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.

A Look at Zumiez’s April 29 Quarter: I Take the Lazy Approach

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I see no reason to spend time explaining what’s going on at Zumiez when CEO Rick Brooks has done me the favor of laying it out in his introductory conference call remarks.  Read them, then I’ll offer short discussions.

“Our top priority is to stay consistent and relevant with our customers in order to expand our market share…”

“We believe there are increasingly blurred lines between retail channels. Our focus is firmly on embracing today’s empowered customer and winning them over for authentic culture and brand. We believe empowered consumer lives in a channel-less world and is not focused on going into a physical store or buying online but rather transacting with a retailer they know and trust.”

“In this channel-less world, we believe that trend cycles are shifting at a faster rate than ever before. New brands emerge that can quickly move from locally recognized brands to global brands. We believe there is a level of customer transparency in retail that is driving out inefficiencies within the market and forcing consolidation in the industry.”

“We’ve established a strategic presence in six countries across three continents, with a digital presence that allows us to reach even further. This scale allows us to work together with our brand partners to serve our customers globally. These include existing emerging local brands, both domestically and internationally in their evolution to global brands.”

In past analyses, I’ve talked specifically about what Zumiez is doing as far as I can tell from public information.  Regular readers know what I’m referring to but let me pull a few words out of Rick’s mouth where I suggest you focus.  I’ve highlighted those words above.

Okay, the first one. They think they can expand market share even though store openings are declining.  They ended the quarter with 700 stores worldwide.  Since the end of last year’s quarter, they added a net of 5 stores in the U.S., 6 in Europe and one in Australia.  At 50 stores, I expect Canada is pretty much done building out.  13 total openings are expected this year.

They think they can increase share because of their Trade Area concept, their systematic approach for identifying and introducing new brands, the integration of all their revenue streams, and the constantly improving quality of their data.  A trade area has a geographic concept, but it’s more than that.  Exactly how they will function and what they will turn out to be even Zumiez isn’t clear on yet.  They are clear it will evolve.

Second, focus on the words “authentic culture and brand.”  Notice they didn’t say surfing, or skateboarding, or action sports or anything like that?  No activity mentioned.  If you are tied to a single activity, it’s going to be hard to increase your market share unless you are small.  But figuring out culture is hard and ever changing- and not in your control.

The third bold underlined phrase, talking about customer transparency etc. isn’t a surprise to anybody.  I hope.  Your customer is in control.  Product cycles are shorter.  Your speed of reaction is everything- follow your customer, I’ve said, but not too far and not blindly.  Your customer connections and data systems are critical- not just to follow them but to manage your costs as they ask for more quality and continual newness at lower prices.

Zumiez believes that if they get culture and brand right, they will be able to “…serve our customers globally.”  So far, the acquisition of Blue Tomato in Europe, for which they paid a lot of money, isn’t quite working out as it’s losing money.  Strategically, I expect they are looking to role out world wide the process they have in the U.S. for identifying new brands and Blue Tomato is important to that end.  They introduced about 150 new ones during the last complete year.  I’ll be interested to see the extent to which they can identify and bring brands from one geography to another.

For that to work, Zumiez has to have a target customer that embraces a “culture” that crosses national cultural lines.  No small challenge, but the only way Zumiez will get a chance to serve its customer globally with the efficiency it has to realize.  One of Zumiez’s big legs up is that its 40-year-old internal culture is consistent with that.

It would have been easy to write several thousand words on each of the four conference calls quotes.  But let’s leave it at this before moving on the numbers.  If anything I wrote was a surprise you are a candidate to be involved in the forced consolidation of the industry Rick is referring to, and to help Zumiez increase its market share.

Zumiez’s revenues for the quarter rose 13.8% from $181 in last year’s quarter to $206 million.  82.7% of revenue was from the U. S., up from 85.1% in last year’s quarter.  “The increase primarily reflected the increase in comparable sales of $15.2 million [8.3%] and the net addition of 12 stores…By region, North America sales increased $18.7 million or 11.5% and other international sales (which consists of Europe and Australia sales) increased $6.4 million or 34.3% for the three months ended May 5, 2018 compared to the three months ended April 29, 2017.”

The gross profit margin rose from 28.7% to 30.3%.  “The increase was primarily driven by a 160-basis point increase due to the leveraging of our store occupancy costs.”

SG&A expenses were up from $58.3 to $64.3 million but fell 1.1% as a percentage of revenues.  “The decrease was primarily driven by 160 basis points from the leveraging of our store costs partially offset by a 30 basis points increase in corporate costs and 30 basis points increase due to the timing of annual training events.”

Please pay close attention to both those mentions of “leveraging” costs.  It happens when you open more stores, but in this case, it also has something to do with Zumiez thinking of it’s online and brick and mortar revenues as one revenue stream and managing ecommerce through it’s stores.  That is the future.

The pretax loss improved from $6.6 million in last year’s quarter to a loss of $1.9 million in this year’s quarter.

The balance sheet is stronger than a year ago.  Besides losing money in Europe, the only financial issue I might raise is a continuing problem with inventory shrinkage.  It’s at about 1%.  They’ve been talking about it for some quarters now.  I wonder if it doesn’t relate to the system changeover and the movement of responsibility for ecommerce relationships into the stores.

When I do these analyses, my goal is always to make you think.  Zumiez had a strong quarter.  What I really want you to focus on is their decision to ride the whirlwind.  At the most fundamental level, the organization collectively said, “I’ve got no clue as to how this is all going to work out, but we’d better get out in front of it even if there’s a bit of chaos.”

They did, and there is, but what was the choice.  What’s your choice?

 

 

 

 

Deckers’ Results for the Year; Sanuk Continues in Cleanup Mode

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For the year and quarter ended March 31, Deckers improved its results as discussed below.  Related to that improvement is the progress of its restructuring and operating profit improvement plans.  As we review these results, we’ll see that Deckers is confronting the same issues other brands/retailers are confronting as the internet changes the role of stores and the way people shop.

In the year ended March 31, Deckers reported a revenue increase of 6.3% from $1.79 to $1.903 billion.  The UGG brand, at $1.507 billion for the year, represented 79.2% of Decker’ total revenues.  Sanuk’s revenues fell slightly from $91.8 to $90.9 million.  The brand’s wholesale revenue rose from $77.6 to $78.3 million.  Direct to consumer fell from $14.2 to $12.6 million.  Just to put that into perspective, Sanuk’s wholesale revenues by themselves, for the year ended December 31, 2013 were $94.4 million.

CEO Dave Powers, explaining Sanuk’s result, said it “…was driven by mid-single digit growth in US wholesale, offset by the planned decline internationally as the brand is in the process of resetting its distribution.”

“We also significantly reduced the amount of closeouts in an effort to clean up the marketplace and drive margin improvements.”

I’ve got no problem at all with revenue stalling if it means a higher gross margin and cleaner, more appropriate, distribution.  That’s how you build, or I guess I mean rebuild, the brand.  What took them so long?

Sanuk’s operating profit on its wholesale business only was $14.5 million, up from a loss of $110.6 million the previous year.  As explained in the 10K, “The increase in income from operations of Sanuk brand wholesale was primarily due to impairment charges for goodwill and long-lived assets incurred in the prior period, as well as higher sales at higher gross margins in the current period.”  For none of their brands do they give an operating profit that includes direct to consumer.  At best, it would be very difficult to calculate- probably meaningless.

Deckers’ overall gross margin rose from 46.7% to 48.9% “…primarily driven by lower input costs as we execute our supply chain initiatives through our operating profit improvement plan, a higher proportion of full-priced selling partly due to favorable weather conditions, as well as favorable foreign currency fluctuations compared to the prior period.”

Weather and currency fluctuations, of course, are outside of Deckers’ control.  We don’t find out how much of the increase was from company controlled “lower input costs.”

SG&A expenses declined 15.3% from $837 to $709 million and, as a percent of revenue, from 46.8% to 37.3%.  BUT that includes $118 million of Sanuk related impairment charges from the previous year.  Total impairment and depreciation charges last year were $138 million.

Pretax income improved from a loss of $7 million to a profit of $221 million.  Big improvement even taking in to account last year’s big charge offs.  Net income rose from $5.7 to $114 million.  This year’s net income would have been higher, but the tax provision rose from a benefit last year of $12.7 million to an expense this year of $106.3 million.  As a result of the so-called Tax Reform Act, Deckers “…recorded provisional US federal and state tax estimates for the one-time mandatory deemed repatriation of foreign earnings of $59,114 [$59.1 million] …”

For the March 31 quarter, revenue rose 8.7% from $369 million in last year’s quarter to $401 million.  The gross profit margin rose from 43% to 48%.  CFO Thomas George tells us in the conference call that the increase “…was largely due to fewer closeout sales and an improved promotional environment in the quarter, which contributed 160 basis points, continued realization of significant progress on our supply chain improvements worth approximately 170 basis points and 120 basis points from FX, with the balance being driven by favorable channel mix.”  Again, it’s important to recognize how much of the improvement was the result of factors out of Deckers’ control.

Last year’s quarter had a loss of %15.7 million.  In this year’s, net income was a positive $20.6 million.  Last year’s quarter included restructuring charges of $29 million.  Comparable charges this year were $1.7 million.

Starting in February 2016, Deckers implemented, and continues to implement, a restructuring and, a year later, an operating profit improvement plan.  The goal of the restructuring plan is to “…streamline brand operations, reduce overhead costs, create operating efficiencies and improve collaboration.”  The operating profit improvement is to come from “…reducing product development cycle times, optimizing material yields, consolidating our factory base, and continuing to move product manufacturing outside of China.”  As they describe it, the plans are working with the savings and improvements already significant.

As part of the plans, Deckers is reevaluating its retail stores.  They ended the year with 165 of them worldwide, having already closed 32 as part of their plans.  Their long-term plan is to further reduce that number to 125.  Talking about the stores, the 10K says the following.  “While we are seeing initial signs of improvement, our decision to open or close store locations will be evaluated based on the operating results of each store and our retail store and fleet optimization strategies, which may ultimately impact our global retail store count.”

Then, talking about their direct to consumer strategy, they state, “…we believe that our retail stores and websites are largely intertwined and interdependent. We believe that many consumers interact with both our brick and mortar stores and our websites before making purchasing decisions. For example, consumers may feel or try on products in our retail stores and then place an order online later. Conversely, they may initially research products online, and then view inventory availability by store location and make a purchase in store.”

No kidding.

One of their risk factors is about opening retail stores.  It says, “It may be difficult to identify new retail store locations that meet our requirements, and any new retail stores may not realize returns on our investments.”  Risk Factors have tended to become blinding glimpses of the obvious, so that’s fine.  However, the discussion of this factor takes a business as usual approach to store opening decisions; no mention of ecommerce.

Maybe some retailers need a new risk factor: “If we don’t figure out how to think about and manage our stores and ecommerce as if they are one and the same, we’re screwed!”  Probably some lawyer will stop them from putting it quite that way.

Let me go on and quote for you some of their Trends Impacting Our Overall Business.

“• We believe there has been a meaningful shift in the way consumers shop for products and make purchasing decisions. In particular, brick and mortar retail stores are experiencing significant and prolonged decreases in consumer traffic as customers continue to migrate to shopping online.”

“• In light of the shift in consumer shopping behavior, we are seeking to optimize our brick and mortar retail footprint. In pursuing store closures, we have been impacted by costs to exit lease agreements, employee termination costs, retail store fixed asset impairments, and other closure costs. However, we do not expect to continue incurring significant incremental store closure costs, primarily because the majority of our remaining store closures are expected to occur as store leases expire to avoid incurring additional lease termination costs.”

“• We expect our E-Commerce business will continue to be a driver of long-term growth…”

All I know, of course, is what I read in the SEC filings and conference call transcripts.  Perhaps their ongoing reduction in stores is their thought-out response to the integration of ecommerce with brick and mortar, but I can’t tell that from the information I have available.

What I want you to take away from the above discussion about their brick and mortar strategy and risk factors is that while they give lip service to the integration of brick and mortar and ecommerce, they don’t give us much information on just how their “fleet optimization strategy” relates to their ecommerce strategy.

Deckers has a solid balance sheet, great cash flow, and is making money.  Their restructuring and profit improvement plans seem to be working.  I (mostly) like what they are doing with Sanuk.  It seems like they’ve figured out what the brand can, and cannot, be.  They grew their revenue last year and did it in the right ways.  CEO Powers says in the conference call, “…we are making strategic decisions that will generate some topline pressure in the current year but are in the best interests of the brand’s long-term success.”

You know I love that approach.

But from Deckers, and from any retailer by the way, I need to know what exactly the “optimization” of their brick and mortar footprint means.  When a retailer finally starts to talk in some detail about how brick and mortar and ecommerce are one revenue stream, I know they’re making progress.

Defying Gravity: VF’s Quarter and Van’s Results

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I’ve been opinionating for some time now that careful control of distribution was a requirement of brand building in a world of products very similar to competitors.  I’ve further said that it might be a good idea to give up some sales and build the bottom line at some expense to the top line.

I’m squirming around here trying to discern some platitude that explains Van’s results and gets me off the hook.  “The exception that proves the rule” is all I can come up with, though I’ve never entirely known what that meant.

In the quarter ended March 31st, Van’s revenues grew “…39% with strength across all regions, channels and franchises.”  The reported increase was 45%, but that included 6% from favorable foreign exchange rates.  They continue in the conference call, “Revenue in the Americas increased 44%. Europe increased 36%. And Asia Pacific increased 24%. Our wholesale business increased more than 30% and our direct-to-consumer businesses increased nearly 50%, including more than 75% growth in digital, and over 40% total comp growth supported by our customs platform, which tripled in the quarter.”

The brand’s expected growth for fiscal year 2019 that will go through the end of March 2019 (they’ve changed their fiscal year and the quarter we’re talking about now is the transition quarter) is 12% to 13% with 20% growth in the first half.

I can understand that kind of growth for the year, though I continue to wonder how long they can keep it up without a hiccup.  President and CEO Steve Rendle pointed to their product development and launches, specifically noting that 75% of revenue was from other than Old Skool.  He also noted that Van’s “Retail inventory levels are in great shape and we remain disciplined with respect to inventory management, merchandising and assortment planning.”  I like that, but note he specifically said retail inventory levels rather than just inventory levels.

North Face revenues rose 11% and Timberland 5% during the quarter compared to the numbers in last year’s quarter.  The numbers without the foreign exchange impact were 7% and (1%) respectively for the two brands.  The Outdoor and Action Sports segment grew 19% overall for the quarter so the influence of Vans is obvious.

CEO Rendle made a comment about VF becoming a “…a purpose-driven company” and noted it was the title of this year’s annual report.  “It will help us attract and retain the industry’s best talent, it will provide clarity to our decisions and actions, and it will galvanize our associates around a shared purpose and enable us to serve as a powerful force for good in the world. It’s no longer enough to just focus on what we do. It’s equally important to consider both how and why we do it.”

When you are this big, this diverse, and trying to maintain your flexibility, there is a lot of organizational value in having a consensus among employees as to what the company is trying to do and why.  This is an overused word, but it empowers people because when a phone call comes in or a piece of paper comes across their desk, they are more efficient in dealing with it.  Just to use one example I’ve personally dealt with, and one VF is certainly interested in, if you have a potential acquisition come across your desk, there might be a lot of effort put into whether or not it’s of interest.  But if there’s already clarity about what an attractive acquisition candidate looks like, there won’t be.  No paralysis by analysis.

Meanwhile, and in a related vein, VF is changing.  As you know, it’s increasingly dominated by its outdoor and action sports segment.  But it’s brands are changing as well.

On October 2, 2107 VF purchased Williamson Dickie for $798.4 million.  The workwear company contributed $233.1 million in revenue and $10.7 million in net income (net of restructuring charges) during the quarter.

On November 1, 2017, VF bought Icebreaker, an outdoor brand focused on “…high -performance apparel based on natural fibers, including Merino wool…”  No income statement was disclosed.  Probably too small to require it.  They did note a $9.9 million gain on the derivatives used to hedge the purchase price.

As announced on March 10, 2018, VF is in the process of purchasing Altra, “…an athletic and performance-based lifestyle footwear brand…”  The purchases price is $135 million.

VF has also, on March 17, 2018, signed an agreement to sell Nautica for $289.1 million.  Earlier in 2017, VF sold Jansport and its licensing business.

With brands coming and going, and with the increasing dominance of Vans and the outdoor and action sport segment, being “purpose driven,” as Steve Rendle described it, becomes even more important.  Not just because of acquisitions.  VF has always been disciplined and focused in its approach to those.  CEO Rendle goes on to say, “We’re making changes to reposition and strengthen our business, get us closer to our consumers, encourage greater collaboration, and position us to win…”

Yeah, this is all good, but kind of touchy feely.  What might it mean?

Let’s return to Vans for a second.  Obviously, Vans has moved way past being a skate/surf brand.  That may be its roots, but you don’t do however many billions of dollars in revenue Vans is doing without transcending what, I’m kind of sorry to say, is a niche market.  And they expect to keep growing the brand.  What products are they going to sell to whom through which new distribution channel?  How do they make the brand stand for something to people who don’t know or care much about skate/surf?

I think “purpose driven” though it may sound like a platitude, has something to do with figuring that out.

The other thing I won’t be surprised to see, based on some of the comments as well as the coming and goings of brands and the dominance of outdoor and action sports and especially Vans, is some kind of restructuring of which brands are in what segment and what the segments are called.  Here’s what they said on page 18 of the 10-Q

“In light of completed and pending transactions resulting from our active portfolio management strategy, along with recently effected organizational realignments, we are evaluating whether changes need to be made to our internal reporting structure to better support and assess the operations of our business going forward. We expect to finalize our assessment early in Fiscal 2019. If changes are made to our reporting structure, we will assess the resulting effect, if any, on our reporting segments, operating segments and reporting units.”

VF’s revenues for the quarter grew 21.8% from $2.5 to $3.05 billion.  Of that growth, $233 million came from acquisitions, $120 million from foreign exchange and the remainder from their existing brands (organic growth).  You can see this broken down by segment below.

 

 

 

 

Without outdoor and action sports, there is no organic growth.  Below, you see where the operating income came from and how it’s changed since 2017.  2018 in on the left, 2017 is on the right for the quarter ended in March of each year.

 

 

 

 

Wholesale revenue, excluding acquisitions and foreign exchange, rose only 1%.  Looks like direct to consumer is where the growth is.

The gross margin rose from 50.3% to 50.5%.  “Gross margin was favorably impacted by increases in pricing, a mix-shift to higher margin businesses in the Outdoor & Action Sports coalition and foreign currency changes, offset by lower margins attributable to the Williamson-Dickie acquisition and certain increases in product costs.”

Wish I could get my hands on some gross margin information by brand.

SG&A expenses rose from 38.5% of revenue to 40.3%.  “The increase was due to expenses related to the acquisition and integration of businesses and higher investments in our key growth priorities, which include demand creation, customer fulfillment, direct-to-consumer and product innovation. Higher compensation costs also impacted the three months ended March 2018.”

Net income rose 21% from $209 to $253 million.  Even with $10.7 million of income from the Williamson-Dickie acquisition during the quarter, the imagewear segment operating income (which includes Williamson-Dickie) didn’t budge.  All the growth in operating income is from outdoor and action sports and I’d love to know, of that total, how much is from Vans.

The balance sheet, largely due to acquisitions, got weaker.  Working capital fell from $2 billion to $1.23 billion.  The current ratio fell from 2.1 to 1.4 a year ago and debt to total capital was up from 37.2% to 50.4%.  Stockholders’ equity declined 15.7% from $4.37 to $3.69 billion.  What I’d highlight is the increase in short term borrowings from $289 million to $1.53 billion.  They expect to reduce that “in coming months.”  Certain of the current asset accounts rose, but the increases were consistent with revenue growth and the Williamson-Dickie acquisition.

Cash used by operating activities was a negative $243 million.  In last year’s quarter, it was negative $210 million.

I still worry about VF’s dependence on Vans and what happens when the inevitable soft spot comes along.  But this is a company that “gets it.”  They understand the pace of change and the need to be flexible in an unprecedented environment.  They recognize (not everybody seems to yet) that no distinction can be made, for both financial and marketing reasons, between a sale made online and one sold in a store.  They are not (far from it) paralyzed because the future is a bit more blurry than usual.  They try new things.  Some work, some don’t.  They move on.

Not a bad approach.

Retail Jobs, the Internet, and the Role of Customer Service

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I want to introduce you to a web site I subscribe to called Wolf Street.  It’s free and you can sign up for emails if you want.  Here’s the link  the chart below comes from.  You don’t have to read Wolf’s article to follow what I’m discussing, but you might take a look at it.

If you did go through the article, you’d see that there were 15.8 million U.S. retail jobs at the end of April as reported by the Bureau of Labor Statistics.  In terms of total number of jobs, that’s second only to health care at 15.9 million.

Retail has added 76,000 jobs in the last 12 months, the BLS tells us.  From our more focused industry perspective, the picture is a bit different.  Here’s the chart from Wolf’s article.

Look, I had my “Aw shit” moment when I saw this.  But I’ve shaken it off and you should too.

First, it’s hardly a surprise.  We’ve known for some time now that we were over retailed as a country and an industry.  We’re going through an unpleasant but necessary process (The economist Schumpeter called it “creative destruction”) that I see ending with the next recession, whenever that happens.

Second, some part of the decline, as you can see above, is being offset by growth in ecommerce jobs- what the chart calls “Nonstore retailers.”  That may not make you happy if you’re the business closing stores or going out of business, but I can assure you it makes the people getting those jobs happy.

Third, brick and mortar is obviously not going away.  But it is evolving in response to the growth of ecommerce, improvements in distribution, and accelerating knowledge and connectivity among consumers.  You can see in the chart it’s growing in those industries that don’t lend themselves to ecommerce and declining in those that do.  Big surprise.

Fourth, talking about brick and mortar “declining” or “growing” misses the point.  If you follow Tillys, The Buckle, Zumiez or other industry retailers you will certainly see a reduction in the rate at which they open stores or even, net of closings, no new stores openings.

Opening new stores, by itself, is no longer the obvious, standalone path to growing revenue and profitability.  You know that.  Retailers are struggling (a fair word I think) to figure out where to place stores, how to structure them, and what their role should be in an increasingly seamless, interconnected retail market.

Let me put this another way.  If you forget about making a distinction between brick and mortar and ecommerce revenues, how do you use your store locations, budgets, staff and layouts to maximize the bottom line?  What is a “store” and what is it supposed to do?

If you figured that out, based on your excellent and improving customer information systems, it might just be possible to improve revenue, or at least the bottom line, with fewer stores.  I’m already certain it’s required, for both financial and customer relation reasons, that stores absorb much of what used to be thought of as the standalone ecommerce costs.  Here’s why.

We’ve all known for years that ecommerce is expensive.  The now obviously inadequate challenge I made years ago was to make sure your incremental operating profit from ecommerce operations at least covered those ecommerce costs and to not cannibalize your existing sales.

What I now know you need to do is make the issue of cannibalization irrelevant.  The only way to do that is to have an organization structured to see no difference between online and instore sales and to place as much of the ecommerce cost structure as possible within the brick and mortar footprint.  That might include, for example, eliminating any difference between ecommerce and brick and mortar inventory, making brick and mortar sales people responsible for the customer relationship online or in person, and no doubt a dozen other things I haven’t thought of.  It’s already happening at many retailers.

If you do this well, can you grow your revenue?  Probably.  Can you reduce costs and improve the bottom line?  Yes.

The very related activity I see changing is customer service.  I started thinking harder about it when I read and pointed you to these articles on some emerging retail technologies, including 3D printing, and the millennials’ approach to money.

So what does the customer need you to do that we might call customer service?

Find and compare prices? Compare one brand with another? Locate the product? Understand features?  Find out how the product wears/functions and what others think about it?  Oops.  That sounds more like the list of things they don’t need you to do any more.  What should you do?

On May 3rd the FDRA (Footwear Distributors and Retailers of America) held an executive summit called Retail Footwear Revolution: Succeeding in the Age of Consumer Chaos.  Good title- though it’s only chaos for the brands and retailers.  The consumers are just fine.

Among the speakers was Footlocker CEO Dick Johnson.  SGB Executive reported here on what he said.  I couldn’t find a transcript.  I strongly recommend you read it.  It will resonate with all of you.

Among the interesting things he notes is that Footlocker has closed 1,000 stores in the last ten years, but overall square footage has grown.  That, I think, is because the function of stores has changed.  As he puts it, “…we’re building more exciting space.”

Also more expensive spaces I’m thinking.  And just what does “exciting” mean?  We all continue to try and figure that out.

The article continues, “Johnson said the discovery phase used to be heading to Foot Locker to find out ‘what was cool’ and that you ‘had to know the guy who knew the guy’ to find out about launch products.  ‘Not anymore,’ said Johnson, ‘Discovery and researching happens constantly with our consumer. They know more than we know sometimes.’”  Yes, they do.

The article notes that Footlocker is “…leveraging data to bring a higher level of personalization…Johnson said one of the biggest investments Foot Locker is making is in data, which is being used to drive messaging, merchandise decisions on its website and stores, product buys and even service levels and the overall customer experience. The focus is on tapping algorithms and machine learning ‘so we can learn faster’ and more quickly adapt toward where consumer preferences are heading.”

Wow.  Is that customer service or customer management?  Consumers, I’ve written, have found themselves in control.  Retailers and brands want to (have to) respond to consumer demands, but it feels like they are also trying to get some of that control back.  I don’t blame them.

Finally, the article reports, “Foot Locker plans to invest in local content and local artists to ‘change the way that people think about our stores.’ More experiences, such as bringing in a barber chair for a special promotion, or offering sneaker cleaning on certain days in exchange for loyalty points, will help local stores stand out. Data will be tapped to ensure marketing and product assortments are tailored to local tastes. Said Johnson, ‘Not every market is treated the same.’”

Can you, then, have hundreds and hundreds of stores and each of them, to a greater or lesser extent based on improving data, each act as a specialty store?  That certainly seems like what Footlocker (and other retailers) is trying to do.

People will still want to come to brick and mortar stores, though perhaps not so many, not so often, and for different reasons.  Customer service does not mean what it used to mean unless you have a product that’s distinctive and somewhat scarce.  As I talk with executives and read what they say, I find them very specific about the problems, but often speaking in generalities about the solutions.  Like I said, we’re all still trying to figure it out and, if we think we have, don’t want to tell our competitors.

Do two things for me.  First recognize the difficult economic process we’re going through and prepare for it.  Some people I talk with don’t precisely want a recession, but some part of them wants to get on with it to perhaps come out the other side and complete this consolidation.  I’m generally in that boat.

Second, think hard about customer service.  You can’t afford to do all the things you used to do in the same way and do all the new things the consumer wants you to do.  If only financially a transition is necessary.

On a personal note, I’m just back from two weeks in Tuscany with my wife.  Good food, good wine, nice people, beautiful country.  Recommend not driving in hill towns.

I started this article in Tuscany when the jet lag started to wear off.  I’m finishing it at home where the jet lag has not worn off.  Moan.  Maybe I need to proof read this after my nap.  Thank you for reading.  I really feel lucky you’re willing to spend a few minutes on my ideas and always look forward to your comments.

No Store Growth; Perhaps a Good Decision, But What’s the Strategy? The Buckle Annual Report

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The Buckle ended its February 3rd fiscal year with 457 retail stores and expects to end the current year with the same number.  These days, that may be exactly the right decision; the days of open more stores, automatically earn more money, are gone.

So what’s the strategy?  Over three years, revenues have fallen from $1.120 billion to $975 million and to $913 million in the recently completed fiscal year.  Pretax income is down from $235 million in the year ended January 30, 2016 to $156 million last year and $139 million in the most recent year.  Gross margin, however, rose from 40.7% last year to 41.6% in the year just ended.  On the other hand, SG&A expenses rose a bit in the face of declining revenues.

Here’s how The Buckle describes its business and operations in the 10-K:

  • “The Buckle, Inc….is a retailer of medium to better-priced casual apparel, footwear, and accessories for fashion-conscious young men and women.
  • “The Company’s marketing and merchandising strategy is designed to create customer loyalty by offering a wide selection of key brand name and private label merchandise and providing a broad range of value-added services. The Company believes it provides a unique specialty apparel store experience with merchandise designed to appeal to the fashion-conscious 15 to 30-year old.”
  • “Management believes the Company provides a unique store environment by maintaining a high level of personalized service and by offering a wide selection of fashionable, quality merchandise. The Company believes it is essential to create an enjoyable shopping environment and, in order to fulfill this mission, it employs highly motivated employees who provide personal attention to customers.”
  • “Merchandising and pricing decisions are made centrally; however, the Company’s distribution system allows for variation in the mix of merchandise distributed to each store. This allows individual store inventories to be tailored to reflect differences in customer buying patterns at various locations. In addition, to ensure a continually fresh look in its stores, the Company ships new merchandise daily to most stores. The Company also has a transfer program that shifts certain merchandise to locations where it is selling best.”
  • “The Company’s management information systems (“MIS”) and electronic data processing systems (“EDP”) consist of a full range of retail, financial, and merchandising systems…The system includes PC based point-of-sale (“POS”) registers in each store. The registers trickle transactions to a central server using a virtual private network for collection of comprehensive data, including complete item-level sales information and employee time clocking. The transactions are then swept into the central computer (IBM iSeries). Price updates are sent daily for the price lookup (“PLU”) file maintained within the POS registers.”

This is all good stuff.  Indeed, it’s all necessary stuff.  Doing it, however, is the price you pay to get a chance to compete rather than a source of competitive advantage.  And I have a hard time with the use of the word “unique.” I’ve always thought The Buckle did a great job integrating their owned with purchased brands, but “unique” is pushing the envelope.

The balance sheet remains strong with no long-term debt, though equity has fallen 9.1% since last year from $531 to $391 million.  Two years ago, cash flow from operations was $159 million.  Last year it was $149 million and in the most current year, $120 million.  It’s profitable but, as we’ve already reviewed, revenues and earnings are down over three years.  I’d add that they had a 7.2% decline in comparable store sales.

Here are the questions I’d like to ask The Buckle’s management.  For all I know, they may have great answers.  They just didn’t want to put them in the 10-K

  1. What is your process for identifying and bringing in new brands? If that’s as important as I think it is, you must have one to succeed.
  2. Your online sales in the fourth quarter were $33.5 million, or about 12% of fourth quarter revenue. But there’s no discussion of how you tie your brick and mortar and online presence together.  I think that’s become increasingly important to critical.  Have you made a decision to focus on a brick and mortar strategy?
  3. Your private label business was 36% of revenue in 2017, and you list ten private label brands you carry.  I can’t tell if this is all of them.  I’ve noted how well you merchandise private label and purchased brands together, but I’d sure like some more information on what limits, if any, you consider the private label business to have.  You note you expect purchased brands will continue to be a majority of sales.  You actually have “Dependence on Private Label Merchandise” as a risk factor and note, “The Company may increase or decrease the percentage of net sales from private label merchandise in the future. The Company’s private label products generally earn a higher margin than branded products. Thus, reductions in the private label mix would decrease the Company’s merchandise margins and, as a result, reduce net earnings.”
  4. The purchased brand Miss Me/Rock Revival was 18.2% of the year’s revenues.  Another purchased brand, Axis Denim, was 14.0%.  That’s 32.2% from two brands and seems like a troubling concentration.  Are you confident those two brands will remain popular?
  5. You aren’t opening any new stores this year but are doing four full remodels. You note that construction costs for a remodel are about the same as for a new store.  Should we expect remodels rather than new store openings to be emphasized in the future?  What kind of sales bump do you get from remodels?

So there you have it.  The Buckle is a profitable business with a strong balance sheet.  But the three-year trends are going in the wrong direction, and the public information doesn’t describe a strategy to address the issue or respond to the new retail environment.

 

 

A Brief Remembrance of SPY CEO Seth Hamot

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This isn’t the kind of thing I usually choose to write about.  After some thought, I wanted to express how sad I was to hear about the recent passing of SPY CEO Seth Hamot.  For years before I met Seth, I gave him a hard time.  As a public company, SPY was a valuable source of information for us all into how a smaller industry company competed.  So every quarter for years I would write about how SPY was doing.

Like clockwork, I would review Spy’s balance sheet and criticize some of the problems they had created for themselves.  As things evolved, and as Seth got more involved, I’d still critique their upside-down balance sheet, but over time I began to become a supporter of what I considered to be realistic and appropriate strategies. It felt like they were doing most things right.  But SPY was still an experiment in a small company building a brand niche in a highly competitive market.  I didn’t know if they could pull it off and said so.

One day at a trade show, some years ago, I was at the SPY booth and somebody said, “Hey! You should meet Seth.”

Yeah, great.  I always have terrific meetings with CEO’s of public companies I’ve criticized in print.

It didn’t come down that way.  Seth was engaging, funny, and open minded about my take on the company.  And smarter than I am- a trait I always love to run into.

That conversation lasted as long as we had time for.  Over the years that followed there were more phone calls, informal meetings at shows, and occasionally I’d get together with Seth and perhaps a couple of other SPY people to talk about the company.

Damn. Just realized I did all that for free.  Nice work Seth.  Well, the secret of getting me to work for free is to make sure I learn more from you than you learn for me.

Seth and I didn’t always agree, and that was okay.  If you only talk to people you agree with, you aren’t likely to learn much.  What was important was the quality of our conversations.  Coming from outside the action sports/active outdoor industry, Seth wasn’t burdened with the baggage of preconceptions we all carry around.  I’d spew some industry common knowledge that “everybody” knew was “the way you had to do things,” Seth would ask me why, and when I didn’t have a solid answer Seth would suggest an alternative that I, in my brainwashed, industry groupthink mind set, would never have thought of.

Seth tried a bunch of such things at SPY.  Some worked, and I imagine some didn’t.  But if you’re trying to differentiate a small brand in a market dominated by big guys what possible reason could you have to do anything else?

And that is Seth’s legacy to me.  And maybe to you.  Question every assumption you ever had and talk to people you don’t agree with.  And have fun doing it.

Had Seth and I lived near each other, I imagine we would have been good friends and I regret we didn’t spend more time together.  If I’ve turned this remembrance into a bit of a business lesson well, sorry.  But you know what?  Seth would be fine with it.  I hope he might even laugh a bit.

Zumiez’s Annual Results; And Tales from its Conference Call

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My favorite part of a Zumiez’s conference call is when CEO Rick Brooks apparently decides the analyst has asked the wrong question or doesn’t quite understand the implications of what’s been asked.  Two plus pages of transcript later, sometimes ably supported by CFO Chris Work, we may have forgotten the original question, but we’ve always learned something new and intriguing.

So it was for the recent call discussing the quarter and year ended February 3rd, 2018.  But before we have that fun, let’s go through the numbers.

The Numbers

Fourth quarter revenues rose 16.9% from $263.6 to $308.2 million.  “Contributing to this increase were positive comparable sales growth of 7.5%, the net addition of 13 stores since the end of last year’s fourth quarter, the 53rd week in 2017 were $10.3 million and the positive impact of foreign exchange were at $5.3 million. Also benefiting fourth quarter 2017 net sales is an adjustment to deferred revenue related to our STASH loyalty program were $3.8 million,” explained CFO Chris Work.

The gross margin rose 1.5% to $37.2% compared to last year’s fourth quarter.  Chris notes, “The increase was primarily driven by 120 basis points of leverage in occupancy, 80 basis points related to the recognition of deferred revenue due to changes in our STASH loyalty program, estimated redemption rate, and 70 basis points of improvement in product margins. These increases were partially offset by 70 basis point increase in inventory shrinkage and 20 basis point increase in incentive compensation. Inventory shrinkage has been difficult for us in 2017.”

I’d say it has been.  When your improved product margin is 100% eaten up by disappearing inventory, it’s a problem. Zumiez has always tried to drive responsibility down to the store level.  Remember that a year or two ago, they transferred responsibility for online sales to their stores?  I’m wondering if that isn’t somehow related to the shrinkage problem.

SG&A as a percentage of sales for the quarter rose just slightly from 25% to 25.2%.  “The…increase was primarily driven by 100 basis point increase related to our annual incentive compensation partially offset by 40 basis points of leverage in our store operating cost and 30 basis points of leverage across other corporate costs.”  I never mind seeing incentive compensation expense rise, as it’s indicative of good results.

Net income for the quarter rose 9.6% from $18.2 to $19.9 million.  For some perspective, the chart below shows the quarterly results for the last two years.

 

 

 

 

 

 

 

 

 

 

 

 

Zumiez ended its year with 698 stores; 607 in the U.S., 50 in Canada, 34 in Europe, and 7 in Australia.  The number of new store openings, especially in the U.S., is declining.  But Zumiez has been telling us that would happen for some years.  Over the last three years, stores opened has declined from 57 to 28 to 17.  The 2016 number of 28 was impacted by the acquisition of five stores in Australia.  The estimated number for this fiscal year is 13 new stores worldwide.

The chart below shows the composition of sales by category during the last two years.

 

It’s always intrigued me to see how much revenue is from men’s’ apparel compared to women’s.  It seems unusual for a mall-based retailer (if I can still classify Zumiez that way?).  I don’t know if it’s a problem, an opportunity, or a competitive advantage.  Also note the decline in hard goods as a percentage of revenues- takes up a lot of room but doesn’t offer great margins.  But it’s an important part of Zumiez’s market positioning.

For the whole year, revenues roses 10.9% from $836 to $927 million.  Sales in the U.S. were $774 million, or 83.5% of the total.  In fiscal 2016, they were $711 million, or 85% of the total.  “The increase reflected a $48.6 million increase due to comparable sales and a $23.6 million increase due to the net addition of 13 stores (made up of 12 new stores in North America, 5 new stores in Europe, and 2 new stores in Australia offset by 6 store closures). Net sales include $10.3 million related to the additional week in the 53-week period and a $6.3 million increase due to changes in foreign currency rates.”

Zumiez’s business in Europe has not performed as management hoped.  They’ve had some losses there.  As Chris put it, “…we have not had the results from the investment we’re hoping [for].”  Rick Brooks talks about the “amazing results” they had in 2015 driven by a “…really huge long board trend and then in 2016 it basically completely reversed and of course we were still playing out as Chris said investing and building the business at that point when sales actually went – got considerably more difficult relative to what we assumed to be appropriate pace of growth at that point.”

By 2015, most of us were amazed the long board market hadn’t cracked already, but none of us had any doubt it was going to.  Because that’s what bubbles do.  If Zumiez was looking at success with their European acquisition that they could see was overly reliant on one product category, perhaps they could have called it out.  But who want to sound a note of caution on a new (second half 2012) acquisition you paid a hefty price for.

Zumiez launched “…over 150 new brands…” during the fiscal year.  It was just last year they were saying they tended to launch 100 a year.  These are not Zumiez owned brands, but brands where Zumiez works with the owner at various levels to launch them in Zumiez stores.

The gross margin rose to 33.4% from 32.9% the previous year.  “The increase was primarily driven by an 80 basis point impact due to leveraging of our store occupancy costs, 30 basis points related to the recognition of deferred revenue due to changes in our STASH loyalty program estimated redemption rate and 20 basis points on product margin. These were partially offset by 60 basis points in higher inventory shrinkage and 10 basis points due to higher annual incentive compensation.”

Net income rose 3.5% from $25.9 to $26.8 million.

There’s no need to discuss the strong balance sheet, except to remind you of the competitive advantage it offers, allowing you to pursue your strategy and initiatives even in the face of a bump in the road.

One last financial note before we get to the fun stuff.  Zumiez 10-K includes the following risk factor: “The reduction of total outstanding shares through the execution of a share repurchase program of common stock may increase the risk that a group of shareholders could form a group to become a controlling shareholder.”  It’s last in a list of many risk factors.

Companies, as you know, have been buying back their shares to boost their earnings per share.  Some (not Zumiez) have been borrowing money to do it and leveraging up their balance sheets.  We’ll see how that works out as interest rates rise.

Share buy backs are inevitably touted as a benefit to shareholders though you might also view buy backs as an admission by management that they can’t figure out any good investment opportunities in their business.  I find it amusing that this benefit requires a risk factor in the 10-K.  You might also consider that if the buy backs reliably raised the share price consistent with the reduction in shares outstanding, the cost to a potential controlling shareholder, in dollar terms, doesn’t change.  If that were the case, I don’t think a risk factor would be required.

Tales from the Conference Call

Now for the fun stuff.  I’m not going to start by reviewing Zumiez’s Competitive Strengths.  They are the same they’ve been for 20 plus years and, most importantly, work in any retail environment.  Instead, I want to remind you of two issues I’ve written about- not just related to Zumiez.

I’ve characterized the term “omni-channel” as the authoritative sounding word legacy brick and mortar retailers have used to make it sound like they’ve got things under control and know how to manage the brave new retail world where the consumer is in charge.  I’ve also stated that doing ecommerce right is a continuingly expensive undertaking.  Unless you can generate enough incremental revenue and operating income to at least pay for it, you are failing.

Being online- selling on line- having web sites and connecting ecommerce with brick and mortar do not represent a strategy.  They are the necessary tools for implementing a strategy.

“We believe now we’re entering into a new phase in servicing our customer,” says CEO Brooks, “moving beyond omnichannel into a new consumer environment with yet higher expectations. While we’re not sure what to call this new consumer phase, the New World will be characterized by key themes and words, such as trade area, localization, optimization, speed, intimacy, engagement, connection, innovation, and community.”

I’m relieved I’m not the only one who doesn’t know what to call it.  If Rick’s descriptors of the consumer environment are reasonably accurate, or at least not too far off from what the future holds, they are the basis for a strategy using the tools Zumiez has in place or is developing.  If forced to reduce his already short list of words, I come down to flexibility and informational immediacy.  Let’s talk about some things Zumiez is doing to succeed in the world Rick is describing.

As you know, Zumiez introduced 150 brands in fiscal 2017, up from around 100 the previous year.  At this point, I imagine Zumiez has a robust system for onboarding, and offboarding when they don’t work out, new brands.  In the environment Rick describes, imagine the value of seeing these new brands and the trends they may, or may not, represent when they are still small and, for lack of a better word, pure.  How else does a retailer find enough new brands to satisfy the consumers’ requirement for constant newness?

Zumiez’s largest third-party brand accounted for 8.5% of revenues in 2017.  That’s up from the previous two years.  Meanwhile, Zumiez’s private label revenues have fallen over three years from 21% of revenues to 20.2% and 16.8% in 2017.  Given the emerging competitive environment, I wonder if the Zumiez management team might not be conflicted if private label (regardless of the margin) grew too much or a single brand became a larger chunk of total third-party revenues.

Obviously, Zumiez’s size and resulting ability to support the new brand process gives it an advantage.  Here’s how they describe it in the 10-K.  “Given our scale and market position, we believe that many of our key vendors view us as an important retail partner. This position helps ensure our ability to procure a relevant product assortment and quickly respond to the changing fashion interests of our customers. Additionally, we believe we are presented with a greater variety of products and styles by some of our vendors, as well as certain specially designed items that we exclusively distribute.”

Zumiez’s new brand process isn’t restricted to the market the brand originated in.  Says Rick, “…we have brands as well as trends that are already flowing across the oceans for us and working on multiple continents.”

Finally, Ricks longest answer to a short question highlighted another Zumiez’s advantage I, I’m embarrassed to say, hadn’t focused on before.  You know that Zumiez has trade areas, and the goal is to maximize revenue from that area, not just to open new stores in it.  You might find yourself closing stores to grow revenue.  You also know that Zumiez has transferred ecommerce fulfillment to their stores.  I always thought that was a great marketing/customer relations thing to do.

I hadn’t focused on the financial benefit.

“…when our web business grows digital sales today, we’re now able to lever physical store, our physical store cost structure,” says Rick.

“Lever our physical store cost structure.”  Just a few little words.  Where the hell has my mind been!  Zumiez is in the process of solving the problem of making the cost of the “omnichannel” pay off.  By having fulfillment done through the stores they’ve made what used to be two cost centers into one and made that one more efficient.  Completely in sync with their customers, Zumiez literally doesn’t even have to think about whether it’s an ecommerce or a brick and mortar sale.  They don’t care because there’s largely just one cost structure.  Rick continues:

“…this is one of the measures of what you mean when you say you have an integrated seamless experience right, you have to integrate it into everything you do in the service of customers. And of course our store teams and digital sales teams they all work as an integrated unit now, looking at all the touch points and how we can best drive consumers to whatever channel the empowered consumer prefers.”

“Probably the easiest example, Sharon, I could give you of evidence here about this idea of how we’d recreated this kind of new integrated business model is localized fulfillment. So through localized fulfillment and in particular already our order routing algorithms, we’ve now levered store payroll and our other store cost structures in two successive holiday seasons. And when I hear a lot of retailers talk, they talk about how a significant growth in web revenue is de-leveraging their business.”

Brick and mortar retailers were initially dragged into ecommerce as a defensive measure focused on giving their customers what they wanted.  Zumiez has said that with their trade areas, new systems, and brick and mortar responsibility for ecommerce, they have figured out how to synchronize market and financial imperatives.

Can you make ecommerce a competitive positive if you don’t do that?  I’m guessing no and expect all successful retailers with a brick and mortar footprint to have to do the same as Zumiez.

VF’s Management Process and Strategy: Thoughts on Their Annual Report

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I’ve spent some time on VF’s 10-K filing for the year ended December 31, 2017.  It was a thought provoking read (yes, I know I’m the only one who would say that about a 10-K) that left me thinking about how VF tries to derive its competitive advantage.  There are some lessons in it for all of us who sell products that are an awful lot like your competitors’ products.  Here are some VF facts on which we can base the discussion.  I’ll also review their numbers for the year.

  • More than 30 brands (23 of which they call primary) divided into three segments; Outdoor & Action Sports, Jeanswear, and Imagewear. Vans, The North Face, Timberland, Wrangler and Lee are the five largest.
  • They sell through specialty stores, department stores, national chains, mass merchants, and through theirs owned brick and mortar and online retail. In international markets, they also sell through licensees, agents, distributors, and independently operated partnership stores.
  • 65% of revenue is from the Americas, 24% from Europe, and 11% from Asia-Pacific region.
  • Total revenue for the year was $11.8 billion.
  • Direct to consumer revenues were 32% of total revenues. At the end of the year they had 1,518 stores worldwide, opening 111 in 2017.  They also have 1,100 “concession retail stores” mostly in Europe and Asia.
  • Vans, Timberland, The North Face, Kipling, Dickies, Lee, Napapijri, and Wrangler have stores under their names that sell only that brand’s products. There are also 80 outlet stores that sell many VF brands.
  • Ecommerce is 21% of direct to consumer.
  • VF owns 21 factories and produced 23% of 473 million units there. It works with approximately 1,000 other factories in 50 countries.  It has 38 distribution centers.

Consider the complexity.  How many combinations of where it’s made, where it’s sold, how it’s distributed, who the customer is and how the brands are positioned against each other (where that’s an issue) are there?  That’s a big, big number.  To some extent, it’s simplified by the fact that the five largest brands are a big chunk of total revenue, but still, this is quite a management challenge.  Here’s how they describe part of it in the 10-K.

“Managing this complexity is made possible by the use of a network of information systems for product development, forecasting, order management and warehouse management, along with our core enterprise resource management platforms.”

Talking about how VF manages its manufacturing base, the 10-K says:

“Products manufactured in VF facilities generally have a lower cost and shorter lead times than products procured from independent contractors. Products obtained from contractors in the Western hemisphere generally have a higher cost than products obtained from contractors in Asia. However, contracting in the Western Hemisphere gives us greater flexibility, shorter lead times and allows for lower inventory levels. This combination of VF-owned and contracted production, along with different geographic regions and cost structures, provides a well-balanced, flexible approach to product sourcing.”

CEO Steve Rendle’s nearly full-time job must be getting quality people he trusts into the right positions.  They had 69,000 employees at the end of the year.  He notes in the conference call, for example, “To support the execution of our strategy and better enable the growth of our large global brands, we have realigned the roles of our Group Presidents and redirected our leadership talents at our most important objectives. Going forward, each Group President will be responsible for a single geographic region and have one global brand reporting to them.”

So, what are the foundations VF builds its business on?  People (like any organization), systems, procedures, and disciplined management processes.

Oh – wait – I didn’t say brand or product.  From the 10-K: “In addition to the design functions of each brand, VF has three strategic global innovation centers that focus on technical and performance product development for apparel, footwear and jeanswear. The centers are staffed with dedicated scientists, engineers and designers who combine proprietary insights with consumer needs, and a deep understanding of technology and new materials. These innovation centers are integral to VF’s long-term growth as they allow us to deliver new products and experiences that consistently delight consumers, which drives organic growth and higher gross margins.”

I’m guessing they have one innovation center focused on each of their geographic areas.  For certain of their brands (surely the top five) they have enough size to develop, if appropriate, area specific product.

They can do this because of their size.  But size can be dysfunctional if you don’t have the four foundations I mention above.  What are the other benefits of being this big and managing like VF tries to?

Higher gross margin.  Your volume, number of contract manufacturers, and having your own factories will give you some advantage.

Lower advertising and promotion expense as a percent of sales.  They spent $716 million, and in fact have accelerated their brand building spending, but it was just 6% of revenues.

More flexibility and faster response to market changes.  Anybody think that’s competitively useful these days?  It’s valuable in brand building but having the ability to make some product quickly and perhaps in smaller quantities rather than making too much of the wrong stuff is also good for your margin.  There’s also value in having a distribution network that lets you move product around in response to changes in demand.  Also improves inventory control which, I believe, helps with brand building.

The cost of increasingly complex logistics and important systems is more efficiently spent.  That is, VF, as an $11 billion business, doesn’t have to spend 11 times as much as a $1 billion business.

As I watch companies like VF focus on flexibility and shorter product cycles, I continue to wonder about the changing role of trade shows.  For certain products, they seem built on the assumption of product cycles that increasingly don’t address what the market and end consumer want and when they want it.

Let’s move on and look at the numbers.

VF showed a revenue increase of 7.1% in 2017 from $11.0 to $11.8 billion.  $489 million was from existing brands and $247 million from the Dickies acquisition.  $49 million was from a positive foreign currency impact.  The gross margin improved 1.2% to 50.5%. “…reflecting a 180 basis point benefit from pricing, a mix-shift toward higher margin businesses and lower restructuring costs, which was partially offset by a 60 basis point impact from foreign currency.”  SG&A expenses grew 11.9% from $3.99 to $4.46 billion.  As a percentage of revenues, it was an increase of 1.6%.  “This increase is primarily due to investments in our key growth priorities, which include direct-to-consumer, product innovation, demand creation and technology initiatives. The increases were offset by lower restructuring costs in 2017 and a pension settlement charge of $50.9 million in 2016, which did not recur in 2017.”

Operating income rose from $1.368 to $1.503 billion.  Interest income rose from $9.2 to $16.1 million while interest expense was up from $94.7 to $102 million.

Income taxes rose from $206 to $695 million.  The new tax law passed in December resulted in a $465.5 increase.  That’s tax on income that had been earned and held offshore.  It’ a one-time thing.  The result was a 42.7% decline in net income from $1.07 billion to $615 million.

As you probably know, VF acquired Dickies in 2017 and has put Nautica up for sale.  On the income statement, they separate discontinued operations, and provide separate information on the late in the year acquisition of Dickies.  I’m not breaking any of that out in my discussion and want to explain why.

The first of four long term drivers of their strategies is, “Reshape our portfolio. Investing in our brands to realize their full potential, while ensuring the composition of our portfolio positions us to win in evolving market conditions.”  Buying and selling brands is part of their normal operations.  They are very disciplined about what they buy and how much they will pay.  They don’t necessarily buy something every year, but it’s an active and ongoing part of their operations and I don’t believe in viewing their results net of it.

Acquisitions remain a top priority for VF as they are “…transforming VF into a more digitally-enabled consumer and retail-centric organization.”

Below are revenues and operating income by segment- what they call coalitions.  The key thing to notice is that Outdoor & Action Sports provided 69.5% of revenue and 72% of operating income.

 

 

 

 

 

 

 

 

 

 

 

 

Vans’ revenues were up 17% in 2017.  The North Face was up 4% and Timberland 2%.   Total segment revenues were up 8% for the year.

“Global direct-to-consumer revenues for Outdoor & Action Sports grew 17% in 2017, driven by an expanding e-commerce business, comparable store growth and a 1% favorable impact from foreign currency. Wholesale revenues increased 2% in 2017, driven by growth in the Vans brand and Europe, partially offset by the above-mentioned U.S. retailer bankruptcies, lower year over- year off-price shipments and efforts to manage inventory levels in certain markets.”

The dominance of and dependence on Vans, as well as its continued and rapid growth is rather remarkable.  You won’t be surprised to learn that CEO Rendle lists “…protecting and enabling the explosive growth in Vans…” as the first of their 2018 top priorities.  VF expects “…high-teen growth from Vans through the first half of this year.”

During the conference call, an analyst asks the following question, which has been on my mind for a while as well.

“You talked about protecting the brand. You talked about not letting it overheat. What does that mean to how you’re going to manage the brand into the wholesale channel and your DTC, right? Are you going to constrict some of the deliveries into the wholesale channel? Are you going to limit some of the inventory across the channel? Are you going to segment the styles further? How do you plan to maintain a double-digit growth rate, as you alluded to, so that this doesn’t roll over, like we’ve seen other brands do in the not-too-distant past?”

Good question.  You can read into it the inevitable and often discussed in Market Watch public company problem; How do you grow without screwing up the brand?  Here’s part of Steve Rendle’s answer.

“…our Vans team is really the benchmark business on how they look at product segmentation across the different consumer touch points that we have to sell into, with our stores being the most premier expression of our brand. They’re really evolving how they’re looking at using stores and coming up with a mix of formats that play into the specific communities across the globe, but being very thoughtful, and direct partnerships with those wholesale partners, placing the right amount of inventory, being very thoughtful about not having one style over-torque, but really having it be a balanced approach with the right amount of newness to keep the brand moving forward each season.”

His answer sort of comes down to, “We manage the brand better than other brands are managed.”  Apparently so.  Yet it doesn’t really address the public company conundrum and I’ve never known a brand that didn’t, eventually, hit a dump in the road- “roll over” as the analyst puts it.  And I wonder, given the relative growth rates, why they can’t manage The North Face and Timberland as well as they are managing Vans.  It has something to do with the brand and the competitive environment, not just the brand management it seems.

Given the dependence on Vans, I hope they can continue to be disciplined in how they grow sales while protecting the brand.

A quick note on “risk factors” as listed endlessly in the 10-K.  I used to spend a lot of time on them.  Now, I find myself skimming them and rarely having anything to say about them- and not just for VF.  That’s because risk factors seem to be evolving from meaningful business considerations to a list of anything that the lawyers think could possibly go wrong.  They aren’t written to inform investors as much as to protect the company.

The balance sheet is weaker compared to a year ago.  Total equity fell 25% from $4.9 to $3.72 billion.  The current ratio is down from 2.4 to 1.5 times and cash declined from $1.227 billion to $566 million.  Debt to total capital was up from 31.9% to 44%.

The growth in receivables and inventories seems consistent with revenue growth and the acquisition of Dickies.  Also due to the Dickies acquisition, short term debt jumped from $26 to $729 million.  Hope they can refinance that before rates rise.  Long term debt was also up a bit from $2.04 to $2.19 billion.

The percent of their earnings they paid out as dividends was 96.2%.  That’s up from 59.9% last year and 38% in 2013.  It’s not that the balance sheet is weak- it’s just not as strong as it was.  If I were an investor in VF, the balance sheet changes and payout ratio would leave me wondering what happens if Vans should hit that bump.

The majority of VF’s growth for the year came in it’s fourth quarter, when revenues jumped 20.5% from $3.04 to $3.65 billion.    They reported a loss of $90 million in the quarter but remember the big accrual for taxes they were required to take due to the new tax law.  Vans, by the way, was up 35% in the fourth quarter, which puts some perspective on the 17% growth for the year.

Like all companies, VF tries to put its best foot forward in its public filings and conference calls.  I’m sure they have as many things go wrong as the next company.  Still, I walk away from reading their 10-K (and that of some other companies) with a strong sense that what used to give smaller companies a chance for an advantage is no longer exclusively available to those smaller companies.