SPY Optic’s Quarter: Sales and Loss Both Grow

SPY’s sales for the quarter ended March 31 increased 22% during the quarter to $8.1 million compared to $6.7 million in the same quarter last year. The company had a net loss of $2.58 million compared to $1.52 million in the quarter last year.

Sale of SPY branded products were also up 22% to $7.9 million. The remaining sales represented close out product from the licensed brands (O’Neill, Melodies by MJB, Margaritaville). Apparently those sales represent the last of the licensed brand inventory and that’s really good news.

Though gross profit grew from $3.4 to $3.8 million, the gross profit percentage fell from 50.9% to 46.5%. Most of this decline came from blowing out the remaining inventory of the licensed brands, but there were also “…modest increases in close-out sales related to our SPY products…” SPY closeout sales were $600,000 (7.6% of SPY brand sales) during the quarter compared to $500,000 in the same quarter last year.
Total operating expenses rose from $4.75 million to $5.95 million. As a percentage of sales, they grew from 70.9% to 73.1%. Almost all of that came from growth in sales and marketing and general and administrative expenses. The 10Q (which you can review here) says that most of this is related to staffing for growth and marketing the SPY brand.
This is a good place to pause and remind you of where SPY is and how it got here. Or, you can read my earlier reports on SPY as long as you’re on my web site.
SPY is in business and independent only because its largest shareholder has been in a position to put a whole lot of money into SPY. The balance sheet shows $13.7 million of subordinated stockholder long-term debt. Aside from the same problems with the economy we’ve all had, SPY has had the issue (and cost) of the licensed brands, the purchase, then the sale and ongoing liability of its Italian factory, endless (and hopefully now ended) management changes, The No Fear lawsuit, and has generally been through a whole bunch of chaos- self-inflicted and otherwise.
But through it all somehow the SPY brand itself is still here and now growing. But to justify the expense structure they’ve put in place, it needs to grow a lot more. There’s light at the end of the tunnel, and if they can just finally get out from under all these non-operating expenses and distractions (which they are closer to) and keep growing the brand, they’ll have a viable business. But it’s going to be a long time before the major shareholder has a return on his investment.
Okay, back to the analysis. 
Interest expense has approximately doubled to $505,000 for the quarter. This reflects the increase in debt from a year ago.
Speaking of cash, though the company had a loss of $2.6 million, they only used $0.4 million in operating activities. That’s because they had $800,000 of noncash expenses (much of their interest, depreciation, amortization, stuff like that) and they generated $1.5 million from their “…working capital, which relates primarily to cash generated from significantly higher accounts payable and accrued expenses primarily associated with the timing of inventory purchases…” They note that paying these will require the use of cash in the second quarter.
Accounts payable are up almost $1.4 million since December 31, 2011. Increasing liabilities is a way to generate cash. Simply put, you have the money because you haven’t paid the other guy. Not that it would ever happen in this industry. Likewise, decreasing assets increases cash; like collecting a receivable for example. Cash flow represents the changes in balance sheet accounts. You can be making an accounting profit but be in trouble because you aren’t generating enough cash.
There must be a finance professor in me struggling to break out. Let’s move on to SPY’s balance sheet.
The balance sheet has deteriorated since a year ago, but in some ways it doesn’t matter as long as there’s willingness on the part of somebody to continue to lend to the company. Equity has declined from $840,000 to a negative $9.8 million. Total liabilities have risen from $13.3 million to $22.8 million.
Net inventory has risen over the year from $3.4 million to $6.3 million. Even with the sales increases, that seems like a lot. We know the March 31, 2012 inventory is clean of the licensed brand inventory because they say it is. And that number is net of a $900,000 reserve for obsolete inventory. There was a note that they had purchased some inventory during the year for anticipated sales that did not materialize, so maybe they are still working through that and perhaps it’s part of the $900,000 reserve. I would love to have more detail on the quality of that $6.3 million of inventory.
Gross trade receivables are $6.7 million. There’s an allowance for doubtful accounts of $300,000 then an allowance for returns of $1.4 million. The net account receivable number of $5.011 million is what’s on the balance sheet. This, I think, is related to the licensed brands. Since the reserve is already established, and the income statement hit taken, any product that comes back can just be sold without an income statement impact but will generate cash.
However, “The Company anticipates that it will continue to have requirements for additional cash to finance its working capital requirements and to invest in marketing and sales activities deemed necessary to achieve its desired business growth.”
They discuss that they have borrowed the maximum allowed under the arrangement with Costa Brava (owned by the major shareholder), though they will continue to accrue rather than pay the interest in cash. They say they intend to borrow more under their line with BFI, but as it’s an asset based line, it’s hard to know how much will be available. BFI can also yank it any time they want if they get nervous.
Then the company says, “However, the Company believes that it will have sufficient cash on hand and cash available under existing credit facilities to enable the Company to meet its operating requirements for at least the next twelve months without having to raise additional capital if the Company is able to achieve some or a combination of the following factors: (i) achieve desired net sales growth, (ii) improve its management of working capital, (iii) decrease its current and anticipated inventory to lower levels, (iv) manage properly the increase in sales and marketing expenditures required to achieve the desired level of business growth, and (v) achieve and maintain the anticipated increases in the available portion of its BFI credit facilities.”
So they are going to need additional cash. They think they’ll have enough for the year if things go well, if Costa Brava lets them continue to not pay interest in cash and if BFI lends them more money. Lots of ifs.
The brand seems to be performing, the impact of the licensing deals is apparently a thing of the past and they’ve got, as far as I can tell, a good team in place. There still appear to be some inventory issues and commitments to their former Italian factory that may continue to cost them money. And then there’s the acknowledgement that more cash will be required and at least some uncertainty of where it will come from if things don’t go really well.
At the end of the day, though, the brand seems strong enough to justify the effort, though more and higher margin sales are needed to support the infrastructure and make a profit.   



2 replies
  1. Thomas
    Thomas says:

    Hey Jeff,

    I noticed quite a bit of SPY in Costco Stores recently and it was decent product (not likely closeouts). Could they have sold Costco this product and recorded this as growth, but in reality it is just a bluff? Well technically it is growth, but not where you would want it. I guess my questions is 22% growth is pretty significant in a crowded marketplace, do companies count sales from Costco the same as they do from independent retailers?

    • jeff
      jeff says:

      Hi Thomas,
      I haven’t seen any SPY product in my local Costco. I would not expect SPY to have enough product overall to interest Costco. Though if they are selling their product to Costco, that hardly makes them unique in our industry, and a one time sale of older inventory almost anywhere doesn’t bother me. And sometimes, as you know, Costco gets hold of a lot of product from somebody else who originally bought it from the company and that might be situation here. Anyway, that’s all speculation on my part.

      As to accounting, and their growth being a bluff, the answer is no. Or, at least, unless they lied in their 10Q, the answer is no. They’ve told us the decline in their gross margin is due largely to selling the rest of the inventory from the licensed brands, though there was SPY closeout sales of $600,000 (7.9% of total SPY sales). And they’ve spent and are spending a whole bunch of money on hiring good people and on advertising and promotion. They should be seeing some results from that. As I’ve written, the brand has had some strength even as the company went through all its problems. With those problems finally fading, and good programs and people in place, I’d expect to see some success.

      Thanks for the comment,

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