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

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.