Three days ago, Quik filed its annual 10K with the Security and Exchange Commission for the year ended October 31, so I’ve had the happy task of wading through it and rereading the earnings conference call from a few weeks ago. You can see the 10K here if you want.
I’ll look at the results for the quarter and the year, but I want to talk about the company’s strategy first and its similarity to other industry companies.
This is right from page one of the 10K. “Quiksilver,” it says “is one of the world’s leading outdoor sports lifestyle companies. We design, develop and distribute a diversified mix of branded apparel, footwear, accessories and related products. Our brands, inspired by the passion for outdoor action sports, represent a casual lifestyle for young-minded people who connect with our boardriding culture and heritage.”
They continue, “Our mission is to be the most sought-after outdoor sports lifestyle company in the world by inspiring individuality, creativity, and freedom of expression through our authentic products along with the lifestyle and culture of our brands.”
Last year they said “We are a globally diversified company that designs, develops and distributes branded apparel, footwear, accessories and related products, catering to the casual, youth lifestyle associated with the sports of surfing, skateboarding and snowboarding. We market products across our three core brands, Quiksilver, Roxy and DC, which each target a distinct segment of the action sports market, as well as several smaller brands.”
What I’d like you to notice is that there is an evolution in how they define their target market and competitive environment. They acknowledge, of course, their heritage in action sports, but the focus seems to be moving away from it towards the broader outdoor market. Their potential market just got a lot bigger, but so did the number and size of their competitors.
A couple of years ago, I started asking where Quiksilver would get its growth from. Here’s their answer to me; they are now an outdoor lifestyle company.
Also from page one, Quik has three long term strategies. They are “1) strengthening our brands; 2) increasing our sales globally; and 3) increasing our operational efficiency.”
Can’t disagree with any of those, though I find them a little general to be useful. To be fair, nobody in these public documents wants to give their competitors more information than they have to, so there’s a limit on what we can expect to learn. Still, those three strategies, if that’s what we’re calling them, are pretty much the same thing everybody in this industry is trying to do. Or in any other industry I guess.
Some years ago when Burton took the “Snowboards” out of their name, it was because they wanted to address the broader apparel and fashion market. That’s a difficult road to travel not just because Burton is so closely identified with snowboarding but because once you get out into the fashion world, the competitors get bigger and more sophisticated and fashion is a different market than action sports.
That’s not a perfect analogy because Quiksilver has never been a hard goods company like Burton and, at $2 billion in revenue, is larger than Burton (I don’t have any actual numbers on Burton- that’s my best guess).
Companies like Quiksilver may, in reality, not have any choice but to go after the outdoor market. The outdoor market is certainly coming after them and as somebody once said, “The biggest risk in business is to not take any risks at all.”
Okay, on to some numbers.
Revenues in the quarter ended October 31 were $559 million, up 3% from $545 million in the same quarter last year. The growth mostly came from the Americas, which was up 12% to $279 million. Asia Pacific was up 6% to $87 million. Europe fell 9% to $192 million.
“Q4 results also point to 2 areas of concern. First is that we need to be careful managing inventory in light of uncertain economic situations in some of our key markets. The second and related area of concern is the level of clearance sales and discounting we saw in Q4. We ended Q3 with past seasons’ product, representing 16% of our total inventory. We focused on liquidating this inventory in Q4. We had significantly higher volume and lower recovery margin on these liquidations than in Q4 last year. The volume and recovery of liquidating the past season’s inventory had a meaningful impact on our Q4 gross margins.”
“Gross margin fell from 52% to 46% and was down in all three regions. “The gross margin erosion was driven by several factors, including increased sales of prior season goods in our wholesale channels, along with lower margins on those sales; increased discounting in our retail stores; increased sales to larger multi-door accounts who typically earn volume discounts that erode our margin; currency exchange rates; and the impact of decreasing sales in Europe, which has traditionally generated the highest margins of our 3 regions.”
Sorry for the long quotes, but sometimes I can’t say it any better and don’t want to put words in people’s mouths. Europe’s a bit of a mess (no surprise there) and Quik’s inventory got bigger than it should have is how we might summarize. At the end of the third quarter, 16% of Quik’s inventory was from past seasons. By the end of the 4th quarter, they’d sold $40 million of the old stuff, and the total past season’s inventory remaining was down to 7% of the total. They note in the conference call that “…the store of Q4 is really that we overbought during fiscal 2012 and we had higher liquidations through the wholesale channel because of that.”
SG&A expenses were down $12 million to $236 million. They reduced marketing and other expenses but increased e-commerce spending. There were charges of $4.7 million for severance and $3.1 million for lease termination costs.
Net income was $4.4 million during the quarter compared to a loss of $22.1 million in last year’s quarter. I don’t have all the numbers I’d usually have for quarterly results, so I can’t take a hard look at what caused that change. Let’s move on to the whole year.
Revenues for the year rose from $1.953 billion to $2.013 billion. Quik lost $11 million in the year ended October 31, 2012 compared to a loss of $21.3 million in the previous year. Reported operating income improved from $41.5 million to $57 million. But last year, above the operating income line, it had asset impairment charges of $86.4 million. This year those charges were $7.2 million.
If we just remove those charges from the income statement, last year’s operating income would have been $127.9 million and this year’s $64.2 million. That would represent a decline of $63.7 million or 50%.
Quiksilver shows adjusted EBITDA which is net income or loss before interest, income taxes, depreciation, amortization, non-cash stock-based compensation and asset impairment. As they calculate it, their adjusted EBITDA fell from $194.3 million to $140.6 million.
The Quiksilver brand represented 39% of revenues during the year, down from 41% the prior year. The numbers for DC are 30% and 28% respectively, and 26% and 27% for Roxy. Pretty good balance. Other brands, including Mervin Manufacturing, are up from 4% to 5%.
Wholesale business as a percentage of revenues fell from 76% to 73%. Retail was up from 22% to 23%. E-commerce doubled from 2% to 4%. Apparel’s percentage of total revenue rose from 61% to 63%. Footwear was up 1% to 24% while accessories and related products fell from 16% to 13%.
I was interested to see that Quik ended the year with 605 retail locations, up from 547 at the end of the previous year. 291 were what they characterized as full price. 194 were shop-in shops (within larger department stores) and 120 were outlet shops. Of the total, 110 were in the Americas, 271 in EMEA (which is primarily Europe), and 224 in APAC (Australia and the Pacific).
Talking about their sales strategy, Quik notes, “We believe that the integrity and success of our brands is dependent, in part, upon our careful selection of appropriate retailers to support our brands in the wholesale sales channel. A foundation of our business is the distribution of our products through surf shops, skateboard shops, snowboard shops and our own proprietary retail concept stores, where the environment communicates our brand and culture. Our distribution channels serve as a base of legitimacy and long-term loyalty to our brands. Most of our wholesale accounts stand alone or are part of small chains. Our products are also distributed through active lifestyle specialty chains.”
Gross margin for the year fell from 52.4% to 48.5%. “We experienced gross margin decreases
across all three of our regional segments during fiscal 2012, primarily due to increased clearance sales at lower margins within our wholesale channel compared to last year (240 basis points), increased discounting within our retail channel (80 basis points), and the impact of changes in the geographical composition of our net revenues.”
Selling, general and administrative expense (SG&A) rose 2%, or $20 million, to $916 million. As a percentage of revenue, it fell from 45.9% to 45.5%. The increase was mostly due to spending more on their online business and to non-cash stock compensation expense.
Overall, the balance sheet hasn’t changed that much in a year, but there are a couple of things I’d point out. Cash is down from $110 million to $42 million. Inventory is actually down a few million, from $348 million to $345 million. Receivables were up from $398 million to $434 million, pretty much consistent with sales growth. Average days sales outstanding (DSO) rose from 78 to 85. “The increase in DSO was driven by the timing of customer payments at year end and longer credit terms granted to certain wholesale customers.”
Inventory days on hand fell from 119 to 103 “…primarily due to the increased clearance sales that occurred during the fourth quarter of fiscal 2012.” Long term debt was more or less constant. Equity fell by more or less the amount of the loss.
Quiksilver’s sales for the year rose slightly, but it sounds like if hadn’t overbought and then been forced into liquidating, revenues would not have been up. We saw the big impact on their gross margin. It’s hard to be a public company and not plan for revenue growth I guess, but I’d argue they would have been better off if that’s exactly what they’d done. Wonder what the bottom line would have looked like if they’d left revenues even but held their gross profit margin by not overbuying.
Actually, I guess there’s no reason I can’t figure that out at the gross profit line.
If revenues had been the same as in 2011 at $1.953 billion but the gross profit margin had held at 52.4%, then gross profit would have been $1.023 billion. That’s about $40 million higher than reported in 2012. I don’t know what the tax impact might have been, but I’m pretty sure they would have earned a profit.
How many years is it now I’ve been suggesting it was time to focus on gross profit dollars rather than revenue growth?