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

Hi. My name is Kim Greenberger, and I'm the branded apparel and footwear and softlines analyst here at Morgan Stanley. We're very pleased to host Skechers today. Skechers is a company that, in our view, should benefit from longer-term trends that were in place before COVID and accelerated over the past year. We discussed this in our latest [indiscernible] and recently upgraded the stock to overweight. Skechers is an $8 billion market cap branded footwear company with over -- with a number of stores across 170 countries around the world. Skechers' product offering spans over 3,000 styles and 30-plus brands serving all genders, ages and categories. It ranks as the #1 brand for walk, work, casual and casual lifestyle shoes in the U.S. And Skechers generated over $5 billion revenue -- $5 billion in sales in 2019, nearly 50% of which are international. They're on track to deliver over $6 billion here in 2021. Today, we're joined by Skechers CFO, John Vandemore. John joined the company in 2017 and directs Skechers' overall [indiscernible] policies and functions. He has over 2 decades of business finance experience, including senior finance roles at Mattel, International Game Technology and The Walt Disney Company. John, thank you so much for joining me here today.

Thanks for having me.

We'll spend the majority of today's session in a Q&A-style fireside chat, where we'll explore how COVID impacted Skechers' business and its long-term strategies and as well as some of the investor questions that I heard most often here in recent months. We've also reserved time to answer your questions. For those of you joining via the webcast, please click the Ask a Question button on the webcast to submit your questions, and we encourage you to do that throughout the session today. Lastly, before we begin, I need to remind everyone that for important disclosures, please see the Morgan Stanley disclosure website at www.morganstanley.com/researchdisclosures. And with that, John, let's kick off the fireside chat session.

So first, I wanted to start with a couple of big picture questions and really start with the peer set and your global peer set. How do we think about Skechers' peer set and who the business primarily competes with, both here in the U.S. and globally? What metrics do you concentrate on when you're benchmarking yourself against your peers? And finally, how has your peer set and relevant metrics evolved over time?

Absolutely. And again, Kimberly, thank you for having us. We enjoy participating in your conferences in particular. I would say, first of all, it's -- as a global footwear player, it's important to recognize that we have multiple peer sets across the globe. And I think that's one instance where, as a global brand, we need to be more cognizant of what's happening in myriad markets. Obviously, there are some massive global brands against whom we compete, the Nikes, the Adidas of the world. And they are formidable competitors in most markets in which we participate, but they're not our only competitor. In many instances, we actually don't compete with them at all, depending upon what we're offering in a marketplace in a specific jurisdiction. What we tend to find is that our competitive set includes those global brands as well as several local brands and sometimes, specialty brands. It really depends on what segment of our business we're talking about at a given point in time. As we compete in each market, we are extraordinarily cognizant of our relative position, relative to both the local players, the specialty brands as well as the global players. And we believe we have a pretty strong niche that sits, at least from a price point perspective, below some of the top-tier, top-price providers, but above both private label and local market solutions. And our primary metric in any market though is how quickly are we growing, how quickly are we penetrating, and how quickly are we gaining new customers. Because, for us, that's the key indicator of how well we can extrapolate our value orientation into the marketplace. I would say it's certainly a globally competitive environment, and each market has its nuances. And you're seeing more and more brands get better and better at both competing on a product level, but also competing on a marketing and scale level. We do believe, though, as the third largest footwear provider out there, that we have many scale advantages of our own. And then what I would say is our product distinguishes us universally in every market. Our focus on style, comfort and quality at a reasonable price really distinguishes Skechers. And I think the 2 most important characteristics there tend to be our comfort, which is resonant in every market in which we participate, and the value we provide for the product we deliver.

Fantastic. Okay. That's excellent. Maybe we can dive into some of the sort of key financial metrics like revenue growth. When [indiscernible] I reflect on historical revenue growth pre-COVID, I think the business delivered like a 17% 5-year compounded annual growth rate in revenue over the last 5 years. It's been sort of consistent double-digit year in and year out and really stands out when we look just across our coverage universe. When I -- when we think about the historical context and the strategies and the growth opportunities ahead, how should we be thinking about your revenue growth over the coming years? What's the run rate that you are all targeting and the sort of key drivers to deliver on that growth?

Well, first of all, I certainly appreciate you acknowledging something that we feel is distinguishing about our brand, which is, over the last 5 years, a mid-teen or higher compound annual growth right on the top line is exceptional. We think it's a reflection of our strategy, which has been focused largely over the last, really 5 to 10 years, on 3 core principles: one is delivering a breadth of great product; two is expanding internationally; and three is expanding in our direct-to-consumer channel. And that's going to continue to be our strategy going forward because we believe the markets we're in, the footprint we have internationally affords us the opportunity, over the next couple of years, to look very much like the last couple. And obviously, I'm going to exclude 2020 because that was influenced by rather exogenous events that nobody could control. But what we're seeing in our business now gives us every indication that we will be able to get back to that trajectory relatively quickly as markets reopen. What we've come to believe and see in the data is that once we're allowed to be open as a brand, our brand performs exceptionally well. And I think it's also a reflection of the portfolio of opportunities we have internationally because that is where we see abundant opportunity. Obviously, China has been a terrific market for us as have other nascent markets. But when we look across the globe, we get excited about almost every market we're in. It's China. It's the balance of Southeast Asia. It's South America, that is really becoming a foothold market for us. It's Europe, both developed and developing markets. And again, it's a testimony to the product. It's a testimony to the breadth of the product. But also we think that, that value equation for consumers matters in every market and is uniquely Skechers. I think that's the other point that I would make is that we really focus on that market, that market niche in a way that we don't see other brands being able to capitalize on, not nearly with the same amount of success as we've seen. So we're excited about the next 3 to 5 years because we believe the trajectory we've evidenced over the past 5 to 7 years can hold, and it's through a continuing execution on those 3 strategic priorities.

That is excellent. So I just wanted to peel back the onion on the international opportunity a little bit. It's very clear here that that's been a key driver of the growth in the past, and also, it's expected to be a key driver of revenue growth in the future. Can you talk about the way the international revenue growth flows through the P&L? And how -- you've obviously got a top line driver. How does it show up in gross margin or SG&A? Or -- and more importantly, the bottom line, what are the sort of levers, if you will, to perhaps extract more profitability out of the business over time?

Well, the first thing I would mention, and I think this is important, there is no one single other market outside of the United States. What you're dealing with is several different markets, each with its own characteristics. And one of the things I think distinguishes Skechers is our ability to be flexible and adaptable to those markets. In some, we're very heavily into our own direct-to-consumer presence via physical retail and online. In others, we employ a combination of both wholesale and direct-to-consumer channel operations. In others still, we use franchises and third parties to grow our brand. Generally speaking, as we begin a market, we're looking to expand the brand as quickly as we can because once we have a customer, we know that the LTV of that customer, they experience our product, grows exponentially with each successive pair of shoes they buy from us early on. And so we're looking to obviously establish the brand and grow the brand. And then what we obviously do is want to transition that to profitable growth after we've established a strong brand foothold. And we've been able to accomplish this in market after market. What we're looking for from those international markets, in particular, is an accretive gross margin to our overall average as well as high flow-through at an operating margin basis once we've gotten past an initial investment stage. And that can be one level of investment, it could be multiple levels, depending on how a market grows. But it's important to keep in mind that we want to balance the investment with the opportunity to grow profitably. Our end expectation is for a mature market, that it evidences superior operating margin contribution to the overall business. However, I would note that we don't do a lot of cost allocations from this corporate universe. So product development, management, a lot of marketing is centralized. So the natural algorithm of our business requires that those international markets over-contribute at the operating margin perspective. And what we've seen from time and time again is a market goes through an investment phase, it comes to a plateau level of maturation, and then it starts to grow more steadily from there as it introduces more divisions of our product, as we grow more sophisticated in the market, as our retail presence is further established. And then usually, what happens is there's another curve of growth as the brand really begins to resonate in a marketplace and we can support that scale with marketing. The net effect of that is a key component of our strategy, as I mentioned, which is as we grow that international business, we expect gross margins to be accretive, we expect operating margins to be accretive. And as each market gets more mature, it contributes more and more to the bottom line of the company. And then in some instances, we do go to market through a joint venture, so there is a potential minority interest charge that we need to keep in mind. But generally speaking, that's in markets where we feel we are strongly advantaged by having a very capable partner, like in China.

Fantastic. Okay. That's an excellent rundown. I wanted to pivot a little bit to talk about the last year. And COVID has obviously changed how consumers shop, certainly during the last 12 months. And it's really afforded businesses like Skechers to accelerate, in many cases, your direct-to-consumer efforts and e-commerce, in particular. I'm wondering if you can talk about how Skechers sort of adjusted its direct-to-consumer strategies and in particular, your e-commerce strategies through COVID. And what are the benefits to kind of revenue and margin from accelerating direct-to-consumer and e-commerce?

Well, I mean, the first comment I would make is, quite frankly, COVID has changed almost everything about how you run a business from -- to the number of employees you have sitting outside your office on a given day, to how you deliver product presentations to customers, to how you actually go to market at the consumer level. I mean thankfully, for Skechers, we had made the decision a few years ago to amplify our investment in our direct-to-consumer capabilities. That was everything from our website and our mobile applications, to our digital marketing platforms. And that's been a huge advantage in the pandemic, not that we were planning for a pandemic, but we were able to continue that investment and bring to market really some cutting-edge capabilities on very short notice that significantly advantaged our growth rate in digital-only transactions over the course of 2020. Now what we're aiming for, though, is what we believe is the long-term solution for the consumer, which is the ability to transact with Skechers in a manner that is responsive to what consumers want. That's the veritable, when you want it, where you want it, how you want it. And so what we're focused on is eradicating points of friction between the myriad methods through which consumers want to shop, either a digital-only transaction, a store-only transaction and anything in between. So a lot of the investment firepower we're focused on delivering complements that approach to the consumer. Now that being said, quite frankly, we believe in physical retail. We believe that will be a cornerstone of how we continue to go to market and complement to the digital capabilities. And we're being very cautious about ensuring that they will be able to equally contribute, both top and bottom line, over the course of time. I think the reality is the one thing that the pandemic has taught us all is that we don't know exactly what's going to transpire in the future. And so we need to be both flexible and adaptable to a variety of potential occurrences in the marketplace, like a pandemic or other challenges, that may occur. Now as we go forward, we will continue to invest in those core capabilities to augment our omnichannel solutions to consumers. We think that's a win-win. We will also continue to support our wholesale partners so they can deliver product to consumers in a way that we believe is advantageous at that consumer level. And we think that continues to be the recipe for the second pillar of our strategic growth formula, which is enhancing our direct-to-consumer relationships with consumers, both to get them the product that they want, but so we can know more about them and use that as a positive feedback loop on how we design, deliver and market product in the future.

Fantastic. Okay. Excellent. That sort of brings us to a debate that we've been hearing and questions that we're getting from investors. And the key question is around how operating margins are likely to perform after COVID. There are -- a lot of businesses in the space are talking about how margins can actually be higher after COVID. Some are getting there by using different levers, cost cuts. Others are expanding their direct-to-consumer efforts, scaling e-commerce. I'm wondering if you can talk with us about how you're thinking about margins post-COVID. What are the levers that you see? I think you've targeted a low-teens operating margin longer-term. What are the levers to get there from what was about [ 10% ] in 2019?

Well, I want you guys -- I know I won't resonate with every participant out there, but we do exactly have an operating margin plan. It is something we focus on as a company. I mean obviously, 2020 was a bit of a setback year for everybody. I think we did a beautiful job of responding where we felt appropriate, to make reductions in what we spent in SG&A in particular, but also in other categories. But we also wanted to maintain our posture of growth because where we believe we will deliver the most value for investors is by continuing to grow this brand globally. And so we were conscientious throughout the pandemic not to cut into areas that we felt were going to be necessary to reemerge on the trajectory of growth that we were aiming for. I would also say, to be fair, we also felt a certain amount of responsibility to many of the people who have become key components of the Skechers organization. And so we didn't want to take a short-term situation, use it to reduce jobs at the expense of our employees, who are key stakeholders in helping this brand succeed. In the long term, our formula for growing operating margin remains the same. In the near term, obviously, we need to get over some of the hurdles the pandemic provided, most notably in the retail space. And then we will continue to grow at scale in many of our international markets as well as in our direct-to-consumer channel domestically, while, at the same time, fostering investments that we think are absolutely critical to the long-term health of the brand. Now we've said before, and we continue to reiterate here, our goal is to maintain that envelope of operating expenditure below our top line growth rate. That gives us points of accretion to the operating margin. And then, in addition, as we spoke about it earlier, there's the gross margin accretion that we expect as direct-to-consumer and international growth continue to outdistance our domestic business. And that's going to be the formula for success. I think the only potential obstacle that we talk about, and that's investment, investing for the health of the business. And we're trying to be clear about when we make those investments, what they cost, why they will be a short-term drag. But I can assure you that they will lead to ongoing improvements in operating margin long-term. And I would even point to the pandemic as a great example of that. I mean we have always consciously invested in our distribution capacity. Maintaining that capacity and that throughput throughout the pandemic has allowed us, we believe, to be an above-average performer in deliveries to our wholesale partners and our retail outlets. And we think that's evidenced itself in what we're seeing in the sell-through in the marketplace broadly. So we have a plan for the operating margin. We stand firmly behind that plan. Obviously, 2020 was a short-term irritation against that, but we will continue to march along that path to accrete the operating margin, first to '19 levels and then beyond because that's absolutely our goal. And then in the long term, I would say, the comment I've made repeatedly before, is there's no structural impediment to this company achieving those low-teen operating margins on a consistent long-term basis. The only thing that ever gets in our way is our tendency to want to invest, to continue to grow that brand because we believe it is definitely within this brand's potential to become the de facto #3 player in the world.

Fantastic. Okay. Great. I want to reflect back on -- and I think you and I have talked about this in the past. We've always had this sort of puzzling -- I have always felt like there's this puzzling disconnect between what is really one of the strongest revenue growth rates and long-term profit growth rates in the sector with what struck us as, frankly, a discounted valuation relative to your peer set, John. And we did some work on this, and our work suggested that maybe the volatility in operating income flow-through rate was contributing to that haircut. But frankly, when we put Skechers up against some of your peers, that same sort of volatility was there with the peer group as well, yet their multiple was not getting punished. But I suspect it's because there's a little bit more guidance offered by the peer set than perhaps Skechers has historically. But here in the most recent quarter, you guys turned over a new leaf and provided full year guidance for the first time. It was great, in our opinion. I really welcome the change. And I'm just wondering if you can talk about the change in guidance philosophy, the thought process behind it. And is this something you've been contemplating for a while, but obviously, COVID last year sort of maybe threw a wrench into that plan?

Well, I don't know that there's any CFO out there who wouldn't argue that he's undervalued in some way, shape or form, [ so ] I'll spare the complaining, although I will say we wholeheartedly agree. I think as it relates to guidance, and actually many other aspects of how we're trying to communicate with The Street, I would characterize those as evolutionary improvements we've been making behind the scenes that are only now coming to the visibility to the external markets. I think we've done a lot of work over the last couple of years, in particular, to improve our ability both to provide the guidance that we've unveiled this past quarter, but also to sustain that because the reality is guidance is only as good as the foundation upon which it's laid. And so what we wanted to make sure is that we got into the habit of being very clear about what we expect and why, and that we were in a position to be able to explain if that worked or didn't work, why. Because I think that's the -- that's maybe one of the areas where we had an opportunity to improve as a market player, and I think you'll see us continue to improve on that score. Now obviously, retail is a volatile business so there's going to be inherent volatility from quarter to quarter based on whatever number of factors impact the business. But that's not unique to Skechers. What we wanted to do is support the business in a way, both in terms of functional capabilities that advantage our ability to make decisions, but also then allow us to provide better guidance, more reliable guidance, to the world. And then when things do or don't work out, explain why. And so we're on a path to improve that. I would say, again, it's an evolutionary step in a business of our size and scale. And I think it will advantage us long-term, both in terms of the valuation of the company but also, more importantly, in the execution of the business. And at the end of the day, we're firm believers that the execution of the business will eventually appear in its valuation. And I don't think, as we've said earlier, I don't think anybody can hold a candle to the top line growth, to the penetration we've been able to evidence globally. And I think that eventually will shine through in the valuation. But we also want to make sure we do our part to communicate clearly about that, to dampen the volatility where we can and then also to be a reliable guide to what we're seeing in the business for everybody out there who relies on that information.

Great. That's excellent and very clear. I do want to ask a couple of questions on the latest quarter. The Q1 numbers were just far better than we expected, frankly, and I think far better than the consensus expected. What elements of the performance this quarter most surprised you and the management team? And is there anything that you would point to in the quarter that sort of speaks to Skechers' underlying long-term opportunity?

Well, I think from our perspective, what we've been saying for a while is that when our stores are allowed to be open, when consumers are allowed to shop, we were seeing evidence of very strong sell-through and demand for the brand. I think what we saw in Q1 was that on scale and in particular, in the domestic marketplace. So what we saw is, about mid-quarter, a fairly pronounced turn of events where restrictions were removed on consumer behavior, where marketing was allowed to actually shine through and pull demand, where our product was resonating well. And to be fair, there were certainly some externalities in stimulus checks arriving that were an aid as long -- as well as some pent-up demand. And that was incredibly encouraging because we've spoken for a while that as we look at the operating margin solution for the company, we really need retail to get back operating at a commensurate level with 2019 or close thereto. Until then, it was going to be a drag on our operating margin. We didn't have that for the full quarter but we had it for a decent part of it, and that was extremely encouraging. Our hope is obviously that, that continues in some way into the balance of the year. We're certainly encouraged by what we had seen through our Q1 announcement, as we made reference on the call, and that was encouraging. I think probably the other aspect of what we've seen is that the brand is really selling through well. And that's across channels, it's digital, it's store, it's wholesale partner. And so when you have a good product, we know and you market it well, consumers will want your product and seek out your product. And we've seen a lot of evidence to suggest that, in particular, our focus on comfort technologies in our Arch Fit product, in our Max Cushioning, in our Hyper Burst, in our Flex, all the solutions that -- where we focus on a consumer comfort proposition is resonating very well. And then you add to that kind of the general vein of the casualization of footwear, and I think it speaks to the long-term capacity of our brand to continue to grow at above-average rates in the marketplace.

Great. And to support that growth, obviously, inventory is a key component. I was just noticing here, at the end of the first quarter, inventory is up about 8%. We've been hearing from a number of different sources that there have been sort of logistical challenges in the supply chain, port delays, limited container availability, some pressure in the freight market. And I assume you're seeing that. But can you comment on -- with only 8% inventory growth, I'm guessing you're going to need that to grow a little faster to support double-digit revenue growth. Are you -- is there any sort of light at the end of the tunnel on some of the supply chain kind of logistics? And then we're just starting to hear early [ indications of ] on cost pressures in the back half of the year in 2022 in sourcing costs. Maybe you can just give us your perspective on those.

Yes. Let me first by very quickly acknowledging our supply chain team here because they've done an admirable job dealing not just with one of those issues, but as you mentioned, 3 very significant issues in the logistics space: container availability, transport lane availability, blockages at the port, last-mile freight. I mean it's all been a triple or quadruple witching. And so they've done a great job navigating through that. Not that anybody has been able to navigate around all of those factors, but they've done a great job. And I do think that most of those we expect to continue for the near term, with some abatement potentially towards the end of the summer. But it's a day-to-day management activity right now, whereas in normal circumstances, it wouldn't be something we need to focus on that [ intently ]. And we are also starting to see some indications of input cost pressures coming from both the transportation challenges that we just spoke about, but also some input cost pressures owing to both FX as well as some raw material cost pressures. We believe we can account for those in some pricing adjustments that we've already unleashed, but we're obviously going to be mindful of that going forward. It's also, I think, an excellent point to illustrate the benefits of having a global footprint. When some brands speak about those pressures, they're speaking very locally to the domestic marketplace. We can balance it across myriad marketplaces, some of which have actually had some currency favorability that offsets some of that detriment. So I think, for us, it's a little bit more manageable as a portfolio, but we're certainly seeing some evidence of those issues. And our sense is that against that, we've done a good job of bringing inventory in. We've consciously left it leaner than maybe in normal circumstances, reflecting the pandemic. But we're also working mightily to ensure that our supply chain and our deliveries going forward are there to be able to meet the demands of the order book we have, but also the demand we're seeing at the consumer level because we do think that could be an ongoing challenge for the marketplace. And we want to be prepared to satisfy our consumers as best we can.

Excellent. Okay. Well, that's a great place to wrap our session today. We thank you all for joining us. And please stay tuned for the next session. Thanks so much, John.

Thank you.