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

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

Strategy

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

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

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

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

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

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

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

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

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

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

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

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

Housekeeping

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

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

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

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

Makes sense to me.

The Numbers

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

 

 

 

 

 

 

 

 

 

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

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

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

 

 

 

 

 

 

 

 

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

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

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

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

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

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

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

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

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

VF to Spin Off Denim Business as Separate Public Company

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

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

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

Why Are They Doing This?

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

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

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

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

Why Not Just Sell the Jeans Business?

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

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

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

A Complicated Deal

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

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

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

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

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

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

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

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

Big 5 describes itself as “…a leading sporting goods retailer in the western United States, operating 435 stores and an ecommerce platform as of July 1, 2018. The Company provides a full-line product offering in a traditional sporting goods store format that averages approximately 11,000 square feet. The Company’s product mix includes athletic shoes, apparel and accessories, as well as a broad selection of outdoor and athletic equipment for team sports, fitness, camping, hunting, fishing, tennis, golf, winter and summer recreation and roller sports.”

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

How Brick and Mortar Retail Has to Change

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

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

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

What Stores Are Not Doing as Much Of

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

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

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

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

What You Have to Do More Of

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Okay, breaks over.

What Retailers are Doing More Of

  1. Customer service
  2. Community building

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

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

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

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

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

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

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.