Quiksilver’s 10K: It’s Results for the Year and Some Issues of Strategy

If you haven’t noticed, I’ve been working to not just report the numbers (it’s hard to grab readers attention with the drama of a changing current ratio) but to draw some larger business lessons from company reports and make us all think about the issues. You can think I’m wrong, or you can think I’m right (I’m not always sure). I just ask that you pause and think. 

Quiksilver is giving us the chance to pause and think. I’ll get to the numbers of course, but let’s dive right into some more strategic issues, starting with this quote from their discussion of distribution channels in the 10K (which you can see here).
“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.”
No kidding. I suspect I’d define “careful selection” differently from Quik management, but then I don’t have to answer to the stock market. As I’ve said, it’s hard to be public and do the right thing for a brand in our space.
“A foundation of our business is the distribution of our products through surf shops, skateboard shops, snowboard shops, sporting goods stores, 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 for our brands. Most of our wholesale accounts stand alone or are part of small chains.”
I’m all for communicating brand and culture. But outside of its own stores and certain core shops, it’s tough for any brand to do. Damned near impossible once your distribution gets past a certain point. Perhaps, I’ve argued, even a detriment as some of those further removed customers may know your brand, but not know or care about your story. And then, how are you competing? I’d also love to hear what Quik’s definition of a “small chain” is. 
Next, here are some comments CEO Andy Mooney made in the conference call. They are in the order I came to them.
“… retail brick-and-mortar sales were very steady and e-commerce sales continued to show robust double-digit gains. And…we continue to see very slow erosion in the specialty core surf and skate chain worldwide, offset by pretty robust growth in emerging markets, particularly for us, Russia, Brazil, Mexico and Southeast Asia, and even Japan this quarter.” 
Okay, here’s the next one.   “In the case of Quiksilver, we believe there’s opportunities to take share within the core channel, particularly when we see the current weakness of some of our competitors in the marketplace.”
Subject to definitional clarity, I’m wondering just how big the core market is. I’ve suggested it’s not really that large a market overall. I’d be curious what percentage of its total revenues Quik sees as coming from the core market. And if it’s “slowly eroding” how significant to revenue growth can taking share be? It was years ago I first pointed out that even robust growth in the core channel (if by “core” we mean specialty shops) doesn’t really move the revenue and profit needle much once a company is larger.
And third from CEO Mooney, talking about their Board Rider stores. “These are very exciting stores that have within them restaurants, bars, barbershops. We offer in those stores a broad range — array of our own products, but also other products that would be relevant to our consumer. So products like GoPro or mophie, the battery charge — battery packs for iPhone, headphones, that type of thing. We think that makes for an interesting environment for consumers that cut across all 3 brands. Those stores are performing very well for us. We’d like to experiment with a few of those stores here in North America in 2014…”
A couple of weeks ago, I wrote about Zumiez’s quarter and asked if it really mattered how we defined our industry or if maybe it was up to our customers to define us and our job was just to give them the product they wanted where and when they wanted it. It sounds like that’s how Andy Mooney looks at things given his description of the Board Rider stores. Interesting implications for branding however. Will any of these products carry a Quiksilver brand? How much and what kind of product can you carry before these stores no longer “communicate the brand and culture?”
And next: “Well, one of the things that we’ve been doing because we can is we’ve been doing product injections into our retail stores ahead of the calendar that’s required to introduce new product for the wholesale channel…So we’ve got some of the products, the newer products that we want to have in retail in the stores quicker. One of the other kind of really important changes that we’re going through, which again gives us the level of confidence that we can actually go deeper in SKU reductions is that, as an organization, historically, we have designed for wholesale, and retail has been an afterthought. Increasingly, what we’re seeing is, we’re going to design primarily for our own retail stores, our own website and our own key wholesale partners.”
I guess I just have to wonder what actual core retailers, which Quik says are a foundation of their business, think when they read this. I am not saying I wouldn’t do the same thing if I were in Andy Mooney’s place. But as a core retailer, it might make me think about my commitment to Quik’s brands. 
And finally, just to put the cherry on the whipped cream, Andy notes:
“I think our wholesale business is in transition, in that we’re seeing a rotation out of the small independent mom-and-pop operators in surf, skate and snow into other — in some cases, other wholesale players. That could be, in the case of Europe, it could be large multi-outdoor players like Decathlon or it could be pure play e-commerce players like Surfdome in their own stable in Europe, or Amazon, even here in the U.S., or eBay. There’s a lot of activity happening on web for pure-play retailers that clearly didn’t exist before. So you’ve got a rotation out. Definitely, the small independent operators are much more challenged than they’ve ever been, today. And we’re seeing, I’d say, some modest contraction in that channel, but it’s rotating into other channels.”
Once again, I think Andy’s perception may be accurate. But where does it leave Quiksilver (and other industry brands and retailers) who get their credibility and legitimacy from having their roots in a sport and lifestyle that, with revenue growth, is less important to a bigger percentage of their customers? How can Quik’s “…distribution channels serve as a base of legitimacy and long-term loyalty for our brands” under these circumstances? 
Now, here’s how Quik defines its strategy in the 10K:
“In our efforts to increase shareholder value, we have adopted three fundamental strategies: 1) strengthening our brands; 2) growing sales; and 3) driving operational efficiencies.”
Those strategies (if they are strategies, and I don’t think they are) offer no competitive advantage or point of differentiation. Everybody who owns a brand is striving to do those three things all the time. Always have been, always will. Granted, they’ve become more important since the economy went to hell. I suppose I expect too much from the information provided in a 10K.
We’ll move onto the numbers now.
The Numbers
Revenue for the year fell 6.8% from $1.942 billion to $1.811 billion “…due to the expected decrease in DC sales.” Argh. Some of you may remember that several years ago I expressed concern that Quik might push the DC brand too hard in a search for revenue. They did. It’s the public market pressure again. You’ll note some more indications of this below where I present more data on DC.
Wholesale fell from 74% to 71% of the total. Retail rose from 23% to 25% and ecommerce from 3% to 4%. Apparel was 62% of the total. Footwear and accessories were 25% and 13% of revenues from continuing operations respectively. The Quiksilver brand was 40% of revenues from continuing operations (unchanged from the previous year). DC represented 30%, down one percent and Roxy 28%, up 1%. Other brands were 2%.
The Quiksilver brand’s year over year revenue fell 8% as reported from $784 to $721 million. DC was down 9% from $588 to $542 million. Roxy fell 4% from $530 to $511 million. Total wholesale revenues were down 9% to $1.294 million. Retail was down 2% to $447 million and ecommerce rose 25% to $69 million.   
I’d note that revenues from continuing operations are surprisingly even over the quarters, with the 1st quarter being lowest at 23% of the total, and the 3rd and 4th highest at 26%. As a finance guy, I love that.
38% of this revenue was generated in the U.S. The next biggest single country is France at 12% with Australia/New Zealand coming in at 7% and Canada at 6%. Below is the table that shows net revenues and gross profit by operating segments. Note that revenues were down in all three segments for both the quarter and the year.
For the quarter ended October 31, the Quiksilver brand had flat revenues of $190 million. Roxy stayed the same at $137 million but DC was down $47 million to $139 million. That is a 25% decline. Wholesale revenue fell 12% to $353 million. Same store sales in company owned stores were flat and ecommerce revenues grew 22% to $16 million. The gross margin for the quarter rose 1.4% to 47%. It would have risen 1.9% except for $2 million in restructure related costs.    
The gross profit margin for the year was down from 48.5% to 48.2%. The decline was “…primarily due to increased discounting associated with DC brand net revenues within our wholesale channel. We entered fiscal 2013 with a higher level of DC inventory in the wholesale channel than we planned, which resulted in higher discounting to clear this product.”
SG&A expenses declined from $227 to $200 million. “The decrease in SG&A was primarily due to reduced employee compensation expenses and event related marketing expenses, partially offset by higher severance and early lease termination costs as well as increased e-commerce expenses associated with the expansion of our online business.” As a percentage of revenue, SG&A rose 1.7% from 45.7% to 47.4% “…primarily due to net revenue declines outpacing any SG&A reductions in fiscal 2013.”
Quik spent $93 million on promotion and advertising during the year, down from $118 million the prior year.
Asset impairment charges (noncash) were $1.7 million compared to $6.7 million last year. Interest expense rose from $15.3 to $20 million and the loss before taxes and discontinued operations (businesses they are selling) rose from $11.2 to $18.7 million.
And then, there was a provision for income taxes of $157.5 million compared to a benefit of $9.7 million the prior year. That left Quik with a net loss from continuing operations of $176.2 million compared to a loss of $1.5 million the previous year. After then taking into account the discontinued operations, we’ve got a net loss of $171 million compared to a profit of $4.4 million last year.
I usually stay away from income tax issues, but a charge of $157 million (it’s noncash) requires some respect and a little attention. Here’s how CFO Richard Shields explains it:
“The Q4 tax provision includes a noncash charge of $157 million related to taking allowances on the net operating loss carry forward deferred tax assets in France. We have NOLs of EUR 356 million in France, which were created in the Rossignol disposition in 2009. These deferred tax assets were carried on the balance sheet, tax effected, at $157 million. Based upon the cumulative losses we have incurred in France in recent years, we took valuation and reserves against those deferred tax assets. This does not preclude our future use of those NOLs, and those NOLs do not expire.”
I’m sure you all understand that as well as I do. My take is that they don’t expect French results to be good enough to let them utilize those assets in the near future, so they might as well write them off now while nobody is expecting much from them on the bottom line. I think that, having written them off, they will have more value if they can be used. One of you CPAs out there want to explain this to us on my web site?
The balance sheet requires a little attention. Trade accounts receivable are up like $1 million to $412 million, but with the sales decline, you might have liked to see them go down. I see their allowance for doubtful accounts has increased from $57.6 to $60.9 million. Deductions for bad debts were $2.38 million compared to $7.81 and $9.26 million respectively in the prior two years. The average number of days it took them to collect receivables rose from 85 days to 97 days or by 14%. We can’t tell if that’s because they extended longer terms or had trouble collecting.
Total inventories rose slightly from $327 to $338 million. Again, with a decline in sales, you’d like to see that fall. They tell us that, “As of October 31, 2013, aged inventory was approximately 6% of total inventory, a reduction of 100 basis points versus October 31, 2012,” and it was 15% lower than a year ago.   CFO Richard Shields tells us in the conference call that they added $8 million in U.S. retail inventories because they thought they were too thinly stocked.
It is, of course, good to see aged inventory falling. But what, exactly, does 6% represent? Is that a good number or a bad number? Is “aged inventory” anything older than three months or three years? Not knowing that, I have no idea how to react to that number. It wasn’t available during the conference call, so nobody could ask. I’ve emailed Quik to ask that question and will let you know if I get an answer.
By the way, the receivable and inventory numbers exclude the assets associated with the businesses being sold. Total assets fell from $1.72 to $1.62 billion, largely due to the write off of the tax assets.
Current liabilities are up from $357 to $367 million. However, long term debt, net of current portion, rose 12% from $721 million to $808 million. Mostly due to that increase, total liabilities increased from $1.116 billion to $1.233 billion.
As a result, stockholders’ equity fell 35.6% from $583 million to $370 million. Total liabilities to equity rose from 1.85 times to 3.18 times.
The Profit Improvement Plan     
You remember that last May, Quiksilver introduced its Profit Improvement Plan (PIP). Here’s how they describe it.
“Important elements of the PIP include:”
“• clarifying the positioning of our three core brands ( Quiksilver , Roxy and DC );
• divesting or exiting certain non-core brands;
• globalizing product design and merchandising;
• licensing of secondary or peripheral product categories;
• reprioritization of marketing investments to emphasize in-store and print marketing along with digital and social media;
• continued investment in emerging markets and e-commerce;
• improving sales execution;
• optimizing our supply chain;
• reducing product styles;
• centralizing global responsibility for key functions, including product design, supply chain, marketing, retail stores, licensing and administrative functions; and
• closing underperforming retail stores, reorganizing wholesale sales operations, implementing greater pricing disciplines, and improving product segmentation.”
CEO Mooney notes in the conference call that the fall and holiday SKU count is 47% lower than last year. That’s progress. Remember that licensing agreement like the one for children’s apparel and the sale of Mervin and other assets helps with the SKU reduction.  
I pretty much agree with all of this and wish Quiksilver, as a company, had started it sooner. I’m sure we all realize that some of these things make sense whether times are good or times are hard.
They go on to say:
“We expect that the PIP, when fully implemented by the end of fiscal 2016, will improve Adjusted EBITDA by approximately $150 million over fiscal 2012 Adjusted EBITDA, of which approximately one-half is expected to come from supply chain optimization and the rest is expected to be primarily comprised of corporate overhead reductions, licensing opportunities and improved pricing management, along with modest net revenue growth compared with fiscal 2012 results.”
I wish they’d tell us what “modest net revenue growth” means. I’m seeing in Quiksilver what we’re seeing in a lot of other companies- not just in our industry. Bottom line improvement is coming largely from expense reduction driven by layoffs and improved efficiency. Top line growth with a solid gross margin is harder to come by. Trouble is, you can’t cut expense and become more efficient forever.
The Retail Footprint
Quik ended the year with 631 owned retail stores. They had an additional 243 stores licensed to independent retailers around the world for a total of 874 retail locations. Here’s how the owned stores break down by type and location.
Quik closed 17 retail stores during the last quarter of the year. They see a chance to add “…a few more full-priced stores in developed markets…” and believe “…there’s tremendous opportunity to open stores in emerging markets.” They believe they’ve got a big opportunity in ecommerce, where they “…received 30 million visitors to our own branded sites last year.” But they “…only converted, on average, 1.5% to 2.0% of them.” Part of the PIP is the consolidation of their three independent ecommerce platforms. Good idea.
I applaud what Quik is going as part of its profit improvement plan. But I’m going to ask the same question I’ve been asking about Quik for years now. Where will revenue growth come from? Like most public companies with roots in traditional action sports, they are ultimately conflicted by the need to grow revenues but also to manage distribution carefully to differentiate products that don’t have meaningful competitive advantages. You can see that conflict highlighted in some of the quotes and the discussion at the start of this article.
Why might Quiksilver be more successful than its competitors? There are three possible reasons. Better management, better brands, and/or a stronger balance sheet. Actually, you need some of all three.



Quiksilver’s Decision to License Children’s Apparel

On November 26, when Quik announced that LF USA  (a subsidiary of Hong Kong headquartered Li & Fung, a multinational consumer goods sourcing, logistics and distribution group) would “…design, manufacture and market children’s apparel bearing the Quiksilver and DC brand trademarks in the Americas…” I tried to ignore it. It was a short press release and, on the surface, consistent with Quik’s announced strategy of focusing “…our energies and resources on our core apparel business and significantly reduce product styles and SKUs in our supply chain,” as CEO Andy Mooney put it in the press release

Then one of my readers inconveniently messed with my comfortable mind set and asked, more or less, “Hey Jeff, if kids aren’t part of Quik’s core business, what is?” I thought that was a good enough question to require some discussion.
I’ve talked before about brands aging out. That is, the customers who grew up with them (and with whom the brand grew up) get older and decidedly less cool. The brand may retain those customers. They may even sell them new products.
I’d like to pause for a moment and tell you just how hard it is to move on here without stopping to have some fun imagining what those products might be. Send me your ideas. I’ll put them on my web site (anonymously of course).
But the future of a business can’t be only with those existing customers because they are going to start buying less and eventually buy nothing at all. New demographic groups have to discover the brand as they grow up and, with luck, make it their own.
Quik’s management team knows that kids matter. My reader is implying that Quik is somehow making a mistake by licensing the kid products because of its critical importance to the company’s future. Maybe, but maybe not.
Let’s recall that Quiksilver has been losing money. They’re working hard to turn that around by reducing expenses, improving operational efficiency, and focusing their limited resources where they think they can get the most bang for the buck. Remember in recent years they’ve tried selling bathing suits in vending machines at resorts, board shorts with NFL logos, etc. I sense perhaps they’ve learned a lesson.
A royalty revenue stream, no operating expenses and, as CEO Mooney points out, fewer SKUs, may be the right way to go operationally and financially given their resource constraints. I’m guessing this is as much a financial as a marketing decision.
More important is what’s in the license agreement and how LF USA will handle this. We know nothing about that. What products, exactly, will they sell? Through what distribution in what quantities? At what prices? How will product quality be? Does Quik have any input into design or any of these other issues?
The devil is always in the details in any licensing agreement I’ve seen. Obviously, poorly made products only tangentially related to Quiksilver’s market showing up in schlocky distribution would bad no matter how much royalty income it generated. Quik knows this and I am sure it’s managed in the agreement.
Do I wish Quik was doing and completely controlling its own kid’s products? Sure. They probably wish that too. Do they recognize the importance of the kid’s market to their future? Of course. Is it a mistake to license the product? Not if they know they need to be in the kid’s market and don’t’ have the resources to do it the right way themselves.
The product will hit retail in 2014, and I guess we’ll start to find out then what kind of deal they made with LF USA.



Market Evolution; Things to Think About from Quik CEO Mooney and My Spin on Them

I wrote about Quiksilver’s quarter maybe a month ago. In the conference call, CEO Andy Mooney had some really interesting things to say about how the market is changing. I set them aside to think about. I felt they were comments that were appropriate to a general discussion of market evolution, rather than the particulars of Quik’s situation, though obviously they apply there as well.

The first thing he says, talking about Europe, is that we’re seeing “…a transition from smaller independent operators to larger big-box formats.” He went on to explain that their management team in Europe saw the decline in the number of independent specialty retailers as normal during a down economy, and that they expected a recovery in their numbers as the economy improves.
But CEO Mooney doesn’t share that expectation. “I’m a little less optimistic than they are because of the impact of – largely of e-comm because I think e-comm in some ways is creating systemic pressure on those smaller independent retailers, which for us is actually somewhat of a blessing because it’s actually less expensive for us to service e-comm retailers – pure play e-comm retailers – than it is to service remote onesie, twosies sub-specialty shops, particularly ones that by definition are kind of undercapitalized, have problems paying their bills, et cetera, et cetera.”
He expects some rebound in the number of specialty shops, but not as much as in past cycles. I also think his analysis for Europe is relevant in much of the rest of the world as well and certainly in the U.S.
However, I don’t think pressure on specialty shops has come only from ecommerce, though certainly that’s a big issue. I’d remind you all of the (apparent) strength of the economy up to 2007 and of the length and depth of the (continuing) recession that followed. Because the good times were as good as we’ve ever seen them, a lot of independent specialty retailers opened that would probably never have gotten off the ground in less favorable economic conditions. That they’ve closed in historically bad economic times and won’t reopen unless things get fabulous again is hardly a surprise and isn’t only about the internet.
One analyst asks if he thinks the action sports market is shrinking globally. Mooney responds, “…It’s not necessarily a contracting market; it’s a transitioning market.” He talks about the impact of ecommerce again, and then goes on to discuss another piece of the transition.
“You’re seeing,” he says, “…fewer more professional players who are allocating their open-to-buy to fewer more professional brands…my viewpoint is that there will be consolidation both in the retail theater, but I think there’ll also be consolidation in the branded theater. It’s that the stronger, more professionally-run companies will continue to gain share in what has historically been a very fragmented industry…what occurs when you’re going through this type of phase is you’ll end up with 4 to 5 major players who will have significant footprints in the specialty channel, and we absolutely intend to be one of those players.”
I assume if he thought it was a contracting market and that Quik wasn’t capable of being one of those four or five major players, he wouldn’t have taken the job in the first place. And, of course, what else is he going to say?
Still, I find his answer incomplete as it ignores a couple of elephant in the room issues that impact all the larger brands in our industry.
First, as I’ve written, the real action sports market is a pretty small market and has always been a pretty small market. Right now, judging from the evidence I have in terms of participation, it is shrinking. So Quiksilver, and any other brand with its roots in action sports of any size, is already competing way outside of action sports in fashion, youth culture, urban or whatever we want to label it as.
The second is that I don’t know what he means by specialty channel. Can‘t believe some analyst didn’t ask that. My assumption is that it includes not just independent specialty shops, but chains up to and including Intersport, Zumiez, Journeys, Tilly’s, etc. It used to be so clear and now it’s not. Is Intersport really “specialty?” I am not sure PacSun is with its new positioning. Maybe it’s correct to say it’s specialty, but in a much broader market. How broad does a market have to get before retailers who serve it are no longer “specialty” retailers?
Andy doesn’t seem to be that concerned about the independent specialty retailers and I don’t entirely blame him from a strict operating and revenue point of view. But some of those shops would say, “Right back at you, Andy.” Quik’s brands are widely enough distributed that I’m not sure shops can really compete with them and certainly they won’t help differentiate shops.
But Quiksilver is certainly a surf based brand. Can you be a “surf based brand” and not be in core surf shops? Can DC not be in core skate shops? Maybe they need to have product in those channels even if they aren’t the fastest growing, most profitable, easiest to work with accounts in the world. It’s not, of course, that Quiksilver isn’t in those shops, but it doesn’t feel like an area of emphasis and it’s fewer than it used to be.
Meanwhile, even if a big action sports brand kills it in the specialty market up to and including the chains I’ve mentioned and their ilk, it’s not going to be enough- especially as a public company. Macy’s, Nordstrom’s, Dick’s, Sports Authority- you can’t decide not to be in them. You can only decide when, with what product, and try to make sure they present you well.
I think Quiksilver, Billabong, and Skullcandy, just to name three, would be much better off if they were private. They’d be able to be more discriminating in their distribution in ways that would benefit their brands and, as a result, I think they’d be more profitable.
From their public discussions, we already know that these three companies are taking steps to improve their operations and become more efficient. Good for them. I have no doubt it will improve their bottom lines. But that doesn’t impact brand positioning (unless it changes distribution?) and leads us to the next elephant in the room.
Who’s the customer? It wasn’t discussed in the conference call.   Brands, we all know, have life cycles. As they grow and succeed, they resonate with a group of customers. If they are lucky enough to be around long enough – not an easy thing to accomplish – they age right along with that customer group. The customers’ lifestyle, shopping habits, priorities and lifestyle evolves. The company evolves with them.
As those customers shop differently, the brand distributes differently. I won’t bore you with specifics you already know, but distribution tends to become broader as brands age. And broader. And broader.
How do you accommodate those customers but be relevant and “cool” enough to attract new ones? Look at the winter resort business. They’ve built facilities and created experiences that appeal to their older, aging customers. But that customer group is only one who can afford that experience. Given the economy and existing resort cost/price structure, who do they replace current customers with as they age out?
When Andy Mooney says it’s “something of a blessing” that they don’t have to deal with so many small shops, I knows what he means. But if a brand doesn’t have product that those stores want to carry and can sell for margin, what does that say about its ability to attract new customers as the old ones “age out?” How, in short, do you follow your customers along their lifestyle curve while still attracting new ones?
CEO Mooney also talks about the product review the company is undergoing and how they are trying to focus on those products where they can differentiate and be a leader. We won’t see the results until 2014, which I’d say is about as fast as we could see the results. I’d expect that is part of their answer to my question.
At some level Vans is the poster child for a brand that seems to be accomplishing this transition. They’ve made their heritage a foundation of growth with new customer groups without, as far as I can tell, alienating the old ones.
It’s important to remember, however, that Vans didn’t manage that without some bumps in the road. They were a $400 million public company in trouble before they were acquired by VF in 2004.
Having the kind of success Vans is now having requires a steady hand, objectivity, and money. The “who’s the customer?” issue has to be addressed early and realistically before pressures from the inevitable market evolution lead to product and distribution decisions that compound the difficulty of making the required changes. This is particularly difficult in public companies, where the correct decisions don’t typically contribute to immediately improving quarterly results. This is why I’m such a fan of what Skullcandy is doing. I think they are doing the right things in spite of the short term impact on quarterly results.
Then there’s the whole ecommerce thing which is changing the playing field in ways we don’t understand yet. At least I don’t. I’ll just say here that I wonder if ecommerce accelerates the traditional brand life cycle- or, alternatively, maybe makes it irrelevant? Can it be that distribution will become less important, replaced by how you connect with your customers at all your touch points with them? Will it still matter if you’re in “specialty” distribution? We’ll all be finding out.
Finally, and still on the issue of who the customer is, Andy Mooney talked, as I noted above, about consolidation in the brands and ending up “with 4 to 5 major players who will have significant footprints in the specialty channel, and we absolutely intend to be one of those players.”
We’ve had a few conversations about consolidation over the years and the path he describes is certainly a familiar one. Snowboarding comes to mind when you think about consolidation. How’s that worked out as far as keeping customers and attracting new ones goes?
Operationally, I understand why CEO Mooney would expect the kind of consolidation he describes. But for me the strategic issue is how a company like Quiksilver, if it becomes one of four or five major players with broad and broadening distribution, positions its brands so that many of the specialty retailers want and need to carry them.
I don’t perceive that has been accomplished very often in the past. I hope in future conference calls (Not just Quiksilver’s) companies explain how they are going to do it with particular attention to who their customer is.



Joining the Party; Quiksilver’s July 31 Quarter

It’s almost unanimous. Companies in our industry, (whatever industry we’re in) or for that matter most other industries, are cutting expenses, rationalizing supply chains, targeting marketing efforts, cutting SKUs, creating omni channels, growing ecommerce business, being more discriminating in distribution and generally doing all the things they have to do if they assume that sales growth will continue to be hard to come by. 

In their 10Q for the July 31 quarter, they list the action items for their Profit Improvement Plan:
“Important elements of the PIP include:
• clarifying the positioning of our three flagship brands (Quiksilver, Roxy and DC);
• consider divesting certain non-core brands;
• globalizing product design and merchandising;
• consider licensing of secondary or peripheral product categories;
• reprioritization of marketing investments to emphasize in-store and print marketing along with digital and social media;
• continued investment in emerging markets and E-commerce;
• improving sales execution;
• supply chain optimization;
• reduction of SKUs; [Note from Jeff: CEO Andy Mooney says they want to reduce SKUs by 40%]
• centralizing global responsibility for key functions, including product design, supply chain, marketing, retail stores, licensing and
administrative functions; and
• closing underperforming retail stores, reorganizing wholesale sales operations and implementing greater pricing discipline.”
They plan to be finished with plan implementation by the end of fiscal 2016 and expect it could “…improve adjusted EBITDA by approximately $150 million.” And they are only expecting “…modest new revenue growth compared with fiscal 2012 results.”
According to CEO Mooney in the conference call, Quik continues to focus on its “…3 key strategies of strengthening our brands, growing revenues and driving operating efficiencies.” However, “…revenue growth in the short-term will be difficult to achieve.” They don’t expect to see improved revenue results until the fall of 2014, “And we’re really looking at spring 2015 for the teams to hit full stride.” 
This all feels like good stuff. But to the extent it’s kind of ubiquitous, where does the competitive advantage come from? Let’s keep that in mind as we go through the numbers.
Income Statement
Sales were down 3.3% from $512 to $496 million. Last year’s quarter included $2.5 million of Quiksilver Women’s sales, a line the company has now exited. CFO Richard Shields tell us that, “…The decline was primarily in the Americas wholesale channel, where revenues decreased $16 million…”   As reported, the Americas fell 6.3% to $268 million, EMEA (Europe, Middle East and Africa) grew 6.3% to $164 million, and APAC (Asia Pacific) was down 11.5% to $63 million. In constant currency the Americas was down 6%, EMEA grow 3% and APAC was down 1%. More than 60% of Quik’s revenue came from outside the U.S.
The Quiksilver brand’s revenue was down 10% as reported to from $191 to $172 million. Most of the decline was “…due to a high-teens percentage decline in wholesale channel net revenues…” worldwide. It’s noted in the conference call that sales of Quiksilver product to clearance channels was down $5 million. I hope that’s an intentional trend.
Roxy revenues fell 1% to $130 million “…due to a high-twenties percentage decrease in the APAC wholesale channel and a high-teens percentage decrease in the retail channel within both the Americas and APAC segments…These decreases were largely offset by a low double-digit percentage increase in the Americas wholesale channel and growth across all channels within the EMEA segment.”
DC was also down 1% to $166 million “…with a low-double digit percentage decline in the Americas wholesale channel largely offset by growth across all other channels and regional segments. This growth was largely driven by increased discounting and clearance sales as we continue to reduce slow-selling DC inventories. Based on current channel inventories, we anticipate that DC brand net revenues in the fourth quarter of fiscal 2013 will decrease by approximately 15% from the $166 million recognized in the third quarter of fiscal 2013.”
You know, I seem to remember somebody writing that they hoped Quik wouldn’t push the DC brand too hard in their search for revenues because they might hurt it. Oh wait, that was me! I know- I shouldn’t do that, but once in a while I just can’t resist.
Revenues in Quik’s wholesale channel fell 7% from $369 to $345 million. Retail was constant at $120 million, and ecommerce grew 33% to $31 million. From the 10Q:
“Wholesale net revenues declined across all three regional segments, particularly in the Americas and APAC segments. Wholesale net revenue declines were focused within the Quiksilver brand across all three regional segments and the DC brand in the Americas segment.”
“Retail net revenues increased in the EMEA segment but were offset by decreases in the Americas and APAC segments….Retail net revenues in the DC brand increased significantly across all three regional segments but were offset by single-digit percentage decreases in the Quiksilver and Roxy brands. Retail same-store sales increased 2% during the third quarter of fiscal 2013.”
They are continuing to close underperforming stores and had 15 fewer than at the end of last year’s quarter. This accounts for most of the decline in retail sales. Quik ended the quarter with 562 stores. I didn’t get a sense for how many additional stores they are planning to close.
Gross margin was essentially unchanged, going from 49.5% to 49.4%, but total gross profit fell from $253 to $245 million with the sales decline. Quiksilver and Roxy gross margins improved, but DC’s was down. We are told they “…expect continued discounting on DC footwear product in the back-to-school and holiday seasons.”
Selling, general and administrative expenses fell 4.1% from $226 to $216 million. As a percentage of sales, it was down from 44.1% to 43.7%. Quik accomplished that decline in spite of $9 million of SG&A expense for employee severance and restructuring costs.
Those pesky, but noncash, asset impairment charges were $2.2 million compared to $141,000 in last year’s quarter, resulting in an operating income that fell 5.5% from $27.6 to $26 million.
Interest expense rose from $14.8 to $20.2 million, but was offset by a foreign currency result that went from a loss of $2.2 million to a gain of $4 million. Net income fell from $12.5 million to $1.8 million. The result for the quarter includes a total of $14.8 million in restructuring charges. For the nine months ended July 31, Quik had a net loss of $61 million compared to a loss of $15 million in the nine months the previous year.
Balance Sheet and Cash Flow
Quiksilver continued to use (rather than produce) cash in its operating activities. They used $12.5 million, down from $16.9 million in last year’s quarter. Trade receivables rose a bit from $399 to $418 million. The number of days it takes them to collect their receivables increased by 6%, “…driven by the timing of customer payments, longer credit terms granted to certain wholesale customers and the net revenue decrease…”     Inventory was also up from $391 million to $399 million, or 2%. Mostly, that’s because of the sales decline. However, inventory from prior years represented 9% of the total compared to 16% a year ago. Wonder how much of the old inventory is DC?
The current ratio dropped from 2.3 times to 1.7 times a year ago. Leverage increased with total liabilities to equity rising from 2.06 to 2.97. However, their debt includes $409 million that they paid off now from the $409 million in restricted cash that is part of their current assets, so be careful what conclusions you draw.  Basically, they’re refinancing their senior notes to push out the maturity and improve liquidity.
The Secret Sauce
I don’t have much doubt as to Quik’s ability to generate the cost savings it expects. It feels like there’s just too much low hanging fruit and we’re already seeing the results. And things will also improve on the cost side once they are mostly done with closing stores and with incurring restructuring expenses.
The question is around sales growth. I’ve been saying that those might be hard to find and I still feel that way. Quik is taking the approach of building their plan around low increases but expecting, as they note in their conference call, that they can do better.  But even if larger increases don’t happen, I think their approach will give them the ability to improve profitability. Let me quote from CEO Mooney in the conference call to explain this.
“We’re not really using discounting to drive the top line growth in our retail or e-comm channels.”
“But I think the other aspect that really caused the kind of slowdown of sell-through in North America is that the men’s product line wasn’t particularly well-segmented across the various distribution channels. And that’s one of the things that we’re very much focused on right now.”
“…we have just made significant progress on over the last few months is a reallocation of the marketing mix to a downshift in athlete endorsements, a downshift in events, a downshift in headcounts. So we freed up within the current percentages significantly more demand creation dollars that we believe will have some potential to drive demand at a higher rate. But even within the model that we’ve developed, the $150 million profit improvement model, we have factored in taking up demand creation from 5% as a percentage of revenue to 8%, basically stair-stepping up a percent point per year.”
“…the issue on the gross margin side for our company has never been one of the delta between pricing and cost. The issue has been one of — entirely of inventory management, so buying too much and then having to flush it through the clearance channel.”
Do you see the relationships here? Better inventory control and fewer SKU’s means lower closeout sales and makes it a lot easier not to use discounting to drive revenue growth. More thought as to distribution and better focusing marketing dollars to support that distribution strengthens the brands. Does this mean unexpectedly good sales growth? Not necessarily. In fact I’ll not be upset if it means lower sales for a couple of quarters, and it looks like that what we can expect. But the profitability of the business should improve, and I’d hope they can reduce their working capital investment and maybe, over time, debt and interest expense, further enhancing profitability.
We’re still left with the conundrum of being a public company that comes out of the action sports world. How and where do you grow while maintaining your brand’s strength and positioning? At some level, the two can be contradictory.



Quiksilver’s Quarter and Strategy Update

Quiksilver reported a net loss of $32.4 million in the quarter ended April 30 compared to a loss of $5 million in the same quarter last year. They also released information on their efforts to reduce costs and refocus the business. 

To start, here’s a link to the press release in the 8K with the financial statementsHere’s the 10Q which, to my surprise, came out the day after the earnings were released. Next, here’s where you can see the company overview they released. Among other things, it discussed their profit improvement plan. Just click on the link to open it as a PDF. Finally, here’s where you can read the conference call. I’ll be quoting from that document quite a bit.
Let’s Review
If you’re a regular reader, you know I’ve been harping on the following themes (which you may or may not agree with) for a while:
1)  Focusing on gross margin dollars and operating income is important because sales increases are hard to come by.
2)  Operating well is the price of getting a chance to compete.
3)  Being a public company in our space is damned difficult because of the revenue growth expectations. 
4)  The actual action sports market is a small market.
5)  Having a strong brand requires some discipline in distribution because your brand is all you have and product differentiation is hard to come by.
6)  The further you get from action sports and the more dependent on fashion/youth culture the tougher is your competition. The target customers may know your brand, but they don’t know your story.
Now, I’d like to remind you of a couple of things I wrote about Quiksilver in the past:
 In March of 2011, I wrote “Quik bought a great brand in DC and has managed its growth impressively. I just hope, with the Roxy and Quiksilver brands not growing as well right now, that they don’t expect more from DC than it can deliver. Their goal is to double DC’s revenues in five years.”
In April of 2010 I said, “The source of their future revenue growth…is not clear to me. I’ve said that a couple of times before in comments on their filings and it’s still true. Like all of us, they are dependent on and hoping for a recovery in consumer spending. They’ll get- are getting- some. Like all of us, it won’t be as much as we’d like or have gotten used to. But what they really need are some new places to sell their products. At least in the U.S., I don’t know where else they can go with their distribution. Maybe there are some opportunities in the rest of the world.”
Next, let’s summarize the numbers then get on to the strategy.
Results for the Quarter- Income Statement
Reported revenues fell 6.8% to $458 million from $492 million in the same quarter the prior year. They were down 5% in constant currency. Below is a chart from Quik showing the results by operating segments as reported. EMEA is Europe and APAC Asia/Pacific.
As reported, revenues in the Americas were up 3%. That was due, we’re told to strong sales of Roxy, but also to “…increased clearance sales of DC product in the wholesale channel…” Opps.     
They were down 16% in EMEA. It was mostly in the wholesale channel and all three brands declined. Part of the problem was poor weather and lousy economies. Net revenues in Spain “…declined in the high twenties on a percentage basis.” It was a high single digit decline in France and low double digits in Germany. But the biggest chunk ($16 million) was due to a system conversion that was supposed to stop shipping for a week but ended up stopping it for two weeks and “…resulted in cancelled orders from wholesale accounts.”  They lost some business and had to offer additional discounts to get some of it back.
The revenue decline was 14% in APAC. The Roxy and Quiksilver brands were down and both wholesale and retail declined. DC continued to grow in this segment, as did ecommerce. “Net revenues from Australia, New Zealand and Japan declined in the low-twenties on a percentage basis versus the prior year, although the decline in Japan was only high single digits in constant currency. These declines were partially offset by net revenue growth in all other APAC countries.”
The numbers look slightly better in constant currency, being up 4% in the Americas, down 14% in EMEA, and down 9% in APAC.
By brand as reported, Quiksilver fell 12% to $182 million, Roxy by 6% to $129 million, and DC by 1% to $129 million. Wholesale decreased 9% to $344 million. Retail was down 7% to $91 million. Same store company owned retail sales were down 4% on a global basis. Quik finished the quarter with 564 owned retail stores compared with 549 in last year’s quarter. There are 296 licensed retail stores worldwide. Ecommerce revenue grew 31% to $23 million, representing 5% of total revenue for the quarter. More than 60% of revenue came from outside the U.S.
Gross margin percentage declined from 49.2% to 46%. As you see above, it fell in dollars in all three segments. In the Americas, it fell from 44.2% to 40.5%. In EMEA, it was from 55.7% to 53.2%. It rose in APAC from 48.6% to 49.5%. There were, they tell us, four reasons for the overall decline.
 “a) increased discounting and clearance sales of our DC brand within our wholesale channel to clear slow-selling product, primarily in the Americas segment.” They expect that to continue in the second half of 2013.
“b) increased discounting in our EMEA segment across all three core brands associated with shipping delays encountered with our implementation of SAP; c) $3 million of additional inventory reserves recorded related to certain non-core brands and peripheral product categories that were discontinued.” They characterize that as a one-time issue.
“d) a net revenue mix shift from the higher gross margin EMEA segment toward the lower gross margin Americas segment. These unfavorable factors were partially offset by improved gross margin in the APAC segment, particularly within the retail channel and the Roxy and Quiksilver brands.”
Selling, general and administrative expenses SG&A) declined from $224 to $218 million but rose as a percentage of revenues from 45.5% to 47.6%. As you can see in the chart, they fell in all three operating segments, but rose in Corporate. They had noncash asset impairment charges of $5.3 million compared to $0.4 million in last year’s quarter.  These charges “…were related to certain underperforming retail stores and certain other assets associated with non-core denominated assets of our European subsidiaries and, to a lesser extent, certain foreign currency exchange contracts.”
Quik reported an operating loss of $12.4 million compared to an operating profit of $17.7 million the prior year. It fell from $8.9 million to $2.4 million in the Americas segment, or by 73%. In EMEA, it was also down 73% from $25.8 million to $7 million. APAC went from an operating loss of $4 million to a loss of $6.1 million, a change of 52%.  
Interest expense at $15.3 million was essentially the same as last year’s quarter. They had a foreign exchange gain of $2.6 million- $2 million higher than in the quarter last year. At $7.1 million, their provision for income taxes was more or less the same as last year in spite of having a pretax loss in the quarter.    
The Balance Sheet
Neither current assets nor current liabilities changed much in total over the year. Cash fell from $79 million to $48 million. Trade receivables rose from $371 million to $375 million. The allowance for bad debt on those receivables rose from $42 million last year to $57 million. Days sales outstanding (how long it takes to collect) rose by 10% “…driven by the timing of customer payments, longer credit terms granted to certain wholesale customers and the net revenue decrease during the first half of fiscal 2013.” I guess that given the sales decline, that might not have been what I hoped to see.
Ditto for inventories, which rose the slightest bit from $359 million to $366 million since a year ago. Inventory from prior seasons was 10% of total inventory compared to 14% a year ago.
On the liability side, I’d note that lines of credits and long-term debt rose from $769 million to $814 million over the year. Total liabilities to equity rose from 1.87 to 2.08 as equity fell from $591 million to $546 million. Net cash used in operating activities during the first six months of their fiscal year was $18 million- the same as the six months in the previous year.
What’s the Plan?
Like most companies in most industries these days, when revenue increases are harder to come by, managers are looking to operate more efficiently and cut expenses. Quiksilver is no exception.
CEO Andrew Mooney starts by reminding us of their three core strategies: strengthening brands, expanding sales, and driving operational efficiency. There’s nobody at any company that isn’t in favor of all those things, but Mr. Mooney increased my confidence level dramatically when he noted in the conference call that “…the plan is quite detailed with tactics and areas of responsibility clearly defined. It includes 71 specific initiatives. These initiatives are being tracked and monitored by our project management team, which has been implemented and is being led by one of our senior staff that has accepted this position full-time.”
So responsibilities have been identified and assigned, there is specificity as to goals, and progress is being measured. Good. “…the plan,” he continues, “calls for an increased focus on our 3 flagship brands of Quiksilver, Roxy and DC, each with a clear plan and a clarified brand positioning. Modest sales growth [2.5% a year, though they believe that conservative], improved cost structure and increased investment and demand creation. We believe the plan, when fully implemented in 2016, will improve EBITDA by approximately $150 million compared to fiscal 2012 results.”
As we talk about driving operational efficiency, I want to share with you what CEO Mooney calls an extraordinary statistic. I was kind of past extraordinary to jaw-dropping and I’d love to know what his reaction was the first time he heard this.
Quiksilver “…purchased 100 million units of products annually, but our average order placed at the factory level is only 1,400.” The silver lining in that humongous cloud is that it gives some credibility to the goal of $150 million in additional EBITDA by 2016. There’s got to be an awful lot of money to be saved there.
In the process of changing that, the company will go from a regional to a global organization. They expect to go from 620 to 230 vendors and from 51,000 styles developed annually to 31,000. They’ll have global rather than local design and sourcing (going from 21 to 2 locations where those functions are carried out) and will consolidate warehousing by eliminating those that are redundant under the new structure.
Operationally, this plan is similar to what Billabong CEO Launa Inman is implementing at that company. In fact, you’ve probably noticed that lots of companies, and not just in our industry, are trying to drive more dollars to the operating income line by getting more efficient.
CEO Mooney had an interesting comment on marketing I’d like to share:
“In the area of marketing, we have exited or canceled most event sponsorships and released a significant number of sponsored athletes who we were not able to activate [They’ve still got 500]. Over time, we expect to further reduce both the number of sponsored athletes under contract and the events we sponsor. Importantly, we will redeploy the marketing savings to focus on permanent and seasonal in-store display, print advertising and social media.”
My interpretation of that comment is, “We’re focusing on the fashion business rather than the action sports or surfing market.” As a public company, that’s probably what they are required to do and I know it. However the danger, as I’ve written, is that they are going to find themselves competing with way bigger companies for customers with whom their brands don’t resonate in the same way they do in surf/action sports. I’ve proposed a solution for the problem (See Let’s Review above) but it’s hard to adopt as a public company with pressure to grow revenues. I take solace in their planned growth rate of just 2.5%.
And I also take solace in how Andy Mooney talks about what happened to DC and what they are doing differently.
“The other growth that was generated 12 months ago [By DC] was really driven by moving fairly aggressively into the mid-tier channel. With hindsight, that could have been done a little bit more thoughtfully in terms of segmentation strategy. So we’re committed to having a multichannel strategy. But going forward, we definitely need to be more considerate in the segmentation of the product line so that each of the channels can meaningfully coexist and continue to have good sell-through.”
Those are the words of somebody who understands that distribution is complicated and matters, and who realizes that one of his brands was pushed to grow a little too hard. Or at least that what I hope he thinks. He specifically states later on that they don’t expect to push the Quiksilver brand into new channels.
That there is a ton of money to be saved at Quiksilver by rationalizing and coordinating design, production, and logistics and reducing SG&A I don’t doubt. Wish they’d started sooner but, as is often the case, it just took a new management team. I am still unsure where growth is going to come from. However, it sounds like management is cognizant of the importance of distribution as a brand building tool, as indicated by the low level of expectations they are creating for revenue growth. If they can be patient with their distribution, we may all be pleasantly surprised with the results down the road.



Quiksilver’s Quarter and the Impact of New Management

Using Quik’s recent changes as an excuse, I wrote a week or so ago about the dynamics of organizational change in companies experiencing new business environments. You can see that article here. Now, Quik has come out with their 10Q for the quarter ended January 31, 2013 and held a conference call. A lot of what they said in the call resonates with the article I wrote and is worth exploring. First, though, let’s look at the numbers for the quarter. 

The Results
Revenues for the quarter were down 4% compared to the same quarter the previous year from $450 to $431 million. The Quiksilver and Roxy brands were each down 8% globally. DC was unchanged. Wholesale revenue was down 9% from $295 to $268 million. Retail fell 1% from $131 to $129 million. E-commerce rose 40% from $24 to $33 million.   
Revenue fell 9.3% in the Americas segment from $205 to $186 million. It was down for all three brands and in both wholesale and retail. The decline was due to:
“…a) lower sales to wholesale clearance customers, largely driven by the timing of shipments between the first and second quarters of fiscal 2013; b) lower net revenues in our Company-owned retail stores due to 17 store closures since the end of the first quarter of fiscal 2012; and c) increased markdown
allowances and sales discounts to wholesale customers to assist the sell-through of inventory in this channel.”
The comment about lower clearance sales being partly responsible for declining revenues is kind of intriguing. It’s a big enough number that they have to call it out?
EMEA (Europe, Middle East, Africa) rose 1.2% from $169 to $171 million “…with high-single digit percentage growth in DC net revenues and low single digit percentage growth in Roxy net revenues largely offset by a high-single digit percentage decline in Quiksilver net revenues. Growth in the e-commerce and retail channels within EMEA were largely offset by a decline in the wholesale channel.”   
APAC (Asia, Australia, New Zealand) fell 2.3% from $75 to $73 million “…with a high-single digit percentage decline in Roxy net revenues and a low-single digit percentage decline in Quiksilver net revenues largely offset by a low-teens percentage increase in DC net revenues. Wholesale channel net revenues decreased in the high-single digits on a percentage basis, while retail net revenues were flat and e-commerce net revenues grew substantially…”
The gross profit margin was up slightly from 50.7% to 51%. It was up from 42.8% to 43.4% in the Americas, down from 60.3% to 57.8% in EMEA, and up from 51.1% to 53.9% in APAC.
Selling, general and administrative expenses (sg&a) fell about $5 million from $230 to $225 million. There was one of those asset impairment charges for $3.2 million (none in the quarter last year). As a percentage of sales it grew from 51.2% to 52.3%.
The operating loss rose from $2.5 to $8.7 million (including that non cash asset impairment charge). In the Americas it worsened, growing from a loss of $1.6 million to one of $8.8 million. AMEA reported an operating profit of $1.41 million, down from $15.7 million. APAC’s operating result improved, rising from $901,000 to $2.1 million. 
Interest expense was more or less unchanged at $15 million. There was an exchange rate gain of $3.2 million compared to a loss last year of $1.85 million. That’s a $5 million positive turnaround.
The net loss grew by 46.4%, rising from $20.9 million to $30.6 million. Quik ended the quarter with 840 owned or licensed retail stores worldwide. Over 60% of revenue was generated outside of the U.S.
Overall, the balance sheet is not much changed from a year ago. You would like to see further improvement and debt reduction, but that’s not likely given the losses. I would note that trade receivables have risen 5.5% from $322 to $340 million while sales have declined and the time it takes them to collect their receivables has risen 13%. “The increase in DSO [days sales outstanding] was driven by the timing of customer payments, longer credit terms granted to certain wholesale customers, and the net revenue decrease during the first quarter of fiscal 2013.” None of that sounds exactly good.
Inventories were up $7 million to $419 million. Inventory days on hand rose 7%. “These increases were primarily due to the net revenue decline in the wholesale channel during the first quarter of fiscal 2013, resulting in higher ending inventories than planned. Inventory from prior seasons was 14% of total inventory at January 31, 2013 compared to 19% at January 31, 2012.”
Generally, you’d like to see inventory decline if sales are down all things being equal. Of course, they never are equal. Timing (inventory received the last day of the quarter instead of the first day of the next quarter) and inventory cost (which can make the value in inventory rise even when units aren’t up that much) can make significant differences. But they didn’t really offer an explanation, so it’s worth mentioning.
Comments from the Conference Call
When Quiksilver got through the Rossignol mess I said, “Good! Now they can finally focus on making and selling great product.” But I also wondered, and wrote, that given the distribution they already had in place, where was sales growth was going to come from? A lot of companies thought they’d see significant growth in Europe. But with at least Greece and Spain in depression, and weakness in most other countries, that doesn’t seem to be happening.
We also heard in various conference calls about marketing initiatives, Quiksilver Women’s, selling board shorts in vending machines at resorts, and other things. I liked some of these ideas, but I didn’t see them generating the revenue growth a public company needed.
Now new CEO Andrew Mooney has come along and, with regards to most of these initiatives said, “FAGETABOUTEM!” His key theme is focus; on “…strengthening our brands, expanding sales and driving operational efficiency…”
We will increase our focus, energies and resources on our 3 flagship brands of Quiksilver, Roxy and DC. Within these brands, we will further focus on critical product categories. To that end, we have clarified the brand positioning and gender focus of each brand, with Quiksilver being a male brand for surf and snow; Roxy, our flagship brand for women; and DC, refocus on skateboarding and snowboarding.”
None of this can happen overnight. SG&A reductions have already started, but there’s more to come and “…some of them will be actioned on this year, and others will be actioned on over the next 12, 18 and 24 months.” Apparently there are some contracts that will keep some from happening sooner. In terms of product lines, they “…can’t be significantly affected until fall of ’14.” CFO Richard Shields, talking about operational efficiencies, said, “…we’ll see some initial rewards from the work for the spring 2014 line come over. [What] I would just say is that the lion share of the opportunity, when I think about style rationalization, when I think demand aggregation, when I think about vendor consolidation, still remained to be done.” He expects this will not just decrease costs, but improve the gross margin.
CEO Mooney’s discussion of some of the already announced product line decisions is interesting.
“Within the 3 brands that we have, say, for example, in Roxy and in Quicksilver, we were doing skate products that were generating marginal revenue. And after all costs were attributed to those categories in terms of athlete endorsements, et cetera, et cetera, we were losing money on. Similarity in DC, we were in the surf category. So exiting surf in DC and skate in Roxy and Quicksilver was relatively a very, very easy decision to take, both strategically and financially.”
“When you go into categories like swimwear, it was impossible to tell the difference between a Quicksilver girls swimsuit and Roxy girls swimsuit because so we believe even within the wholesale channel, much of those sales were cannibalistic, plus again once you start loading the costs up to the subset of the business that was truly viewed as incremental, the profit was just not there. So it was a difficult decision to make emotionally because we had a lot of — we have 30-some people had given up to us doubling but the bottom line wasn’t there we really need to focus with a Quicksilver brand and the Roxy brand.”
He has more to say, but you get the picture. Isn’t it interesting how two different managements can have such different perspective and can reach such different decisions? I’d refer you again to my article I referenced in the first paragraph above and to Andy Mooney’s comment about the decision being difficult to make emotionally.  I would assume there were reasonably business differences on the potential of the initiatives and the investment required, but there were also issues of organizational momentum and personal relationships.
Okay, let’s move on to some related issues of distribution and product discussed in the conference call. Here’s CEO Mooney again:
“I think increasingly, the larger accounts, whether it’s JCPenney or Kohl’s, Famous Footwear, et cetera, I think increasingly, we’re going to have to move to fully segmented lines. We’re essentially unique to each account, custom-made for each account, which I think is becoming more the norm for the industry because in that way, we can make the best use of our resources to meet the expectations of both the consumer and the retail in that particular store, and the volume warrants that type of dedicated attention.”
Now, I need a lot more information, but it sounds like he’s saying they’ll do special makeup lines for each big account. Not unique, I’m sure and there’ll be overlap, but still. Damn, I’m usually not at a loss for words, but I don’t quite know what to say.
Here’s CEO Mooney talking about Quiksilver product:
“We believe really that our products are performance-oriented products. And I think that future lines will present themselves as much more bold and performance-oriented than the current line is, because that is — that’s really the origins of DC as a footwear company. And it’s an area where we can feel we can really excel in.”
One more quote from CEO Mooney, then I’ll have some comments.
“Today we launched the Diane von Furstenberg collection within Roxy, and it’s- we were very optimistic about the success of that collection and it’s exceeded—wildly exceeded our expectations so far, which kind of reiterates my earlier point about this very much being a product, this is a product driven business.”
Do they really believe that real, actual, performance oriented products are important to the customers at Kohl’s and JC Penney (excuse me, JCP)? Would those customers know a performance oriented product if they saw one? I don’t know exactly what a Diane von Furstenberg collection within Roxy means, but does the Roxy name require that? I thought we were refocusing on the three core brands here.
Much of what Andy Mooney is doing seems right to me. He’s getting rid of money losers, going to tighten up the supply chain, continuing to close losing retail stores, make the business global rather than regional, put in the systems he needs to do that (a process under way before he got there) and focus on the three core brands. In a lot of ways, it’s what Launa Inman is doing over at Billabong.
His bet is that the three brands can grow and remain credible, and in fact take market share in this economy, while remaining distinctive in very broad distribution. 
The problem I see is that he’s trying to do it as a public company. He’s going to be required to make some decisions for growth that I wonder if he’d make if Quiksilver were private. Unless he’s very, very careful, the requirements of brand building and growing revenues may not mesh up very well.



The Changes at Quiksilver; A Broader Industry Organizational Perspective

On Monday, The Editors at Boardistan, posted a still evolving story about cuts to Quiksilver’s team rider programs. Here’s a link to the post. As Boardistan points out, at that time there had been no official announcement from Quik, so we didn’t know the extent of the changes. 

They then make the insightful comment that “…Hollister doesn’t spend a dime on “core teams” and they don’t seem to be having any problem in the “So Cal inspired clothing for Dudes and Bettys” space.” Good point.
Since the Boardistan posting, Transworld Business and Shop-Eat-Surf have reported related stories, and we’ve also learned that Quik is also cutting certain brands and staff.
With the management changes that have happened and are happening at Quik, it’s hardly surprising that we’d see some things done differently. Tactically, it would make sense to me to cut team programs some. I can’t find the article (I have too many articles) but it was some years ago I suggested that your very best team riders have value and the guys you flow product to and maybe pay for wins or photo credits have value, but that it was time to take a look at the value of the members in the middle of a larger team. A lot of brands have done that.
Strategically, if it makes sense to cut your team budgets now, then it probably made sense a few months ago or even longer. Why didn’t it happen sooner at Quik? Or, for that matter, at other companies.
In recent years, we’ve watched management and organizational transitions at Spy, PacSun, Billabong, Burton, and Quiksilver. In at least some cases we’re still watching and I’m sure there are some other companies that should be included in the list.
Remember when Burton cut The Program? In the press release, or in an interview, Jake said something like, “I didn’t want to do this, these people are my friends, I fought it and tried to figure out another solution, but the annoying and persistent finance people on my board wouldn’t leave me alone.” From time to time, I am one of those annoying and persistent finance people, so I know exactly what he meant.
Organizations have momentum. People don’t like to change. Successful entrepreneurs have a high level of self-confidence and capability or they wouldn’t be successful entrepreneurs.   
A founding entrepreneur or long time CEO is successful partly because of the values she has imbued the organization with and the consensus around what the company is about. There is a sense of “how we do things” that gives comfort not just to the stakeholders (of which the employees are one part) but to the CEO as well. People have an understanding of their place in the company and their responsibilities that goes beyond their box on the org chart. At its best, this can be liberating and create efficiencies.
But it only works as long as the competitive business environment it was created to function in doesn’t change too quickly or dramatically.
In 2008, we experienced that quick and dramatic change. We are still experiencing it. And we experienced it suddenly after the best economy for the longest period anybody has seen for, well, forever.
Those of you who might have followed the travails of JC Penney (Excuse me, I mean JCP) know that attempts to fundamentally change a company’s market positioning and way of doing business aren’t unique to the action sports/youth culture market, nor are they easy.
You’ve probably also noticed that it’s typical for the pressure to build and then for the change to begin with a defining event.  The period immediately following that event often seems a bit chaotic.
If you’ve reflected on my descriptions of organizations above, maybe that’s not such a surprise to you. My experience in turnarounds is that really fundamental change is resisted as long as it can be (hence the need for the turnaround. Typically, it is some outside stakeholder that forces the change. It can be the banker, the accountant, investors, or a tax authority (hint: it’s a really, really, bad idea to use payroll taxes as a short term source of working capital).
Prior to the defining event that leads to the organizational change there’s almost always, as I’ve described it before, “more of the same” going on. “If we do the same thing, but work harder, we can solve this problem,” is the way the thinking goes. I have also called it “denial and perseverance in a period of change,” and I think that’s a damned good phrase. That will often extend to claiming that required changes are being made, but they are tactical rather than strategic and don’t truly address the new business environment.
But what would you expect when you’ve got an organization created to function under a set of assumptions and positive business conditions that have lasted for decades that suddenly, in a few months, change so dramatically that in some sense those business conditions cease to exist? The existing organization, the existing management, the existing relationships, may simply not be capable of coping with the new environment and making the required changes. That’s not what they were optimized for.
When you’re dealing with a difficult business situation, it starts to wear on you after a while. Where it used to be fun to get up and go to work (most days- there is no perfect job), now it’s a struggle. If it’s tough enough, you spend most of your time talking with suppliers, bankers, and investors and worrying about cash flow. It takes an incredible amount of time and energy, but doesn’t do anything to help you address the new business environment. The management team, and the entire organization, starts to get a little beat up. Attitudes can turn negative.
Interestingly, that’s the moment when you can get the most accomplished in the shortest amount of time. The CEO’s I respect the most are the ones who figure out what has to happen but decide they don’t want to be the ones to make those changes and aren’t the right ones to do it.
So you end up with a new CEO. That CEO has incredible situational authority, at least for a while, exactly because the change has been resisted long enough that things are tough. He doesn’t have the personal relationships or vested interest in the organization that the previous CEO had. Look, when you walk into a company and they say, “Welcome Jeff. We can’t make payroll next week. What should we do?” it’s incredible liberating because there’s nothing you can’t try.
Inevitably, the changes are a bit chaotic because they’ve been put off too long, change fundamental things about the company, and usually happen fast. Insecurity among employees can also be coupled with a sense of relief, because they all knew something had to happen.
When we hear about these dramatic and maybe unexpected changes from Quik or any other company going through this process, let’s by all means feel bad that people are losing their jobs. Let’s also remember that the goal here is to keep Quiksilver a successful, profitable company that supports the surf industry and provide jobs and careers to the people still working there.
For the reasons I’ve described above, the change process in companies facing a dramatically new business environment can often by chaotic and look pretty awful at first. Typically, however, it’s happening for a good reason and needs to happen. To that extent, I look at it as positive.



Quiksilver’s Year, Quarter, and Strategy; EBITDA Declines

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.
The Quarter
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.
Annual Results
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?



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.


Quik’s April 30 Quarter: Adjusted EBITDA Falls 39%

Quik had a 3% sales increase in the quarter, growing to $492 million from $478 million in the same quarter last year but, as I define and discuss below, their adjusted EBITDA fell by 39%.

 The gross margin percentage fell from 54.8% to 49.2%. That rather significant decline, they say in the 10Q, “…was primarily the result of higher levels of clearance business, the timing of certain royalties, higher input costs and the impact of fluctuations in foreign currency exchange rates.” The higher level of clearance represented 36% of the decline, we learn in the conference call.

In constant currency (ignoring the impact of foreign currency fluctuations), the wholesale business was up 2%, retail revenues increased 9%, and ecommerce was up 131%. Also in constant currency, Quiksilver brand revenues rose 4%. Roxy was up 5% and DC, 13%. As reported, Quiksilver brand revenues were $209 million, up 1%. Roxy revenues were up 3% as reported to $135 million, and DC had revenues of $131 million, up 11%.

According to GAAP (Generally Accepted Accounting Principles) Quik had a net loss in the quarter of $5.1 million compared to a loss of $83.3 million in the same quarter the previous year. The loss in the quarter last year included an asset impairment charge of $74.6 million for goodwill in the Asia/Pacific segment. The asset impairment charge in this year’s quarter was $415,000. Those are both non-cash charges and don’t have anything to do with how much product they sold at what prices and margins.
The net loss in last year’s quarter also included an income tax provision of $39.7 million “… to establish a valuation allowance against deferred tax assets in our Asia/Pacific segment. As a result of this valuation allowance and the valuation allowance previously established in the United States, no tax benefits were recognized for losses in those tax jurisdictions.”
My eyes glaze over when it comes to accounting for income taxes, but I think that relates the big asset impairment charge. The tax provision in this year’s quarter was $7.2 million.
If you ignore the asset impairment charges, then Quik had pretax income in last year’s quarter of $32.6 million. The comparable number for this year’s quarter is a loss of $4 million.
On page 28 of their 10Q, (see the whole 10Q here) Quik reports their adjusted EBITDA. That’s earnings before interest, taxes depreciation, amortization, asset impairment, and non-cash stock based compensation expense. In last year’s quarter that number was $62.1 million. In this year’s April 30 quarter, it had fallen to $37.6 million.
As reported, revenues were up in the Americas from $211 million to $221 million. Gross profit percent fell from 49.1% to 44.2% and total gross profit was down from $104 million to $98 million. 
Europe’s sales fell 5.5% from $207 million to $196 million as reported. In constant currency, they remained more or less the same. Gross profit fell 15% from $128 million to $109 million. The gross margin was down from 62% to 55.7%.
CFO Richard Shields made an interesting comment about their financial strategy in Europe during the conference call. He said, “We’re trying to make sure that we repatriate cash in Europe back to U.S. dollars so we’re not at risk there.”
Let me loosely translate that for you a bit. He’s saying that if he wakes up one morning (it would probably be a Monday) and the Euro has gone to hell and capital controls are in place and the capital markets have frozen up again because Greece has left the Euro zone or some Spanish banks have collapsed or whatever, he doesn’t want to be stuck with money he can’t get out of Europe that’s going to be worth half of what it was in U.S. dollars when he can finally get it. I hope you’re all thinking about that.
Asia/Pacific sales rose from $58 million to $74 million, or by 27.3% as reported. It was a 24% increase in constant currency. Note that this improvement was “…primarily driven by improved performance in Japan, where net revenues in the three months ended April 30, 2011 were significantly impacted by the earthquake and related tsunamis in the region.”
So they’re saying that the growth only looks good because of the natural disaster in Japan last year and that there wasn’t much growth in the rest of the region.
Gross profit in the Asia/Pacific segment rose 16.5% from $30.9 million to $36 million. The gross margin fell from 53.1% to 48.6%.
Operating income fell in all three segments. In the Americas, it was down from $17.9 million to $8.9 million. In Europe, it declined from $43.8 million to $25.9 million. Asia/Pacific fell from a loss of $81.1 million to a loss of $4 million, but remember the $74.6 asset impairment charge in the quarter last year.
As you think about how Quik did this quarter compared to last year, you need to  isolate the funky tax charge, the asset impairment and the Japanese earthquake/tsunami in last year’s quarter. If you do that, it’s hard to see progress in the income statement.
On the balance sheet, equity has risen from a year ago to $591 million from $535 million. The current ratio is a healthy 2.61 times, very slightly down from a year ago. Total liabilities have barely changed, so the total liabilities to capital ratio has improved with the increase in equity.
In the current assets, cash has fallen from $139 million to $79 million. And inventory rose 24% from $290 million to $359 million. That’s a bigger increase than you’d like to see given the associated sales increase. However, Quik notes that, “The increase in consolidated inventories was primarily the result of higher input costs and the early receipt of goods in comparison to the prior year. “ They think that higher product costs were responsible for 10% to 15% of the inventory increase.
Accounts receivable rose 8.5% from a year ago. They were up 17% in the Americas (with only a 4.7% sales increase), down 3% in Europe, and increased 22% in the Asia/Pacific segment due mostly, I assume, to the recovery in Japan. In constant currency, they were up 15% overall. 
So those are the numbers and they reflect not only Quik’s difficulty in finding places to grow (I’ve mentioned that before), but just how hard the whole economic environment is for everybody.
In the conference call CEO Bob McKnight mentions product for NFL teams as being shipped. He also says, “NBA board shorts will follow with some teams introduced this summer…” There will also be National Hockey League product, and they are “…expanding the program into Australian football leagues.”
They also talk about taking DC into JC Penney for back to school, and CFO Richard Shields says, “So DC continues to expand distribution as [there is] demand in a lot of channels where we don’t currently sell. And our overall global segmentation strategy, I think, positions us well to succeed in those channels. So we are going to continue to roll out distribution globally.”
And here, I guess, we get to the crux of the matter. What is Quik’s global segmentation strategy exactly? When I first heard about Quik’s selling NFL board shorts, I said something like, “You know just because you can sell something somewhere doesn’t mean you should. Not all product extensions are good.” I recognize the need, especially as a public company, to grow. But in the conference call discussion about growing sales, there’s a sense of selling a brand somewhere because you can and you haven’t yet. I hope Quik is careful with that. I hope all brands are.
Quiksilver’s operating performance declined rather precipitously from the same quarter a year ago even with the recovery in the Asia/Pacific segment. I still think it’s better to focus on generating more gross margin dollars with strong, brand supporting, sell through and clean inventories than it is to struggle for that incremental sale, but then I don’t have to meet with the analysts every quarter.