Losing a Big Customer Sucks: SPY’s Quarter

Long time readers have been through the saga of Spy with me. But for the last couple of years, they’ve pretty much done things right. They’ve cleaned up inventory, managed expenses down, focused on a niche they can compete in, strengthened the management team, done some innovative product things, gotten out of products that weren’t working, and created and communicated a company vision consistent with their market position.

So then, in the quarter ended June 30 their largest retail sun glass customer stops carrying their brand. They also chose not to ship to their largest moto customer due to credit issues. I’m okay with that. I’ve always thought that only shipping to people who could pay you was a pretty good idea.

Quarterly sales declined 18.1% from $10 to $8.2 million, the first quarter over quarter decline in a while. The good news, they tell us in their conference call, is that the sales to the big retail sunglass customer were their lowest margin sales. We see that in their gross margin, which rose from 52.8% in last year’s quarter to 54.4%. But there’s a bit of lipstick on pig syndrome here, as total gross profit fell 13.9% from $5.28 to $4.54 million.

I also want you to see what they say about the sales decline in the 10Q, as it’s not as specific as the conference call in attributing most of the decline to the loss of one customer. “The decrease in sunglass sales during the three months ended June 30, 2014 is principally attributable to an overall decline in the consumer market coupled with several key retailers currently holding lower levels of inventory and fewer closeout sales of our sunglass products.” I am left wanting to know exactly how much in sales the one customer cost them.   I’m wondering why they didn’t mention it in this section of the 10-Q.  If most of the decline was from one customer, well, fortunes of war.  But if that customer doesn’t explain most of it, there’s a whole different problem.

International sales rose 24.3% from $930,000 to $1.16 million. U.S. and Canadian sales were down 22.5% from $9.1 to $7.0 million. The amount of sales considered to be closeouts fell from $800,000 in last year’s quarter to $300,000 in this year’s. I imagine that’s helpful to gross margin as well as inventory levels.

Partly in reaction to the sales decline, I imagine, SPY’s sales and marketing expenses were down 7.6% from $2.95 to $2.73 million. “The decrease is primarily related to decreases in commission expense of $0.2 million [because sales were down], royalty and athlete expense of $0.1 million, and in-store display expenses of $0.1 million, which is partially offset by an increase in marketing events and promotions of $0.1 million.”

General and administrative expenses were down 22.5% from $1.79 to $1.39 million. “The decrease is primarily due to lower expenses related to salary related expenses of $0.1 million, outside consultant expense of $0.1 million, stock comp expense of $0.1 million and legal and corporate expenses of $0.1 million in 2014 compared to 2013.” Much of that does not sound related to the sales decline, which is good to see.

Overall, operating income dropped from $327,000 to $101,000. The net loss rose from $574,000 to $742,000.

Interest expense remained more or less constant at $751,000. Notes payable to stockholders rose from $20.2 million a year ago to $21.6 million at June 30 this year. There are two things you should keep in mind with regards to the shareholder debt. The first is that SPY is now paying its interest on $19.86 million of debt in cash rather than accruing it as further debt due to improvement in its cash flow. Cash generated by operations rose from $1.08 million in last year’s six months ended June 30 to $1.45 million this year. Second, the shareholder has cut the interest rate from 12% to 7%. That’s $1 million a year less in interest expense and is a big help to the income statement. The reduction in the interest rate was tied to the agreement to pay interest in cash.

Apparently, they may continue to accrue the interest due on the $1.74 of Harlingwood Notes as additional debt, though they did pay $104,000 of the accrued interest during the first six months of the year. The Harlingwood Notes continue to have an interest rate of 12%.

Just one random note from SPY’s 10-Q. “We may have incurred one or more ownership changes, as defined by Section 382 of the Internal Revenue Code…in the current and previous years, and, as such, the use of our net operating losses may be limited in future years. We have not completed a formal IRC Section 382 study and analysis to determine the annual limitation on the use of the net operating losses; however, the limitations could be substantial.”

SPY has quite a net operating loss. It would suck if they couldn’t utilize it to shelter profits they may realize in the future.

What’s wrong with SPY? Nothing that higher sales wouldn’t cure. I’m kind of hoping that the loss of the large sun glass retailer means customers will look to find SPY product at other locations where maybe SPY can recoup some of the lost sales at a higher margin.  We’ll watch to see if they can get those increases.