Earnings Presentation” you can see it for yourself.  I recommend reviewing the slides.

If you do that, you’ll notice three major things. 

First, there is what the presentation described as a “New Management Team.”  Everybody isn’t new, but there are at least three senior executive hires since Ms. Shankland came on board. 

Second, take a look at the strength/weaknesses slide from the presentation below.  There is more detail on each point in the presentation.

I can’t speak to the B to B trade show market outside of the active outdoor industry, but certainly the at least temporary cancellation of Interbike, the decision to consolidate two OR shows into the single end of January show in Denver with the Snow Show and what I see as the general industry desire to spend less money on trade shows suggest the first strength can be questioned in our industry.

I have no idea as to the dedication and passion of the employees.  However, my experience in turnarounds (of which Emerald is surely one) makes me certain, given the weaknesses slide (more on that in a minute), that the employees must be happy and relieved to have new leaders acknowledging and addressing the weaknesses that I guarantee the employees all knew about.

Those weaknesses on the right side of the slide are, I agree, fixable.  But as a group they are pretty staggering.  The list runs the gamut of operations.  Maybe 10 years ago when trade shows were “had to go to” events and when Emerald wasn’t a public company you could get away with this.  But not now and I’m glad to see them getting on with it.

One of the outcomes of addressing these issues is the introduction of value pricing.  As COO Brian Field puts it, “…this is research and analysis of live event pricing and promotion based on customers’ perceived values of available locations and packages.”  They’ve already begun the value pricing process at six shows including OR and Surf Expo.  They believe it can increase show revenue by four to eight percent.

For value pricing to work, the shows have to provide clear value.  They are working to use what they describe as their “unlinked and underutilized” customer information.  The idea is that “Bringing these types of data together allows for refinement in messaging, segmentation strategy and customer insights,” says COO Fields.

First, they have to identify the data.  Then they have to develop the best ways to sort and access it.  Then they have to look for insights.  But booth revenues are two thirds of total revenue.  CEO Shankland says she could “…see us in a place where our booth revenue is 50% of our total revenue. And the other half comes from conferences, from education, from sponsorships, from content marketing, from a whole list of things that we can be doing given the fact that we have a digital presence that we’re not offering today.”

Well, the digital presence not being offered is a little scary.  But the real challenge is to take the insights they develop from their (long overdue) data mining and create value customers will pay for when the trend in our industry trade shows is to pay less.

The third thing I noticed, in both the presentation and the conference call, is what’s summarized in the last strength as “Opportunities to supplement organic growth with tuck-in M&A.”  CEO Shankland puts it this way. “…we plan to continue to pursue M&A opportunities that make sense for us, which means where they meaningfully strengthen the existing business that we already own or where we bring considerable value to the acquisition that dramatically enhances the acquisitions growth trajectory. We will apply an even higher level of discipline and rigor to this process than we have in the past.”

When Emerald went public (May 2017) they presented the opportunity as a chance through acquisitions to roll up an industry with many small players.  It was portrayed as a major focus.  Now it’s not.  That’s a good decision- especially if they can grow “non-booth revenue streams” as they are trying to do.  Trade shows and conference events represented 83% of revenues in the nine months ended September 30.

Being public and having access to capital markets might make sense if you’re busily rolling up small players in a consolidating industry.  If that isn’t the strategy anymore and you’re focused on operating better and generating non-booth revenues then perhaps you’d be better off as a private company.

Let’s spend a little time on the numbers.

Emerald currently operates 55 trade shows in additional to other conferences.  Remember when looking at their balance sheet that they receive a bunch of cash for shows in advance of the event.  They carry it as deferred revenue ($149.2 million at September 30) and don’t record it as income until the event is completed.  Most of you reading this, including me unfortunately, don’t get cash for your product before you provide it. 

Revenue was $75.6 million for the quarter, down $26.7% from $103.1 million in the same quarter last year.  The reduction “…partly reflected a net $13.3 million reduction from several show scheduling differences in the third quarter of 2019, most notably Outdoor Retailer Summer Market, which staged in the second quarter of 2019 versus the third quarter of 2018. In addition, revenues for the quarter were further reduced by $7.1 million as our Surf Expo and ISS Orlando shows were forced to cancel due to the impact of Hurricane Dorian. We recorded the associated $6.1 million insurance settlement…as other income in the quarter. Further, acquisitions made in 2018 contributed $1.9 million of incremental revenue in the third quarter of 2019, while 2018 third quarter revenues included $5.3 million from discontinued events, primarily our Interbike show, which did not stage in 2019.”

They tell us that including these adjustments, organic revenue was down $3.7 million, or 4.4%. 

Cost of revenue fell by $1.3 million compared to last year’s quarter to $24.6 million.  SG&S expense rose 13.5% to $33.7 million.  “The increase in selling, general and administrative expenses for the third quarter of 2019 reflected approximately $1.6 million in incremental costs from the 2018 Acquisitions and $1.2 million in higher non-recurring other items, offset by $0.6 million of lower costs attributable to show scheduling differences and $0.9 million in reduced costs related to discontinued events. The remaining $2.7 million increase in 2019 partly reflected additional senior management costs and incremental investment initiatives.”

There were also asset impairment charges of $26.3 million.  There were none in last year’s quarter.  “The impairment charges were due to a decline in fair value compared to the carrying value of goodwill, certain trade names and certain customer-related intangible assets, which were primarily driven by changes to future forecasted performance and decline in our stock price, which management deemed a triggering event and requiring quantitative analysis.”

Yes, it’s a noncash charge.  But you can see it implies a decline in future performance so it’s very real.

Pretax income was a loss of $23.3 million, compared to a pretax profit of $28.8 million in last year’s quarter.  For the nine months ending the same date, pretax income was $28.5 million, down from $86.7 million in last year’s nine months.

Sounds like the new management team is doing the right things and is fundamentally changing the business model.  I haven’t been following Emerald Exposition every quarter, but I think I’ll start.  This should be intriguing.

The Disaster of Negative Interest Rates

On October 31, I posted an article called “What’s Wrong with Capitalism?” After a couple of paragraphs of me ranting and raving there was a link to an article that described what Ben Hunt calls the “financialization of Texas Instruments.  It was disturbing to a few people I heard from and, I hope, to some others I didn’t hear from. 

In the spirit of continue to disturb you in a good cause, here’s another article you should read called, perhaps not surprisingly, “The Disaster of Negative Interest Rates” published by the Mises Institute.

If you’ve never heard of the Mises Institute, named after the economist Ludwig von Mises, you might consider adding their web site to your favorites or even signing up for their free occasional emails.  This is another of my attempts to get you information you really need but won’t find if you rely on mainstream media. 

The point of the article is not just that negative interest rates are a business and economic disaster if maintained too long, but that they threaten the structure and functioning of our republic.  Here’s the link to the article.

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.

What’s Wrong with Capitalism?

Well, uh, nothing actually.  Okay, not nothing.  Some things- sure.  There’s no perfect system.  But the real problem is that what we actually have is less and less like real capitalism.  Adam Smith’s invisible hand and Schumpeter’s idea of creative destruction have both taken it on the chin.  Quantitative easing, low to negative interest rates, too much debt, and the growth of oligopolies and perverse management incentives are knocking capitalism for a loop. 

Follow this link to Epsilon Theory and read Ben Hunt’s article, “Yeah It’s Still Water.”  Please take the time to understand his analysis of what Texas Instruments has done with its cash flow in recent years.  Recognize that this is going on all across the public company space in our industry as well as others.

When you’re done, you might consider signing up for Epsilon Theory’s free weekly emails or putting the web site in your favorites for occasional consideration. 

If Texas Instrument had taken all that cash flow and put it into competitive enhancements rather than share buybacks and management compensation, what might they have accomplished? Our GDP as a country only grows because more people are working (population growth) or they are each making more for each unit of labor (productivity growth).  With population really only growing due to immigration we are dependent on productivity growth.  Unfortunately, stock buy backs, dividends and management compensation don’t contribute anything to it.

Kathmandu Buys Rip Curl: Analysis and Questions

I admit it.  Before this deal, I’d never head of Kathmandu, a public company headquartered in New Zealand.  If you haven’t either, you can visit their consumer facing web site or their investors web site where you can pour over all the deal related documents I’ve looked at.  Mostly, though, I think you’re happy to leave that chore to me.

Kathmandu “…is a designer, marketer, retailer and wholesaler of clothing, footwear and equipment for travel and adventure. It operates in New Zealand, Australia, United Kingdom and United States of America,” as described in their public filing for the fiscal year ended July 31, 2019.  Below are some summary numbers for its last two full years.

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