Quiksilver’s April 30 Quarter; There Are Some Numbers that Need Explaining

/0 Comments/in /by

Quik’s revenues for the quarter rose 2.1% to $478 million compared to $468.3 million in the same quarter last year. The gross profit margin rose from 53.2% to 54.8%. Sales, general and administrative expenses were up slightly, but fell as a percentage of sales. Interest expense was down as a result of their balance sheet restructuring from $21 to $15 million.

So how, you might ask, did they go from a bottom line profit of $9.4 million last year in the quarter to a loss of $83.3 million in the quarter that ended April 30, 2011?

First, there was a noncash asset impairment charge of $74.6 million compared to zip, zero, nada in the same quarter last year. If you ignore that charge, operating income was up from $35.9 million to $45.4 million.
 
The charge was “Due to the natural disasters that occurred throughout the Asia/Pacific region during the three months ended April 30, 2011 and their resulting impact on the company’s business…” Okay, I guess we can’t hold Quik responsible for earthquakes, tsunami, and core meltdowns. Although, I guess we’re all a bit responsible for the core meltdown we’ve had in our industry.
 
But I digress. That write down represents a real impact on Quik’s business going forward.
 
“The value implied by the test was affected by (1) a reduction in near-term future cash flows expected for the Asia/Pacific segment, (2) the discount rates which were applied to future cash flows, and (3) current market estimates of value. The projected future cash flows, discount rates applied and current estimates of market value have all been impacted by the aforementioned natural disasters that occurred throughout the Asia/Pacific region, contributing to the estimated decline in value.”
 
This says that cash flows are going to be reduced for some period (I don’t know what “near-term” means), risks are higher (that’s what you mean by raising discount rates, we finance trained people think) and, inevitably, given the other two factors, values are lower. It’s a noncash charge but not a meaningless charge given the impact on future business.
 
With that charge, pretax income fell from $19.5 million to a loss of $42 million. But the provision for income taxes rose from $9.4 million to $39.7 million. Huh? More taxes on a big loss? Shit. I’m going to have to delve into the dreaded income tax footnotes. Those of you who are into self-abuse can see the filing here and read the footnote starting on page 15. But beware- reading this can make you go blind.
 
I think I used that joke last week. I need some new material.
 
I’d urge you to go take a brief look at that footnote. Not because you’re likely to want to figure it out, but because hopefully you’ll then feel sorry for me as I attempt to explain it.
 
A deferred tax asset is a future tax benefit. It’s easy to understand why they exist. A company wants to tell its shareholders it made as much money as possible. It wants to tell the government it made as little as possible so it can at least postpone the payment of taxes. Quik has decided (I think it’s related to the asset impairment charge above) that their deferred tax assets were $26 million too high in the Asia/Pacific region. That is, they don’t think they are likely to get the benefit they were expecting, so they wrote them off.
 
There, that wasn’t too bad. Sorry to spend so much time on these two issues, but the numbers were so large I felt it was necessary.
 
Revenues rose 5.5% in the Americas to $210.7 million and it was fueled “…largely by our retail business,” according to CFO Joe Scirocco in the conference call. Company owned retail comparable store sales rose 23% in the quarter, and e-commerce sales grew 68%.   The Quik and DC brands were up, while Roxy was down. Wholesale revenues in the Americas “…were on plan and a couple of percentage points higher than last year.”
 
Wish they’d give us some numbers on how the wholesale business was doing in the U.S. 
Revenues fell 0.8% in both Europe and Asia/Pacific to $207 million and $58 million respectively. Europe was down 4% in constant currency and Asia/Pacific 12%.
 
Gross profit margin in the Americas rose from 46.6% to 49.1%. This was “…primarily the result of a favorable shift in product mix and, to a lesser extent, a greater percentage of retail versus wholesale sales.” 
 
It was up in Europe from 59.9% to 62% as a result of improved retail margins. It fell in Asia/Pacific from 53.5% to 53.1%.
 
In a trend that’s hardly unique to Quiksilver, you can see why lots of U. S. companies are more interested in international rather than domestic expansion. Oh- Quik is going into India and expects to open 10 new stores there in the next 12 months.
 
Quik reports, in one line in its 10Q, what it calls its Adjusted EBITDA. This is net income before “(i) interest expense, (ii) income tax expense, (iii) depreciation and amortization, (iv) non-cash stock-based compensation expense and (v) asset impairments.”
 
I’m kind of a bottom line, generally accepted accounting principles kind of guy, but sometimes this is worth looking at because it does eliminate some distortions. For the three months ended April 30, it was 13% both this year and last. For six months it was 10.7% last year and fell to 10.2% this year.
 
On the surface, the balance sheet is almost identical to a year ago, though equity has grown about 10% to $535 million due to the balance sheet restructuring. Liabilities have only fallen by about $42 million to $1.1 billion, but debt maturities have been pushed way out so there are no big repayments due over the next four years.
 
Inventories are up from $226 million to $290 million, or by 28% (18% in constant currency). They describe that as being to “…ensure timely production and delivery” and as representing “…a restocking relative to very lean inventories a year ago.” I wonder if there are any cost increases in inventory numbers yet. They note that “Consolidated average annual inventory turnover was approximately 3.0 at April 30, 2011 compared to approximately 3.6 at April 30, 2010.” Higher turns are generally better until you get to the point where you’re not able to fill orders.
 
Those are reasonable reasons to increase inventory, but I’d still be happier to see increases a bit more in line with sales growth. Maybe there’s also some stocking for the Quik girls line which just started shipping in February.
 
Quik makes it clear that they are not going to be rolling out a bunch of mall stores as their old retail strategy called for. But they do discuss a cautious experimentation with some concept stores. They talk about a couple of stores at Capbreton and Hossegor in Southwest France and a Paris store. All three are used for events and promotions. At Capbreton, they have a summer concert series and it includes an athlete training center. Apparently, they include not only all of Quik’s brands, but “…a deep stock of surfboards, wetsuits, skateboards and other products that reinforce our heritage and authenticity…”
 
They plan to import this concept into the U.S. The first such store is scheduled to open in Venice, California in the fourth quarter. It will be about 10,000 square feet.
 
My point of view on Quiksilver hasn’t changed much since they finished their financial restructuring. I’m still wondering where their sales growth is going to come from. Like most companies, they see some possible margin pressure in the second half of the year because of cost increases and uncertainty as to consumer response to price increases. Their conference calls have focused recently on lots of good things they are doing with product, teams, retail and brands. They are good things, but so far they haven’t translated into much top line growth.
 
It feels like they’re doing the right stuff but this market just isn’t going to respond like it used to.            

 

 

PacSun’s April 30 Quarter; How Long for the Strategy to Get Traction?

/0 Comments/in /by

While CEO at Pacific Sunwear, Sally Frame Kasaks took some appropriate tactical actions. The problem, I conjectured at the time, was that she just didn’t “get it” when it came to the youth culture market/action sports market. Gary Schoenfeld, when he became CEO, knew that PacSun’s success ultimately depended on its ability to reconnect with its core customers and be relevant to them. No amount of tactical change and expense control, as important as those were, was going to change that. The customer had lost a reason to come into PacSun stores and had to be helped to rediscover it if PacSun was to have a future.

That implied a major organizational change that is long term, difficult, and a bit chaotic. Mr. Schoenfeld replaced almost the entire management team with the goal, I assume, of implementing a new way of thinking and approach to the business through the entire organization. He launched new marketing initiatives, closed (is closing) nonperforming stores, reintroduced the footwear that Ms. Kasaks had eliminated, localized the inventory assortment (an ongoing project), and revamped stores that needed new fixtures and merchandising (that initiative is constrained by cash flow issues).

PacSun undertook this not short term project at a time of economic weakness and reduced consumer spending. Now, with the economy possibly weakening again, and cost increases likely to show up in the second half of the year (not just for PacSun), there’s some additional urgency to see improvement.
 
And for the quarter ended April 30, they saw comparable store sales increase by 1%, which is improvement. Sales were down 2.39% from the same quarter the previous year to $185.8 million, but they ended the quarter with 827 stores versus 883 a year ago, so you’d expect some sales decline. Women’s comparable store net sales rose 4%. Men’s decreased 3%.
 
Their e-commerce business is about $50 million. They relaunched the web site in April. Their e-commerce sales were flat for the quarter. I haven’t heard many companies say that their e-commerce sales weren’t up, but they just relaunched so we’ll wait and see. My concern, of course, would be that flat e-commerce sales could be indicative of their marketing programs not getting traction. 
  
Gross margin, however, fell from 22.3% to 19.1%. Of that decline totaling 3.2%, 2.7%, or 84.4% of the total decline, came from a “Decrease in merchandise margin rate primarily due to increased markdowns as a percentage of sales.” I would expect that one indication that their new programs were having a positive impact would be an improving product gross margin. 
 
The remainder of the gross margin decline was due to deleveraging of costs because of fewer stores and a lower sales base.
I’m going to scurry right over to the balance sheet and point out that merchandise inventory on May 1, 2010 was $106.6 million. On April 30, 2011, it had actually risen it was $115.8 million. Now, an inventory number is as of single day, and there can be big timing issues (if you receive inventory on the last day of the month, it shows up in the quarter that day is in. If it’s received the next day, on the first of the month of a new quarter, it doesn’t show up in the quarter that just ended).
 
Still, with stores being closed, sales down, and additional markdown being taken, you might expect a drop in inventory levels. However, management indicated in the conference call that they were comfortable with inventory levels. As you think about inventories, there’s another issue impacting companies in our industry. As cost increases show up, the same number of units will appear in inventory with a higher value, increasing inventories to the extent of the price increase. No idea if that is involved here or not.
 
Sales, general and administrative expenses fell 9.7% to $66 million. As a percentage of sales they fell from 38.4% to 35.6%. The net loss for the quarter of $31.5 million was similar to the loss of $31 million for the same quarter last year.
 
Comparing the current balance sheet with the one from a year ago, we see that the current ratio has fallen from 2.25 to 1.80. Total debt to equity has risen from 0.59 to 1.03. Cash and cash equivalents fell from $56.6 million to $24.7 million, accounting for almost all the decline in current assets. Current liabilities rose slightly from $79.6 million to $88.6 million. Long term liabilities rose from $84.9 million to $101 million due to the mortgaging of certain of the company’s facilities to raise cash.
 
PacSun closed 25 stores during the first quarter, and anticipates closing a total of 40 to 50 during the whole fiscal year. They note in the 10Q that they have almost 400 lease expirations occurring through 2013. That will result in some additional closed stores, but I’d expect that some of the leases they keep will be renegotiated under more favorable terms.
 
I don’t have to come up with a conclusion for this article, because CEO Schoenfeld pretty much stated it for me during the conference call:
 
“There’s no question that the merchandising and execution in our stores has vastly improved, yet we know we still have a lot of work ahead of us. Customers have many choices. We still have real estate challenges to resolve. Consumer response to higher prices this fall is hard to predict, and having made so many organizational changes internally, it will still take some time for our team to consistently execute at the levels that I believe we are capable of.”
 
On the other hand, it’s my column, so I get the last word. It’s more or less what I said after their last report. Can PacSun’s new strategy get traction with the target consumer before the economy and cash flow issues get in the way?    
 

 

 

A Little More Information on Volcom’s Sale to PPR

/1 Comment/in /by

Often when a deal happens, all you know for sure is what’s in the press release. Typically that press release doesn’t offer a completely objective perspective about the process and motivations that lead to a deal. But if it’s a public company, and you’re willing to dig into mounds of fine print, sometimes you can find out a bit more.

That would be true with PPR’s acquisition of Volcom. Don’t get all excited. I don’t have any deep dark secrets to tell you. There’s nothing that would change my opinion that Volcom made themselves a good deal at the right time for the right reasons (in fact, this reinforces my opinion). But we’ll know a bit more about how and why the deal happened.

When I reviewed Volcom’s last quarterly report, I noted that a law suit had been filed as a result of the deal alleging that Volcom and PPR had done various bad things not in the shareholders’ interest. A second one was also filed but both are now being settled. We don’t know the terms, but one of the conditions was that Volcom amend its Schedule 14D-9 to include some more information on the deal. So we have the plaintiffs in those two lawsuits to thank for some of the additional insight.
 
From various documents filed as part of the deal, we know that the first contacts between PPR and Volcom management was on February 8th and 9th, 2010 where “…there were initial discussions about the businesses and histories of Volcom and PPR, as well as ways the companies might work together.” On March 11, PPR told Volcom they were interested in a potential strategic transaction. No purchase price was mentioned. There were ongoing meetings and conversations through April, but around April 28, Volcom told PPR that it intended to pursue its strategic plan “…rather than continue talks with regard to any potential strategic transaction…”
 
There was further contact on July 15 that lead to an informal meeting in Newport Beach, California between PPR CEO Pinault and Volcom CEO Richard Woolcott and President Jason Steris. Nothing happened and there were no further discussions for several months.
 
Meanwhile, on October 22 another company contacted Volcom and said they were interested in acquiring Volcom. Volcom had conversations with that company between October 25 and the end of December, 2010. Bidder A (as this company is called) signed a confidentiality agreement and proceeded with its evaluation of Volcom. On February 1, Bidder A informed Volcom that its review supported a price from the low $20s up to $25.00 a share.
    
It was December 16, 2010 when PPR contacted Volcom again about a potential strategic transaction. A confidentiality agreement was signed on February 1, 2011. Due diligence was undertaken for about two months and on March 4, PPR told Wells Fargo Securities (representing Volcom) that their analysis supported a price of $23.00. On March 17, Wells told PPR that Volcom was talking to other potential buyers as well.
 
PPR formally bid $23.00 a share on April 21. There were some additional meetings. PPR increased its offer to $23.50 on April 29.  The first offer was contingent, among other things, on CEO Wolcott’s “…entry into a new employment arrangement with PPR.” The second offer “…was not conditioned upon Mr. Richard Woolcott’s entry into a new employment agreement.”
 
I have no idea if that change has any significance at all. But the lawyers thought it was important enough to be included in the narrative so I’m just curious.
 
Now it gets interesting. On May 1, Wells contacted PPR’s representatives and told them their bid of $23.50 per share was not the highest. Bidder A had bid $24.00 earlier in the day. They recommended that PPR increase its offer before the Volcom Board of Directors started discussing the offer later that day.
 
Damn! This even gets exciting when you read about it in lawyer speak. It’s what makes doing deals “fun.” Think of the sense of urgency, the impact of different time zones and the fact that there were three companies involved. And three sets of lawyers. And, I assume, three sets of financial advisors. PPR increased its offer to $24.50.
 
In what I’ll call “dialing for dollars” Volcom’s representatives went back to both PPR and Bidder A and asked them to increase their bids. Both declined.
 
“Later in the night (Central European Time) of May 1, 2011…” Volcom’s lawyers told PPR’s lawyers “…that if PPR were willing to modify certain terms of the proposed merger agreement, the Volcom Board of Directors was prepared to approve the merger agreement and sign it immediately.” Those modifications obviously happened and “The Merger Agreement and Share and Voting Agreement were executed by the parties in the morning (Central European Time) of May 2, 2011.”
 
The Schedule 14D-9 lays out this whole process in much more detail on pages 10-22. You might want to take a look at it.
 
In those pages, we also learn something about the motivation for the deal. In the normal course of business successful companies will be approached by various entities about possible strategic transactions. This was true for Volcom from 2007 through 2009. As a public company, they have a fiduciary responsibility to consider if any of these transactions might be in the best interest of their shareholders. It feels from reading the pages above that it was somewhere around the end of 2009 when Volcom decided to look at the possibility of a transaction more seriously.
 
Not that they had to do one- but the world had changed enough (financial crisis, great recession, difficulty in growing) that taking a more serious look made sense. Still, in August 2010, Volcom released some financial projections as part of their five year plan that showed the company growing its earnings per share from $0.91 in 2010 to $3.37 in 2015. If they thought they could accomplish that, why sell at $24.50 a share?
 
I don’t know the answer to that, but I do know that in August of 2010, and prior to that when the projection was being prepared, we were all hoping for an economic recovery that has turned out to be more anemic than expected. People who don’t change their opinions when the facts change probably shouldn’t be running companies. Maybe those projections were part of the negotiations. The documents indicate they were provided to the potential acquirers.
 
As noted in the Schedule 14D-9, Volcom considered the risks of being independent when evaluating the offers to buy the company. “The Board of Directors considered in its assessment, after discussions with the Company’s management and advisors, the risks of remaining an independent company and pursuing the Company’s strategic plan, including the risks relating to:
               • increasing competition in the branded apparel and eyewear industries; and
               •trends in the branded apparel and eyewear industries, including industry consolidation, input costs and pricing trends.”
 
They put it a little more strongly in the revised Schedule 14D-9 where they replaced an existing paragraph with the following as they explained the background and justification for exploring a transaction (emphasis added by me):
 
“…in light of the Company Board’s further review of the recent state of the sports apparel and eyewear industries and the increased competitive challenges for the Company, the Company Board authorized members of Volcom’s executive management team to formally engage Wells Fargo Securities to act as financial advisor to Volcom to explore a potential sale of Volcom and authorized Wells Fargo Securities and members of the Company’s executive management team to continue discussions with Bidder A.”
 
In a fairly short time, then, Volcom management had gone from a very positive August 2010 projection to thinking they should sell the company for a price that would be way too low if they still thought they could make those projections while staying independent. Good for them. I can’t resist pointing out that I’ve highlighted the same issues Volcom identified in my analysis of their public filings, so I can’t really do anything but congratulate them on their insightfulness.
 
For those of you who might want to sell a company someday, I’d note again that Volcom negotiated from a position of strength when they did not have to do a deal. Look how long it took, and of course it’s not closed yet. Even when you’re not a public company, doing it well takes a long time and is a lot of work.    

 

 

Orange 21’s (Spy Optic) March 31 Quarterly Results; Additional Financing Required.

/0 Comments/in /by

Really, not that much has changed at Orange 21 since I wrote about their annual report and management restructuring back in April. But its quarterly 10Q “…anticipates that it will need additional capital during the second quarter of 2011 and in subsequent periods to support its planned operations in 2011, and intends to raise cash through a combination of debt and/or equity financing from existing investors.” The discussions with the shareholders had already started at the date of the filing.

With revenues for the quarter of $6.7 million (down from $8.3 million in the same quarter last year) Orange is pretty small for a public company. Frankly, I have no idea why it went public. Probably, when times were better, there was a plan to use it as a base to build a larger company through acquisitions. But it’s to our benefit that it went public because they are required to tell us what’s going on.

Sales for the quarter were below expectations, falling 9% even ignoring the $900,000 decline that resulted from the sale of its factory in Italy (LEM). Gross profit fell, but gross margin rose from 45% to 51%. However, most of that increase resulted from the sale of LEM and the elimination of the lower margin product it produced for third parties.
 
Sales and marketing expenses were up 40% to $2.8million. Around half of the increase was due to the new licensed brands. General and administrative expenses, in contrast, fell by 15% due mostly to the elimination of costs associated with LEM.  There was a net loss of $1.57 million compared with a loss of $937,000 in the same quarter last year.    
 
As you may recall, Orange was a smaller, solid brand that got into some trouble due to a bit of management chaos, and the general economic and competitive environment. I’ve told the complete saga on my web site in various articles as well as the public filings allow me to. More recently, to make a long story short, they decided (correctly I think) that the Spy brand by itself didn’t have enough critical mass to support the expense structure it needed and they didn’t see it getting that mass quickly enough. So they diversified  by making deals to make and market sunglasses for O’Neil, Jimmy Buffet’s Margaritaville brand, and Mary J. Blige.
 
Those deals came with various financial requirements, including minimum royalty payments, research and development expense, marketing costs, and the need to build inventory prior to the launch. As enumerated in other articles, it was a bunch of money. The major shareholder, whose company owns nearly 50% of the stock, has already contributed $7 million to Orange and apparently, along with other shareholders, he’s being asked to put in more.
 
Three things have happened that explain the need for more capital. The first one I’m certain of; the economic recovery just hasn’t gotten the traction we all hoped it would.   The second I don’t know for certain but strongly suspect; sales of the licensed brands haven’t been as strong as was hoped. Finally, the deal to sell LEM included certain minimum purchases from LEM for 2011 and 2012. As of March 31st, the minimum purchase amount for 2011 was almost $5 million at the current exchange rate. For 2012, it’s about $2.5 million. It would be interesting to know what kinds of gross margins those purchases will generate. Certainly part of the reason you get rid of an Italian factory is that the product is expensive- especially when the Euro is fairly strong. We’ll see how long that lasts.
 
The really interesting thing to focus on in the story of Orange 21 is the dynamics of entrepreneurial companies that get into some trouble. That where the learning is for us and it seems to be more or less the same in every turnaround I’ve ever worked with or heard about.
 
It all begins, as I’ve said before, with denial and perseverance in a period of change. It starts with some unrealistic expectations (entrepreneurs are, by definition, optimists). There are frequently some clashes of egos and often an entrepreneur can’t get out of their own way as the business grows and changes. The environment that’s created can be highly charged. Employees can be intimidated and pointing out issues or suggesting that some plans are too aggressive can be viewed as negative.
 
With a bias towards believing that the sky’s the limit and a conviction they can solve any problem, it’s hard to ever get to the point where you don’t see it working out and consider cutting your loses. Suddenly, you find yourself “all in” with no obvious options but to march forward.
 
I don’t know that this describes the evolution at Orange 21. Certain events, such as the purchase of the factory, and the dispute with former CEO Mark Simo might fit the pattern but it’s hard to know. Whatever the internal dynamics, the company finds itself with a weak balance sheet supported by their major shareholder and with additional cash requirements. There’s now a new management team and we’ll have to give them some time to work. But lacking a stronger economic recovery or a takeoff in sales of the licensed brands, one wonders what the next step is.

 

 

Skullcandy’s Latest Filing for its IPO

/0 Comments/in /by

On June 1st, Skullcandy filed a third amendment to the registration statement for its initial public offering. Once again, I haven’t compared the documents word for word to spot every change. The addition I want to bring to your attention is the inclusion of financial statements for the quarter ended March 31, 2011. Here are the summary financial statements for the quarter directly from the filing.

 

       

Three Months Ended March 31
         ( in millions of dollars)
         

2010

2011

Net Sales
        

$21,658

$36,018

Cost of Goods Sold
      

$10,660

$17,703

Gross Profit
      

$10,998

$18,315

Selling, General and Admin. Expense
  

$7,572

$14,399

Income from Operations
    

$3,426

$3,916

Other (Income) Expense
    

$1,526

($13)

Interest Expense
      

$2,189

$1,998

Pretax Income
      

($289)

$1,913

Income Taxes
      

$512

$852

Net Income
      

($801)

$1,079

 
 

 

 

 

 

 
 
You can see the improvement from last year’s first quarter to this year’s yourself. Sales were up 66 percent. The gross profit margin stayed constant at 50.8% and instead of a loss of eight hundred thousand dollars they made a bit over a million bucks. Domestic sales rose $9.5 million, or 50.3%. They represented 78.9% of first quarter sales. $4 million of the increase was due to “…net sales to large national retailers, including Best Buy and Target…”  It’s worth noting that during the quarter, three customers accounted for 37% of sales (two were 14% each and one was 9%) and 51% of receivables. I assume Target and Best Buy are two of them.
 
They provide two March 31 balance sheets. The first is the actual one and the second a proforma balance sheet that assumes that certain convertible debt and preferred stock is converted into common stock as if the public offering had occurred on March 31st.
 
The actual balance sheet shows negative stockholders’ equity of $20.2 million. The pro forma balance sheet has a positive equity of $8.9 million due to those conversions. But this pro forma balance sheet does not include the capital that would be raised by the offering. Skullcandy really needs that capital to solidify its balance sheet and pursue its growth strategy.
 
I wrote about Skullcandy when they first filed for their IPO, which they filed the first amendment, and the second. My thoughts really haven’t changed. Let’s hope that in a couple of more weeks, we see their team on CNBC ringing the opening bell on their first day of trading.