Quiksilver’s July 31st Quarter: Sales Down, But Profits Up and Balance Sheet Stronger

Quik is the poster child of a company that’s done what it needed to do following the twin blows of the Rossignol acquisition and the recession. As somebody who’s done a bit of turnaround work, I can tell you it’s no fun, for either management or employees, to be dealing with negative stuff month after month. Quik maybe has a little more work it wants to do on its balance sheet, but it’s largely out from under the reverberations of that deal though, like all of us, not of the recession.

I still have the same question for Quik (and for other brands) that I had before; how do you grow sales? You can’t improve profitability by controlling expenses and improving gross margin forever. I imagine the new Quik women’s brand and DC’s efforts in racing will be part of the answer. They note in the conference call that 95% of Roxy’s customer base doesn’t know that Roxy is related to Quik. Partly as a result of that, they believe there’s room for a Quiksilver Girls brand. It will debut in spring, 2011 and be directed at the 18 to 24 year old market.

While we wait for that to happen, I’d like to start with the balance sheet and discuss the improvement there.
Quik raised some rather expensive money from Rhone Capital as you call, and refinanced its bank lines pushing out the maturities. When you look at this year’s July 31 balance sheet and compare it to last year’s at the same date you can see the impact of those actions and of their control of expenses. Trade receivables are down by 19.6%, and average days receivables are outstanding is down by 6 days, which is good for cash flow. Inventories fell by 19% from a year ago to $271 million.   
Current liabilities have fallen by 41%, from $658 million to $390 million.  I’d particularly point to the decline in the line of credit outstanding from $221 million to $25 million. The amount of debt that Quik had was an issue, but also important was that way too much of it was coming due in the short term at the same time.
 Long term debt is up by around $25 million to $759 million, but total liabilities fell from $1.43 to $1.19 million. The current ratio has improved from 1.65 to 2.26 as has total liabilities to equity from 3.21 to 2.45. I imagine they’d like to reduce that further.
Actually, they have. After the quarter ended, they did a debt for equity swap with Rhone Capital that reduced their debt by an additional $140 million in exchange for 31.1 million shares of stock at $4.50 a share. I’m oversimplifying a bit, but if I take the July 31 balance sheet, reduce long term debt by $140 million and increase equity by a similar amount, the total liabilities to equity ratio falls further to 1.68. As a result of this exchange, Quik will have a “non-recurring, non-cash and non-operating” charge in the quarter ending October 31 to write off some costs associated with issuing the debt. 
I’m not the only one who sees this as a lot of progress. On August 27th, Quik was able to amend its North American credit agreement with an interest rate reduced to Libor plus 2.5% to 3%. Before the margin over Libor was 4% to 4.5%. Libor stands for London Interbank Offer Rate. The interest savings will be substantial. Wonder if they’ll be able to do the same thing with any of their other bank lines.
Net cash provided by operations rose from $150 million to $193 million. Increasing cash generation from operations is always a good thing.
Income Statement
Quik’s bottom line for the quarter was a profit of $8.3 million compared to a profit of $1.3 million in the same quarter the prior year. For nine months, it had a profit of $12.4 million compared to a loss of $190.3 million for nine months the previous year. Of that loss, $132.8 million was from discontinued operations- Rossignol. They had a profit from continuing operations for the nine months of $13.9 million compared to a loss of $56.5 million the previous year. For the quarter, the continuing operations profit was $8.4 million compared to $3.4 million the prior year.
Reported revenues for the quarter were down 12% from $501 to $441 million. Gross profit fell 1.55% in dollars to $230.7 million, but the gross profit percentage rose to 52.3% from 46.7% in the same quarter the prior year. The gross margin improvement worldwide was largely the result of less discounting and some improvements in sourcing. Quik CFO Joe Scirocco clarified this by saying that “…the vast majority of it [margin improvement] is in fact, a better mix of sales because we have cleaned inventory so well.”
In a related comment he noted that “…a lot of the contraction that we’re seeing this year in volume is intentional. It is done as part of our plan to clean up distribution, to get better, higher quality sales and it is coming through very strongly in the gross margin.” I’m guessing that cleaning up distribution and higher quality sales refers to some extent to only selling to accounts who are likely to continue in business and be able to pay you; a good idea.
You know what would be really interesting? If they would break out the wholesale gross profit margin from the retail. That way, we could look at the two segment’s performance individually. And it might make for some easier (and probably interesting) comparisons with other brands and retailers.
Sales, general and administrative expenses fell by 8.8% to $193 million, but rose as a percentage of sales from 4.2% to 4.4%. There was a noncash asset impairment charge of $3.2 million this quarter related to the Fiscal 2009 Cost Reduction Plan.
Interest expense rose from $15.3 to $20.6 million. The foreign exchange loss was $213,000 compared to $3.5 million last year and the income tax provision rose a bunch from $396,000 $5.1 million.
That’s a lot of movement in various stuff. Before all the charged that followed the impairment charge, operating income was up 52% from $22.6 to $33.5 million for the quarter and from $53.5 million to $89.2 million for nine months. Sales fell 6.7% for the nine months.
That’s the summary. Let’s dig in a little.
As reported on the financial statements, sales in Quik’s three segments (Americas, Europe and Asia/Pacific) fell by 9%, 20%, and 1% respectively during the quarter. Sales in each of the segments were $234 million, $152 million, and $55 million respectively. In constant currency, the Americas drop stays the same, but the European decline becomes 11% and the Asia/Pacific decline increases to 11%. Overall, the constant currency decline was 10%.
The gross profit margin (as reported) in the Americas segment rose from 37.7% to 46.7%. It provided $109.6 million or 47% of total gross profit for the quarter. Europe’s gross profit margin rose from 57.7% to 60.6%. It provided 40% of gross profit for the quarter. The remaining 3% of gross profit dollars came from Asia/Pacific, where gross margin percent fell from 53.7% to 52.7%.
Operating income in the Americas jumped from $4.5 million to $27.7 million. Europe’s fell from $25 million to $15.6 million and Asia/Pacific went from a profit of $2.33 million to a loss of $1.63 million.
The revenue decrease in the Americas segment “…was primarily attributable to generally weak economic conditions affecting both our retail and wholesale channels, with particular softness in the junior’s market. The decrease in the Americas came primarily from Roxy…and, to a lesser extent, DC. The decrease in Roxy…came primarily from our apparel product line, but was partially offset by growth in our accessories product line. The decrease in DC…came primarily from our apparel and footwear product lines and, to a lesser extent, our accessories product line. Quiksilver brand revenues remained essentially flat…”
“The currency adjusted revenue decrease in Europe was primarily the result of a decline in our Roxy and Quiksilver brand revenues and, to a lesser extent, a decline in our DC brand revenues.”
On the retail side, they note that “…retail store comps in the US were again modestly positive overall in Q3.” They saw “…strong in-store gains in the Quiksilver and DC brands…” In Europe, “…retail comps were down in the mid single digits on a percentage basis for the quarter…” Quik has opened 12 new stores in Europe over the last year, but they’ve also closed 12 so the net number has not changed. Twelve underperforming retail stores have been closed in the U.S. since the end of the third quarter of 2009. Two were closed in the quarter just ended.
The Future
Quik expects fourth quarter revenues to be down 15% after taking into account a weaker translation rate for the Euro and demand softness in Asia/Pacific. Remember that Billabong said its Australian forward orders were down 20%, and they expect a similar decline in sales. Quik isn’t immune to the late arriving economic downturn in Australia.
They expect to be able to deliver gross profit margins in the fourth quarter that are 4% to 4.5% higher than in the fourth quarter last year. Remember, that’s not 4% higher than this quarter I’m writing about now, but 4% higher than the same quarter last year. Pro forma operating expenses are expected to be “as much as” 7% lower than in the fourth quarter last year. Wish they’d tell us what they expect to report instead of giving the pro forma number.
Diluted earnings per share are expected to be “…in the mid single digit range…” At this time, they aren’t providing any guidance on fiscal 2011.
Joe Scirocco has the following really interesting comment that shows their focus on retail and ecommerce; not unlike some other major brands. “Well, I think the key to operating leverage frankly is getting higher sales through the retail channel – through our own retail stores. And those areas of the business in which we have a fixed cost infrastructure. So, it is basically retail stores and eCommerce are going to be the two areas at which we can most drive leverage.”
Quik has great brands and has largely finished deleveraging their balance sheet. They’ve taken out a lot of costs and improved their operating efficiency. But sales (especially the wholesale portion) are down. Partly, this is due to their focus on cleaning up distribution as described above. But it’s also due to lower demand and caution in who they sell to. The positive result is the big improvement in gross margin.
But lacking an improvement in the economy and in banks’ willingness to lend, a lot of that lost distribution isn’t coming back. Certainly new, innovative products can generate some additional sales, but I’d expect most of their growth will have to come from retail (brick and mortar and ecommerce) and new initiatives like Quik Girls.
It’s not just Quiksilver that approach will apply to, and there are interesting implications for competitive strategy in our industry. Maybe that’s worth a Market Watch column.



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