https://www.jeffharbaugh.com/wp-content/uploads/2014/08/logo_color_640.gif 0 0 jeff https://www.jeffharbaugh.com/wp-content/uploads/2014/08/logo_color_640.gif jeff2013-06-10 14:18:512014-09-25 10:15:02Quiksilver’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 statements. Here’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.
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.