Quiksilver’s July 31 Quarter: Net Income Rises due to Lower Tax Rate

Quik’s net income for the quarter rose 16% to $12.5 million compared to $10.7 million in the pcp (prior calendar period- same quarter the previous year). But the provision for income taxes fell from $9 million to $2.5 million or from 45.6% to 16.8%. Here’s what Quik says in their 10Q about why that happened.

“This decrease resulted primarily from a shift in the mix of income before tax between tax jurisdictions. As a result of our valuation allowance against deferred tax assets in the United States, no tax provision was recognized for income generated in the United States during the three months ended July 31, 2012.” 

Operating income in the Americas (don’t know how much of that was the U.S.) was $33.2 million. Due to a normal loss in corporate operations of $14.4 million (there was an operating profit of $7.3 million in Europe and $1.5 million in Asia/Pacific), the Americas actually provided 120.4% of the reported total operating income of $27.6 million. As stated, they recorded no tax provision for the U.S. part of that.    
 
Accounting for income taxes can be complex, tax rates can move around a lot (obviously), and the tax provision may or may not be indicative of how the business is doing fundamentally. Ignoring, then, the impact of the lower tax rate, how did Quiksilver do? As always, I’ll start with the GAAP (generally accepted accounting principles) numbers.
 
Sales rose 1.8% from $503.3 million to $512.4 million. They were up 10% in the Americas, down 13% in Europe and rose 9% in Asia/Pacific. In constant currency those numbers are, respectively, 12%, 0%, and 13%. That’s an 8% constant currency increase overall.
 
Wholesale revenues rose 5% to $370 million. Retail revenues were up 7% to $119 million. Comparative store retail sales were up 4%. All those numbers are in constant currency, and I really wish they’d give us the “as reported” numbers as well, though of course they aren’t required to. Ecommerce generated $23 million in revenues, or 4.5% of total revenue.
 
Still in constant currency, Quiksilver brand sales rose 4%. The numbers for Roxy and DC were 5% and 16% respectively. They go on to say:
 
“Fluctuations in quarterly brand revenues are highly dependent on the timing of shipments, replenishments of inventory in the retail channel and special order sales, and therefore, are not necessarily indicative of longer trends. Also, decisions regarding customer segmentation and distribution within our wholesale channel may affect net revenues in a manner that is not consistent from period to period.” [Emphasis added]
 
The first sentence in that quote was in their last 10Q. The second one is new. The 10Q wasn’t out at the time of the conference call, but one of the analysts, during the call, asked, “…maybe you could update us on how DC is doing in some of the new distribution hubs here?” referring, I assume to JC Penney.
 
America’s Region President Robert Colby responded, “We’re really happy with the performance. We’re really happy with the decision that we made.”
 
Another analyst followed up, asking, “…if there were any initial sell-ins of large product lines, particularly in the Americas. And in department stores may have driven some of the strong revenues in those — in that region.”
 
In response, Bob Colby gave another iteration of “We’re really happy!”
 
The analyst was having none of it and asked a little more directly “Can you talk at all about how much that might have — just the initial sales there may have driven the quarter?”
 
Bob Colby said, “I’d rather not comment.”
 
This is a great example of why I don’t do my analysis until I received and reviewed the SEC filed document. And it’s also a pretty good example of why companies like to do a press release and conference call before it’s out. I wish the analysts would rise up and refuse to participate in the call until they’d had time to review the filing. 
  
Total gross profit declined very slightly from $255.1 million to $253.5 million. As a percentage, the gross profit margin was down from 50.7% to 49.5%. “The decrease in our consolidated gross profit margin was primarily the result of higher levels of clearance business, discounting, a shift in channel mix and the impact of fluctuations in foreign currency exchange rates. These factors also, in various degrees, had an impact on each segment’s gross margin.”
 
Selling, general and administrative expenses (SG&A) rose from $221.2 million to $225.8 million. That increase “…was primarily due to costs associated with staff eliminations, as during the three months ended July 31, 2012, we enacted personnel reductions in all three of our operating segments to reduce our SG&A in the future.” The severance and restructuring expense was $3.9 million.
 
Operating income was down 18.8% from $33.9 million to $27.6 million. Basically, the gross margin decline more than offset the sales increase. Interest expense, at $14.8 million, was down from $15.8 million in the pcp. There was a foreign currency gain of $2.24 million compared to a gain of $1.46 million in the prior pcp.
 
That gets us to a pretax income of $14.98 million, down 24.2% from $19.74 million in the pcp. I’ve already talked about the income taxes and net income lines.
 
The balance sheet hasn’t changed that much from a year ago. The current ratio fell from 2.45 to 2.33 times and total debt to equity was basically the same, falling from 2.13 to 2.07. Receivables rose 3.3%. They were up 10% in the Americas, down 12% in Europe (reflecting economic conditions there) and up 28% in Asia/Pacific. 
 
Inventory was up 7.2% (15% in constant currency). It was up 2% in the Americas, 16% in Europe and 3% in Asia/Pacific. They note that the increase was “…primarily the result of lower revenues than we had planned in our European segment and, to a lesser extent, higher input costs.” 16% of their global inventory, we learn in the conference call, is prior seasons’ merchandise.
 
Total lines of credit and long term debt rose from $748 million to $783 million. Total equity rose from $551 million to $563 million.
 
CEO Bob McKnight, in his opening remarks in the conference call, referred to Quik’s three long term initiatives as “…strengthening our brands, expanding our business, and driving operational efficiencies. Hard to disagree with those.
 
He mentioned that “…Roxy launched its outdoor fitness line, which is projected to do about $6 million in sales its first year. We know what’s going on with DC at JC Penney. They didn’t say anything about Quiksilver’s women’s line.
 
You wouldn’t expect to hear about it in a conference call, but I’d love to be a fly on the wall at a meeting where Quiksilver management was discussing market positioning and how to grow sales given that positioning. As you know, I’ve wondered in the past where Quiksilver’s growth would come from, and have expressed some concern they would be too dependent on DC and push the brand too hard.
 
If Roxy succeeds as an outdoor fitness line, is it less attractive as a surf brand? Is DC still cool if it’s in JC Penney or, as I’ve been writing about, maybe distribution is less important if you control the points at which the customer touches your product? Skullcandy is probably the best industry example right now of a company trying to prove that’s true. If you can be cool at Fred Meyer……………………
 
Quiksilver’s sales increase was negated by the gross margin decline. The discussion in the conference call and the new language in the 10Q lead me to hypothesize that stocking the new DC channel had a significant positive impact on their revenue numbers. Their income would have been down if not for the decline in the income tax provision. Europe is obviously a very tough market right now, and not just for Quik. 
 
For all the things Quik is doing right, I pretty much have the same concerns I’ve expressed over the last year or two.  I should point out that a bunch of people apparently think I’m out of my mind, as the stock soared the day after Quik released its earnings.  We’ll see.