Skechers U.S.A., Inc. (SKX) Earnings Call Transcript & Summary

Hey, everybody. Good afternoon. Thanks for being here virtually for the Third Annual Wells Fargo Consumer Conference. For anybody who doesn't know me out there, I'm Tom Nikic, senior footwear and sporting analyst at Wells Fargo. I'm pleased to introduce John Vandemore, CFO of Skechers, one of the world's largest footwear brands, huge global presence. And if you want a pair of comfortable value-priced shoes, Skechers is your place to go. So I'm going to start by asking a few questions. I'm going to leave some time at the end for Q&A. If you have a question for John, either use the Raise Hand function in Zoom or e-mail your question to me at [email protected]. And with that, I'll jump right in.

John, let's talk about the elephant in the room, the COVID-19 pandemic. What are the key learnings? What are the key takeaways you have from this period? And does the pandemic change anything from a strategic standpoint for your company?

Well, Tom, first and foremost, thanks for having us here. We appreciate it. We would vastly prefer we were doing this in person, but understand the situation.

That makes 2 of us, John.

Sure. I'm sure, it makes -- I'm sure it makes a lot of us on this call. The first thing I'd say is that I think, from the COVID pandemic perspective, we haven't seen a lot of substantive changes in either strategy or long-term objectives. What I think we have seen, though, is a dramatic acceleration of many of the facets, in particular, in the retail space that we all knew were coming, but have taken on a new urgency in the current environment. I mean, obviously, the continued penetration of e-commerce is something we've been focused on across the spectrum for quite a while. I think the fact that many retailers like Skechers at stores that were closed, outright closed for a period of time, evidenced the need to have a robust digital offering. And that's only gotten more severe of a need going into the depths of the pandemic. Add to that, I think, features that really support an omnichannel solution have become more and more critical. And you're seeing more and more retailers invest in that. I mean, thankfully, for Skechers, we had been investing behind digital for the last couple of years. And so what we were able to pull off in this pandemic, I think, surprised both our internal expectations and, I think, delighted our customers. But it's still going to be an area of focus. So I think at the end of the day, this is a pretty extraordinary event. And if anything, it's really simply doubled down the intent for -- for almost everybody, certainly I can speak to Skechers, to continue to invest to develop a robust digital presence and then marry that with an omnichannel capability that serves consumers. The one other observation I'd share, and I think this is, in some cases, particular to Skechers and a few others is, I think the power of having an extraordinarily robust balance sheet when faced with unique circumstances like a pandemic have proven themselves in this period of time. Thankfully, for Skechers, we did not spend a lot of time focusing on liquidity solutions and answers to challenges in that sphere. But it was because we had a fortress balance sheet coming in, and we had actually just last year finished off increasing liquidity available to us through other means. So I think that preparedness actually is something that the people will take with them from this circumstance and realize it's important to be well poised from a balance sheet perspective at all times because it's just very difficult to foresee when an event like this is going to occur.

Yes. I hear you. So within that response, I'd love to dig into the comments around digital a little bit more. You had extremely strong digital growth in Q2, up over 400%. Can you talk a little bit of -- about what you're doing specifically in the digital channel, your strategy there? And how "sticky" do you think that e-commerce business will be in a more normalized world?

Well, certainly, I'm the least to not highlight that 400% growth right now, to be fair, that was in a period when all of our stores were closed. So our expectation has not been to continue that level of torrid growth. But even before the pandemic, our e-commerce business was performing at plus 50% growth year-over-year. And we've seen that pace continue to get better and better. We're just probably not going to hit 400% again anytime soon. Look, I think the investments that we've made that we've focused on in e-commerce have been very soup to nuts. They've extended all the way from the back-of-house operations all the way through to the primary consumer interface. We just recently relaunched a website using some best-in-class infrastructure that we can actually take across the globe now. We've recently launched 2 native applications on mobile, an iOS and an Android application. We've been investing in, and we will shortly, late this year or early next, relaunch our Skechers loyalty program to complement that. And the focus for us is making sure that we are giving consumers an adequate experience that meets their expectations both online and in store and ultimately between those 2. Because, again, at the end of the day, we feel that the combination of online and in-store capabilities is what consumers are looking for from a brand like Skechers. So even as we speak, we're in the process of rolling in out a new point-of-sale system across our retail estate that complements our digital assets. We do believe that the customer contacts we've made through the online channel, in particular, during the pandemic, are going to be sticky. I would add to that we're getting better and better as a company at leveraging that direct relationship. I mean, to be fair, it wasn't something that we had a ton of experience with historically because our e-commerce business had been underdeveloped. I think the catch-up pace we've applied in the digital space is commendable. And we're learning every day how to better interact with our customers, how to serve their needs, how to make sure what we're delivering for them satisfies those needs and, quite frankly, ultimately, gets them closer to our product because, now, even as you point out, when you try on our product, if you're looking for style, comfort and quality at reasonable price, there's no match for Skechers.

Got it. That's helpful. So as a follow-up there to the other part of your direct-to-consumer business, which is the physical presence that you have built up a pretty sizable brick-and-mortar footprint over time. Given what's happened over the past 6 months, how do you think about the -- how your physical stores fit into your strategy? I mean, are they kind of there from an omnichannel perspective, but maybe there's a little bit more focus on the digital side going forward? Just any color there would be helpful.

We remain completely dedicated to our retail estate, and we feel like that still has extraordinary opportunity to grow. I mean, if you just take our domestic numbers, we're just north of 500 stores. There's a lot of markets that we're not even reaching yet, much less fully penetrated. So we certainly believe there's continued runway for a retail store environment. Now what those stores look like will continue to evolve. Over time, we've been gravitating away from our concept stores, which tend to be more mall-based or high-street-based locations, and gravitating to more freestanding environments like a warehouse store or what we refer to now as a big-box store. And I think you're going to continue to see a transition to more freestanding solutions. That's actually where we achieve our greatest level of turnover in the store, our greatest level of profitability. It's also lower rent structures, lower labor structures, which all appeals to us. And I also think they provide the right foundation to deliver a true omnichannel solution to consumers. At the end of the day, we know that consumers in the footwear space, in particular, want to have some capability to try on and see and observe the product, sometimes before they buy it, but sometimes also concurrent with, making that pickup purchase. And we want to make sure we offer that. But we also believe, ultimately, those stores can be a launching point for distribution capabilities when it makes sense and other interface points with consumers. It also leaves the door wide open for us to continue to penetrate our apparel offering. Because in a freestanding store, we have more latitude to work with the space. We have the ability to accommodate dressing rooms and the like. And so it really helps us as a brand fulfill what we believe are a promise can be to consumers. And again, it's not to the exclusion of the digital. It's really working in concert with the digital. Because at the end of the day, we feel our consumer is not really -- is not looking to buy a pair of Skechers shoes at a Skechers store. He just really wants the shoes. That's what's comfortable. That's what delivers to him. And so we want to make it as easy as possible for him or her to buy the product. And maybe that means they start out digitally and they gravitate to an in-store pickup because they need it that day or maybe they're comfortable getting it via delivery. So it's a purely digital expression. Or maybe they're out and about, and they have a need and they see a store and they want to shop there. It's incredibly important for us to be able to address all those consumer options so that we're delivering to them what they need when they're looking for Skechers product.

Got it. Yes, that was very helpful. So going back to the e-com growth, you obviously, can't grow 400-plus percent without having strong underlying demand for the brand. What is it about the product, about the brand, et cetera, that you think cause consumers to seek out the brand during the pandemic, given everything else that was going on?

Well, I don't think it was the CFO, unfortunately. Look, we exited 2019 as a brand with tremendous heat and strength. Our fit features were resonating with consumers in a fantastic way. When we came out of the fourth quarter, quite frankly, we couldn't have been more excited about 2020. And in many instances, we're simply wondering how big can we make the growth next year. Obviously, the pandemic has thrown a bit of a wrench in that overall plan. But at a product level, we're still seeing our shoes resonate with consumers. And again, it came -- comes to those 4 characteristics, but chief among those is being able to deliver comfort at a reasonable price is something we excel at. In every study we've looked at and every viewpoint of the consumer we've looked at, that's what people know most and best about Skechers. And so I think our continued focus on fit features, everything from our Arch Fit solution to our Max Cushioning, to bringing forward technology like our Hyper Burst, which started out as a primarily athletic outsole that we're actually now working into more elements of the product line because we've been able to do that from a product and pricing standpoint, all the way through to just providing really simple casual solutions that are resonating consumers. I think you add that, plus you add an environment where individuals are working from home, they're studying from home, those are all compelling tailwinds to our brand that we think will continue. And quite frankly, even going forward, we'll continue to play because they're part of broader trends we see that we think are being accentuated in the current environment.

Okay. So one comment from the call that raised a few eyebrows was a comment around July comps slowing slightly from June. Can you talk about what happened there? Was it stimulus running out, pent-up demand tapered off, delayed back to school? Any color there would be helpful.

Yes. Let me first admit it's very tough to identify a single variable when so many things are occurring at once in the marketplace. What I would say generally we saw was, in the latter half of Q2 as stores reopened across United States and began to open across the globe, you definitely saw a resurgent pent-up demand come to play. Subsequent to that, in early parts of July, you saw 2 phenomena that were not visible in the back half of Q2 and in June in particular. The first was you did see the virus begin to reemerge in certain marketplaces, so you started to see that impact the ability of consumers to get out and shop and get out and actively participate in activities that lend to shopping. So that certainly began to occur in July and actually persisted through July, as I think we all know, any of us in the States that are continuing to be locked down can see. You also started to face a back-to-school comparison that was being influenced by that same standard, right? You have a pretty significant portion of school-age children this year who are not actually going back to school. They're going back to their room or back to the computer, but they're not going back to school. And so you started to see evidence of that difficult comparison emerge in the early part of July and then through the back end of July and August. And you've heard a lot of folks speak about that. I mean, I think we're all hearing the same thing and seeing the same behavior, which is an incredibly muted back-to-school window this year, at least in the same time frame. And I think what we've got to be cognizant of is, at some point, kids go back to school. That's going to trigger -- that's going to trigger that same back-to-school buying behavior, but in a different time period. So we're cautiously optimistic that as schools begin to get back to in person instruction, that back-to-school buying will come back, but it clearly wasn't evident in July and August. I would also just note, keep in mind, we do over -- we do almost 60% of our revenue outside the United States. So even though the United States plays a critical role in our results, it's not the only market. So we're also subject to a bit more variegation coming out of the different opening patterns of different markets. And the one we would use there is Europe was a little late in some areas coming back to retail. South America was definitely being challenged. So what we're dealing with across the globe is different positions on that recovery curve almost by country. And what it really has to do with is both the impact of the virus, but also the response of that -- of the virus from the governments that end up restricting both retail traffic and retail volumes.

That segues perfectly into my next question, which is about the international business. I mean, look, you've grown it to, I think, 60-ish percent of your sales. How big can that ultimately be? Where are the opportunities now? Just any sort of color around international growth would be really helpful.

Yes. And I think the first thing I'd mention is we don't think that pandemic has permanently dented any of the long-term opportunities we've spoken about endlessly internationally. We still feel very good about how the brand is positioned, very good about how the product is resonating. It really is this impact from the pandemic that we've seen pronounced effects from in our international markets. For us today, as I sit here, it's a broad envelope of countries. We still think China has tremendous room to grow for our brand. We're seeing that and how it's coming back from the pandemic and the success it's having and the resonance of the product. India is another market we've been incredibly excited about. Obviously, they're going through a relatively difficult iteration of the pandemic's effect. But once India normalizes, we feel like that market has significant opportunity long term to continue to grow. I'd also throw in a balance of a handful of other very sizable, important Southeast Asian countries that we're really just scratching the surface of, Vietnam, Thailand, Malaysia, Indonesia, Philippines. A lot of opportunity across that marketplace that we're tremendously excited about. And then I would even throw in a significant portion of Europe. I know many people have the perception that across Europe you're talking about fully developed, fully penetrated economies. But one of our fastest-growing markets right now is Germany. It's been a stalwart country for us, but it's really seeing a resonance with the brand. There's parts of Western Europe that are seeing very strong growth of the brand. But there's also significant portions of -- from a brand perspective, underdeveloped economies in Eastern Europe that we think provide significant long-term opportunity, not to mention the big market there, which is Russia, which we're in today via distributor relationship, but we still think the brand is in very early stages with. So you take that together, it's a pretty wide swath of opportunity internationally. I think that gives us 2 things. One, it gives us the opportunity really to grow the brand to what we want it to be, which is the runaway #3 footwear and, ultimately, also apparel brand in the world. But also, it gives us the ability to put a lot of chips down, which we know all those markets are going to succeed at the same pace at the same time. It's not cooking out there. You have to be responsive to the marketplace. But we have the ability to put more chips down, we think, in more places and that gives us long term better opportunities to succeed.

Got it. So let's turn the lens a little bit closer to home. U.S. wholesale, obviously, not as big a piece of the business as it used to be, but it does get a lot of focus. What's the outlook for that channel? How should we think about shrinking store footprints from partners post pandemic, stuff like that?

Yes. I mean, I think, first, we all got to acknowledge, it's not like the U.S. retail landscape has been calm waters for last 3 or 4 years to begin with. So in many respects, again, to that theme, I mentioned in response to your first question, in our view, the pandemic has really just accentuated some of the preexisting conditions that were in the marketplace already. Obviously, that's meant a handful of names coming off the board in a retail respect. I mean, thankfully, none of them were extraordinarily critical to Skechers, although obviously we actively participated with a handful of them in some way, shape or form. I mean, our view is ultimately that some of this attrition is absolutely necessary and warranted. I think it's a pretty clear held believe at this point that the U.S. had been overstored in some respects, certainly in apparel and footwear. What we're hoping for, ultimately, is once we reach stasis on the number of stores in the marketplace, the domestic wholesale marketplace actually gets back to a position of growth. Now it's not going to be double-digit teens level growth. It will be mid- to single digit top line growth, but that, certainly, we think is an achievable metric for that side of the business once we start to see stability. I mean, even looking back the last 3 to 4 years, if you look at it on a compound annual growth basis, we've been up a little. And while that's not necessarily something we would cheer about normally, against the backdrop of all the retail attrition that's occurred, both -- in terms of both over bankruptcies but also just shrinking door counts, it's actually showing increased productivity per door. And so that's an encouraging sign. And again, we're not in a position to want to walk away from a wholesale partner. I mean, we will work with partners. We want them to have access to our brand to be able to deliver that brand to their consumers. We're not of the mind that we're going to cut off certain wholesale partner in favor of others. That's not how we want to do business, and we don't ultimately think that's what consumers want. Consumers want the ability to access the Skechers brand when they want it, where they want it, with those same characteristics of style, comfort and quality at a reasonable price. And so any wholesale partner that wants to support that approach to market, we're going to get behind 100%.

Perfect. So just as a reminder to the participants out there, if you've got a question for John, you can either raise your hand via Zoom or send me an e-mail. In the meanwhile, let's talk margins, John. Big -- always a big topic of conversation with you. Gross margins were very strong last quarter. How should we think about gross margin tailwinds or headwinds going forward? And then just how you think about OpEx and SG&A expenses at a high level would also be helpful.

So from a gross margin perspective, obviously, very strong in the second quarter. A significant portion of that was mix benefit. We were obviously much more heavily invested in our direct-to-consumer business and our international business in Q2 than would be the normal case, obviously, because of the restrictions on being able to ship in to many of our wholesale partners over that window of opportunity. And while that's anomalous, I would point that out as a clear reflection of our long-term strategy to accrete gross margin, which is our business, we believe, will continue to get more direct-to-consumer-focused, more internationally exposed. And with that will come gross margin accretion. That's how our business is structured today. And longer term, that's absolutely what we want to take advantage of. And quite frankly, the only thing that could stand in the way of that is if that domestic wholesale business started to grow at above normal clip, which, while is probably not likely, would be a welcome surprise if that's what evolves. In terms of the operating margin, again, we're consistent. We say that we're going to continue to invest in growing the brand. In Q2, we pulled back. We pulled back because we recognize the situation. There were some instances where it didn't make any sense to continue investing in operating expenditures like advertising because all the stores were closed. But there were also other areas where we've tightened our belt because we realized that cash would be king in that environment, and we wanted to be prudent with our management. Longer term, we want to get back to growing the brand, and so that will mean ultimately reinvesting in operating expenditures where it makes sense. But even if you look back the last 3 or 4 years, where we've invested in G&A, although I know it pains a lot of analysts out there, not you, of course, but others, is in building -- opening new stores, investing in international markets, into building capabilities in our omnichannel solution. So that's where we'll continue to invest. Now we'll be cautious because we want to make sure that we understand the environment and we have as much visibility as we would expect on a normalized basis before we really start to plow resources back into those areas. But I can assure you, once we have the opportunity to get the brand growing, again, we absolutely will. Now that being said, we've also made no unclear statement about our desire to try and keep that within the bounds of top line growth rate. It won't always prove out in any given quarter, but over time, we want to match that. So we're not looking to actively deleverage. And then the upside opportunity comes when we're able to gain leverage in that because either the investments are more efficient or the top line growth is better than we expect. At the end of the day, we have said repeatedly there's nothing structural in our business that prevents us achieving those low-teen operating margins that David spoken about extensively. I've spoken about this. There's nothing structural in the business that prevents that. The only thing that gets in the way short term is our willingness and our desire to grow this brand across those geographies, I mentioned across the globe, because we feel like there's more than ample opportunity to continue to drive value by growing the brand. And ultimately, for shareholders, we think that's what will matter most.

Got it. So we got a question in my inbox here. So when we think about the expansion of e-commerce, what are sort of like the margin implications there? Obviously, there's more fulfillment costs. And it is a channel that a lot of brands have difficulty making money in. There's a lot of variable costs, difficult to scale. How do we think about the impact to your business and to your margins overall if digital and e-commerce continues to rise in penetration?

So our expectations for a more robust e-commerce channel is that they will continue to be accretive to the business overall. Now I have to backtrack a little bit and just explain. We came from a position where e-commerce was not a very big business. It really was very selective. It was predominantly in line. So it was small, but it was extraordinarily accretive to the business. As we've transitioned to building what I would describe as a more mainstream e-commerce solution, we know that's going to pull back a little bit because we're getting into a broader area. And our full expectation is that begins to look a lot more like retail than it does a very small e-commerce business. But we're welcome to that because it's more profit dollars, absolutely. Longer term, we absolutely expect it to continue to be accretive. It's what we've seen thus far. But I would also point out we've spent a lot of time and energy on growing that business. There's not a lot of work going on today in optimizing every aspect of that supply chain, and that's work to come. It is work we'll do and it is another, if you will, arrow in our quiver on driving profitability in that segment. But we feel that gives us a big bullwork against ever getting into a situation where it could be detrimental to our margins because it's not what we've seen traditionally, it's not what we're aiming for and it's not our expectation. And we also feel that, that retail fleet of ours gives us a hidden weapon in that to really optimize how we prosecute a digital business. I would also just point out, longer term, as I've said before, the right answer for consumers is an omnichannel solution. So there's absolutely a situation in the future where we don't even talk about the difference between something happening in store and digitally. Because for a consumer, it doesn't matter. And we want to optimize our business to serve consumers in both ways. So it really doesn't matter to us either.

All right. Another question here in my inbox. Promo activity. I think you were able to do pretty well on -- from a promo perspective in Q2. How do we think about promo activity in the industry? How do you respond to what competitors are doing, et cetera?

So, so far, I think one of the things we're seeing in almost every market is, once a market reopens, there needs to be a little bit more promotional activity to invigorate consumer activity. Customers need a reason to get into the store. Now what we've seen in most successful markets is that, that windows over time gets smaller and smaller, but there does need to be a little bit of promotional activity. We've seen some of that, but not in an extraordinarily material way. Going forward, that's our expectation. However, we're certainly mindful that it's a dynamic marketplace, and we'll need to be vigilant about what other brands and other retailers are doing. I think it serves everybody's interest to get back to a normalized and, quite frankly, if not even normalized, a better promotional environment longer term. And this is an opportunity for us collectively to do that. And it's certainly something we'll be aiming for. But we'll be responsive to what we see in the marketplace. Right now, though, our expectation is not for an extraordinarily abnormal amount of promotional activity other than what may occur as a result of the natural cadence in the selling season. And by that, I'm most mindful of things like, in China, Singles Day is a promotional environment. So that's going to be more promotional to the extent it represents a bigger mix of the overall pie because China is definitely further along on the recovery. That may have a weighting mix, but within that channel, within that business, we don't expect it to be extraordinarily above average.

Got it. And then we're almost out of time. Last one before I let you go, John. Just thoughts around holiday.

Yes, cautiously optimistic we are about the holiday. I mean, I think -- again, our primary focal point has been to get through '20 as best we can to get out lean and put ourselves in a position to grow going into '21. We're seeing some very interesting and intriguing activity that would suggest maybe holiday will be a little bit better than we thought. But right now, I would say, we're cautiously optimistic. We're vigilant about what's transpiring. We feel like we're in a good inventory position to meet the needs that we see. Quite frankly, we'd love nothing more than to be chasing at the end of this quarter so that we can move inventory into a more robust holiday season, but we're also cautious about the impacts of the virus and the government restrictions that have heretofore caused some limitations on people's ability to get out and shop. So cautious, but optimistic.

Well, John, I also hope that you're chasing better than expected demand. So fingers crossed.

[indiscernible]

John, thank you very much for the time. Thanks for being here virtually with us. Hopefully, next year, we're back in Dana Point, California, for the fourth annual conference. But...

I look forward to it.

This is a -- given the circumstances, we're still happy to have you here virtually. So...

Thank you for having us.

Thanks, again, and take care, everybody.