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

Hello, everyone. This is Jim Duffy, Stifel analyst following sports and lifestyle brands. Welcome to the Stifel cross-sector insights conference. We're well into the third day here, so hopefully, it's been a productive experience for you. Very pleased this afternoon to be hosting John Vandemore from Skechers. The format for today's session is Q&A.

John, thank you so much for being with us. I'm going to dive right in. Let's start with the state of the business discussion and trying to put the influence of COVID behind us, seeing some progress in some markets, some challenges in others. You're a global business. For your largest markets maybe, John, just start by talking about what you're seeing from consumer behavior and business trends.

Well, first off, Jim, thank you. And thanks, Stifel, for having this conference. We appreciate the opportunity to chat with the investors out there. I think you've hit upon it in your lead-in. We are trying as best as we can to put the pandemic behind us. That's not something that we're seeing everywhere across the globe, but we do believe many markets are making significant progress. We started to see a pretty significant positive churn of events domestically in the middle of last quarter. That was propellant for some pretty good results we were quite proud of. And there's a few other markets that continue to move along in a fashion that's consistent with their historical growth trajectory. That being said, there are still impacts emanating from the pandemic across the globe, a handful of markets that haven't quite yet fully reopened or recovered from third and second wave impacts from the pandemic. What we are most pleased by, though, is that as markets reopen, as consumers aren't able to get out and shop and shop without restriction, they are eager to spend. And they're eager to spend on the Skechers brand. They're looking for the products we deliver that focused on style, comfort and quality at a reasonable price. They're encouraged, I think, by many of our comfort technologies that we've infused into our product lineup. And that's really hitting the sweet spot of what they're looking for as they emerge from the pandemic. So we're cautiously optimistic that things are trending in a better direction; and that as we get further and further away from the most significant impacts of the pandemic, things will continue to get better and better for everybody.

Yes. So there's lingering impacts to demand in pockets of the market. There's also impact on the supply chain and product flow. Can you speak for a moment, John, about how Skechers is dealing with disruptions to inventory flow?

Absolutely. And let me first start by thanking the many people, certainly in our organization, who focus day in and day out on ensuring that smooth flow of product from manufacturing, into the stores like the one behind me. It's a difficult condition for them all mostly because we're not really just looking at one issue. We're seeing myriad issues pop up across the supply chain, everything from some inavailability of raw materials through container shortages, shipping and transport challenges, everything from pricing through availability, through unloading in ports. I mean we've even had an entire canal blocked up. So that's caused a lot of challenges for traditional supply chains, especially those that tend to operate on a more just-in-time basis. I think Skechers has done an admirable job of overcoming many of those challenges. Now we haven't been immune from some of the negative side effects that they offer, but we're doing a very good job of managing through it to the best of our ability so that we can continue to ensure that we're delivering our product in a timely fashion to our partners; to our stores; and ultimately at the end of the day, to our consumers. We're optimistic that many of these issues are transitory. They are aftereffects of the fairly significant changes that most companies made to their supply chain demand in the early stages of the pandemic. So our hope is that as we get past this year, many of these issues dissipate and that things get back to normal. That being said, we're becoming really adept as an organization of managing through these issues. And we'll continue to focus on ensuring we're bringing product in for our customers and our consumers that they can rely on because we know how important that is in this moment, especially in an environment where I think almost everybody has agreed at this point inventories are pretty lean. And that's something we want to resolve.

Yes, for sure. And I want to talk about the demand momentum in a moment, but before we do, though, this seems like a good jumping-off point to speak about the margin view for the year with the transportation challenges, some incremental costs creeping into the model, yet your outlook calls for gross margins at least flat year-to-year. Can you talk about some of the puts and takes considered with that, John?

Yes. Well, the takes, which we're not happy about, are a lot of what we just talked about, the supply chain challenges; some challenges on FX; some challenges on raw material pricing; certainly the transportation lane pricing right now, which is maybe 3, 4x what we would've historically seen. On the flip side, I think what we've seen in our brand and in particular our products that are appealing to consumers' desires of having comfort, having our comfort technologies embedded in them is that we've been able to price for that. Now we're not being overly aggressive on pricing. We're taking what we think is a fair increase to offset these costs but also really to make sure we're matching price for value because one thing we know is, on a pound-per-pound basis, Skechers' product delivers to the consumer and consumers are willing to pay for that. We've seen some of that materialize already. We have a few more pricing adjustments coming intended to match some of those cost increases we're seeing. Our long-term hope, though, is again we can begin to mitigate some of those cost impacts and maintain the value-oriented pricing that we've established here and all the while continuing to deliver on our core customer promises.

Well, let's talk about that top line now, the guide for the year, 11% to 13% [ above a ] fiscal '19 baseline. If you just take a step back and look at that relative to your peer set, pretty impressive global share gains. If we were to think about kind of different dimensions of what's driving that growth for Skechers, how would you compartmentalize the largest buckets?

Well, I mean I think, first of all, I'd comment we're really pleased by that trajectory. We were a bit worried in the depths of the pandemic that might be a lingering impact that we had to overcome over the course of a couple of years. What we've seen in consumer demand has really propelled us faster along that recovery curve to those growth rates. And we're excited about that because again it's a testimony in our eyes to the strength of the product, the value of what we're delivering. And we're always product first. I also think it's a testimony to the breadth of our product line and the breadth of our distribution. I mean, if we were confined to any one market, we would be more exposed to the vicissitudes of the pandemic impact, but having a diverse footprint geographically speaking has been a huge advantage to us. Clearly, China as a market has experienced the least-significant impact from the pandemic when all things are considered. That has helped us because China continued to grow against the backdrop of markets that were otherwise experiencing more pronounced impacts from the pandemic. So that was a helpful aid to us during the course of 2020 and really continues to propel us forward in '21 to capitalize on that growth, as we've been doing in China for many years now. We've also seen, I think, as the breadth of product we deliver addresses the market, it's able to capture multiple needs. The comfort footwear we offer, obviously, is a clear benefit in times where people are focused on health and wellness. Obviously, casualization in that trend continues, which is strong, but we've also seen really good productivity out of our work category because a lot of our work footwear helps aid first responders, medical personnel, service economy workers who are getting back into the flow of things and actually in many instances were working diligently throughout. So it's many facets of our strategy around product, around distribution platform that has enabled us to continue to grow, but ultimately, at the end of the day, the product is resonant at the consumer level. And I think we were hugely advantaged to be coming into the pandemic with several very strong product tailwinds that have continued to carry us on throughout the pandemic. And we think that means really good things even beyond this year of recovery, to '22, '23; and will continue to be propellent for a fairly traditional, albeit extraordinary by market standards, growth trajectory on the top line.

Absolutely. Skechers has always been a product-driven company. And not just this year, but over the last couple of years, it seems like you guys have really been on it with product. I wanted to talk a little bit about retail. Inclusive of your partner doors, over 4,000 doors globally -- you've got about 1,200 doors in China. Can you talk about what you're seeing with retail traffic? It's come back in some markets. Some other markets are clearly lagging for obvious reasons, but are you growing more confident in retail in a post-COVID world based on the trends that you're seeing?

I think you touched upon it. I mean, retail stores, physical stores, it's really a bit of a mosaic at the moment. You have some markets where I'd say we're well on the path to recovery, others still that remain challenged. Our long-term confidence in physical retail doors is not diminished in any way by the pandemic. Now we realize there may be some alterations to how do -- you utilize stores, where you locate stores that need to be adjusted as a result of the pandemic influences and those that may continue, but our confidence in retail long term is absolutely unshaken. How we grow that base remains to be seen. How we effect some of the changes that we now believe are more important in how we structure leases or build out stores, that's something we're continuing to incorporate into our design and development of incremental doors. What we've seen overall, though, is that aside from a few holdout categories like tourism-concentrated markets or mall-based properties that are still experiencing either restrictions or diminished foot traffic, outside of those categories, our freestanding stores, our outlets are well on the path to recovery. And that's exciting for us because those are our most productive doors. Those are the doors that allow us to bring the maximum amount of our product to the consumer, in addition to add in a healthy dose of accessory and for us a bit newer apparel, which is going to be a long-term complement to the brand and growth drivers. So we continue to remain excited about that. That being said, we are absolutely focused on ensuring we're going to be delivering the best omnichannel experience we can to consumers. Our view is people want the product. We need to get it to them in the least-frictioned environment possible. That could be a digital-only transaction. That could be a "buy online, pick up in store" transaction. That can be an in-store transaction enabled by digital tools. So we're focused as a company figuring out how do we blend our e-commerce solution, our physical stores into the right offering that drives value for our consumers. And in many ways, we think that's a bit of a price of entry going forward, so it's why we've put a lot of investment dollars behind upgrading our point-of-sale systems, upgrading our digital platforms, upgrading our mobile platforms. We will be shortly relaunching our loyalty program. All of that combines together for us to create an offering at the consumer level that is free of friction, that addresses their needs and leverages both our strength in retail and our strength online.

You've talked about digital as a cost-of-entry investment. And the company has made a lot of those investments over the past couple of years. Can you just give us some global perspective on where you stand with those investments for that e-commerce platform and what you're seeing with e-commerce as a percentage of the mix in different regions?

Sure. And I think it's probably not apparent, but we've actually gone through almost a complete rebuild of our digital presence, a complete rebuild of the technology stack behind everything that we're going to be operating with going forward. And we've done so in a way that we think actually will be leverageable globally. In the United States, I think, had we not engaged in that rebuild in a timely faction, we probably wouldn't have been as successful as we have been over the last years, particularly during the pandemic, capturing sales that were restricted to an online-only world for a while. And so we're encouraged by the progress we've made, that we made it in a timely enough fashion to capture that customer but also what that means for the future domestically. Then we take that internationally, and we want to bring that solution to as many markets as we can sustain them in. And that, for us, we'll start internationally with our current owned markets where we operate an online channel but also, very shortly thereafter, new markets where we haven't yet operated in a digital-only way. And we think bringing that array of capabilities, that omnichannel experience is going to be a huge opportunity for us because in many of those markets, Jim, what you're seeing is they're not as advanced yet as the United States or China or a handful of other countries in their digital conversion, but it's on its way. It's going to happen. And we know consumers are going to begin to expect that level of omnichannel experience. So we're well on the path to delivering that. It's going to start this year. It will continue into next year. And that will actually advantage us, we think, significantly in many markets because we'll be at least with the industry leaders, if not one of the industry leaders, in being able to deliver a true omnichannel solution, but it all goes back to the hard work we've done in the last couple of years to rebuild the technology stack for the future. And we're so glad that's behind us. It was done in a timely way, but it was also a tremendous effort that the team here deserves great compliments for handling.

Yes. And I know Skechers thinks about the consumer first. And I've heard you represent that the consumer doesn't think, "I want a pair of shoes through e-commerce," or, "I want a pair of shoes through the store." And they just want a pair of shoes, and whatever the most convenient channel for them to get them is the channel that they choose, but I get a lot of questions from investors, John, about the margin influence of the different channels. Can you talk about how e-commerce influences the margin for Skechers both from a direct-to-consumer standpoint and also e-commerce through wholesale channel partners?

Well, I can certainly speak to our own experience because that's at the core of how we've thought about building out our digital economy. And for us it's actually an accretive contributor both at the gross margin line and the operating margin line. Now to be fair: It's leveraging a lot of common infrastructure in areas like merchandising and product, but much like we expect out of our retail stores, it's contributing accretively at that level. And that's good because it keeps us in a position where we don't have to try to influence the consumer. Because you're right. What we view the consumer is wanting is the product and it's our goal to get it to them in the easiest manner possible. And so we need to be agnostic about that internally. And having differential or significantly differential margin structures would not enable that, so we've been focused on making sure that's the case. And as we continue to grow out, there may be instances where we're going to be chasing bigger dollars at a slightly lower margin, but it will still, in our eyes, be incremental and accretive to what we're doing within the company as a whole. And we'd like to maintain that. That's important to us.

I want to think about it through the lens of returns and return on capital. Is there an argument that -- with e-commerce that it's a more inventory-efficient business than a traditional wholesale distribution model or retail model? Is that something you've factored into your calculus of it?

Yes. Well, I mean we use a lot of shared inventory, but I actually think that's an incredibly good point because I think it points to another evolution available to us in the future. In a digital model, clearly you can leverage amassed inventory for a much broader distribution footprint, but what we're aiming to be able to do is to combine that with our own retail stores and use the total of that inventory to fulfill digital demand. Now we're not there yet. We need to make some advancements in our technology and our distribution platforms to be able to enable that, but our long-term view of the future is that we'll be able to use all of that inventory seamlessly. And that will provide us another leg advantage of fulfilling at the last mile, continuing to be frictionless at the consumer level. And it does allow for greater working capital efficiency in the grand scheme of things. I mean nothing really compares, though, to the wholesale distribution. That's a maximally efficient process when it's run right. And we do a very good job as a company managing our working capital in that capacity, but we don't think retail and digital on a combined basis is far behind. And we've seen some really good progress lately of that, that we think can actually add significant value longer term.

[indiscernible]. Our LEEDs -- LEED-certified building here turns the lights off on me if I don't move enough. Fairly, I'm not dynamic enough. I was -- so let's -- domestic wholesale business, John, it's really outperformed expectations, a super positive surprise, particularly in Q1 and the '21 outlook. How much of this is product versus shifting competitive dynamic? Can we think about this as a growth business over a multiple-year period?

Well, we've been incredibly pleased by the performance in the domestic wholesale, but to be honest, it's going to come down to the same core attributes. It's product and product selling through well. And in fact, in many instances I think we've outperformed the expectations of our wholesale partners, whom -- we're in the habit of embracing. If they're willing to treat our brand in a manner that we think is constructive for the overall business, we want to support them. We want to support them with product, with product margin. And I think we're a very good partner in that situation, especially when others are walking away from the channel. What we've seen is that the product is doing very well. Then our ability to deliver product in a timely fashion and continuing to do so has been very well received from a partnership perspective. I think also, quite frankly, our willingness to ensure that it's a profitable transaction for all involved has absolutely been constructive in those relationships. Certainly, the domestic wholesale marketplace has gone through its share of challenges over the last 5 years really. There's been attrition before the pandemic. Obviously, the -- I think the pandemic accelerated some of that. However, our long-term view has long held that, once that rationalization in retail was over or largely over, what would be left is a fairly healthy domestic wholesale channel that was probably a mid-single-digit growth, on average, marketplace for us. And that's fantastic. It's incredibly profitable for us. It allows further leverage of many shared costs that help drive our business across the globe. And it also gives us tremendous insight into what's happening outside of our own stores. I mean, obviously, we know our consumers well. We know them when they're in our stores, they shop online, but also being able to have visibility into what's going on at our partner doors is exceptionally important. And I would even argue, to be honest, we have a long way to go to continue to leverage that for our overall benefit. And we'll do it with our partners, as long as they're willing to help support the brand and help support consumers who need the brand and want the brand.

Great. So looking back historically: Your multiyear double-digit CAGRs, that's really been led by international growth. Let's start by talking about your direct distribution markets, which have been the key markets behind that growth. Are these the markets you expect will continue to lead in '22 and beyond as we move beyond the pandemic? I guess that's an important caveat, yes.

Yes. Listen, I think this is a challenging question for us because it's -- it always comes down to which markets are you most excited about or have you been most successful in. And the challenge for us is we tend to recite every market because, quite frankly, over the last couple of years, as we put up a compound annual growth [ around ] the top line that is, I think, the envy of many, it's come from a lot of different areas. It's come from South America. It's come from Western Europe. It's come from Eastern Europe. Obviously, Asia has been a strong contributor. And we look forward. All of those markets for us offer continuing opportunity. Now it's a different shape and flavor between them, but all of them have opportunity to continue to grow the brand, which is why we're so excited about the long-term prospects of our business. China, Asia, that market will continue to grow well. There's significant under-penetration on our front in many other Southeast Asian countries. South America, we believe the whole continent can perform much like Chile for us, which is a high-impact, high-market-share environment. And our brand is resonant throughout that continent, but even in Europe one of our fastest-growing markets over the last probably 6 quarters has been a highly developed German market, which is fantastic. So we really get excited about the portfolio we have. We think all of them are experiencing incremental opportunities for the brand because of the product breadth or just the inherent dynamics of that marketplace as well as our willingness to be flexible and go to market in a manner that, I think, is reflective of what both the local market wants but what our product delivers on.

And I saw you just signed Michael Ballackone (sic) [ Michael Ballack ] to an endorsement contract, so clearly you have big expectations for the German market going forward.

Indeed. And we like football as a sport, for sure.

Great. Let's talk specifically about China for a moment. I'm going to give you credit for being on a $1 billion run rate in the China business if we carry that forward. Maybe I'm jumping the gun some, but that's a business operated through a joint venture. We think of China as the brand's single largest growth opportunity. Can you give us an update on the China business, the drivers of recent strength? And what are keys to growth for the next leg of growth in China?

Yes. Well, certainly, we don't have any diminishing expectations for the growth opportunity in China. I mean the percentages may change because of the law of large numbers, but we absolutely expect China can remain on a trajectory that takes it well past that $1 billion waypoint you mentioned and even higher. We have a very good working relationship, and I would very much describe it as a working relationship, with our partner in China. They've been one of the keys to our success there. And working tightly with them, we think we've got a very good road map for future growth. I mean it will continue to be heavily influenced by e-commerce. E-commerce in China is clearly a standout, but we absolutely believe there's more room for more doors across the market. There's even room for additional product line expansion, not to mention new categories like apparel where we're still developing a strength that can be deployed globally, but absolutely in China is a marketplace opportunity. I'd put a crazy number out there on China, but I think the reality is we fully expect it to grow. We see market opportunity. We see unaided awareness for the brand in China that's right up there with all the other top players. And we'll continue to extrapolate on that through those relationships and more if opportunities develop because we think we have the product that works. We think we have the pricing that works. We have the marketing that works. We certainly have the execution, which is going to be aided now by our own distribution capability that we've built up over the last year. So we're excited about China. And certainly, it suffers from no small level of expectation for growth in our house.

Great. Let's talk about margins in China. You've made a number of infrastructure investments there. You mentioned the new distribution center. Can you speak about opportunities for leverage and improving margin contribution from China?

Well, I think it's important to note China is an accretive margin for us, to begin with. So our expectation, it continues to do so. Now some of that is because it benefits from some of the centralized costs we absorb domestically, but we also don't see any reason why that should diminish over time. And in fact, we think there are opportunities to augment that. They'll take time to develop in some areas, like getting this new distribution center up and running. It takes a little bit of time before those come to maximal efficiency. We'll need some more distribution capacity that we'll have to think about in the next couple of years, but long term, we absolutely expect the margin to continue to be accretive, no reason in our minds why that wouldn't be the case. And we'll continue to look for opportunities to gain on that operating margin level by just making ourselves more and more efficient, which I think is aided when you think about some of the primary growth drivers coming out of categories like franchise development and e-commerce.

Got it. And China is a joint venture business. I know there's a lot of complexities to operating in China. And no doubt the partner helps you address execution on many fronts that would require specific expertise, but you have consolidated joint ventures in the past. Can you talk about kind of the calculus and how you think about that relative to businesses as they get to a scale of this sort?

Yes. I mean we always consider the structure of our partnerships, be they distributorships or joint ventures, relative to the market they operate in. Where we find that those are most effective is when that key partner delivers something to the relationship that we're not equipped to deliver. And I'd say [ in the instance of ] China but also in other markets, you're dealing with markets where you benefit greatly from having some local expertise. And I think, quite frankly, I doubt that we've been able to grow China as quickly as we have without the partnership we have today. We always look at it from both an operational perspective and an economic perspective, but mostly what we look to do is reinforce those relationships where they work well. And when they haven't, that's when we step in and we make a change. That's not to say that we would never make a change of structure or partnership, but it would only be in a manner that was conducive to strengthening the relationship or strengthening the business overall. We have no strong desire just to undertake a financial transaction that puts at risk the execution of the business because that's not going to serve us good in the long term.

Understood. Zooming out a few clicks: We're approaching $6 billion business, gross margins approaching 50%. Looking at your peer set, John, it's suggestive of operating margin opportunity in the low teens. Is that how the Skechers management team and Board of Directors sees this?

Absolutely. I mean we've said for a while our long-term objective and the long-term capacity of this business is to see operating margins in that low-teen range. David used to speak about it long before I arrived, and that's absolutely still the case. Now the thing that somewhat makes that cloudy from time to time is our push to grow, but what we know is, if you look at the brand capacity, the surest way to deliver shareholder value over time is to grow the brand as big as possible. That all being said, we are working daily to make sure we're chipping away at the opportunity to get into a higher-operating-margin profile while still making the investments that are critical to growing markets like China, India, Southeast Asia. And all times, we're trying to balance those two as best we can. Sometimes that works in a quarter. Sometimes it doesn't, but over the long haul, no question in our mind this is a low-teen operating margin business. And hopefully, it will be a much larger one because we have aspirations well beyond $6 billion. And I won't give those out other than to say they're big. And they will remain big because we think that's what the brand can sustain. We can sustain that with growth domestically, growth in our direct-to-consumer channel and most importantly growth internationally.

What are the -- what are some key mileposts you'd have investors focus on to gauge you with your performance relative to these objectives across 2021 but also into 2022 and beyond?

Well, short term, we're looking to restore margins to where they were in '19, absent any sizable investments of which we're not aware at the moment. That's the first way post, but we'll continue to move beyond that. I guess the thing to keep in mind would be if we foresee the opportunity to grow faster or grow more robustly, we'll take that opportunity. We'll make that investment. Now what I think you can expect from us, though, is you'll give transparency and visibility to those investments so people understand when they're being made and why they're being made. To date, though, I would say the first waypoint or we're getting back to '19, getting beyond that through continued growth and operational excellence that sees that gross margin accreting, that will contribute. And then we'll continue to work on opportunities to gain efficiencies over the course of the long-term horizon that helps push up that operating margin.

All right, parting shot here, John. So the balance sheet is super strong. You've got more than $8 a share in net cash. Despite that net cash position and stronger revenue growth than your peer set, the stock is trading at a discount to the peer set. What are the considerations for use -- this is my most leading question of the session. What are the considerations for use of this cash position as you start to see stabilization in global markets?

Yes. I'd say we're still in the process of shifting from a more defensive posture that we adopted throughout the pandemic to a more aggressive one. The first step on that is going to be repaying our revolving credit facility, something we drew down on in the early part of the pandemic and we're getting more and more comfortable [ is seen as ] probably no longer necessary. And then we want to make sure we're able to fund our projects kind of in an untethered way. We don't want to be beholden to anybody to be able to fund the growth that we think is necessary for the brand. After that and after we get behind some of the volatility associated with the pandemic, we'll very much look at opportunities to use cash either in organic expansion, inorganic expansion; and then maybe even return cash to shareholders directly, but that's a conversation that's down the road at the Board level that we need to foster once we get past what we've determined to be the kind of the riskiest components of the pandemic. That all being said, we couldn't be happier with how we navigated the pandemic. And thanks in large part to our balance sheet, we didn't have to spend a lot of time like others focused on liquidity or raising capital. And I think that was a real strength for us. It's one of the reasons why I think we are able to focused on supply chain and other aspects of the business challenges that arrived because we weren't distracted with liquidity-related concerns. So you'll -- also should expect that we will continue to maintain a very strong fortress balance sheet to use when we need to.

Excellent. John, thanks for being with us. We really appreciate you sharing your insights. Thanks for dealing with my flickering light situation here. We made it through, and I really appreciate you working with Stifel in this conference.

No, we appreciate being here. Thanks for your time, Jim, and thanks for everything.

Excellent.