Spy’s June 30 Quarter; Things Are Getting Happier

There are two things that really struck me in reading Spy’s June 30 10Q (which you can read here). You may not have seen them because, unlike you, I delight in reading small print and conference call transcripts. Perhaps “delight” is too strong a word. 

Anyway, the first thing I saw was that they had no (as in zero, zip, nada) sales of the “licensed products,” which, if you’ve been following the continuing adventures of Spy, you know was a distraction and cash flow problem for a couple of years. It hasn’t been a big deal for a quarter or so, but I look at this as the official end of all the crap Spy has had inflicted or has inflicted on itself in recent years. Now they just have to run the business.
 
Speaking of running the business, the second thing I noticed was that the cash flow from operations for the six months ended June 30 was a positive $1,077,000. In the first six months last year they used $3,860,000 in cash. I like positive operating cash flow. Sometimes, I like it more than an accounting profit because you can only pay your bills with cash- not with accounting based profit.
 
There’s still the small issue of the company not making any money, but the loss fell from $1.6 million in last year’s quarter to $574,000 in this year’s June 30 quarter. They accomplished that by increasing sales 5.6% to $9.96 million, improving the gross margin to 52.8% from 50.3% and reducing operation expenses by 15% from $5.83 million to $4.95 million.
 
Unsurprisingly, sunglass sales were 95% of total revenues during the quarter, with goggles being 4% and apparel 1%. North American sales (including Canada) were 88% of the total. What they define as closeouts of Spy product were $800,000 during the quarter compared to $500,000 last year. “A significant portion of the SPY ® sales growth was from sales of sunglasses into our North American optical and international channels, and from our optical frame product line and Happy Lens™ collection.”
 
The higher gross margin resulted from “(i) improved overall sales mix of our higher margin products partially due to increased levels of sales into optical channels; (ii) a higher percentage of lower cost inventory purchases from China; (iii) lower overhead as a percentage of sales partially due to the consolidation of our European distribution center to North America…” But they also had to increase inventory reserves, and that reduced the margin a bit. I’d really like more information on the composition of Spy’s inventory.
 
The reduction in operating expenses included sales and marketing that declined by 22% or $800,000 to $3 million. This came from “…(i) a $0.6 million decrease in advertising, public relations, marketing events, and related marketing costs; (ii) a $0.3 million decrease in sales and marketing salary and travel related expenses primarily for reductions in headcount. These decreases were partially offset by a $0.1 million increase in sales incentives and commissions…”
 
The balance sheet reflects both the improvement in operating performance and the continuing issue of too much debt. Over a year, cash rose from $821,000 to $948,000. Receivables were up from $6.39 to $6.45 million. Of course you expect some growth in receivables with sales growth, but I’d really need to see the composition of receivables last years and now to know how I feel about the change and current level. Specifically, I’d want to know how much was related to Spy brand product at both dates.
 
Inventory fell a bunch from $7.7 million to $5.5 million. That reduction is good to see, but some of that is due not only to liquidating the licensed brand product, but to getting rid of some old Spy inventory as well. Is the inventory now “right sized” for a more normally operating Spy business? I can’t tell, but it’s a lot closer than it used to be.
 
On the lower half of the balance sheet, we’ve got negative equity of $14.5 million, up from $13.8 million a year ago. Remember that the reason Spy has had a chance to try and pull off a turnaround is due to a major shareholder who’s been willing to pump in cash. Last June 30, long term debt to shareholder was $15.1 million. This June 30, the number is $23.2 million. However, current liabilities have fallen from $12.3 to $8.5 million, and total liabilities are up just 4.9% from $27.5 to $28.9 million.
 
In the conference call, CEO Michael Marckx talked about how Spy has “…become a much more effective organization, with the idea of Super Service at the heart of our company culture. This can be summed up with the ethos of being in service to our retail partners, the people who wear our products and to one another, inside and outside of the company. Our Super Service mantra is simple: How can we make people HAPPY? This mindset is not only evident in our customer service, it is apparent in how we market our brand…”
 
I know- that sounds a little like a big old platitude, but I don’t think it is. Let me finish quoting CEO Marckx before I explain why.
 
“…our efforts this half and moving forward stem from a focus and brand ethos that will help to further strengthen our unique positioning and product offering in ways that are mutually beneficial to our retailers. With a more diverse and unique selling proposition from SPY, our retailers are able to better serve their communities with higher quality, differentiated products from SPY, and do so knowing we bring an energy, strength and point of view that our competitors are not matching.”
 
What he’s doing is bringing continuity and clarity to the way the organization functions. Everybody knows how to spend their time. They don’t have to ask so often what to do and not do. They know how every stakeholder should feel after dealing with Spy- Happy.
 
They don’t focus so much on what the competition is doing as on how they can run their own business well. Without this focus I bet they couldn’t have increased sales and gross margin while cutting expenses.
 
Financially, Spy isn’t out of the woods. They are still losing money and their balance sheet, though showing operating improvement, is burdened with way too much debt. Solving that problem requires not just that they make a profit but that they grow that profit through increasing sales. I hope there isn’t pressure to grow sales faster than their market position permits. Our industry is littered with damaged brands who tried to pull that off.